Case study

ASSIGNMENT

Case: Burger King (Mini Case)

(J. David Hunger)

ORIGINALLY CALLED INSTA-BURGER KING, the company was founded in Florida in 1953 by Keith Kramer and Matthew Burns. Their Insta-Broiler oven was so successful at cooking hamburgers that they required all of their franchised restaurants to use the oven. After the chain ran into financial difficulties, it was purchased by its Miami-based franchisees, James McLamore and David Edgerton, in 1955. The new owners renamed the company Burger King. The restaurant chain introduced the first Whopper sandwich in 1957. Expanding to over 250 locations in the United States, the company was sold in 1967 to Pillsbury Corporation.

The company successfully differentiated itself from McDonald’s, its primary rival, when it launched the Have It Your Way advertising campaign in 1974. Unlike McDonald’s, which had made it difficult and time-consuming for customers to special-order standard items (such as a plain hamburger), Burger King restaurants allowed people to change the way a food item was prepared without a long wait.

Pillsbury (including Burger King) was purchased in 1989 by Grand Metropolitan, which in turn merged with Guinness to form Diageo, a British spirits company. Diageo’s management neglected the Burger King business, leading to poor operating performance. Burger King was damaged to the point that major franchises went out of business and the total value of firm declined. Diageo’s management decided to divest the money-losing chain by selling it to a partnership private equity firm led by TPG Capital in 2002.

The investment group hired a new advertising agency to create (1) a series of new ad campaigns, (2) a changed menu to focus on male consumers, (3) a series of programs designed to revamp individual stores, and (4) a new concept called the BK Whopper Bar. These changes led to profitable quarters and re-energized the chain. In May 2006, the investment group took Burger King public by issuing an Initial Public Offering (IPO). The investment group continued to own 31% of the outstanding common stock

Business Model

Burger King was the second largest fast-food hamburger restaurant chain in the world as measured by the total number of restaurants and system wide sales. As of June 30, 2010, the company owned or franchised 12,174 restaurants in 76 countries and U.S. territories, of which 1,387 were company-owned and 10,787 were owned by franchisees. Of Burger King’s restaurant total, 7,258 or 60% were located in the United States. The restaurants featured flame-broiled hamburgers, chicken and other specialty sandwiches, french fries, soft drinks, and other low-priced food items.

 According to management, the company generated revenues from three sources: (1) retail sales at company-owned restaurants; (2) royalty payments on sales and franchise fees paid by franchisees; and (3) property income from restaurants leased to franchisees. Approximately 90% of Burger King Restaurants were franchised, a higher percentage than other competitors in the fast-food hamburger category. Although such a high percentage of franchisees meant lower capital requirements compared to competitors, it also meant that management had limited control over franchisees. Franchisees in the United States and Canada paid an average of 3.9% of sales to the company in 2010. In addition, these franchisees contributed 4% of gross sales per month to the advertising fund. Franchisees were required to purchase food, packaging, and equipment from company-approved suppliers.

Restaurant Services Inc. (RSI) was a purchasing cooperative formed in 1992 to act as purchasing agent for the Burger King system in the United States. As of June 30, 2010, RSI was the distribution manager for 94% of the company’s U.S. restaurants, with four distributors servicing approximately 85% of the U.S. system. Burger King had long-term exclusive contracts with Coca Cola and with Dr. Pepper/Seven-Up to purchase soft drinks for its restaurants.

 Management touted its business strategy as growing the brand, running great restaurants, investing wisely, and focusing on its people. Specifically, management planned to accelerate growth between 2010 and 2015 so that international restaurants would comprise 50% of the total number. The focus in international expansion was to be in (1) countries with growth potential where Burger King was already established, such as Spain, Brazil, and Turkey; (2) countries with potential where the firm had a small presence, such as Argentina, Colombia, China, Japan, Indonesia, and Italy; and (3) attractive new markets in the Middle East, Eastern Europe, and Asia.

 Management was also working to update the restaurants by implementing its new 20/20 design and complementary Whopper Bar design introduced in 2008. By 2010, more than 200 Burger King Restaurants had adopted the new 20/20 design that evoked the industrial look of corrugated metal, brick, wood, and concrete. The new design was to be introduced in 95 company-owned restaurants during fiscal 2011.

Management was using a “barbell” menu strategy to introduce new products at both the premium and low-priced ends of the product continuum. As part of this strategy, the company introduced in 2010 the premium Steakhouse XT burger line and BK Fire-Grilled Ribs, the first bone-in pork ribs sold at a national fast-food hamburger restaurant chain. At the other end of the menu, the company introduced in 2010 the 1 ⁄4 pound Double Cheeseburger, the Buck Double, and the $1 BK Breakfast Muffin Sandwich. Management continued to look for ways to reduce costs and boost efficiency. By June 30, 2010, point-of-sale cash register systems had been installed in all company-owned and 57% of franchise-owned, restaurants. It had also installed a flexible batch broiler to maximize cooking flexibility and facilitate a broader menu selection while reducing energy costs. By June 30, 2010, the flexible broiler was in 89% of company-owned restaurants and 68% of franchise restaurants.

 Industry

The fast-food hamburger category operated within the quick service restaurant (QSR) segment of the restaurant industry. QSR sales had grown at an annual rate of 3% over the past 10 years and were projected to continue increasing at 3% from 2010 to 2015. The fast-food hamburger restaurant (FFHR) category represented 27% of total QSR sales. FFHR sales were projected to grow 5% annually during this same time period. Burger King accounted for around 14% of total FFHR sales in the United States.

