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ADDRESSING MCDONALD'S 39B REPUTATION RISK CHALLENGE

By RL Expert Leesa Soulodre

In 2010, only two things mattered in the reputation challenge - the quality of one's products and

services and the quality of one's company.

However, in 2015, based on financial and responsible investment analysis, it is clear that "who you are" now matters just as much as "what your company does".

The 7 key points in this post are:

  1. What makes up McDonald's reputation?
  2. Reputation drives or destroys market value
  3. Closing the gaps on reputation risk
  4. "Who you are" matters more than "what you do"
  5. Where is the Group Chief Risk Officer?
  6. Reputation and its Risk Management is a balancing act
  7. It's about a $39.9B risk AND opportunity

1. What makes up McDonald's reputation?

McDonald's brand was valued by Forbes in 2014 at $39.9B.

With revenues of $28.11 B (tangibles) versus McDonald's brand/reputation value (intangibles) of $39.9 billion, a clear effort is now being taken by the world’s largest fast food Company in living up to new consumer expectations and closing its reputation risk gap.

McDonald's brand value and associated reputation with it's stakeholders is based on the level of trust, admiration, respect and good feelings that its stakeholders have for the company (Fombrun, 2004).

Reputation is based on 3 factors: direct experiences with McDonald's - via investments, engagement with employees, customer service and/or the quality of its food and services.

MCDONALD'S EMPLOYEE OFFER

Source: McDonald's Website

It is based on what the McDonald's as a Company says or does - via its advertising, marketing, social responsibility or communications.

MARINE STEWARDSHIP COUNCIL - FILET OF FISH

Source: Marine Stewardship Council

It is heavily influenced by what others say about the Company - the media, experts, regulators and policy makers, NGO's, community members and via social media.

Source: Grist, Susie Cagle

Reputation, is not only a factor of the actual character or direct behaviour of the company. Rather it is the combination of these in conjunction with the perceptions of the company's stakeholders.

2. Reputation drives or destroys market value

 

Global Reputation Pulse Research (2012) conducted by the Reputation Institute determined that it is this collective respect, trust, admiration and good feeling that drives a company's stakeholder support and company value.

When a Company builds and protects its reputation it is building and sustaining an emotional bond with its stakeholders that ensures:

  • Customers promote you
  • Investors recommend you and invest in you
  • Policy-makers and regulators give you the benefit of the doubt
  • Communities support you
  • Media look for your point of view, and
  • Your employees are engaged and deliver on your strategy

It is this company reputation that either "drives market value"...

REPUTATION INSTITUTE GOOD REPUTATION COMPANIES OUTPERFORM 2012

Source: Reputation Institute, 2012

or "destroys market value".

MCDONALD'S SHARE PRICE SUFFERS DUE TO REPUTATION MISALIGNMENT

Source: MCD: Yahoo Finance, Jan 12th, 2015

Unfortunately, McDonald's has long been battling the mismatch between "who they say they are as a company" with their healthy food options (inside out) and "stakeholder perception" (outside in).

MCDONALD'S INSIDE OUT - OUTSIDE IN VIEW - REPUTATION RISKS

Source: Framework by Schultz, M. Reputation Institute Training 2010 - Images have been modified to reflect the McDonald's Case Study.

When the reputation of a company is more positive/negative than its underlying reality, this gap poses a substantial reputation risk. Eventually, the failure of a firm to live up to its promises will be revealed by its stakeholders - and its reputation and market value will subsequently decline until it more closely matches the reality.

3. Closing the Gap on Reputation Risks

One step that McDonald's have taken to close the gap is the complete transformation of a former McCafe location in Sydney, Australia. The store has now been stripped of nearly all of McDonald's classic trademarks and reopened as 'The Corner by McCafe.'

MCDONALD'S NEW STORE IN AUSTRALIA

Source: McDonald's Australia 2014

This trendy looking café now serves up items absent from any other McDonald's menu, including chipotle pulled pork, quinoa, lentil and eggplant salads and Moroccan roast chicken. Intended as a "Learning Lab", McDonald’s is now testing completely new and different health focused food and beverages never before seen in its restaurants in order to address its Australian consumers obesity and health concerns and demands for "healthy food options" in order to retain relevance.

