The world's biggest chain restaurant company is about to give up its crown. How did Starbucks pass McDonald's in just over 30 years?

In its business model, its store-opening strategy and its read on where consumption is heading, Starbucks has “evolved” past McDonald's.

In 1940, the brothers Dick and Mac McDonald opened a hamburger restaurant in California and named it after themselves. In 1955, Ray Kroc brought in franchising and took over running the McDonald's Corporation. Sixty-two years on, McDonald's has 36,889 stores worldwide.

In 1971, three coffee lovers opened a shop in downtown Seattle that sold nothing but high-quality coffee beans and called it Starbucks. In 1987, Howard Schultz, who had once worked there, raised the money to buy out every share of the company and rebuilt it as a chain of Italian-style espresso bars. Thirty years on, Starbucks has 25,734 stores worldwide.

Nomura analyst Mark Kalinowski predicted early this year that, on the expansion strategy Starbucks has followed for years now, the company would not only hit its target of 37,000 stores by 2021 but pass 40,000 after that, and might even reach 50,000 in the longer run — a scale no retail brand in business history has ever reached. The only company anywhere near 40,000 stores today is McDonald's.

In other words, Starbucks will overtake McDonald's as the world's largest chain restaurant company. Counting from the point when each became the Starbucks and the McDonald's we recognize today, that will have taken less than 40 years.

McDonald's has no intention of halting its own expansion. But over the past few years, in its effort to win back young customers and rescue its results, what McDonald's has mostly done is adjust.

Starbucks, the one young people flock to, has entered a golden age. Over the past decade its global store count has grown by more than 10,000, and it now serves over 85 million customers a week. In China alone it opened more than 300 stores in 2016 — close to one a day.

The stock market tells the same story. As long as the company holds the “red line” of 5% annual growth in global same-store sales, passing McDonald's, now worth more than $100 billion, is only a matter of time. Look at the growth curve of its shares and Starbucks's run stands comparison with Coca-Cola's in its day: the stock is up nearly 170-fold since its IPO.

On future growth, Starbucks is far ahead of McDonald's.

In many ways, though, the two are alike. Both standardize as many steps as they can to deliver consistent, high-quality products and service; both have rebuilt their supply chains and production to raise efficiency. Most important of all: McDonald's doesn't sell hamburgers, it sells a chain service system, and Starbucks likewise doesn't sell coffee, it sells the idea of the “third place.”

In Everything but the Coffee, written in 2009 by Temple University history professor Bryant Simon, he notes that in the 1990s the Starbucks brand still stood in the United States for a mild luxury. But by 2008, citing a survey, he wrote that “many people no longer saw Starbucks as any different from McDonald's.”

Just yesterday, at its annual shareholder meeting, Starbucks said it would get serious about lunch, with a plan to double food sales within five years. Hmm — doesn't that sound even more like McDonald's?

McDonald's, for its part, had already decided late last year to rebuild its McCafé brand, upgrading coffee machines and launching cheap coffee to grab a share of the coffee market. Its aim could hardly be more obvious.

Either way, the two are now competitors in fact. So over these years, what exactly has Starbucks done that McDonald's hasn't — and what has it gotten right?

Put another way: next to the McDonald's of old, what skills has the star restaurant company that Starbucks represents “evolved”?

McDonald's Runs on Franchising; Most of Starbucks's Tens of Thousands of Stores Are Company-Owned

McDonald's began as a roadside stand that sold a handful of things — hamburgers, fries, milkshakes — but ran at extremely high efficiency. What let that model deliver its full value and spread quickly across the United States and then the world was Ray Kroc, who designed its “franchise” model of expansion.

Today more than 80% of McDonald's restaurants worldwide are franchised; in the US, where it is headquartered, the figure reaches 90%. McDonald's China, which had relied mainly on company-owned stores, also switched to franchising early this year, with investment from CITIC and Carlyle.

The advantages of franchising are obvious. The franchisee provides the property, runs the store day to day and guarantees steady cash flow; the brand only has to supply its name and its management know-how to collect a reliable cut of sales and an ever-larger market. The drawbacks are just as plain. In the early days of expanding the business, what gave Ray Kroc the biggest headache was making sure every franchised store met the high standards he had set.

But one feature is hard for a brand to resist: when a company wants to expand fast and reach scale, franchising was, for a time, the best method available.

Starbucks gave up on franchising and runs almost all of its stores itself. Of its nearly 30,000 stores worldwide, the great majority — the US above all — are company-owned, and in overseas markets it prefers to work through local joint ventures.

Behind McDonald's 14,000 franchised US stores stand roughly 300 franchisees; the largest owns just 69 stores. Starbucks runs 6,764 company-owned stores in the US. That plainly demands far more of a brand's operating skill and of the way it uses its cash.

