McDonald’s president for Eastern Europe and the company’s CEO in Russia, Khamzat Khasbulatov, has been at the company since the first day it appeared in Russia in 1990, initially as manager of Moscow’s Pushkin Square restaurant. Starting with that prime location, the company has maintained a particular interest in real estate in Russia. Alexander Teddy spoke to him and asked just how far real estate activities, the mainstay of the company’s international revenue, steer McDonald’s in this country.

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Harry Sonneborn, a McDonald’s executive in the 1960s, said, “We are not basically in the food business. We are in the real estate business. The only reason we sell fifteen-cent hamburgers is because they are the greatest producer of revenue from which our tenants can pay us our rent.” How does it represent your activities in Russia?

Khamzat Khasbulatov: This quote is more relevant to markets where we have franchisees, and as we do not have franchisees in Russia, our entire revenue and income here is derived from restaurant operations. However, globally speaking, yes, a part of our revenue comes from real estate. We lease buildings to franchisees, who run our business — a fair business practice, and certainly no secret — and the corporation receives a considerable proportion of its revenue from this real estate via franchisees’ rental payments for their restaurants.

How relevant is this to the other Eastern European countries you manage?

KK: Well, of the twelve countries that I am responsible for, only one has franchisees — Romania. Eight of the countries have a different structure, which is called a developmental licensee, where our local partner is a real estate owner. So, it’s a different kind of franchising where the franchisee is also the real estate owner. The partner company builds a new restaurant using its own capital, and/or buys the restaurants in that area previously belonging to McDonald’s. There are eight countries where we operate along those lines: Estonia, Latvia, Lithuania, Macedonia, Bulgaria, Moldova, Azerbaijan and Georgia. The business belongs to our local partners in these countries and they pay royalties to the corporation. The amounts depend on the market and on the history of the company in that country. We have a flexible approach to the royalties, depending on the situation and the volume of business. The most important thing for us is that our partner is motivated to develop the business in their area. So our royalty structure depends a lot on the state of the market and the quality of the business there.

	Vedomosti McDonald's Recently won a law suit filed by the Moscow government

Looking at your Russian web site, there is an entire separate section on real estate. How does real estate fit into your activities here?

KK: Expansion is one of the key priorities that I personally oversee. This includes selecting sites for new restaurants, which is not an easy task, particularly when bureaucracy hinders the process. As we are undergoing constant expansion, it is a key part of our business.

Last year you saw 25 percent growth and were planning to open 40 new restaurants. Is this still the case?

KK: Yes, and this figure will be the same for the coming year, irrespective of the current economic circumstances. We planned to open up to 40 new restaurants this year, and we are currently on target. Perhaps it will not be exactly 40 restaurants, but it will be more than 30, and we’ve already opened 18 so far this year. A further 30 are currently at different stages of development. Unfortunately, opening in a location where we are dependent on the surrounding infrastructure means that we cannot open a restaurant until a mall or shopping center, for example, opens.

How has the economic crisis affected your business?

KK: To say that the crisis has had no effect on our business would be untrue and unfair. The economic situation, consumer spending and currency volatility all affect results — on the top line, and on the bottom line. Currency movements affect returns, as a lot of our construction materials are imported. So, if we are buying supplies such as building materials abroad, for instance, in dollars or euros, even price drops in commodities are not necessarily advantageous. Consequently, our work is linked to currency, but we have not seen a decrease in business growth.

Russian McDonald’s restaurants are among the most visited anywhere in the world. An average restaurant sees more than 800,000 guests per year. The number of guests — the key to our success — is continuing to grow, independent of the opening of new restaurants, and so we will continue expansion and development. Peaks and troughs in the economy are temporary, and we have lived through the crisis of the late 1990s and have plenty of experience. So, this doesn’t frighten us — though of course it’s not pleasant.

You said at the end of last year that you were going to sell your office real estate.

KK: We planned and sold the office real estate that we had in the center of Moscow several years ago. We do not intend to sell other office real estate that we own. For instance, the office that we are now in [on Krasnaya Presnya Ulitsa] is our main office building in Russia. There are also offices that we rent out, but these are properties that we do not plan to sell. Although it could be profitable, we have our restaurants there.

