McDonald’s Sales Report Shows Decline Accelerating

The decline at McDonald’s is accelerating with today’s report of global comparable sales in July compared to a year earlier:

• U.S. down 3.2%
• Europe up 0.5%
• Asia/Pacific, Middle East and Africa (APMEA) down 7.3%

Sales were hit in China because of food-safety concerns there, but even without that, the report indicates a decline in customer interest. The slight boost in sales in Europe is an indication that food quality is the core issue. In Europe, where sales are roughly holding steady, McDonald’s food quality and prices are much higher and the restaurant experience is presented as more of a novelty. That could be a model for the chain to follow elsewhere if consumers continue to lose interest in low-quality fast food.

McDonald’s U.S. sales hit a peak as the recession took hold between 2007 and 2009 but have fallen ever since as Americans become more health-conscious. It is part of a larger trend that has seen declines in sales of beer and soft drinks.

Bank Failure: Banco Espírito Santo

Last night Portugal threw its entire bank bailout fund at Banco Espírito Santo, in the most complicated bank resolution I can remember seeing. The funds were used to set up a new bank, tentatively Novo Banco, which is taking over Banco Espírito Santo’s deposits and its regular banking assets.

The old Banco Espírito Santo is now what is called a bad bank. It is left with no banking operations in Portugal. It owns essentially only the loans to the two bankrupt Espírito Santo parent companies and their various subsidiaries, along with the banking subsidiary in Angola. The stockholders of Banco Espírito Santo own only this bad bank, so the stock is almost certainly worthless, although there are some unknowns. Trading in the stock has been suspended. At the close of trading Friday, the bank’s market capitalization had fallen below €1 billion, down 97 percent from its 2007 peak. The €1 billion level is significant because the bank had issued €1 billion in new stock in the middle of June, a move that in retrospect can be seen as a mistake, now that the entire bank is not worth the selling price of the new stock. Nothing can be paid to the stockholders until the bondholders are paid. Bondholders will surely get something from the expected liquidation of the Espírito Santo companies. They can probably expect to eventually get about half of their principal back, but shouldn’t hold their breath in a messy bankruptcy process spread across at least three countries.

The Espírito Santo family owned more than a third of the bank, but other stockholders and bondholders include some of the large banks in Europe. France’s Credit Agricole was apparently the largest single stockholder and has lost something on the order of €1 billion on its investment.

Although Novo Banco will operate under the Banco Espírito Santo name for now, I don’t think that can last. The association with the Espírito Santo family name won’t be good for business while bankruptcies are in court under the same name and family members are being investigated and possibly tried. Thinking pessimistically, that could be going on for the next five years. The central bank will be looking for a buyer for the bank, and a name change could follow when a buyer is eventually found.

Selling the largest bank in the country will not be an easy task, and it will depend on showing that the bank can earn a profit from operations. That remains an open question. The bank had been reporting losses for years even before it was forced to write down loans to its bankrupt affiliates. Portugal’s economy is improving but the real estate loan portfolio will surely suffer more losses before things turn sunny again.

This bank resolution did not follow the pending euro zone bank resolution guidelines, though observers consider it a step in that direction. It is the first bank resolution in the euro zone to even come close to the traditional legal framework for the treatment of a failed bank. It made at least a pretense of protecting taxpayers from losses. Notably, it followed the model of Iceland more closely than the precedents to be found within the euro zone. Senior bondholders were protected, though, something that will surely cause hand-wringing in the months to come. Under next year’s rules, bondholders cannot be treated as too big to fail.

There are two main bank governance questions raised by the Banco Espírito Santo failure. The failure was caused by bad loans to affiliated companies, and the bank’s accounting records disguised both the extent and the quality of these loans. Then, auditors failed to notice the flaws in the bookkeeping. It was almost a repeat of Europe’s last giant bank failure, CorpBank in Bulgaria. This raises policy questions about banks’ loans to affiliates. Should there be more strict rules of disclosure when a bank makes large loans to parties closely affiliated with large stockholders? This could make it harder for banks to disguise the identity of the borrower in these loans. It is common enough in Europe for banks to directly own industrial and hospitality businesses, a situation that presents many of the same conflicts of interest. The secrecy surrounding the high-risk loans at Banco Espírito Santo raises question about audits and oversight. Is it reasonable to expect auditors and regulators to unmask the risks involved when a bank is secretly being used to finance affiliated companies?

