Why McDonald's wins in any economy

August 23, 2011: 5:00 AM ET

Thanks to Jim Skinner's no-nonsense leadership, the global restaurant juggernaut is doing better than ever.

By Beth Kowitt, writer-reporter

French fries do not reflect actual earnings-per-share gains.

FORTUNE -- Jim Skinner, CEO of McDonald's, is inspecting the kitchen of one of his restaurants in Oak Brook, Ill., with the rigor many of his peers might reserve for financial reports. He examines the food-preparation area as he explains, in great detail, the "review of the hash browns" that McDonald's initiated a few years ago -- and admonishes me to not touch anything. "Unless you feel like you want to have a job," he adds. McDonald's, after all, is one of the few places hiring these days.

Skinner isn't a micromanager. He's simply intensely focused on the efficiency and performance of McDonald's (MCD) 33,000 restaurants worldwide and the enormous, complex infrastructure that supports them, a managerial trait that has resulted in nothing short of a Golden Age for the Golden Arches. Since Skinner, 66, became CEO in 2004, the company has delivered an annual growth rate of 5%, with revenue topping $24 billion last year. Same-store sales, a closely watched industry metric, have climbed each of the seven years of his tenure, and in that time the stock has returned more than 250% -- even after the early-August equities selloff -- vs. 16% for the S&P 500 (SPX). [Click here to read our 2005 story about how McDonald's got CEO succession right.]

If you haven't been in a McDonald's lately, you might assume that the company simply has been the beneficiary of the struggling economy in the U.S. and elsewhere in the world, and that cost-conscious consumers are flocking to fast-food eateries instead of sit-down restaurants. But to post the kind of impressive numbers McDonald's has -- and to weather the current turmoil -- Skinner has had to find ways to attract new diners while retaining the hard-core Big Mac-and-fries crowd. And so today, along with burgers and shakes, you can stroll into a McDonald's and pick up a snack wrap or a fruit smoothie or a decent latte (much to Starbucks' chagrin), all of which translates into higher sales per location. Last year average per-store sales jumped to $2.4 million, from $1.6 million in 2004.

Now think of all the things that have to go right to pull off that kind of global transformation: Test kitchens need to churn out winning recipes (no more McPizzas!), the company must line up suppliers who can handle big orders, the crews have to be trained to prepare new items, and marketers must figure out a way to sell them -- all while fending off the food police who, not without merit, dog the company about the nutritional value of its fare. Luckily for McDonald's, Skinner is an operations whiz who has turned the restaurant giant into a well-oiled machine, insisting on planning and accountability throughout the company -- even hash browns are subject to review. "McDonald's has been an execution wonder," says UBS analyst David Palmer. That's why Fortune has named Skinner to the starting lineup of our first Executive Dream Team, an all-star roster of top-performing executives.

Yet few at McDonald's ever expected the publicity-shy Midwesterner, who never graduated from college, to become CEO. "I've been a walk-on in everything; nobody was thinking, 'Get the little guy from Davenport, Iowa,'" says the 5-foot-6 Skinner, who rarely talks about himself in interviews. His transition from supporting player to team captain in November 2004 came under tragic circumstances: Former CEO Jim Cantalupo died of a heart attack that year, and Cantalupo's successor, Charlie Bell, resigned as he underwent treatment for cancer after just seven months on the job. He died in January 2005.

But Skinner's leadership has been utterly self-assured -- it is as though the walk-on had been quietly practicing for his big shot all along. Employees and analysts say he's guided by a zeal for satisfying customers, even if it comes at the expense of his own ideas and preferences. A few years ago the company did extensive testing on new coffee-cup lids and rolled out a version that consumers liked -- and that Skinner, who happens to drink a lot of coffee, really didn't. Rather than overrule the masses, Skinner came up with his own solution: He keeps a stash of the old lids on hand.