Vedomosti An average McDonald's sees more than 800,000 customers per year, and locating each restaurant is a key element of the company's stratgey.

So, to what extent is the McDonald’s image in Russia associated with the location of its restaurants?

KK: It’s a very important factor. As a real estate correspondent, I’m sure you understand the significance of location for any given enterprise. From the outset, when we opened our first restaurant on Pushkin Square in Moscow, this has been the case. Convenience, ease and accessibility are all factors determining success. It is important that clients do not have to look high and low for a restaurant, but that they are within comfortable reach at any time. Therefore, we locate our restaurants in the most convenient spots for our customers: in city centers, on major trunk roads, near the metro or close to residential complexes. So, when we see the plan of a new residential complex we work out to what extent it could be a useful and successful place to locate a restaurant to maximize customer flow.

Convenience for the customer is a very important factor when you are deciding on where to locate your restaurant.

Is it difficult to get hold of good locations for your restaurants in Russia?

KK: In Russia, be it good or bad, the main issue in acquiring a property is the bureaucracy. It takes time. Successful locations for retailers within our industry have several particular characteristics — price, traffic volumes, visibility and whether it is a busy trading area — but obviously they cost more than less attractive and, ultimately, less successful locations. In this it is the same as in other countries.

You work with partners here in Russia on real estate activities. How does this relationship work?

KK: If we are talking about the primary real estate market, the land market, where the seller is generally the state — since land is fundamentally under its control — we work with local authorities in order to acquire plots of land. We make use of the secondary market when we buy existing property or when we rent out property on the basis of long-term leases. We have a few co-development projects with local and global companies, for example joint projects with BP gasoline stations. Our existing plan for purchasing land remains our number one priority because our individually constructed buildings, free-standers, are able to house restaurants that provide a wide number of different services, such as 24-hour and drive-through services. This is very important and allows us to increase revenue and customer numbers. Our freestanding drive-throughs that are open at night generate a significant part of our revenue in Russia. In this way we do invest more and more money in real estate.

It’s not only about the price of real estate. It has to be available and generate returns. We always consider how much cash should be spent on real estate and how much on overall development in order to be profitable.

Does this mean you make long-term investments in quality real estate projects or are you looking for a quick return?

KK: When you are investing in real estate, in a food court project for example, the aim is not to waste money, but the majority of our projects are stand alone and in any case, when we do commit, we do it for the long term. Again, we use most of our capital resources to obtain our own real estate sites since it means that business is guaranteed to be less exposed and less reliant on others, such as a landlord, who can change the conditions of a lease. We want to be less dependent on external factors.

How much money do you spend every year on real estate projects? What is your capital expenditure in this field?

KK: Our capital expenditure in this area increases every year, because the number of restaurants increases. We have several lines of capital expenditure — new construction, revising restaurants’ images, and improving the conditions of facilities in restaurants, such as kitchen upgrades, optimizing drive-through services, or adding the McCafé concept to a restaurant. These are our main areas in terms of expansion and development. Of course, redesigning a restaurant’s image is not necessarily a critical factor, but for us it is a very important one because we want to keep the restaurants modern. This requires a reasonable amount of expenditure since the interiors of the buildings need redesigning.  

We are not necessarily adding services overall, but we are making the restaurants better; they are all becoming completely different. This will be seen next year in Moscow when our newly refurbished restaurants open. They will have new facades, new interiors and landscaping. There are already some of these new-type restaurants in Moscow, St. Petersburg, Kazan and the Moscow region. There are also genuine measures to introduce some new technologies and natural and environmentally friendly materials into our restaurants. We are using new designs that are currently being implemented across all Europe. This new design approach has also been taken in countries in North America, for example.

Do you take out a lot of bank loans?

KK: Mostly we use our own resources, and our cash flow allows us to cover most of our needs. If we need additional capital, then it’s easy to get hold of. If needed, we’ll get support from the corporation.

Is your plan for regional development going as envisaged?

