Fast Casual | January 2015 | By Sam Oches

Tale of Two Brands

McDonald’s used to own a majority stake in Chipotle. Now it might be losing its status as top industry influencer to Steve Ells & Co.
Though McDonalds has long ruled fast food, Chipotle is now the chief industry influence.
With its commitment to high-quality ingredients, Chipotle has become the face of the booming fast-casual industry. flickr / Michael Saechang

McDonald’s has long served as a de facto leader of the limited-service restaurant space. Far and away the largest quick-service company in the U.S. by system-wide sales, the Golden Arches has for generations been the model for fast-food stability and achievement, the benchmark against which all other quick serves are measured.

But while it may be decades before any company overtakes McDonald’s in sales, the company might be losing its stronghold as chief industry influencer. Stuck in a tailspin that has seen declines in domestic sales and traffic, McDonald’s is struggling to resonate with a consumer base that is increasingly demanding a higher-quality product. Executives have publicly acknowledged the intense competitive landscape, as well as the need for the company to adapt to more of a premium model aced by so many emerging fast-casual concepts.

Meanwhile, the rest of the industry is trying to capture some of the magic propelling a brand that was once a member of the McDonald’s portfolio, a brand that might not be such a stunning success were it not for the resources and guidance handed down by McDonald’s executives for eight years. That brand? Chipotle. And, nearly a decade removed from McDonald’s divesture of Chipotle, the two brands appear to be heading in different directions, experts say.

“We’re seeing a generational shift here in the way people approach and think about their eating,” says Jason Moser, an analyst with financial-services company The Motley Fool. “More and more consumers are looking for quality first, before value. And McDonald’s brand just doesn’t communicate quality. It communicates value.” Chipotle, he adds, built its brand around a core ethos that prioritizes quality ingredients above all else. “I have to believe McDonald’s is probably kicking itself in the rear for divesting that interest in Chipotle so long ago, because it obviously turned out to be a very successful endeavor.”

McDonald’s first invested in Chipotle in 1998, when the latter had only 16 restaurants. It was a part of a broader diversification strategy McDonald’s pursued at the time, a strategy that also saw it invest in Boston Market and Donatos Pizza. By 2005, however, the diversification strategy had been replaced by the Plan to Win, which doubled down on McDonald’s core business. In 2006, McDonald’s, which owned about 90 percent of Chipotle at the time and had helped it grow to around 500 stores, announced it would divest all interest in the newly public fast casual.

Today, Chipotle only has about a tenth the number of U.S. restaurants as McDonald’s, and the same proportion in system-wide sales. But recent sales results paint a stark picture of the difference in the two brands’ momentum. Chipotle reported a 19.8 percent increase in comparable sales in 2014’s third quarter and a 31.1 percent increase in revenue. In the first nine months of 2014, the fast casual was seeing a 17 percent sales increase compared with the same period a year prior.

McDonald’s, meanwhile, a reported 3.3 percent decrease in U.S. comparable sales in Q3. It was the brand’s third consecutive quarter of sales declines. In announcing the results, McDonald’s CEO Don Thompson said the company “must demonstrate to our customers and the entire McDonald’s system that we understand the problems we face and are taking decisive action to fundamentally change the way we approach our business.”

Elizabeth Friend, senior foodservice analyst with strategy research firm Euromonitor International, says part of McDonald’s problem is that it spent the recession investing in brand enhancements and attempting to appeal to the demographic that was drawn to fast casuals—a demographic outside the company’s core, she says.

“They spent all this money improving everything, and their franchisees spent all this money buying into this new image, and now they need these higher margins, these higher average-check items to support that,” she says. “But that’s not necessarily what consumers want from them anymore.”

In the meantime, Chipotle is growing by leaps and bounds, with founder and co-CEO Steve Ells recently saying the company still has plenty of room to grow in the U.S. (it has just more than 1,700 domestic restaurants today). “Recent industry trends suggest the Chipotle model is resonating with customers, who are realizing there are better alternatives to traditional fast food,” he said in announcing the company’s third-quarter results. “We believe these trends will continue, and that’s good for our customers and our shareholders.”

Moser says he used to think Chipotle had a ceiling, but that today, he’s not so sure what that might be. The company could reach a unit count of 3,000–4,000 in the U.S., he adds. “This is really an exciting story to think about over the course of the next 20 years for investors,” Moser says, “because of all of the opportunities they still have, and because they have this founder leadership that is still young and passionate about the brand he built.”

While the two brands might be moving in different directions, experts say, it’s too soon to throw in the towel on McDonald’s and too early to know whether Chipotle can sustain its incredible momentum.

“McDonald’s has a very powerful brand out there,” Moser says. “They’ve worked on growing that brand power for many years … and I think when you have a global scale like they do, they’re in a good position, there’s no question. They have the resources to try new things, and I think we’re going to continue to see them trying new things.”

Recently, those new things have included a market test of a build-your-own-burger system in which customers order through a kiosk. In announcing poor November sales results—the brand saw a 4.6 percent decrease in U.S. comparable sales—Thompson said the market test would expand to more than 2,000 restaurants across the country in 2015.

During the Q3 results announcement, Thompson said the company would focus on the “Experience of the Future” plan that “elevates the menu and customer experience” and “capitalizes on investments in reimaging, service, and technology enhancements.” In addition, McDonald’s will continue to roll out more digital ordering and payment opportunities, which it did with the partnership with Apple Pay; reorganize the company structure; focus its marketing efforts on transparency and quality; and simplify its menu, which the company said will include trimming eight menu items.

“What they need to be doing is showing everyone what’s different about them, what’s better about them,” Friend says. “They’re faster, they’re more convenient, they’re much less expensive, and I think they need to be focusing on that side of things. … I always think it’s unwise from a historical perspective to bet against McDonald’s, because they’ve gotten themselves out of some very similar tough spots in the past.”

Chipotle’s weakness may lie in international growth, Friend adds. Whereas McDonald’s is a force globally and still has room to grow overseas, she says, Chipotle has so far only dipped its toe in international markets, without as much excitement from consumers as the brand sees domestically.

The company could, however, be more interested in U.S. potential. After all, it’s recently shown a few moves learned from its former parent company’s playbook: In investing in the ShopHouse Southeast Asian Kitchen and Pizzeria Locale concepts, Chipotle seems to want to try its hand at a little brand diversification.

“As long as they can work out an affective distribution model and supply chain model like Chipotle has done to date, then they can feel like they can just copy that concept and just translate it to whatever style of food they want,” Moser says.


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