NEW YORK (TheStreet) -- Looking at its financials, McDonald's (MCD) is headed down an unsavory path. The introduction of a new daypart, reportedly called "McBrunch," won't lift its numbers and would be the wrong strategy at this time for the burger giant.
The concept of a brunch period that features new products from 10 a.m. to 1 p.m. was put in motion following news McDonald's filed a federal trademark registration for the term "McBrunch" in July. McDonald's denied it's testing brunch options, likely so it doesn't upset franchisees who already are being burdened by costs for ambitious remodels and wage pressures. But if it should soon begin selling super-sized McMuffins dressed with hollandaise sauce for patrons late morning each day, it would be a shortsighted decision that doesn't address McDonald's challengers that are clouding its growth outlook.
To start fixing what ails it, McDonald's must employ a series of bold strategies that while likely to create short-term pain to shareholders given higher investment spending would benefit the franchise's long-term health.
McDonald's has utilized a franchise business model since 1955 -- it pioneered the approach - which has allowed it to open more than 35,000 global restaurants. The model remains quite profitable. According to Bloomberg, McDonald's 2013 operating margin of 30.48% was well ahead of Chipotle (CMG) at 16.57%, which owns all of its locations and is the current dining choice among consumers on the go today. McDonald's franchise agreements typically last for 20 years.
Amid its voracious appetite to expand, and subsequently collect more lucrative fees from franchisees, McDonald's has inflicted harm on itself in two ways -- it has over-saturated the market and has cannibalized sales while heaping more costs on franchisees to support an enlarged menu. As a result, McDonald's likely has hosts of under-performing franchisees in its system, those that have not upgraded their appearances and equipment, which casts a black cloud over the more successful operators in the system.
McDonald's should consider buying out its weaker franchisees, turning the spots into company-owned stores that can be used as testing grounds for completely new menu offerings (organic; farm to table platters) or close them to shift traffic to the best franchisees which would finally create a bit of scarcity in the marketplace. Franchisees are required to pay a monthly fee based upon the restaurant's sales performance, which currently stands at 4.0% of monthly sales -- the fee could be juicier if top franchisees were driving a greater portion of the sales mix.
These actions, however, have failed to reignite same-restaurant sales, which in August declined in all geographic regions. In fact, McDonald's U.S. stores have notched declining same-restaurant sales in the past three quarters. As a means to reconnect with an evergrowing health conscious public infatuated with Chipotle salad bowls and Starbucks (SBUX) cold-dressed juice drinks, McDonald's has to slightly abandon its perceived largest asset: it's name.
By incubating new brands with varying types of cuisines, and then putting its marketing muscle behind them (the company spent $998 million to advertise in the U.S. in 2013, according to The Christian Science Monitor), the company could begin to alter public perception on what's offered at the chain. New brands not led with "Mc" could be tested in the 19% of the restaurants that are currently owned by the company, and then marketed in a grassroots fashion across social media platforms.
Chipotle, formerly owned by McDonald's until its spinoff in 2006, has begun taking stakes in smaller restaurant brands with national potential. In interviews with TheStreet, the CEOs of Buffalo Wild Wings (BWLD) and DineEquity (DIN) both shared an intent to acquire stakes in upstart brands that could be tomorrow's household name fast-food chain.
McDonald's has to return to the acquisition strategy that it abandoned in the early 2000s following the divestures of Donatos Pizza (2003), Chipotle (2006), and Boston Market (2007). But a key difference in the McDonald's 2.0 acquisition strategy is that it has to serve as a seed company to up-and-coming fast-food chains in top metro markets. McDonald's has to avoid existing businesses with Boston Market-type baggage (Boston Market was purchased out of bankruptcy in 2000, and was only marginally profitable for McDonald's during ownership).
By serving as a tech-like incubator, McDonald's will gain access to new avenues of growth as well as businesses led by founders that have sought to establish interesting models. From that pool of businesses, McDonald's would be able to develop its future leadership team, and one not consisting of lifelong employees that have raised the ranks of the franchise model.