From the kitchen up

If Skinner seems as though he knows his way around a McDonald's kitchen, it is because he once worked in one, as did 40% of the company's executives. (Amazon (AMZN) CEO Jeff Bezos and Top Chef Richard Blais did too.) At age 16 he got a job at McDonald's in Davenport. "I was in a family where, if I wanted to have any spending money, I had to work," says Skinner, whose father was a bricklayer. It was 1962 and employees still peeled, blanched, and sliced potatoes for French fries.

Skinner visiting a McDonald's restaurant in Oak Brook, Ill.

After six months behind the counter, he left Iowa behind for the Navy, serving on the aircraft carriers Midway and Oriskany. (He briefly overlapped with Oriskany veteran John McCain.) The hallmarks that came with spending nearly a decade in a highly disciplined, execution-driven environment became classic Skinner. He met his future wife, Kathleen, during his last year in the service -- they're still married 42 years later -- and decided it was time to settle down. He landed at McDonald's as a restaurant manager trainee after a Navy buddy encouraged him to apply.

Skinner earned a reputation as a loyal McDonald's man, one who always did his homework but never felt the need to show it off. Denis Hennequin, who until 2010 served as the company's head of Europe, says the future McDonald's chief would eventually earn the nickname "Jim Skipsdinner" for his preference for having a quiet bite in the hotel once business was finished rather than attend an official meal for the sake of appearances. "Some people have an ego that makes them need to be seen even if it's not necessary," says Hennequin, now CEO of hotel operator Accor. "Jim is not like that." Several former executives described Skinner as having no tolerance for bureaucratic double talk, one noting that he has a "good crap detector." (None of this is to say he's humorless. In fact, he's rather funny. Ask him about one of his favorite shows, Two and a Half Men, and he'll offer his thoughts on how he would write Ashton Kutcher into the sitcom.)

He proved to be insightful too, backing his executives publicly even if he didn't always agree with their tactics. Claire Babrowski, who worked for McDonald's for almost 30 years, remembers, as a manager in the North Carolina region, running into a difficult franchisee who wasn't operating his store the way the company liked. (To this day, 80% of McDonald's restaurants are operated by independent owners.) To top it off, he would never wear a tie -- standard practice at the time for franchisees. Skinner was her boss, and during a visit all parties met to hash out their issues. "For some reason I got off on the tie thing, which was so the least of it," Babrowski says. Skinner didn't stop her, instead turning to the franchisee to ask him how hard it would be to put on a tie. "Later at night Jim took me out to dinner, and he's like, 'Really? The tie?'"

In 1992, McDonald's promoted Skinner to work in its international business, bringing Big Macs and fries to 60 new markets, including parts of Europe, Africa, and the Middle East. By the time he came back to domestic operations he had worked in every region of the world.

Skinner returned to the U.S. business in 2002 to a McDonald's that was floundering. The company was hooked on expansion; in 2001 it was opening more than three restaurants a day. The quality of the food and service had deteriorated as a result, along with the stock price and profits. Long-time McDonald's man Jim Cantalupo came out of retirement to run the company and elevated Skinner to vice chairman. The new executive team implemented a back-to-basics turnaround strategy -- the Plan to Win -- with a focus on growth through increasing sales at existing stores rather than by opening new locations.

In April 2004, Cantalupo and his management crew traveled down to Orlando for the company's owner-operator convention. In the early morning hours the day Cantalupo was to give his remarks, a victory speech of sorts, he had a heart attack and died in the room next to Skinner's. That same day the board named the young, charismatic Charlie Bell as the company's new leader. But less than a month later Bell was diagnosed with colorectal cancer. While he and the company were at first optimistic about a recovery, he stepped aside in November. "The bizarre paradoxical thing was that in the midst of first losing Jim [Cantalupo] and then Charlie being ill, we were performing better than ever," says former McDonald's executive Mats Lederhausen. "It was surreal."

The board looked to the 60-year-old Skinner to become the company's new CEO at one of the most delicate moments in its history. "The fact that it was Jim, at least from my point of view, was a comfort," Babrowski says. To the outside world, Skinner was relatively unknown, which he attributes to always being a good No. 2. "Good No. 2s don't usurp their boss's authority," he says. "They don't go around trying to take credit."