McDonald's Buys Land, Starbucks Leases — Which Lets Company-Owned Starbucks Expand Just as Fast

Break down the revenue McDonald's has collected from its franchisees over the years and you can see the secret of how the company kept making money at a steady rate even as its results slipped: the cut of store sales and the initial fees new franchisees pay are both small shares of that revenue. The biggest share is rent.

This was a peculiarity Ray Kroc built into the McDonald's franchise model early on. To tighten its control, McDonald's headquarters buys the land and property every store needs, then subleases it to the franchisee and collects rent each year at a little below the market rate. When property prices climb, that rental income climbs with them; and if a franchisee performs badly, the company can sweep it out the door at any time. Some hedge fund managers holding McDonald's stock once considered splitting the restaurant business and the property business into two companies, to manage the assets more effectively.

“McDonald's franchising controls the whole chain of steps — acquiring the property, the food supply chain, the IT systems, the management model. Early training and management are handled by headquarters too. All the franchisee takes on is the fit-out and, once the store matures, day-to-day management; headquarters intervenes less once things are on track.

Most of Starbucks's stores worldwide are company-run, but every property is leased, and the strength of the brand gets it relatively low rent. So the money it puts into fit-out and equipment when it opens a store comes back quickly out of steady cash flow. Buying land versus renting it, and the difference in expansion speed between the two models, is the fundamental reason the gap in store-opening pace between McDonald's and Starbucks is now so wide,” Huang Hai, a vice president at FreeS Fund, told QDaily.

Both Open Where the Foot Traffic Is, But Starbucks Blankets an Area With Store After Store

If you live in a first-tier city like Beijing or Shanghai, you can easily feel how “dense” Starbucks is within a single district. You will rarely see two McDonald's that close together.

“Starbucks has adopted a simple expansion strategy: covering an area aggressively with a large number of stores. This helps the company lower transport and management costs, and it spreads customers across the neighboring stores, easing the queues at any one of them,” the American retail researcher Robert Spector wrote of the strategy in his book Category Killers.

On Manhattan, the most developed part of New York City economically, Starbucks's density runs to more than six stores per square mile — on average, one Starbucks within reach of every 15,000 people.

Take Shanghai, one of the most densely covered cities in Starbucks's global network: its nearly 500 stores now cover the entire city center along with several sub-centers developed later.

By the late 1980s, Schultz had already put together a property team at the Seattle headquarters to study site selection for the coffee business. Starbucks's early stores, by one count, were spread across office buildings, urban and suburban community shopping centers, airports and college towns — with office buildings (business districts) and community centers (shopping districts) accounting for the largest shares.

Of those two kinds of store, the business-district ones sit on the ground floors of office buildings: small, with a high share of takeout. The shopping-district ones serve residents who want to talk and socialize while running their daily errands. The benefit is that a smaller floor area brings in more traffic and more sales.

Starbucks stores are generally smaller than McDonald's, which also gives Starbucks more room to maneuver when it goes looking for property.

McDonald's Sells More per Square Foot, But Each Starbucks Employee Earns the Company More

Without enough stores behind it, Starbucks, whose average check is relatively low, still could not match McDonald's on profit per store. In the annual rankings of the trade publication QSR, McDonald's has almost always been the US restaurant brand with the highest sales per square foot of property, overtaken only briefly, in 2010, by the fried-chicken chain Chick-fil-A.

But by the figures in their annual reports, the revenue each Starbucks employee generates worldwide in a year is now roughly four times that of a McDonald's employee. Starbucks may already be one of the most labor-efficient companies in the whole industry.

Lower labor costs mean higher efficiency.

Going Public Sooner and Going Abroad Earlier Let Starbucks Make Better Use of Globalization

In the United States, where both McDonald's and Starbucks started, restaurants are a $709.2 billion-a-year industry employing 14 million people — the largest restaurant market in the world. Its fast growth has also depended on changing habits at home: 43% of Americans now eat out at least once a week, and by 2015 restaurant revenue accounted for 47% of what Americans spent on food.

Because the home market held so much potential, McDonald's spent essentially its first 50 years on it, and only began pushing hard overseas in the 1990s.

But at several key moments around going public and going global, Starbucks CEO Howard Schultz pushed the company to decide faster.

Starbucks had only 165 stores when it went public in 1992, and began expanding abroad on a large scale four years later. McDonald's did not go public until it had more than 700 stores, and did not start pushing into overseas markets until 50 years after the company was founded.

Going public earlier also meant Starbucks could make good use of financing, bond issues, share buybacks and other financial tools to solve, flexibly, whatever funding problems came up during expansion, and to take back control of overseas markets as they matured. Along the way the company's brand value and market capitalization rose too — a strong “leverage effect.”

