By Nancy Millman and Genevieve Buck.

Tribune Business News; 2nd Mar 1997

Michael Quinlan, chief executive of McDonald's Corp., has been sounding the same theme in his annual messages to shareholders for most of the 1990s: The hamburger chain would continue to grow and prosper through a strategy of aggressive expansion and market dominance.

Though McDonald's is the largest and best-known food-service retailer in the world - it now has more than 19,000 restaurants in 100 countries - the company has not been satisfied with its reach. Quinlan and his team seem obsessed with the fact that "on any given day 99 percent of the world's population does not eat at McDonald's ... yet," according to the most recent annual report.

To help increase that ratio, the company a few years ago stepped up its global expansion plans. The strategy was to put restaurants in places where people play, shop and work - theme parks, retail stores like Wal-Mart, Amoco and other gas stations, and in the heart of cities.

McDonald's management was confident, like the ghost of Shoeless Joe Jackson in "Field of Dreams," that "if you build it, they will come." At the company's idyllic headquarters campus in Oak Brook, however, management has learned that making sure every American is within a few minutes from a McDonald's doesn't guarantee success.

It is a lesson that other retailers, like fast-growing bagel chains and clothing stores, are learning, too.

And it helps explain McDonald's bombshell last week - plans to slash prices on its Big Mac and other brand-name sandwiches.

McDonald's may have pioneered the strategy of putting an outlet on every corner, but many other retailers and franchise companies have followed this path. Even the hot Starbucks chain is feeling the same kind of slowdown in individual store sales that forced McDonald's to change its course.

There are sound marketing reasons for food and retail companies to saturate markets. For one, it deprives competitors of sites. The stores also work as brick-and-mortar advertisements, reminding people of the company's name and products wherever they turn.

"Gap windows are one of its most prominent marketing tools," noted Beverly Butler, a spokeswoman for Gap Inc., which has 13 stores in Chicago, mostly clustered on the North Side.

Starbucks Corp. has two stores across the street from one another in Vancouver, British Columbia.

But the strategy can backfire.

The price that McDonald's paid for expanding its core customers was cannibalization of its existing stores.

"Rapid development on an already large store base hurts comparable sales at existing units, but increases total sales," said Dean Haskell, an analyst with Everen Securities in Chicago.

In other words, it's inevitable that if you add another store in an area where two already are prospering, the average sales at the existing stores will suffer.

For chains like McDonald's, where most of the retail ownership and operations are handled by franchisees - 79 percent of McDonald's U.S. stores are franchised - cannibalization doesn't hurt the corporation at first.

Individual franchisees suffer because their sales decline while customers go to nearby outlets. McDonald's, however, still collects royalties from franchisees based on the increasing overall revenue.

But as cannibalization continues, the investment in new stores outpaces the profits earned from increases in total sales.

Now, sluggish sales in U.S. restaurants pushed McDonald's management to develop a price-cutting strategy - a 55-cent sandwich offer, which will be introduced at the end of April. If ubiquity didn't work to build traffic, the company is wagering, maybe a turn back to the chain's 1955 bargain-priced origins will.

"Management believes not executing the market-domination strategy allows competitors to place units where they would hurt nearby units anyway," Haskell wrote in a recent report.

"However, because sales increases are acquired by investing in additional land, buildings and equipment, management must carefully and quickly prune units not meeting profitability standards." The new move on pricing follows McDonald's backtracking on its strategy to make its restaurants as common as its ads on television.

Already, McDonald's has said it is closing more than 100 of its less profitable satellite units; it is slowing down the building of U.S.

restaurants in favor of improving returns in existing stores.

Some companies, like Italian clothing company Benetton, overexpanded to the point that the bubble burst. Benetton was known as "the McDonald's of the apparel business" in the 1980s, when it grew to 6,500 stores, with 13 percent of them in the United States. But by 1986, cannibalization set in and business took a turn for the worse. The chain began drastically cutting back its presence in the United States.

Cannibalization was far from Benetton's biggest problem. Controversial ad campaigns that alienated conservative licensees and customers, and intense fashion-industry competition helped bring down the high-flier.

But overlapping sales territories clearly hurt individual store owners, prompting some to sue the apparel chain for fraud and violation of franchise laws.

Another disciple of McDonald's strategy, Seattle-based Starbucks, is starting to see shrinkage in its year-to-year figures at individual stores as it proliferates all over North America.

With just over 1,100 outlets, all company-owned, Starbucks has said it expects to double that number by 2000.

In a city like Chicago, it seems that Starbucks outlets are sprouting on every block.

"We have found that there is often customer demand for more than one Starbucks in close geographic proximity that causes us to build more than one store in a neighborhood," a company spokeswoman said.

But while net earnings were up 50 percent in the most recent quarter from a year earlier, sales at stores open at least 13 months rose only 3 percent, compared with 7 percent last year.

"As we add more stores, we increase our total business, but we cannibalize our existing stores," Orin Smith, Starbucks' president, has been quoted as saying. "There are some negative effects, but in the long run, it's better to capture market share." -

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