Rather than shake up the already unsettled company by implementing a new approach, the no-drama Skinner came in on a platform of continuity, stressing that leadership change doesn't mean strategy change. "He understood that he didn't need to rebrand the company in his own image," says Jeffrey Sonnenfeld of the Yale School of Management. "He didn't need to imprint his persona."

Keeping the streak going

Under Skinner, McDonald's has become so successful that it now has a challenge only a few companies, such as Wal-Mart (WMT), face. How do you continue to grow a behemoth? Every day 64 million people in 118 countries (Bosnia was just added to the list) eat at its restaurants, which generate revenue that trumps Starbucks (SBUX), KFC, Pizza Hut, and Taco Bell (YUM) combined. From 2008 through 2010, McDonald's was responsible for 90% of the sales growth of the U.S. fast-food and fast-casual industry, according to research firm Technomic. Every month that the company ups its same-store-sales figures, which it has done for the past 99, the harder it is to lap its numbers year to year.

The fact that fast food is a somewhat cyclical business makes McDonald's sales streak all the more impressive. But Skinner doesn't think McDonald's should experience serious ups and downs based on seasons or swings in the economy. He's constantly telling shareholders and analysts that the company's success doesn't hinge on consumers trading down when times are tough; when customers have more to spend, they'll spend it at McDonald's, he says.

To entice consumers to buy more -- and more often -- McDonald's under Skinner has pursued what the fast-food industry calls "platforms" rather than one-hit wonders. (Chicken is a platform; McNuggets are the product.) McCafé, McDonald's beverage platform featuring coffee drinks and smoothies, has added about $125,000 in sales per store and is the company's biggest launch in 35 years. As McDonald's has put its major flops of the past far behind (ever try the McLean or the Arch Deluxe?), the company has gained permission from consumers to branch out into products you'd never expect to see on the menu board a decade ago -- oatmeal, for example. Geographical divisions have even gotten better at sharing ideas around the globe. McCafé originated in Australia, and now Chicken McBites, another Aussie staple, is being tested in the U.S.

Despite having more than 100 items on the menu, Skinner, perhaps more than anyone else at McDonald's, has never lost sight of the fact that the company's roots go back to the burger business. In the late 1990s and early 2000s McDonald's started acquiring stakes in brands like Chipotle (CMG). Those investments diversified the company but barely caused a blip in earnings. When Skinner became CEO, he sold them all off in their entirety in order to keep the focus on the core. "Because you're good with hamburgers, you think you can do pizzas or rental cars or an IT business or sell your know-how," says former executive Hennequin. McDonald's has been guilty of this too -- it once opened Golden Arch hotels in Switzerland. "Jim is always the guy that takes us back to 'What difference is this going to make for the hamburger business? Is that going to help? If that's not going to help, forget it.'"

Today McDonald's is better than ever at figuring out what will or won't work on the menu board, a testament to the discipline Skinner has instituted. Every new item that ends up on customers' trays has to have a strong business case that examines its profitability, the capital it requires, and how it can be built out nationally. McDonald's has about 40 products at different stages in the pipeline, and some, like the Angus Burger, can take over four years to hit the market. Products that meet the company's business-case requirements have a 90% chance of going national. During the testing phase, the company may even try out different prices by market to ensure a new launch is adding incremental sales rather than stealing share from an existing item.

McDonald's buying power

Take the snack wrap, which came about when restaurants started to see a plateau in sales volume of its Chicken Selects. McDonald's executive chef, suppliers, and franchisees got together at headquarters to figure out how to ramp up the turn of the crispy chicken strips. After chefs, food scientists, suppliers, and members of the menu-management team and advertising agency weighed in on how to define the product and pricing, the snack wrap had to pass muster with 150 to 200 consumers in focus groups. It then went into a four- to six-week operational test in a handful of restaurants to determine if changes needed to be made in crew positioning or equipment. McDonald's had mastered the bun, but with the snack wrap, the menu-development team had a lot of work to do operationally around tortillas: What was the right packaging? How do you get them at the right temperature for the customer? What's the right amount of flexibility in the tortilla?