Observers are looking at the Banco Espírito Santo resolution as a precedent for a reason. The assumption is that there could easily be one or two more giant bank failures in Europe before the new bank resolution rules take effect next year.

Mass Mailers for Millionaires

Somehow I am fascinated with mass marketing pieces that primarily target millionaires. They try not to be obvious about it because of course most consumers are not millionaires, but if you look closely you can get a sense of how little the rest of us, the submillionaires as we have lately been called, matter. The word submillionaire was coined independently by dozens of writers, as far as I can tell, because of the obvious need for a word to identify customers and prospects who have an individual or household net worth less than $1 million. A word for these lesser customers is needed for the many marketing contexts in which millionaire status is ordinarily assumed. This may have started, I imagine, in private banking and wealth management, the two elite areas of banking where customers are expected to have millions of dollars in play. There are reasons why people who have less than this might need the same services, yet the bankers want to be careful not to waste time trying to sell higher-cost services to these customers who probably can’t afford the fees.

It startled me when I started to see billboards and television ads for wealth management services, along with enterprise information technology services, around the time of the dot-com bubble in 1999. Why use a mass advertising medium to reach an audience of dozens? My marketing friends explained to me how hard it was to reach business owners and executives. They don’t read their own mail or answer their phones. Some are potentially so lucrative as customers that it may be cost-effective to spend $1 million in advertising just on the chance of bringing in one new customer. That’s why you can be unemployed, on your way to a job interview perhaps, and see a message that’s meant for a multimillionaire to read.

The spending power of millionaires nearly doubled with the tax cuts of a decade ago while the spending power of submillionaires continued to decline, so that a wide range of businesses, including many that would think of themselves as serving the middle class, are forced to try to reach millionaires with their advertising. This is the idea of department stores such as Target, which has had success in positioning itself as the happier alternative to the thoroughly depressing aisles of Walmart. The trend includes restaurants like Ruby Tuesday and auto service centers such as Jiffy Lube. They must get their share of millionaire customers to stay in business. If you are a submillionaire at Target or Ruby Tuesday, these businesses need revenue from you too, but you are also there partly as window dressing to help persuade the millionaire customers that they are getting a good deal. By now, the word submillionaire is essential in describing a broad range of marketing for businesses that get the lion’s share of revenue from millionaires, but where most of the advertising impressions go to submillionaires. To be blunt about it, the goal of a lot of the advertising you see is to motivate millionaires. It must at the same time avoid putting off submillionaires. This is not always an easy tightrope to walk.

I showed an example yesterday, a congratulatory mailer from Discover Card, but Discover Card is not the only one promoting to millionaires without openly admitting it. Look at this detail from a broker’s promotional piece, which also arrived in my mailbox this week. Earn a $2,500 bonus! Who wouldn’t want to do that? Sign me up!

It is only when you look at the smaller print inside that you find you have to actually have a million dollars. As an average middle-income customer, you may qualify for the lesser $200 reward. You can see this as a case of bait-and-switch if you like, but it more fundamentally represents the tension of advertising to millionaires while incidentally reaching submillionaires too.

I personally would not have released this broker mailing piece. I don’t think it is subtle enough in the way it marginalizes submillionaire customers. The full page from which I have taken the second detail above shows one row of three reward categories for millionaires and a second row for submillionaires, potentially creating a sense of winners and losers, where the advertiser’s intention is to make everyone feel like a winner. The monetary disparity between the $1,200 reward and the $200 reward, for example, could trigger a range of emotional reactions. Consider these possible reactions:

• Gloating. “I’m a success, so I get the bigger reward. The rich get richer!”
• Anxiety. “What if my stocks go down during the year? Will they take the reward back?”
• Aspiration. “Someday I’ll be rich and I’ll qualify for the bigger reward.”
• Resentment. “What? A webcam? That’s all they think I count for?”
• Defiance. “Even if I did have a million dollars I wouldn’t invest it with this stupid broker!”

