Lessons from Ray Kroc’s Paper Cup Years
I have been thinking a lot lately about how some of the most important case studies in life are the ones that largely remain out of sight. Ray Kroc, in particular, comes to mind. Everyone talks about McDonald’s Corporation, and of course it’s the big win, but the foundation of what led to many of the insights that caused it to scale so rapidly can be traced to the roughly seventeen years Kroc toiled relentlessly as a paper cup salesman.
First, let’s back up and get some history.
As a teenager, Ray Kroc worked as a pianist, DJ at a local radio station, and salesman, hawking whatever he could to make money. When he fell in love with a girl named Ethel Fleming, he announced to his father that he was going to marry her despite, at the time, being only 19 years old. Kroc recounts in his autobiography Grinding It Out: The Making of McDonald’s that his father responded, “Impossible!” because, his father told him, he “must first have a steady job. And I don’t mean working as an errand boy or a bellhop in a hotel. I mean something substantial.”
Kroc rose to the challenge, saying, “A few days later I went to work selling Lily brand paper cups. I don’t know what appealed to me so much about paper cups. Perhaps it was mostly because they were so innovative and upbeat. But I sensed from the outset that paper cups were part of the way America was headed. I guess my father must have agreed. At least he raised no further objections, and Ethel and I were married.”
Ray referred to the paper cup business as a “bear”, observing that it went into hibernation in the winter so you had to live on what you made during the other seasons as the only profitable customers during the cold months were hospital and medical clinics. He quickly went to work building up such a base of relationships so he didn’t have to suffer a lack of income when the temperature dropped. Never one to rest on his laurels, at one point, before that base of customers was established, he and Ethel took off for a season in Florida, where he worked selling real estate before returning to the frigid Chicago winters. He also figured out ways to increase his paper cup sales, reminiscing, “I was always on the lookout for new markets, and I found them in some strange places. Italian pastry shops, for example, could be sold ‘squat-size’ cups for pastry and spumoni. They would buy a lot of them for big picnics, weddings, and religious festivals. I also learned that Polish places in the old Lawndale neighborhood would buy the same cups to serve “Povidla,” which was a prune butter. Those folks ate an awful lot of prune butter.”
At one point, Kroc had an epiphany that it was better to find a rising tide and let the underlying forces increase your sales automatically and exponentially. This insight came from his interaction with the Chicago-based Walgreen Drug Company, which had begun a period of rapid expansion. It began because he was selling “little pleated ‘souffle’ cups”, which Walgreen used to serve “sauces at their soda fountains. Observing the traffic at these soda fountains at noon, I perceived what I considered to be a golden opportunity. If they had our new Lily Tulip cups, they could sell malts and soft drinks ‘to go’ to the overflowing crowds.” Kroc’s description of the events gives an insight into the mind that built the world’s largest fast food chain:
“The Walgreen headquarters was at Forty-third Street and Bowen Avenue at that time, and there was a company drugstore just down the street. I presented my pitch to the food service man, a chap named McNamarra. He shook his head and threw up his hands at my suggestion.
‘You’re crazy, or else you think I am,’ he protested. ‘I get the same fifteen cents for a malted if it’s drunk at the counter, so why the hell should I pay a cent and a half for your cup and earn less?’
‘You would increase your volume,’ I argued. ‘You could have a special area at the counter where you would sell these things, put covers on them, and take them and the same vanilla wafers or crackers you serve with them at the fountain and drop them in a bag to take out.’
Mac’s face got redder than usual at that and he rolled his eyes toward heaven as if pleading to be delivered from this madman. ‘Listen, how can I possibly make a profit if I go to this extra expense? Then you want me to waste my clerk’s time putting covers on drinks and stuffing them in bags? You are dreaming.’
One day I said, ‘Mac, the only way in this world that you can increase your soda fountain volume is to sell to people who don’t take up a stool. Look, I’ll tell you what I’m gonna do. I will give you 200 or 300 containers with covers, however many you need to try this for a month in your store down the street. Now most of your takeout customers will be Walgreen employees from headquarters here, and you can conduct your own marketing survey on them and see how they like it. You get the cups free, so it’s not going to cost you anything to try it.’
Finally he agreed. I brought him the cups, and we set the thing up at one end of the soda fountain. It was a big success from the first day. It wasn’t long before McNamarra was more excited about the idea of takeouts than I was. We went in to see Fred Stoll, the Walgreen purchasing agent, and set up what was to be a highly satisfactory arrangement for both of us. The best part of it for me personally was that every time I saw a new Walgreens store going up it meant new business. This sort of multiplication was clearly the way to go. I spent less and less time chasing pushcart vendors around the West Side and more time cultivating large accounts where big turnover would automatically winch in sales in the thousands and hundreds of thousands. I went after Beatrice Creamery, Swift, Armour, and big plants with in-factory food service systems such as U.S. Steel. I sold them all, and my success brought me more territory to cover and more possibility.”