MCDONALD'S SERVES HEALTHY CUISINE IN NEW SYDNEY STORE.

Source: McDonald's Australia 2014

McDonald's is clearly being innovative and working hard to change the perceptions of consumers based on what "it does".

4. "Who you are" matters more than "what you do"

But there are still fundamental issues with "what they do". Like any consumer food company, product and food safety are still fundamental success markers for McDonald's.

McDonald’s Japan halted sales of its McNuggets over the weekend after a 4cm strip of vinyl was found in a customer's chicken nugget, another customer found a human tooth in their fries last August and a child is reported to have also cut its mouth with a piece of plastic found in a chocolate sundae.

Source: Wall Street Journal, August 2014

Despite a formal apology by the Company's Executives and swift action, this news comes amidst falling revenues and the lowest share price the company has faced over the past 12 months.

In 2014, McDonald's were forced to close down their supplier in China, Shanghai Husi Food Co., after it was discovered that the company was mixing expired meat with fresh produce and shipping products across the region. This had an immediate impact on sales and consumer confidence in both Japan and China, who were dependent on the supplier for the products.

SHANGHAI HUSI FOOD CO MIXING EXPIRED MEAT WITH FRESH PRODUCE

Source: Reuters / WN Video, July 24, 2014

However, Consumers and other Stakeholder Groups are also concerned about"who they are". According to negative published Stakeholder sentiment sourced from RepRisk AG, since 2013, McDonald's Corp has faced severe criticism from its stakeholders for:

  • Quality and safety of meat supplies (Jan, 2015),
  • Systematic wage theft (Dec, 2014),
  • Labor violations in supply chain (Nov, 2014),
  • Recall of Hello Kitty toys in Happy Meals due to choking risk (Nov, 2014)
  • Allegedly serving products called "Frankenfood" (Oct, 2014),
  • Pay gap between executives and employees (Sep, 2014),
  • Consumer safety and labeling violations (August, 2014),
  • Shut down of Moscow restaurants due to sanitary and other violations (August 2014),
  • Tax evasion allegations (July 2014),
  • Destruction of tropical forests by suppliers (June 2014) and
  • Exploitation of cultural exchange guest workers in its supply chain (October 2013).

These Environmental, Social and Governance (ESG) risks tend to fall into 3 core categories:

  1. Regulatory Risk (Industry specific risk) : can include Environmental, Social and Governance regulations
  2. Physical Risk (Industry specific or Company specific risks)
  3. Business Risk (Company-specific risk) : can include legal, reputation and competitive risks.

When not identified in advance or risk mitigation steps put in place, ESG issues can often be categorised as “grey swans”, due to their subsequent inter-related negative reputation consequences. A grey swan can be defined as "an event that can be anticipated to a certain degree, but is considered unlikely to occur and may have a sizable impact on the valuation of a security or the health of the overall market if it does occur (Investopedia, 2015).The challenge with grey swans is that the exact extent of damage and risk cannot be precisely calculated.

McDonald's ESG risks include (in order of magnitude):

  • Violation of National Legislation
  • Poor Employment Conditions
  • Product related Health and Environmental Issues
  • Supply Chain Issues
  • Impacts on Communities
  • Impacts to Ecosystems and Landscapes
  • Freedom of Association and Collective Bargaining
  • Animal Mistreatment
  • Human Rights Abuses and Corporate Complicity
  • Misleading Communication and
  • Occupational Health and Safety Issues

Source: RepRisk AG - ESG issue topics for McDonald's stakeholders since 2008

These ESG Risks linked to the reputation drivers of governance, workplace, citizenship, products and services and leadership (Fombrun, 2010) should not be underestimated.As a listed company, any risk that has a related impact on environmental, social or governance (ESG) issues could affect the profitability of the company adversely, particularly given that these are all violations for UNPRI investors and in contravention of the Global Compact.

