Can a brand have high sales but low earning power? Read this case study to find out!
This pyramid-shaped framework has 11 tenets and 3 foundations, which, if implemented properly, are helpful in conducting business and achieving wealth and value creation for your firm. Today, let’s discuss this framework with a focus on Tenet 2―Fulfill Otherwise Unmet Customer Needs. Do you want to know how you can successfully achieve this tenet and eventually, ethically maximize your company’s wealth? Read the case study below to find out.
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Can a brand have high sales but low earning power? Read this case study to find out! Air… Water… Shelter… These are some of the basic necessities we need to live properly and healthily… and along with these things, we need food to live. In fact, food is the most essential requirement for the sustenance of human life. It provides us with the nutrients and energy we need to develop and grow, be active and healthy, move, play, work, etc. But, have you ever wondered why in the business perspective, groceries and restaurants aren’t necessarily businesses with the highest earning power? This fast food chain’s case study will explain why… McDonald’s is a multinational fast food corporation founded in 1940. The business originally started as a small hamburger stand, and as it grew and attracted more customers, brothers Richard and Maurice McDonald turned the brand into a franchise.
Today, McDonald’s is the world’s largest restaurant chain by revenue, serving over 69 million customers daily in over 100 countries. It is also the second-largest private employer in the world and as of 2020, the company has the 9th highest global brand valuation. [Brand Valuation: This refers to the process of estimating the total financial value of a brand.] McDonald’s as seen in the lens of Return Driven Strategy’s Tenet Two Return Driven Strategy’s (RDS) Tenet Two talks about fulfilling customers’ otherwise unmet needs. Authors Professor Joel Litman and Dr. Mark L. Frigo discuss this in detail in the book, “Driven.” According to them, fulfilling great customer needs does not alone lead to profitable businesses. This explains why McDonald’s, along with other groceries and restaurants, doesn’t have the highest earning power. Let’s dive deep into this case study… McDonald’s has over 30,000 franchises in different parts of the world. The brand attracts a multitude of customers and its revenues are in the tens of billions. In fact, from 1995 to 2000, the fast food brand averaged 4 new store openings per day! This shows that McDonald’s has offerings that people want and “love”—as stated in its tagline. So… how can Professor Litman and Dr. Frigo say the company doesn’t have the highest earning power? Remember: RDS’ Tenet Two is about fulfilling customers’ otherwise unmet needs. This means if a particular offering is removed from the market, the needs that the product or service addresses would have gone unmet. Let’s look at it in the context of McDonald’s performance. Ask yourself this question: “Are the fast food brand’s products without substitutes?” By answering that question, you’ll understand why the business isn’t as competitive in terms of earning power. Sure, the company offers products that customers want. Its services are great too. However, if you remove McDonald’s from the market, consumers’ needs still wouldn’t have gone unmet because there’s Burger King, Wendy’s, Chipotle, Subway, Pizza Hut, Domino’s Pizza, etc. … and similar to our case study on luxury car company BMW two weeks ago, the presence of these substitutes affects McDonald’s earning power. It’s easy for consumers to choose other fast food brands that offer cheaper yet good-quality products. Unlike if McDonald’s is the only fast food brand in the world, consumers would willingly pay for its offerings regardless of how expensive or cheap they are. Let’s take a look at the company’s ROA (return on assets) chart created by Valens Research using UAFRS (Uniform Adjusted Financial Reporting Standards)… Prior to 2008, the brand’s earning power never reached UAFRS-based returns above 10%, which is in line with long-term US corporate averages.
The company’s Uniform ROAs in 2006 and 2007 were only at 9%. These levels fall below what investors expect from an industry leader. Here’s the thing: Some people think that the term, “industry leader” is applied to companies with the highest sales or market share. However, in a UAFRS-based model, being an industry leader means achieving above-average returns on investment and recording high earning power. The bottom line? Plenty of substitutes prevent McDonald’s from improving its returns. While the company is able to grow sales by increasing the volume of units sold, the prices have not been sufficiently higher than the costs to produce the offerings. Simply said, there’s just too many fast food brands out there that customers could choose instead if McDonald’s attempted to raise its prices… that’s why the company cannot easily do that. — In the book, “Driven,” Professor Litman and Dr. Frigo said the adequate availability of substitutes translates to lack of pricing power and earning power. … and when there’s low pricing power, there will also be low returns regardless of how high a company’s sales growth can be. We hope today’s case study helps you further understand RDS’ Tenet Two! Keep in mind that from a UAFRS-based standard, a brand’s earning power depends on the availability of substitutes. Unless a company has offerings that are classified as unique, customers’ needs wouldn’t have gone unmet even if that certain product, service, or brand is removed from the market. Stay tuned for our next case study on Return Driven Strategy! Hope you found this week’s insights interesting and helpful. Follow us on LinkedIn. Stay tuned for next Tuesday’s Return Driven Strategy! Communication is a two-way street. To be an effective communicator, you have to know how to take turns talking AND listening. Learn more about the benefits of active listening in your career in next week’s article! |