The problem: The structure of Ray’s employment. Lily paper cups were manufactured by Public Service Cup Company. That business worked with a distributor business named Sanitary Cup and Service Corporation. SCSC had the exclusive rights to distribute Lily cups in the Midwest and it was for that business – SCSC – that Kroc worked. SCSC’s biggest stockholders were “a pair of bachelor brothers in New York by the name of Coue”.
The difference in how Ray Kroc viewed customer relationships, and how SCSC’s management and the Coue brothers viewed customer relationships, was significant. Kroc believed that if he acted in his customer’s best interest, he would be rewarded over time even if it meant he made less money in any given period. One source of contention between him and his employer: Kroc would often warn his customers if price increases were coming so they could stock up on paper cups at the lower price. He also would look at their sales projections and inventory levels and tell them if he didn’t think they needed any more paper cups, even if they were keen on ordering more. This honesty led to so much trust that several of his customers let him basically write the sales order for them, believing his judgment to be fair and accurate.
Kroc reminds me of the Dolly Parton quote from almost 50 years ago, “Why should I work for hundreds and thousands when I can work for hundreds of thousands?”. The insights were manifold. Treat your customers right. Affordability with quality can lead to volume and volume at scale can be powerful driving returns on equity far faster than high margins alone make possible if the cost structure is right. (That last caveat should not be overlooked as it’s actually possible for growth to cause an enterprise to go broke if isn’t careful. My case studies are filled with such examples.) Tell the truth not only because it’s the right thing to do but because people will remember when you are honest with them; that they can trust your word whether or not they agree with you. Also, make sure you work somewhere that rewards your efforts and aligns with your personal beliefs and style. In Kroc’s case, he found the problems of business interesting to solve. He couldn’t stand being slowed down by others especially when they reaped the rewards of his insight after he had to fight them to adopt them in the first place. He needed to be constantly challenged. He thought in terms of systems. For example, he famously refused to sell equipment to franchisees because he didn’t want the conflict of interest understanding that even if it began as fair, over time it could twist incentives and cause mistrust.
I know I’ve said it over the years, but the surprising things is the book that led to more case studies than any other was McDonald’s Behind the Arches by John F. Love. The endnotes alone are golden, pun fully intended. It led to so many other businesses, entrepreneurs, business enterprises, real estate empires … so many people and fortunes arose in the orbit of McDonald’s each with their own players and lessons. I mean, think about J.R. Simplot who through a handshake deal with Kroc ended up becoming the wealthiest potato farmer in the world and the 89th wealthiest person in America prior to his death in 2008. Through a series of mergers and transactions, the old paper cup company mentioned earlier with whom Ray’s employers had a deal ended up part of Dart, America’s largest privately owned provider of food and beverage packaging. Prince Castle, which made the milkshake mixers Kroc was famously selling when he encountered McDonald’s in the first place is part of Berkshire Hathaway today. There is Golden State Foods in Irvine, California, which prior to being bought out by private equity, was a family-controlled supplier that made the people behind is extraordinarily wealthy. It just goes on and on … so many multi-millionaires, often married couples, created out of ordinary people living in ordinary towns. I’d have to go back a couple of decades to figure out exactly what the figure is since I hold it in so many places, but McDonald’s has been paying dividends into the Kennon-Green family coffers since Aaron and I were barely out of our teenage years; possibly a bit earlier because I can’t recall if I bought my first shares in high school or not. We exchanged some of those early letterman jacket award profits for an ownership stake in the cheeseburger empire. We’ve given cash to buy shares to our own children, as well as nieces and nephews.
That doesn’t mean I always approve of what the company does. There have been significant improvements in the freshness of Quarter Pounders that have paid off. However, I am deeply critical of management’s short-sighted move to make the dining rooms stripped of color and unwelcoming so people get out sooner. I believe, ultimately, someone will come into the executive suite that will reverse course as society is largely tired of gray walls, cold floors, uncomfortable furniture, and the lack of hospitality. Even small details, like the color of gold being incorrect recently on one of their coffee cup designs, is a bit shocking. Still, I think they’ll course correct, the price is reasonable, and they have some inherent advantages that make inflation and a weaker dollar less of a threat than it is to other enterprises even if Wall Street overreacts and sells off due to a short-term profit hit. (To illustrate: Take a look at the beef inflation crisis of the 1970s and how the company navigated it.)
Anyway, I’ve talked about some of this before … or at least McDonald’s directly or indirectly, such as here, here, here, and here to name a few.