While weighted differently for each country, these factors, influenced by cultural norms and legal and regulatory requirements, are found to have varying short to long term impacts on financial performance. However, ESG risks must not be ignored as they sustain shareholder investment, drive stakeholder trust and engender “social license to operate” support for McDonald's (Weber, Olaf , Mansfield, 2010; Dyck, Alexander, Morse, 2013).

Specifically in China, it was found that supply chain and governance issues, have a fundamental impact on a company's performance due to related impacts to legal and regulatory and/or a company's social license to operate (2010). This researchconducted by Michael Barnett of the Centre for Corporate Reputation at Oxford University and Jimmy Chen, Andreas Hoepner and Qian Li from the Centre for Responsible Banking & Finance at the University of St Andrews, highlight that savvy investors can exploit these factors for alpha. The research also highlights that these identified ESG Alpha opportunities in China will persist for some time, making them a focus for Investors seeking out performance or greater risk management in the region.

For McDonald's in China and their 2000+ stores, food safety impacts are both a political and competitive issue that result in an immediate impact on its economic performance. China, Australia and Japan, collectively accounted for 54% of APMEA’s revenues in 2013. In August 2014, McDonald’s reported that its global sales for the month of July dropped 2.5%, with 7.3% drop in the APMEA segment, thanks to the Husi Food Group scandal.

The risks are clear: market factors such as escalating local competition, labour shortages, rising rents and the challenges of procuring "safe" suppliers in a rapidly growing and fragmented market are a risk management challenge. However, the economic incentives of being a major player in a $200B growth Chinese market that yields net margins of 15-20 per cent should certainly justify the incentive for more effective reputation and enterprise risk management.

Particularly, if "who you are" matters just as much as "what you do" in 2015, it will be interesting to see what radical moves McDonald's is going to take next in their quest in order to rebuild consumer trust and investor confidence.

Source: Google Finance - Yahoo Finance, Monday 12 January 2015.

REPUTATION INSTITUTE 2010 - 7 DRIVERS OF REPUTATION

Source: Reputation Institute, 7 Drivers of Reputation, Fombrun 2004

5. Where is the Chief Risk Officer?

If thriving in the Asian century, requires McDonald's leaders to have a clear plan to seize the economic opportunities that will flow - and to manage the strategic risks and challenges that will arise, one might envisage that it is the role of the Chief Risk Officer who should both own and execute enterprise wide reputation risk management for McDonald's at the company, sector and country levels.

Interestingly, in McDonald's 2013 Annual Report, no such Executive with this job title exists. There is a Chief Financial Officer, Global Chief Brand Officer, Chief Operating Officer, and EVP of Global Supply Chain. This structure implies that reputation risk management and enterprise risk management are both treated as a functional roles within the company and that the owner of the Company Risk Register does not have a Board role, cannot directly contribute to corporate strategy or risk appetite/tolerance, except via an intermediary.

It also implies that risk management is reactive rather than proactive - and that with a Global Chief Brand Officer seated at the Board it's a marketing and communications led effort, rather than one owned by the CRO with a multidisciplinary risk management effort across the organisation. If true, this is an organisational weakness that Responsible Investors might seek to have immediately addressed, given the ongoing risks these factors have to company performance. (I welcome McDonald's Corp's feedback here).

6. Reputation and its Risk Management is a balancing act

The Board and Investors must also understand that reputation and its risk management is a balancing act.

REPUTATION IS A BALANCING ACT - RL EXPERT GROUP - REPUTATION RISKS MANAGED

Source: Fombrun, 2010, Reputation Institute

When the reality of the "inside out" is bad and the "outside in" perception is good – it is the Chief Risk Officer who must instrument the necessary organisational / multidisciplinary changes in order to alter both the operational and/or strategic reality - and collaborate with the communications and crisis management teams to limit stakeholder issues. This requires the McDonald's CRO to have not only a functional role in decision making, but also to be an instrumental voice at the table to contribute to the company's strategy and risk appetite/tolerance at Board level, alongside the Chief Brand Officer.

 

When the reality of the businesses operations are good and perception is bad,only then is "marketing and communications" required to capitalise on the good reality and overcome poor stakeholder perceptions.

