McDonald's specialty coffee plan in hands of former defense engineer

Don Thompson, who oversaw redesign of double cheeseburger, works with franchisees on drink blitz

Don Thompson is a man of science, an electrical engineer who once designed radar jamming systems, but recently, his biggest problem was a simple piece of cheese.

McDonald's most popular U.S. sandwich, its $1 double cheeseburger, was barely profitable for its franchisees. And as head of McDonald's U.S. operations, it was Thompson's job to find a solution that wouldn't alienate cash-strapped consumers.

The answer: Raise the double cheeseburger's price to $1.19, but also launch a new double cheeseburger, with less cheese, for $1.

The great cheeseburger compromise appears to have worked, and it's exactly the type of innovation that has kept Oak Brook-based McDonald's Corp. on a roll, despite an ugly economy, analysts said. McDonald's first-quarter earnings are due out this week, and they're expected to be solid again.

Now, the 46-year-old Thompson has an even bigger challenge: Successfully completing the rollout of one of the fast-food giant's biggest—and riskiest—U.S. product launches, the McCafe specialty coffee offensive.

"This is a big deal and all eyes are on McDonald's," said Steve West, an analyst at Stifel Nicolaus. "If it fails, it will be an embarrassment and will fall right at [Thompson's] feet. It's not his idea, but it is his to execute. He could live or die by that sword."

Thompson notes that the coffee blitz is only a part, albeit a big one, of McDonald's U.S. strategy. But one thing is certain: When Thompson graduated from college in 1984, he couldn't envision he would one day be figuring ways to peddle caramel cappuccino.

Growing up in Indianapolis, he had been attracted to engineering. "In eighth grade, my math and science was always pretty good," he said. So Thompson signed up for a summer engineering program at Purdue University aimed at lower-income students. He got hooked.

Eventually he would earn a degree in electrical engineering from Purdue, and then land a job in the Chicago-area office of defense contractor Northrop Corp. It was a homecoming of sorts.

Thompson had lived on Chicago's near North Side until 6th grade, when his revered grandmother, who raised him, moved to Indianapolis. "As my grandmother would tell it, 'We moved so you would not succumb to certain influences,' " he said. The neighborhood was getting rougher. "I guess she had some concerns I might be a knucklehead."

Fighter jets to food At Northrop, Thompson designed radar jamming systems for fighter planes. One day in 1990, he got an unsolicited call from a recruiter for a job involving robotics. Thompson was intrigued—until he realized the pitch came from McDonald's, not defense contractor McDonnell Douglas.

"Imagine now, someone calling me up, six years after being in the defense industry, saying, 'Would you like to come and work for a hamburger company?' My comment back was, 'Maybe you've got the wrong guy.' "

But after chatting with a McDonald's engineer who once worked for Bell Labs, a citadel of engineering excellence, Thompson accepted a job that year. After a few years in McDonald's engineering department, he switched to restaurant operations, then steadily worked his way up the management ranks.

In August 2006, Thompson was named president of McDonald's USA, which makes up 34 percent of revenues, a little less than Europe, but still is the greatest source of operating earnings, at 48 percent.

Since taking over, U.S. operations—like the overseas units—have been riding a wave of prosperity. And Thompson has played a key role in sustaining the momentum, McDonald's watchers say.

"I think he's a really solid leader and the results speak for themselves," said Larry Miller, an analyst at RBC Capital Markets.

The economy, which is prompting some people to trade down from higher-end restaurants, also poses challenges for McDonald's. Restaurant companies are in the midst of a "value war," Miller said, trying to reel in recession-battered customers with low-price deals, from $5 foot-longs at Subway to 89-cent nachos at Taco Bell.

In the midst of this fight, McDonald's found itself under intense pressure from franchisees to raise the price of the double cheeseburger, the anchor of its dollar menu. Franchisees, who run about 85 percent of the firm's roughly 14,000 U.S. restaurants, were increasingly having trouble making money on it as ingredient costs spiked.

The conundrum, said Thompson: "It's a very tough economy and customers are looking for value, so the last thing you want to do is raise a price." The solution, one hotly debated by franchisees and company executives, was to offset a price hike on the classic double cheese by creating the McDouble, a $1 double burger with one fewer slice of cheese.

"It was a huge decision," Thompson said. But analysts and company executives all say it's been a success since implemented in December: McDonald's hasn't lost customers or cheeseburger sales.

Jim Skinner, the company's chief executive, said Thompson did a bang-up job on the cheeseburger project, which involved a lot of collaboration with franchisees.

"Don has done a great job holding the course on value," Skinner said.

While McDonald's appears to be winning, or at least holding its own, in the value wars, analysts say, another battle—over coffee—is brewing.

In late 2006, McDonald's began regionally rolling out a beverage offensive that initially featured specialty coffees, such as lattes, and will eventually include smoothies and bottled beverages. It's an expensive proposition for franchisees, with investments of up to $100,000 per restaurant, though the company will foot up to 40 percent of the bill.

Specialty coffee is now available in more than 9,500, or almost 70 percent, of McDonald's U.S. outlets, Thompson said. And a company document obtained by the Tribune indicates that a national ad campaign for the product will be launched in the first half of May.

The ad launch is important because it puts the company's formidable marketing muscle behind specialty coffee. And McDonald's appears to be expecting great things.

In the key market of Southern California, McDonald's anticipates that immediately after the national ad burst, sales will more than double and perhaps triple in some areas, according to a McDonald's document obtained by the Tribune.

Fretting at franchisesThe coffee blitz has caused angst among some franchisees, according to several surveys, which covered more than 200 McDonald's outlets, by restaurant industry analyst Mark Kalinowski. Some franchisees fear it will be an expensive flop, and more recently they have worried about diverting precious ad spending to specialty coffee.

"It takes away marketing dollars from other products that have a greater marketing appeal," said one anonymous franchisee in a Kalinowski survey published last week.

Another franchisee said McDonald's is diving headlong into fancy coffee just as Starbucks Corp. has shown how a crumbling economy can hurt sales of the product.

But a McDonald's spokeswoman said ads for specialty coffee aren't a diversion and won't compromise the overall advertising strategy.

And Thompson said the coffee blitz's timing is spot on, precisely because of the economy. "We are able to do this at a value proposition that others are not able to do," he said. Analysts say McDonald's can undercut Starbucks on price and serve up a product with enough quality to woo some Starbucks patrons.

As for jitters over coffee, Thompson said "that what I am hearing [from franchisees] is that it is going well." He added "there will always be concerns, but that's what makes us better as McDonald's."

Franchisee relations are critical for McDonald's, and Thompson gets high marks from Don Armstrong, head of the national association that represents McDonald's owner-operators. "Don's been a great partner," he said. "He has a great rapport with the franchisees."

Thompson said he spends at least 70 percent of his time meeting with franchisee organizations or individual franchisees, crisscrossing the country. Even when he's on personal time with his wife and two children, now 12 and 15, he often stops at McDonald's outlets just to check up on things.

"I love doing that, going out incognito, whether that's in jeans and a jacket or on the way back from church," he said. "If things are going great, I want to stay there and talk with the restaurant manager. If it's not so good, I might try to get back there and help out." He has been known to enlist his family too.

His wife, Liz, a fellow engineer whom he met at Purdue, recalls one understaffed McDonald's suffering from a messy Play Place. She picked up a broom, while her son got to work with a wet rag.

Customers looked astonished. "Here is this family that came in to eat and they're cleaning the play room," she said.