Japan's fast food funk: McDonald's Japan slips into the red for the first time in 30 years. Blame deflation—and fashion - Upfront - Company Profile

Japan, Inc., May, 2003 by Leo Lewis

"[yen] 59 ISN'T A REAL price. [yen] 59 doesn't buy you anything in Japan. You show me a place that can sell something for [yen] 59, and I'll show you a place that's going to end up bust."

This is the grim conclusion of Tomoki Harada, the 48-year-old owner of a run-down ramen shop in the Hongo district of Tokyo. Two doors down from his restaurant is the globally renowned, gleaming red and yellow branding of McDonald's. Underneath it is a blaring poster: "Hamburger [yen] 59."

At face value, this is a great offer: a bite of that world-famous taste for a price that no other establishment can possibly match. But scratch the surface a little and the advertisements read like a desperate cry for help.

There are many levels on which the cracks in McDonald's Japan are starting to show, but the most obvious starting place is the raw financial numbers. At an official revision to its figures in December 2002, the group was forced to announce net losses of [yen] 2.3 billion ($20 million) for the full year--the first drop into the red since 1973. Of even more concern to the shareholders was news that the company would be closing 176 branches of its 3,600-strong network of outlets across Japan.

None of these horrors were supposed to befall a business plan that had only ever delivered growth. When shares in McDonald's Japan were floated in 2001, investors saw gold in the golden arches. Den Fujita, the entrepreneur who brought Ronald McDonald to Japan and the father of the McTeriyaki Burger, spent that year predicting great things for his company. At the top of his list was the impressive forecast that he would have 10,000 restaurants up and running by 2010.

This March, however, Fujita suddenly announced that he would be retiring as chairman and chief executive. In a short statement the company made every effort to deny any link between the loss and the departure--after all, the charismatic patriarch would be turning 77 just a week later.

But the market, the analysts and the general public remained skeptical. The move certainly seemed to take the rest of the board by surprise, and at the very least it could be taken as hugely symbolic.

Fujita was the first to successfully take McDonald's out of America, the first to convert an entire people to a new way of eating, the first to show that the basic menu could be molded to local tastes and the first to take a McDonald's subsidiary public. As the McDonald's empire spread east and west from its headquarters in Oak Brook, Illinois, McDonald's Japan was the perfect proxy for its expansion.

But now that Japan has started to change its mind about McDonald's, the fellows back in Illinois are feeling a cold chill about the global business.

Last month, Fujita was forced to face another sign that the magic has gone. After years of resilience, Japanese branches of McDonald's have now become targets of domestic protests. A group of animal rights activists and other demonstrators descended on a large branch In Shibuya to denounce the way the fast food chain handles meat. The pursuit of cheaper and cheaper prices has, they say, forced McDonald's and others to cut major corners. It is a charge that fits particularly well with the spate of food scares that has dogged Japan.

McDonald's Japan has blamed a lot of its woes on issues beyond its immediate control. The worldwide BSE problem, local scandals over meat labeling and a variety of other scares have periodically dented consumer confidence in beef. But "the problem," says protestor Sachiko Azuma, "is that people don't understand the link between the economics of the business and the food scares. So the diners soon come back."

Accordingly, the analysts and economists believe there is a far more fundamental reason that McDonald's bas run into trouble, and it centers on those [yen] 59 burgers. Rather than an astute player of Japan's precipitous deflationary curve, they say, McDonald's is emerging as its first major victim.

As shares in McDonald's Japan continue their relentless decline, several key figures stand out. Foremost among these are statistics released last September showing customer numbers smashing through monthly record highs. The problem is that those customers have only walked under the golden arches because the food is so cheap. The margins, therefore, have been driven cripplingly low. High turnover and financial losses are a doom-laden combination anywhere in the world, but particularly in Japan where the cost of expansion has been so great.

Apart from the [yen] 59 burger, the rest of the menu is being offered at knock-down prices, too. As Michiharu Sato, a Tokyo history student, explains: "Lotteria, KFC, Mos Burger and the other chains have all got their cheap deals, but a Big Mac set for [yen] 450 is still the best value around. The economic climate has turned us all into bargain-hunters, and so we know where to go to fill up."

As the price war rages between the fast food outlets, McDonald's has used its size mad economy of scale to push the boundaries farther than good business sense would allow. At one stage late last year, McDonald's storefronts became a live-action portrait of Japan's deflation. Postings announcing dramatic new price-cuts were hastily plastered in place before the customers' very eyes. As one Nomura analyst observed: "We sat there wondering whether Fujita had a monkey In there making his decisions for him." When, briefly, the price of a burger rose from the [yen] 59 mark, optimists hailed the end of deflation.