 

7. It's all about a $39.9B risk AND opportunity

 

It is clear that today we live in the age of personal liability – when a director has unlimited liability in a limited liability company. Reputation risk is a top concern for boards and the most significant threat to business. Regarded as a meta risk, it sits alongside a leader's key strategic and operational concerns. When reputation risks are managed poorly we know from experience, that it can be just as deadly as new competition, technology failures, talent issues and changing regulations.

 

For McDonald's this risk represents at minimum a $39.9B business opportunity or43% of the current market cap of the company.

 

McDonald's have the opportunity to reinvent their approach to reputation and risk management and play a key role in its company operations "winning" in the Asian century, ensuring that the brand we know and loved from our childhood not only survives, but also thrives in the Asian century.

 

Disclaimer:

Like many Australians, I grew up with McDonald's. I had the great privilege to work with and be inspired by one of Australia's hardest working Franchise Entrepreneurs and Leaders, Rod Chiapello, during my youth. My childhood friends and I swear that it was in those early years, leading a shift at McDonald's, managing the drive thru, auditing the stock room, hosting those Children's birthday parties and championing McHappy Days that I discovered my passions for entrepreneurship, supply chain management, community citizenship, risk management, brand and reputation management and crisis management. It was at my local McDonald's that I also learned the value of team work, great training, personal initiative and accountability and the importance of consistently delivering on the desired customer experience.

My only mission through the writing of this post is to "give back" to the Company and encourage McDonald's Senior Leadership, Board and Investors to think differently about the way that they are currently managing their reputation and related risks.

Sources:

  • Badenhausen, K. "Apple, Microsoft and Google are the world's most valuable brands", Forbes, 11 May 2014.
  • Barnett, M., Chen, X., Hoepner, A., Li, Q. (2010), ESG Alpha In China, Said Business School, University of Oxford; Centre for Responsible Banking and Finance, School of Management, University of St Andrews; PRI Secretariat.
  • Dyck, I. J. Alexander and Morse, Adair and Zingales, Luigi, How Pervasive is Corporate Fraud? (February 22, 2013). Rotman School of Management Working Paper No. 2222608.
  • Fombrun, C. 2010. The Building Blocks of Reputation. Reputation Institute. Training and Certification.
  • Price, Richard A. and Sharp, Nathan Y. and Wood, David A., Detecting and Predicting Accounting Irregularities: A Comparison of Commercial and Academic Risk Measures (June 2011).
  • Schultz, M. 2010. Corporate Branding and Business Strategy. Reputation Institute. Training and Certification.
  • Weber, Olaf and Mansfeld, Marco and Schirrmann, Eric, The Financial Performance of SRI Funds Between 2002 and 2009, June 25, 2010.
  • Global Reputation Pulse Research (2012), Reputation Institute
  • Databases : Factiva, Euromonitor, MarketLine, LexisNexis, RepRisk, GMI Ratings, Bloomberg and Yahoo Finance.
  • Company information : McDonald's website and Annual Reports.

If you enjoyed reading this post, please click the thumbs up icon above and let me know. For more on these topics, check out my other recent LinkedIn Influencer posts here:

About RL EXPERT Leesa Soulodre:

Founder and Managing Partner of RL Expert Group. A Member of the Global Advisory Council of NY Investment Advisory Firm, Cornerstone Capital; an Innovation Advisor to the University of Illinois Urbana Champaign Advanced Digital Science Centre, Singapore and Board Advisor to Belgian PR Software firm, Prezly and US Sports Analytics firm, Autoscout.

An Adjunct in Corporate Communications at Singapore Management University, lecturing part time on "Risk Issues and Crisis Management "and "Content Strategy" at the Lee Kong Chian School of Business. Prior to moving to Asia, spent 7 years part time in European Academia, lecturing on the Luxury MBA programs in Marketing, Communications and Reputation Management at two french business schools, Ecole Superieur de Gestion and Mod'Art International.

Connect: Leesa Soulodre, Managing Partner, RL Expert Group - ls@rlexpert.com

http://www.rlexpert.com

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