Snack wraps made it to market in 2006, 18 months after executives began discussing them. One of the fastest launches the company has ever had, it accomplished what McDonald's has increasingly tried to do: hit another price point on the menu and offer some food news that gives customers a reason to go back into its stores. The process also helped McDonald's realize the potential of the snacking market -- the growing segment that wants to nibble between meals -- and the chance to increase traffic between mealtimes. An added bonus: The product team then took the same formula for the snack wrap and applied its tortilla know-how at breakfast to create the McSkillet Burrito. Both products use the same tortilla, so the kitchen isn't further complicated with another ingredient.

Skinner likes a new hit product as much as the next guy, but, he says, at this point in McDonald's history another breakout blockbuster is unlikely. Growth these days is about scaling and executing. Hence the operational zeal, which has evolved into a strategy that places a relentless focus on the stores. Whenever his people travel on business, he wants them checking out the local McDonald's. Robbie Hofmann, president of McDonald's supplier North Side Foods and a friend of Skinner's for 30 years, says that whenever they travel together, Skinner always coerces him into stopping for coffee at the nearest McDonald's, where he spends the next half hour chatting with the crew -- after he's secured one of his back-up lids for his drink, of course.

Skinner knows the restaurants are the only place the cash register rings. Headquarters can cook up any idea it wants, but if it overly complicates the kitchen, the product won't fly. This doesn't always endear him to his finance executives, to whom he's been known to say, "I want to remind you that it's a lot harder to make money than it is to count it!" At one time the company floated the idea of putting deli sandwiches on the menu. The deal killer? The crew couldn't get it done in 55 to 60 seconds. "We talk about hospitality, we talk about friendly relationships, but we live in a world of speed today," Skinner says. McDonald's customers at the drive-through don't want to be chatted with, and they don't want to wait two minutes for a turkey sandwich.

Don't be afraid of your No. 2

There was a time when the idea of "Hamburger U," McDonald's training facility, used to elicit titters, but to Skinner, who didn't graduate from college or earn an MBA, management training is no joke. He created a leadership institute a year after he became CEO. One nine-month leadership program brings together top-performing executives to work on addressing big issues for McDonald's. Funding for another program, for all new officers, comes out of Skinner's own budget.

Skinner in company garb in the mid-1970s

This push for talent development may be Skinner's greatest legacy at the company, which has 700,000 employees in the U.S. alone, thanks in part to its April "national hiring day" spree of 62,000 workers. He requires that all executives train at least two potential successors -- one who could do the job today, the "ready now," in McDonald's parlance, and one who could be a future replacement, the "ready future." One could speculate that this redundancy might have to do with the way Skinner came into his current position. Every year the executive team, including Skinner, reviews the top 200 positions in the company and the feeder pool, which means it ends up looking at about 400 people. "We talk about all of them," says HR chief Rich Floersch.

Skinner doesn't show much sympathy for employees who can't handle the thought of having a subordinate right behind them who's capable of tackling their job at any moment. "That's always a danger, and some people can't live with that," Skinner says. "I always like to say that my goal is to surround myself with people smarter than I am. I'm not afraid of it." And Skinner seems to practice what he preaches: At analyst meetings and on calls, he regularly defers to his No. 2, Don Thompson, who moved into his current job as chief operating officer in 2010.

Skinner isn't exempt from having a "ready now," and Thompson is widely believed by analysts to be his heir apparent. McDonald's doesn't have a mandatory retirement age, and the 66-year-old Skinner won't say when he plans to make the move. He does offer one lighthearted hint: "People always ask me when I'm going to retire," he tells me. "I say, 'When I run out of lids.'"

This article is from the September 5, 2011 issue of Fortune.

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