The company competed against market-leading McDonald’s, Wendy’s, and Hardee’s restaurants in this category and against regional competitors, such as Carl’s Jr., Jack in the Box, and Sonic. It also competed indirectly against a multitude of competitors in the QSR restaurant segment, including Taco Bell, Arby’s, and KFC, among others. As the North American market became saturated, mergers occurred. For example, Taco Bell, KFC, and Pizza Hut were now part of Yum! Brands. Wendy’s and Arby’s merged in 2008. Although the restaurant industry as a whole had few barriers to entry, marketing and operating economies of scale made it difficult for a new entrant to challenge established U.S. chains in the FFHR category.

The quick service restaurant market segment appeared to be less vulnerable to a recession than other businesses. For example, during the quarter ended May 2010, both QSR and FFHR sales decreased 0.5%, compared to a 3% decline at both casual dining chains and family dining chains. The U.S. restaurant category as a whole declined 1% during the same time period.

America’s increasing concern with health and fitness was putting pressure on restaurants to offer healthier menu items. Given its emphasis on fried food and saturated fat, the quick service restaurant market segment was an obvious target for likely legislation. For example, Burger King’s recently introduced Pizza Burger was a 2,530-calorie item that included four hamburger patties, pepperoni, mozzarella, and Tuscan sauce on a sesame seed bun. Although the Pizza Burger may be the largest hamburger produced by a fast-food chain, the foot-long cheeseburgers of Hardee’s and Carl’s Jr. were similar entries. A health reform bill passed by the U.S. Congress in 2010 required restaurant chains with 20 or more outlets to list the calorie content of menu items. A study by the National Bureau of Economic Research found that a similar posting law in New York City caused the average calorie count per transaction to fall 6%, and revenue increased 3% at Starbucks stores where a Dunkin Donuts outlet was nearby. One county in California attempted to ban McDonald’s from including toys in its high-calorie “Happy Meal” because legislators believed that toys attracted children to unhealthy food.

Issues

 Even though Burger King was the second largest hamburger chain in the world, it lagged far behind McDonald’s, which had a total of 32,466 restaurants worldwide. McDonald’s averaged about twice the sales volume per U.S. restaurant and was more profitable than Burger King. McDonald’s was respected as a well-managed company. During fiscal year 2009 (ending December 31), McDonald’s earned $4.6 billion on revenues of $22.7 billion. Although its total revenues had dropped from $23.5 billion in 2008, net income had actually increased from $4.3 billion in 2008.

In contrast to most corporations, McDonald’s common stock price had risen during the 2008–2010 recession, reaching an all-time high in August 2010. In contrast, Burger King was perceived by industry analysts as having significant problems. As a result, Burger King’s share price had fallen by half from 2008 to 2010. During fiscal year 2010 (ending June 30), Burger King earned $186.8 million on revenues of $2.50 billion. Although its total revenues had dropped only slightly from $2.54 billion in fiscal 2009 and increased from $2.45 billion in 2008, net income fell from $200.1 million in 2009 and $189.6 million in 2008. Even though same-store sales stayed positive for McDonald’s during the recession, they dropped 2.3% for Burger King from fiscal 2009 to 2010. In addition, some analysts were concerned that expenses were high at Burger King’s company-owned restaurants. Expenses as a percentage of total company-owned restaurant revenues were 87.8% in fiscal 2010 for Burger King compared to only 81.8% for McDonald’s in fiscal 2009.

McDonald’s had always emphasized marketing to families. The company significantly outperformed Burger King in both “warmth” and “competence” in consumers’ minds. When McDonald’s recently put more emphasis on women and older people by offering relatively healthy salads and upgraded its already good coffee, Burger King continued to market to young men by (according to one analyst) offering high-calorie burgers and ads featuring dancing chickens and a “creepy-looking” king. These young men were the very group who had been hit especially hard by the recession. According to Steve Lewis, who operated 36 Burger King franchises in the Philadelphia area, “overall menu development has been horrible. . . . We disregarded kids, we disregarded families, we disregarded moms.” For example, sales of new, premium-priced menu items like the Steakhouse XT burger declined once they were no longer being advertised. One analyst stated that the company had “put a lot of energy into gimmicky advertising” at the expense of products and service. In addition, analysts commented that franchisees had also disregarded their aging restaurants.

Some analysts felt that Burger King may have cannibalized its existing sales by putting too much emphasis on value meals. For example, Burger King Franchisees sued the company in 2009 over the firm’s double-cheeseburger promotion, claiming that it was unfair for them to be required to sell these cheeseburgers for only $1 when they cost $1.10. Even though the price was subsequently raised to $1.29, the items on Burger King’s “value menu” accounted for 20% of all sales in 2010, up from 12% in 2009.

New Owners: Time for a Strategic Change?

 On September 2, 2010, 3G Capital, an investment group dominated by three Brazilian millionaires, offered $4 billion to purchase Burger King Holdings Inc At $24 a share, the offer represented a 46% premium over Burger King’s August 31 closing price. According to John Chidsey, Burger King’s Charman and CEO, “It was a call out of the blue.” Both the board of directors and the investment firms owning 31% of the shares supported acceptance of the offer. New ownership should bring a new board of directors and a change in top management. What should new management propose to ensure the survival and long-term success of Burger King?

(The CASE Burger King (Mini Case) J. David Hunger This case was prepared by Professor J. David Hunger, Iowa State University and St. John’s University. Copyright ©2010 by J. David Hunger, The copyright holder is solely responsible for case content. TheCase has been taken from Book Strategic Management and Business Policy, 13th Edition, publisher, Prentice Hall.

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