In December 2018, McDonald’s India announced that it had posted its first-ever profit after 22 years of business in the country. This was despite the global fast food giant being embroiled in a long-drawn legal dispute with one of its main franchisees — Connaught Plaza Restaurants (CPRL).
On August 21, 2017 McDonald’s had announced that it had terminated the franchise agreement with CPRL for 169 restaurants operating across northern and eastern India. According to McDonald’s, CPRL had violated the terms of the franchise agreement through alleged financial irregularities, mismanagement, and inadequacies with respect to internal control systems. However, Vikram Bakshi, MD of CPRL, challenged the termination in the Delhi High Court and said he would continue to run the outlets until a verdict was passed by the court or an acceptable offer was made by McDonald’s to buy out his stake in CPRL.
McDonald’s long running dispute with its franchisee had cost it dearly, and the company posted a loss of ₹3.05 billion in the financial year ended December 2017. According to some analysts, mass closure of the restaurants disappointed customers and affected McDonald’s brand image in the country. Going forward, the fast food chain could lose a long-term growth opportunity in the country’s rapidly growing quick service restaurant (QSR) sector, they added.
Expansion in India
Globally, McDonald’s adopted a franchise business model to easily penetrate new markets and enlarge its target markets. About 80 per cent of its restaurants worldwide are owned and operated by franchisees. This model helped push up McDonald’s gross margins and operating income, and gave it a stable revenue stream with lower operating costs and risks.
When McDonald’s entered India in 1996, it followed the franchise model here as well. Its operations were managed by two companies: CPRL and Hardcastle Restaurants Pvt. Ltd (HRPL). HRPL started out as an equal joint venture between McDonald’s and Amit Jatia, vice-chairman of Westlife Development, which operated QSRs in India. In 2010, HRPL was converted from a joint venture to a master franchisee of McDonald’s. While Hardcastle operated in the southern and western parts of the country, CPRL handled McDonald’s northern and eastern businesses.
McDonald’s reshaped the country’s fast food culture by serving low-priced, value-oriented products, quickly and efficiently. According to industry observers, a key reason for its success was the ability to customise its menu to suit local tastes by understanding Indian customers’ preferences.
By 2012, McDonald’s was the market leader in India’s QSR sector, with a market share of 10.9 per cent, followed by Domino’s, at 10.2 per cent. However, the chain’s growth slowed in 2013, hit by growing competition, with rivals such as KFC, Pizza Hut, and Domino’s offering lower-priced options on their menus.
Moreover, a string of food quality issues at some McDonald’s restaurants seriously dented its image in the country, said analysts. Same-store sales growth of McDonald’s remained negative for eight quarters between mid-2013 and September 2015. Despite revamping its restaurants and upgrading its menu, McDonald’s still struggled to retain dominance in the QSR sector. In 2016, Domino’s overtook McDonald’s its market share touching 16 per cent, while the latter’s dropped to 7.4 per cent (see Graphic on McDonald’s vs Domino’s in India) .
Franchisee woes
CPRL was a 50:50 JV between McDonald’s and Bakshi, a partnership that flourished for years, outperforming its rivals. The first cracks in the venture appeared in 2008, when McDonald’s tried to buy out Bakshi’s share for $7 million. Bakshi said this was far less than it was worth. Reportedly, consulting firm Grant Thornton valued CPRL at $331 million in 2009.
In a sudden turn of events in August 2013, McDonald’s ousted Bakshi as MD of CPRL, citing financial discrepancies. The allegations included mismanagement of funds, lack of attention to the JV, and conflict of interest. McDonald’s said Bakshi had pledged 51,300 of his CPRL shares without the company’s approval to raise a loan of ₹200 million to fund his real estate business. There were also allegations of Bakshi leasing out his property to a rival company, leading to conflict of interest.