KK: Yes. More than 50 percent of our new restaurants are now in the regions, that is, outside Moscow or St. Petersburg. We are opening new restaurants in the Urals, the Volga region and southern Russia. This year, for example, we are going to open in Penza and Novgorod. So we are adding to our restaurants, just as last year we opened in Ivanovo and a small town, Novocheboksarsk, in the republic of Chuvashia.

So are you often on business trips in Russia?

KK: Yes, I regularly travel around Russia for such trips.

Who are your main rivals?

KK: Here the market has a lot of potential for development. It is in a very early stage; it is not like in the U.K. or in France or Germany. Here there is a great possibility for any company to develop its business. Of course, any similar type of retailer or a restaurateur represents competition for us — even people cooking at home is competition. But we think you need competition because that helps you to do better and attract new customers.

Vedomosti McDonald’s said it makes a concerted effort to enable its restaurants to fit in with pre-existing architectural styles in Russia.

Are you worried by negative films such as Supersize Me, and the image of the company they portray?

KK: No, because I feel we can be part of the solution to such problems. I feel that these sorts of things can be taken as a sign that we in the industry have sensed such problems. When there is a non-objective assessment of our industry, we are given an opportunity to talk more actively about what we do. We are open and are prepared to talk about and show what it is that we do. For instance, the issue of food safety is a key matter. We invest a lot of resources in making sure that our food is safe. We serve billions of customers in Russia, and there has not been an instance when the safety of our food has been a matter for compliance concerns or complaints. For me, that is a great assessment of what we do because we guarantee quality and food safety. We don’t work by thinking ‘let’s go cheap on it’. Transparency and communication tools are the key.

We have both a core menu, but also new items, such as salads, or our ‘healthy choice’ foods — so that there is choice. People need choice. No one can just eat salad; you also need protein, for example.

Do your hamburgers have decent meat in them?

KK: Yes, of course. One hundred percent beef, the freshest vegetables, the best bread and cheese. When we talk about safety and quality, we are unbeatable on these matters.

We also know you need to give the individual nutritional information, a web site, packaging or a brochure on the tray liner. But how you build your own diet is up to the individual. Sport and lifestyle are of course important.

Is your food strategy in this respect the same in other countries where McDonald’s operates?

KK: We have an identical corporate strategy, and in this industry we were the first to implement this nutritional initiative, despite the fact that it creates additional costs. We work with scientific and nutritional experts here in Russia, and their perspective is important too. The most important judge, though, is the client. They vote with their feet.

How does the architectural image of McDonald’s in Russia differ from that in other countries in the CIS for example?

KK: As an example, when we built this building [on Krasnaya Presnya Ulitsa] and the office building in the center of Moscow that we sold, we consulted architects to ensure that we kept in harmony with the local architecture and yet do it on a modern level. But we also use different approaches. In the center of Kazan, we went into the archives, looked at architectural documents and made sure that we put up a building similar to that which stood in that location 200 years before.

When land became available opposite Moscow’s Tretyakov Gallery, our company architects worked alongside local ones to build a restaurant that fitted in with the historical architecture of the city — a process we initiated ourselves. For this we received a diploma from the Russian Union of Architects. We also won prizes for buildings in the Yugo-Zapadnaya district of Moscow and also in the center of Nizhny Novgorod. We put up various types of buildings, not simply what you see on the highway as a freestanding drive-through. The most striking example may be the McDonald’s restaurant on Arbat, which is in an early nineteenth-century building. There we did a complete restoration of the building and tried to reconstruct it in the spirit of a nineteenth century restaurant interior.

Sokolniki is another example; for that we made an agreement with the oldest standing fire station in Moscow to make sure that the architecture blended in with the surrounding. We have experience in working in various styles and we try to respect the local architecture.

It seems to me that in fact you have a lot to do with real estate in Russia, even without it being a franchisee country for McDonald’s. Could you say that for you real estate here is as important as the sale of food?

KK: Absolutely. For me, quality of real estate — quality of location and terms of ownership — is a sign that business is going to be stable, precisely in that very spot you have committed to. Long-term leases are an important factor in our work in cases where we have not been able to purchase. Of course, the factors I cited before — accessibility, location, terms of occupancy — they are all very important for the quality and for the customers.

But you also invest money in agriculture, right?