Note that there is a marketing risk in all five of these reactions I highlighted. The bigger risks, though, are toward the end of the list. Once a customer reaches a state of defiance, it is almost impossible to ever win them over again. The customer, in that case, will usually outlive the business that has slighted them. Marketers may not stop to think about the full spectrum of reactions when their target audience is primarily millionaires. Yet when the vast majority of impressions are made on submillionaires, the reactions of resentment and defiance are almost certain to outnumber the millionaires who are motivated to open a new account, the intended result of the promotion.

The opinions of submillionaires cannot be ignored, and not just because millionaires start out as submillionaires. In many categories, it is no longer the millionaires who give a business its cachet. Ruby Tuesday, as an example, may make most of its profit from millionaires, but it needs more customers than that to create the air of success. If submillionaires abandon the restaurant chain, and millionaires go in and see the place empty, they will sense that something is wrong and they will stop going too. Millionaires are suspicious of businesses that aspire to cater only to millionaires. They conclude, quite rightly, that there must be a better deal somewhere else. And so, many businesses must bring in the submillionaires for cachet or legitimacy and the millionaires for operating profit.

The risks to a business that mass-markets to millionaires are obvious enough, but there is also a chance of broader social change as more and more mass marketing targets millionaires and is careless about the impression it makes on the rest of us. As important as millionaires are to any business that wants to make a profit, remember that submillionaires outnumber millionaires by more than 20 to 1. Millionaires may vote disproportionately, contribute 90 percent of political funds, and hold the most prominent political offices, but 90 percent of voters are submillionaires, and virtually all work depends on submillionaires. If submillionaires start to feel marginalized in areas that they feel are their own territory, you can be sure that the rules of the game will change.

Millionaire or Pauper? Discover Card’s Mixed Feelings

I know I couldn’t be Discover Card’s favorite customer, but this week really brought home the bank’s mixed feelings about me as a customer. First, there was the glossy personalized mailer shown here, congratulating me on passing their millionaire test and explaining the bonus they will shortly be giving me as a prize. Then, by coincidence or not, the very next morning their mobile app announced in a roundabout way (in a technique known as a “forced upgrade”) that it no longer supports my phone, which is a model that hasn’t been on the market in nearly two years. Both messages were surprising, in different ways.

First, I’ll look at the mailer. The image I show here is reasonably representative of the six-panel folder, and it looks surprisingly middle-class for a mailer going out mainly to millionaires. The five stock photos not shown are only slightly more upscale. Partly this is a sign that millionaires are in denial about their wealth and think of themselves as middle-class in a way that wasn’t true 15 years ago. Look at it a different way, though. The mailer is customized with my name, so it could just as easily be customized with the bank’s idea of my cultural surroundings, perhaps based on my ZIP code. I say this not as idle speculation of what might be possible someday, but as someone who has done the computer programming for just this kind of customer segmentation at banks. We try not to make the segmentation in the marketing messages too obvious because we know the logic is never perfect and we are always putting some fraction of customers in the wrong segment, but that also means that the message segmentation happens far more often than you would guess as the recipient of the messages.

This kind of mailer is based on good marketing logic. As a business, when your loyalty program ends, you want to ward off the possibility that the former participants might forget that the business still exists. The mailer is meant as a feel-good reminder.

Yet being dropped by the Discover Card app has the exact opposite effect. It essentially says, “We don’t think you’re an important customer. Your account doesn’t matter.” I struggle to imagine the meeting where this decision was made, and someone saying, “Only 15 to 20 percent of our mobile customers will be affected, so who cares?” In case the irony did not come through, that imagined argument is the exact opposite of corporate marketing thinking, where teams struggle for months or years to eke out 1 percent gains in reach. Arbitrarily dumping a fifth of the user base based on some kind of principle is not a decision a marketing group would make voluntarily. Yet somehow, Discover Card came to that decision.

The key point against me, I imagine, is that people who carry phones that are two years old (three years, in my case) are less likely to be free spenders. They buy things when they need them, and hitting them with advertising messages has little impact. We might even be considered high-risk customers — if we can’t afford to upgrade our phones every year, how confident can a bank be that we can afford to make our credit card payments?