According to McDonald’s, Bakshi was not devoting enough time to CPRL as his focus was on directorship of 25 other companies. However, Bakshi refuted the allegations saying that the CPRL board, which had representatives from McDonald’s as well, was aware of all his actions . McDonald’s accused the franchisee of failing to pay royalties over two years. CPRL was required to pay 5 per cent of overall sales as royalty to McDonald’s. In response, Bakshi claimed that the royalty money was being used to repay bank loans and that both the McDonald’s nominee directors on the CPRL board were aware of it. He said that a debt of about ₹460 million had been repaid to banks in two years alone.
In September 2013, Bakshi moved the National Company Law Tribunal (NCLT) stating that his removal was oppressive in nature and McDonald’s intended to buy him out at a lower valuation to take full control of the business. McDonald’s retaliated by pursuing arbitration against Bakshi in the London Court of International Arbitration (LCIA). The ensuing legal battle saw the acrimony between the partners worsening.
Food safety, health concerns
The first signs of serious trouble appeared on March 21, 2017, when the health licenses, mandatory for running the McDonald’s restaurants in Delhi, were set to expire for 43 outlets. Bakshi, one of the four board members of CPRL, refused to sign the licence renewal applications claiming that unsafe food was being served by some of the outlets, and professing his inability to control the food supply. As a result, in June 2017, 43 of the 169 McDonald’s restaurants in northern and eastern India shut shop.
On July 14, 2017, the NCLT ruled in Bakshi’s favour and reinstated him as the MD of CPRL, a move that McDonald’s vowed to challenge. NCLT ruled that all steps taken in the pursuance of non-election of Bakshi were unlawful, and restrained McDonald’s from interfering in the functioning of CPRL.
Thereafter, on August 21, 2017, McDonald’s announced the termination of its franchise agreement with CPRL for 169 restaurants in the north and east of India, stating that CPRL had violated certain obligations as part of the agreement, including a default on payment of royalty to McDonald’s. McDonald’s India asked CPRL to stop using its brand system, trademark, designs, and associated intellectual property, within 15 days of the termination notice.
Describing the move by McDonald’s as “contemptuous” and “oppressive”, CPRL continued to run the outlets and even moved the Delhi High Court claiming unfair practice and licence termination by McDonald’s. Bakshi alleged that the termination of the franchise agreement was in contempt of the NCLT order. He said that each store was working on the basis of an operating agreement of 20 years. Meanwhile, on September 12, the LCIA passed its verdict asking Bakshi to sell his stake in CPRL to McDonald’s at a fair valuation in accordance with their JV agreement. It rejected Bakshi’s claim that McDonald’s did not validly terminate the JV. Bakshi challenged the LCIA’s decision in the Delhi High Court.
Losses, closure of units
However, on December 26, 2017, CPRL had to shut 84 of the McDonald’s outlets in eastern India as its logistics partner, Radhakrishna Foodland, discontinued supply chain services alleging uncertainty of future and non-payment of certain dues. Bakshi denied the charges, saying RK Foodland in collusion with McDonald’s was trying to hurt his business. With the closure of these restaurants, CPRL reportedly incurred a loss of ₹10 million during the Christmas season. However, two days later, CPRL reopened 16 of the 84 closed outlets after roping in a new distribution partner, ColdEX Logistics.
McDonald’s warned customers that they faced a potential health hazard by eating at the unauthorised outlets operated by CPRL. After termination of franchise agreements, McDonald’s said it had not been able to verify if the CPRL-run outlets were complying with the applicable McDonald’s standards, including those relating to supplies, operations, and safety standards and quality. In response to the allegations, Bakshi questioned the commitment of McDonald’s to safety and hygiene at its Indian outlets. He alleged that McDonald’s followed different food safety standards for India compared to its global standards and had continuously ignored the food quality concerns raised by him.
While McDonald’s was facing problems with CRPL, Westlife Development, which owned the master franchise rights through its subsidiary HRPL, was performing well. It reported a 25 per cent increase in revenue between 2014 and 2017. While CPRL had added just 13 outlets and ₹1.13 billion in revenue during the period, HRPL had added 74 outlets and generated ₹1.92 billion in revenue ( See Graphic on franchisees' performance ).
