Has Japan Outgrown the Big Mac?

The shrimp burgers of McDonald's/Japan's CEO have helped reheat sales, but he may need to take his eateries further upmarket to keep profits up

For most of the past two years, Eikoh Harada's jump from iMac to the Big Mac has looked like a pretty bad move. In March, 2004, Harada quit as president of Apple Computer's (AAPL) Japanese business and took over as chief executive of McDonald's (MCD) in Japan. Although he had earned praise for turning around Apple's operations, many doubted he had what it took to combat slumping sales and profits in McDonald's second-biggest market after the U.S.

Until recently, it looked as if the doubters might be right. True, under Harada, annual sales have risen 8.5%, to $2.8 billion, reversing a three-year decline. But last year, net profits slumped 98%, to a measly $515,000. The weak earnings were partly the result of one-off restructuring costs, but a big factor has been a strategy, introduced in April, 2005, of pricing Big Macs, fries, and other items at just 100 yen (85¢). "The cheap burgers attract customers but don't contribute to earnings," says Yasuhiro Matsumoto, an analyst at Shinsei Securities in Tokyo.

These days, though, it appears Harada may be onto something. McDonald's Japan has outperformed a sluggish market for fast food and posted increases in same-store sales of as much as 11.6% every month since February. Perhaps more important, customers are spending more on each visit. On Aug. 2, the company posted a 650% rise in operating profits to $10.7 million for the first six months of year, prompting Harada to raise his full-year sales projection by $35 million.


  McDonald's now says sales for 2006 could be as much as $3.08 billion. Net earnings, which Harada didn't revise, could jump to as much as $21 million. That's helping lift the fortunes of McDonald's, which owns half of the Tokyo-listed McDonald's Holdings (Japan). Announcing second-quarter sales results on July 17, McDonald's Corp. CEO Jim Skinner cited "strong performance in Japan and Australia."

Harada's efforts have been helped by new sandwiches better tailored to Japanese tastes. One hit has been the Ebi Filet-O, a shrimp burger that generated sales of 10 million in the first three months after its launch last October. New salad plates introduced in May, called Salad Macs, are proving just as successful, despite prices around $5. "The positive customer reaction to the higher prices is important," says Seiichiro Samejima, an analyst at the Ichiyoshi Research Institute in Tokyo.

Still, rebuilding the brand will take more than just a few menu changes. When McDonald's Japan listed in Tokyo in 2001, the company aimed to have 10,000 restaurants by 2010. Today, there are 3,600. At 15.70, the stock trades at less than half its initial public offering price and, so far, hasn't really budged despite the rising sales. Operating margins, which regularly topped 8% a decade ago, remain at about 2% today.


  It seems the Japanese love affair with McDonald's has peaked. Today young Japanese are happy to pony up for a Caramel Frappuccino from Starbucks (SBUX) or a bowl of noodles at a local mom-and-pop eatery. "I don't go [to McDonald's] that often," says Takeshi Miyazoe, a video-game developer in Tokyo. "There are so many other good restaurants."

Another factor has been the growth of convenience stores. Today, some 30,000 sell everything from sausages to sushi, and they account for a third of Japan's $62 billion fast-food market. To hit back, Harada says McDonald's will continue to improve the menu and will keep more restaurants open 24 hours a day. Another concern is Japan's demographics and rebounding economy. With fewer and fewer children being born in Japan, McDonald's traditional customer base is shrinking.


  And with deflation seemingly at an end and consumer confidence growing, the Japanese may be willing to pay more for food and be looking for higher-quality fare than McDonald's. "With the macroeconomic environment picking up, the quality of the food becomes more important and people care less about price," says Yukimi Oda, an analyst at Morgan Stanley in Tokyo.

Harada is keen to steer McDonald's further upmarket. "We have to graduate with our customers," he says. McDonald's now offers free wireless Internet at 2,660 restaurants, increasing traffic as salarymen surf while they sup. More radically, Harada is considering a new type of restaurant with fancier menus and interiors, though he declines to provide details. "But of course," he says, "our Golden Arches will stay." Shrimp burgers and wireless connections, it seems, are just the beginning.

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