At the end of the 20th century, McDonald's was widely seen as the model of a fast-growing multinational, the symbol of American capitalism's glorious victory around the world. But look at the actual growth figures and it was Starbucks that really used the opening and won itself enormous room to grow.

Starbucks Reads Future Market Trends Better Than McDonald's, and Digitization Is the Clearest Case

A report by Nomura analyst Mark Kalinowski once named Starbucks and Chick-fil-A the two chain restaurant companies most focused on technology in the industry. From in-store Wi-Fi to the corporate website, the app and its social media accounts, Starbucks started early in using these digital tools to understand what customers wanted and to adjust its products and service accordingly.

McDonald's did not roll out digital across the company in earnest until 2015. So by 2016 you could watch it testing self-order kiosks, in-app ordering, mobile payment, third-party food delivery — every kind of online channel, in short.

In digitizing, Starbucks has also kept more customer data in its own hands. Take the China market: whether it was opening a flagship store on Tmall or working with WeChat on mobile payment, you can see how careful Starbucks has been. The food delivery business McDonald's wants to grow, by contrast, leaves more user data sitting with third-party delivery platforms. As we analyzed in an earlier article, that may get McDonald's decent sales data while costing it the ability to sense how the consumer market is changing.

But for Starbucks and McDonald's alike, becoming a genuinely data-driven company will take a long time yet, and the process may hurt along the way. The mobile ordering and payment service Starbucks rolled out at 1,200 US stores, for instance, pushed transactions at those stores to their highest level in 18 months — but the “invisible orders” that app ordering created in the prep area, along with the long queues at the pickup counter, may have dragged down the very “efficiency” stores care about most. McDonald's has the same problem.

Starbucks's short-term answer is to put more staff in its stores. Longer term, it plans to redesign the space inside them. McDonald's wants to build an app feature that tracks a customer's location, so an order is ready at the right restaurant at the right time and the food doesn't sit around too long.

Starbucks's “Evolution” Comes Down, in the End, to a Change in What the Market Wants

McDonald's broke people's idea of what a “proper meal” looks like — clean surroundings, standardized products, fast, efficient, high-quality service — but what it satisfies in the end is still the basic need for food. Fast food, after all, is just a quick way to get energy.

What Starbucks offers is an experience, the part of the space that lies outside the food: customers come in mostly looking for a third place beyond home and office, somewhere to relax and socialize, and the coffee is little more than an add-on.

That makes winning customers harder for Starbucks than for McDonald's. Seen that way, this too is where Starbucks has “evolved” past McDonald's. The chart below shows what that means in practice.

What it answers to, in the end, is the change in what we as consumers want from the question of “what should I eat” — a more convenient, healthier, more varied choice of coffee, or the craving for sugar and fat that sits deep in our genes. A Starbucks store can satisfy both.

Starbucks's Standardization May Have Borrowed From McDonald's Too

You may also have heard of the double-sided grill and the V-shaped fry scoop McDonald's designed to speed up food prep — another kind of innovation this giant company gave the industry.

To sell products and service at almost the same level across tens of thousands of stores, that kind of standardization is indispensable. Even suppliers of raw materials have to accept similar quantified management, because once the processed ingredients are consistent and the processing methods stable, product quality is stable too. That removes uncertainty from the service, and the whole process can then be laid out more deliberately to make service faster.

Starbucks holds itself to equally strict quantified standards for what it puts out and how fast, but for a long time it paid little attention to its equipment. Because it was selling Italian espresso culture, its stores used to run machines from the Italian brand La Marzocco — semi-automatic machines on which the barista has to control the espresso's extraction time and pressure, and to tamp and load the grounds by hand.

Ever since Starbucks brought in the fully automatic Thermoplan machine in 1999, things have been much simpler: staff load coffee beans on a schedule and press a button when they need to, a shot of espresso comes out quickly, and the whole line moves faster.

There is no denying that McDonald's, as the world's largest chain restaurant company, has accumulated a great deal of operating experience — or at least inspiration — for the entire industry.

40,000 Stores Is Still Some Way Off, But Starbucks's Challenges Have Already Arrived

From 1965 to 1991, McDonald's revenue in the US grew an average of 42% a year, much of it from the performance of new stores; and during its overseas expansion in the 1990s, McDonald's at its peak could open 2,000 stores in a single year.

But as its global store count has passed 35,000 in recent years, how to work with franchisees to run those stores well — and keep them from closing under fierce competition — has become a more pressing question than opening more. That moment may still be some way off for Starbucks.

But Starbucks's own challenges have already arrived. For five quarters running, its same-store sales have fallen short of Wall Street's expectations, with growth slowing to 3% — the worst showing since 2009.

Get serious about lunch, double food sales within five years. The intent is pretty clear by now, isn't it?

Charts: Feng Xiuxia, Wu Lingwei

Cover image from Flickr and Pexels