KK: When we opened our first restaurant in Russia, then the U.S.S.R., a major factor for us was to ensure that we corresponded to the corporate standards we seek in other countries. There was a lack of a reliable local supply chain that met our standards. So we invested $50 million to build a food-town in Solntsevo, where we built food production facilities. This was a great example of how you can invest $10 million in one restaurant, yet at the same time $50 million into a food facility to ensure quality and consistency of supply. It was a very risky investment; McDonald’s globally does not normally invest in supply chains. It was an exception here in Russia, that we built and owned the facilities.

The idea was to create a modern supply chain. Yes, we did help our local suppliers, with technology and expertise, with the aim of enabling them to provide the standards that we required. In 1990, only 20 percent of our ingredients came from local sources, the rest from outside the country. Now it is the other way around. Our strategy was to turn that around, as you have to have locally sourced food otherwise the currency complications are considerable. Our main reason was not financial; it was only done to ensure quality and consistency. We now have more than 100,000 people working for companies that supply products for McDonald’s in Russia.

Do you build housing for your workers?

KK: No, but McDonald’s was the first company to provide mortgage plans for its management — about eight or nine years ago. This is still in place and can be denominated in any currency. We set up a deal whereby the bank would give a long-term loan with the company paying part of the rate. It was made between banks and our own employees, and the program has single digit interest rates.

Has this suffered since the economic crisis began?

KK: I’m afraid I don’t know the details.

The Moscow government filed a lawsuit against McDonald’s in mid-July. What exactly happened there?

KK: This is the first time I have commented on this. To be clear, let’s retrace the history. It was about two properties that were leased by the Moscow city government. In 1990, when we built the Pushkin Square restaurant, we needed an office. Previously, we had been operating from the Minsk Hotel. So we asked the city government to lease us an office, and they offered us a building that was in a decrepit state.

We agreed with the city government that we were ready to invest a large amount of money in order to renovate the building, and then to rent that building from them. As we actually renovated city-government property, having invested a large amount of money, we asked them to provide a fixed ruble rate for a defined period of time.

In 1992, we signed a long-term lease agreement with the Moscow city government. At that time it was at market price, but then the ruble started to devalue. This was a 40-year lease with a 20-year fixed-rate term. The conditions were: firstly and importantly, we invested money into  this building, an office, and another one, a restaurant; secondly, that the government had a 51 percent stake in McDonald’s and therefore received revenue as a result of this stake.

On top of that, when we bought the city government’s shares in the joint venture in 1996 and 2003, those two real estate deals were included in the share purchase agreement. This is what is often forgotten, but as you may know, the court made a decision in our favor. It was such a clear-cut case; when it went to court, we did not even have to argue.

	Vedomosti Khasbulatov likes to drink McDonald’s own cappuccino.

Do you think that the government just decided to sue you because they were no longer shareholders in the company?

KK: No, they wanted to receive more money for a property that had, by that time, become more interesting. But you cannot change these rules every second day. We said that we were ready to renegotiate in three years’ time, when the contract ends; we will of course reconsider the rental rate. We also offered to buy it from them, but they still have not replied to this offer.

Who benefited most from this deal?

KK: Both the city and us. The city benefited because we reconstructed two buildings that were in need of repair at our own cost without them having to pay a kopek. Although we rebuilt them, they remained the city’s property. Also, the city received profit through the joint-venture partnership for more than 10 years.

Is there any tension between you and the city government?

KK: No, we get on very well. The city and the company get on very well. I do not think that it was at the executive level that this happened, but at a lower level, among people who did not know the whole story.

Finally, did the full convertibility of the ruble in 2006 greatly affect your operations?

KK: Not really. For us to convert rubles into currency to support our imports or to pay dividends or royalties was very important. I think we did occasionally have difficulties obtaining construction materials in the beginning. In the early 1990s we got a license to generate hard currency from office tenants and also to export products from McComplex, our food processing and distribution center. But since we always reinvest money back into the market, we do not take our profit out of Russia, so the convertibility has not really been so much of an issue.

I heard that your business card is in the shape of a Big Mac.

KK: No, the Big Mac is in the shape of my business card!