Impact on business
The closure of the McDonald’s outlets in northern and eastern India was hurting the fast food chain’s business in the country. In the year ended December 2017, McDonald’s India posted a loss of ₹3.05 billion. Reportedly, the company had made a provision of ₹1.98 billion in its financial statements to cut back losses accumulated following termination of the franchise contract with CPRL.
The uncertainty hanging over the McDonald’s franchise in India had helped its competitors in many ways. Rivals such as Domino’s, Subway, and KFC quickly gained market share by offering exciting meal offers. According to market research firm Kantar IMRB, since the closure of the McDonald’s outlets in Delhi, Subway and KFC had gained 5 per cent and 2 per cent market share respectively.
The dispute also impacted the market share of McDonald’s in India. The fast food chain’s overall market share dropped from 9 per cent in June 2017 to 3 per cent in July 2017. Expansion was hit as McDonald’s opened just one outlet in 2017 compared to 27 outlets in 2012 .
Since the termination of the agreement by McDonald’s, some vendors had stopped supplying ingredients and packaging material to CPRL. This led to inconsistencies in the menu, with some popular products such as McFlurry and Soft Serve ice-creams becoming unavailable across some of its Delhi restaurants. Due to the shortage of supplies, these outlets were turning customers away. Analysts said this could create a negative impact in the minds of customers, who might move to rival brands.
Rivals gain ground
Domino’s had emerged as the biggest QSR chain in India due to a surge in online orders for home pizza delivery. Other competitors, such as KFC and Subway, were quickly gaining market share, eroding the hold of McDonald’s in the country (See Graphics on 'Revenue Growth of QSR Players' and 'McDonald's vs major competitors in India') . Moreover, with new players like Burger King and Dunkin’ Donuts making their presence felt, the fight for market dominance was set to get tougher.
Analysts said the standoff had not only dented McDonald’s growth prospects in India but had also taken the fast food giant on a downhill ride in terms of quality of service and hygiene at its outlets. While the franchisee tried to keep several restaurants open despite the dispute, McDonald’s faced notices on the quality of food served in these restaurants.
For instance, in 2016, there were several instances of foreign objects, such as worms, fungus, and fried lizards reportedly being found in the McDonald’s menu at some outlets in northern and eastern India. Moreover, the closure of the restaurants affected about 6,500 McDonald’s employees in northern and eastern India, besides indirectly impacting 3,500 people working as suppliers and business associates, said analysts.
Looking ahead
In an out-of-court settlement that ended a six-year-long dispute, McDonald’s India announced on May 10, 2019 that it had bought out Vikram Bakshi’s 50 per cent stake in the joint venture. CPRL is now wholly owned by McDonald’s India which, in the months following the buyout, has focused on reviewing the 160-plus outlets in the regions and getting many of the closed units up and functioning again. It is also actively looking for a business partner, or development licencee, for the northern and eastern regions.
Despite all these problems McDonald’s posted a net profit of ₹6.52 million during FY17-18, compared to a net loss of ₹3.05 billion the previous year, according to its filings with the Registrar of Companies. The QSR market is projected to grow to $250 billion by 2020, and faster expansion in the region could help McDonald’s capture this growth.
Assignment
Consider yourself part of a team tasked with solving the situation faced by McDonald’s in India.
· What, according to you, led to this situation at McDonald’s India?
· What is at stake for McDonald’s in an emerging market like India? Have its problems impacted the brand’s overall image?
· How can McDonald’s revive its brand awareness and customer interest in the north and the east and, going forward, what should its franchising strategy be in those regions?
· How can the fast food chain reinvent itself to drive long-term growth in the country?
(Prof Purkayastha is Dean and Head, and Ms Qumer is a Consultant, at the Case Research Centre, ICFAI Business School, Hyderabad. This case was compiled from published sources, and is intended to be used as a basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation.) )