NEW YORK—In recent years, McDonald's Corp. has puzzled over how to expand beyond two core markets, young men and children.
But now, it is facing a bigger problem: the loss of some of its kids' business.
Sales of its Happy Meals have fallen three years in a row. McDonald's, based in Oak Brook, Ill., won't specify the rate of decline but suggests it was in the low single digits in 2002.
People familiar with the Happy Meal business say the decline has been 6 percent to 7 percent over the past two years combined, and some McDonald's franchisees say that that is consistent with their experience.
The Happy Meal -- which consists of an entree (hamburger, cheeseburger or chicken nuggets), fries, small drink and free toy -- is crucial to McDonald's. It accounts for more than 20 percent of U.S. transactions, or approximately $3.5 billion in annual revenue, according to McDonald's. It also generates sales from the adult who buys a child a Happy Meal. Some restaurants report that average orders with Happy Meals, whose prices vary according to market but start at $1.99, are 50 percent higher than those without Happy Meals.
No other restaurant chain that primarily serves adults has been so successful at wooing children. The 1976 introduction of the Happy Meal and subsequent arrival of in-restaurant playgrounds gave McDonald's a dominant share of the fast-food market for kids, which remains an insignificant business for competitors like Wendy's International Inc. and Yum Brands Inc., parent of Pizza Hut, KFC and Taco Bell.
Even Burger King Corp. is a relative newcomer to the children's market, having begun its Kids Meal in 1990.
But the McDonald's hold on children is weakening. "We can do better with Happy Meals," said Bill Lamar, McDonald's U.S. marketing chief. "We continue to be the leader, but the gap we had with our competitors is not as wide as it was a few years ago. We want to return to a wide gap."
To that end, McDonald's is exploring a novel concept. A key attraction of the Happy Meal is the toy that comes with it. What if Mom, a primary purchaser of Happy Meals, got a gift of her own? "A Mom's Meal with a lip gloss or a chance to go to the spa -- these are all ideas we're looking at," Lamar said. "Mom is a very, very important customer for us."
Indeed, McDonald's has created a new marketing team focused on attracting women 18 to 34 years old. And some of the chain's new products, such as the chicken flatbread sandwich and Cobb salad, are aimed at women.
Improving the Happy Meal toy is another goal. In 2002's second half, McDonald's began investing "significantly more dollars" in toys to improve their quality, Lamar said. It also started securing more "A" properties that have high appeal to kids, he added. Included in the 2003 lineup are miniature versions of the hot-selling Bratz dolls.
Sales reached stratospheric heights when Happy Meals came with Teenie Beanie Babies in the late 1990s. But since then, McDonald's has been short on big hits.
One problem is that the restaurant chain signed a 10-year licensing agreement with Walt Disney Co. that prohibits it from featuring promotions involving any Disney competitors. In 2001 and 2002, about half of the 15 annual Happy Meal promotions were related to Disney's characters or movies, some of which weren't faring well.
Meanwhile, competitor Burger King says its Kids Meal sales have grown with promotions featuring cartoon characters from "The Simpsons," "Rugrats" and "SpongeBob SquarePants."
In an interview, new McDonald's Chief Executive Jim Cantalupo said he is reviewing the Disney arrangement.
The Happy Meals sales decline has created its own promotion: a "2 for You!" program, in which kids for several weeks each year receive two toys instead of one. Its purpose is purely to rid the company of excess inventory. McDonald's says that this year it hopes to do better predicting sales.
Ed Bailey, a McDonald's franchisee in the Dallas area, blames the Disney deal for a decline in Happy Meal sales at his 45 outlets, including a 10 percent decline at a store whose overall sales grew 4 percent in 2002.
But Mr. Bailey said that another problem is that he and other franchisees have raised Happy Meal prices to offset higher toy costs. A hamburger Happy Meal can cost as much as $2.69 in some markets. Bailey now is proposing to offer a $1 Happy Meal with a cheaper toy.
In its early years, the Happy Meal came with an original toy, including McDonald's figurines such as Grimace and the Hamburglar. Some observers believe the fast-food chain, the world's largest toy distributor, should return to that strategy, instead of constantly promoting toys from the likes of Disney, Mattel Inc. and Lego Co.
"Rather than creating loyalty to McDonald's, they create a loyalty to a trinket," said Max Valiquette, president of Youthography Inc., a Toronto youth-marketing consultant.
But the Happy Meal doldrums may go beyond missing out on the hottest toys.
Some franchisees and industry observers worry that today's kids, weaned on videogames, are growing bored with traditional toys at a younger age. Sensing the changing habits and tastes of kids, McDonald's already has begun to install Nintendo videogame stations in some markets. Those close to the company say the chain is exploring offering more interactive-toy giveaways. McDonald's confirmed that it is releasing an interactive toy this year tied to Disney/Pixar's "Finding Nemo."
Flagging Happy Meal sales also may be a result of parents' focus on healthy eating following publicity about rising child-obesity rates. In response, McDonald's is considering a variety of menu add-ons -- including apple slices, fruit juices, peanut-butter-and-jelly sandwiches and carrot sticks -- according to a person familiar with the matter.