To be clear about what a “forced upgrade” involves, the app message said I was using an obsolete version of the app, even though I installed the latest version in June. It went on to explain that I would have to upgrade my phone operating system to install the newer version of the app. All functionality in the app other than displaying this message had been disabled. However, there is no newer operating system for my phone, so that would mean turning my phone in for recycling and purchasing a new phone — not something I’m likely to do just so I can keep tabs on my credit card account wherever I am. “Forced upgrade” is a known concept across the banking industry, but it is rare to see it used this way. All my other banks either allow me to continue to use the older versions of the app while they roll out more advanced app versions for customers who have the latest technology, or they make their designs flexible enough that they can run on last year’s operating system version. As I said, I have a hard time understanding how Discover Card could have decided that they could not take this same approach. But I hope I do not sound too critical. There must be a perfectly sensible reason behind this decision, and I am curious about what the reason is.

To summarize, Discover Card cannot decide whether I am millionaire or a pauper. My high level of transactions suggest the former, my out-of-date phone, the latter. Someday, my phone will fail and I will buy a new phone. Will that qualify me as a millionaire again? In the digital marketing age, it seems reputation hangs on just such random events.

This Week in Bank Failures

Unraveling: The last six weeks of reassurances about the financial condition of Banco Espírito Santo were false. The financial report released Wednesday revealed €3.5 billion in losses, the worst report ever for a bank in Portugal. The loss is bad enough to wipe out the bank’s capital and put it at the brink of insolvency. The bank would be effectively insolvent right now but for a €1 billion recapitalization completed in June. Those who invested then will surely be asking for their money back, as it seems unlikely that current shareholders will end up owning any part of the bank after its next round of capital. The bank’s stock has plummeted accordingly. After being temporarily suspended (again) by the stock exchange in Lisbon, the stock fell by nearly half yesterday and again today. In all, the bank is down to one eleventh of its stock value at its April peak. The low stock value casts doubt on the central bank’s newly reiterated plan of fixing the bank with private capital.

Banco Espírito Santo was said to be financially stronger than its two parent companies, which share the Espírito Santo name and the association with the family of that name, but if so, those two companies will surely be headed for liquidation in the coming weeks. After the earnings report, the central bank removed the three family members who remained on the board and hinted broadly at more arrests to come. It also removed KPMG as auditor, faulting it for failing to notice billions of euros in unreported loss exposure.

Comeback: Bank of Ireland reported a profit for the first time in 6 years.

Standoff: New economic sanctions from the European Union and United States target banks in Russia. They are meant to isolate Russia after it apparently provided weapons, training, and support, if not the actual staffing, for the anonymous military unit in Ukraine that shot down a passenger aircraft. The economic sanctions come with plenty of loopholes which make it possible for Russia to keep trading internationally, but those loopholes could disappear on short notice, creating risks for anyone involved in trade between Russia and other countries in Europe. Among other restrictions, the banks are prevented from selling stocks and borrowing money in European and American markets. Russia’s central bank is more than capable of supporting the banks affected, but only at considerable cost to the Russian economy. Few banks outside Russia are expected to be affected, but those that have the most at risk in Moscow are banks based in Austria, and they may need a measure of support to maintain liquidity.

Guilty: Bank of America must pay a $1.27 billion fine for the systemic fraud in subsidiary Countrywide Financial’s HSSL or “Hustle” program, in which the lender bypassed most of its usual underwriting process in order to reduce the time it took to package mortgage loans into mortgage-backed securities from weeks to days. Many of these mortgages were missing required paperwork, for example, because the HSSL timelines didn’t allow time for an independent review of loan documentation. The court concluded that the lender concealed its looser underwriting from Fannie Mae and Freddie Mac and defrauded these two companies of about half of the $3 billion that they paid for the mortgages. An executive in charge of HSSL was fined $1 million.

Raising capital: Barcelona-based Catalunya Caixa is selling a portfolio of residential mortgage loans mainly in Catalonia to Blackstone for €4 billion, about a 40 percent discount from nominal value. JPMorgan is selling a $1 billion global loan portfolio to Bain Capital.

Closing: Congress is leaving for vacation without coming to any agreement on the Export-Import Bank, so the U.S. trade financing agency will prepare to shut down September 30. The shutdown will leave a $1 billion hole in the federal budget, the approximate size of the bank’s annual profit. It will also limit the ability of major equipment exporters to sell overseas.