McDonalds takes on Starbucks

If McDonalds can score with expresso based coffee drinks, the way they have with Iced Coffee, then Starbucks is in trouble.

Here's the latest McNews:

MCDONALD'S COFFEE'S STRENGTH STIRS QUESTIONS

Specialty sales satisfy company, but analyst sees 'slow start'

McDonald Corp.'s Venti-size ambitions to take on Starbucks as the preferred purveyor of up-market coffee may not be showing signs of the jolt to sales some analysts had hoped.

Specialty coffee sales in the company's test markets seem tepid—under 3 percent of sales per restaurant.

"Those numbers indicate they are off to a slow start," said Ron Paul, president of restaurant consultant Technomic Inc., after analyzing company sales data obtained by the Tribune.

But a McDonald's senior executive who heads the national franchisee association said specialty coffee sales are on target. "It is absolutely to our expectations and actually a little greater," Don Thomspon, president of McDonald's USA, said in an interview. He reiterated that position to reporters Thursday after McDonald's annual meeting.

Analysts, including Paul, noted that the coffee rollout is in its nascent stages; national advertising for the product, a vital sales tool, hasn't begun. So far, only about 1,400, or 10 percent, of McDonald's U.S. restaurants are selling carmel cappuccinos and the like.

Jason West, a stock analyst at Deutsche Bank Securities, said he would "probably like to see higher" specialty coffee sales at this point, but added he's "not shocked" by sales data. "It will take awhile for it to catch on."

Specialty coffee is the anchor of a bold offensive to make Oak Brook-based McDonald's a beverage destination, a hub for fancy coffee, smoothies and even bottled sodas and energy drinks. It's an important driver for McDonald's long-term growth and a way into a lucrative market dominated by Starbucks.

But it entails big risks for franchisees who must invest tens of thousands of dollars to accommodate the beverage blitz.

McDonald's began testing specialty coffee in Michigan in late 2006 and in Kansas City in late October 2007, launching regional advertising and marketing campaigns in both areas. For the four weeks ended May 1, Kansas City outlets on average sold 301 specialty coffee items per week; Michigan stores, 286, according to a company document obtained by the Tribune.

For all test market stores combined, the average was 293. Paul said a restaurant operator would want a new product to constitute at least 3 percent of sales after six months to a year on the market.

For a well-known brand like McDonald's, closer to six months, he said. But McDonald's appears to be missing that 3 percent threshold in Kansas City and Michigan. For example, take the price of a medium-size specialty coffee, $2.79, and multiply it by 301 Cafe Mochas sold per restaurant per week recently in Kansas City.

Then assume total weekly sales of $40,000 to $42,000 per restaurant, the average for McDonald's stores. Specialty coffee would make up roughly 2 percent of sales in Kansas City and less in Michigan. "That's low," Paul said. "They can't be where they want to be." Thompson, however, dismissed the notion of analyzing specialty coffee sales with a 3 percent threshold.

"If we were just a coffeehouse, I could understand that," he said. But a McDonald's has a far broader menu than a coffeehouse, therefore new coffee drinks wouldn't have the same percentage sales impact they would have at a coffee specialist, he said.

The gradual rollout won't be done until next year. The company won't say when national advertising will begin. "There's nothing like the [ad] muscle we will get when we roll this out nationwide," said Art Phillips, who owns 10 McDonald's in the Kansas City area. "In the Kansas City market, we set targets and we are meeting or exceeding those targets."

In test markets, based on a McDonald's document, specialty coffee appears to be roping in at least $40,000 in annualized sales per store. When the beverage initiative is completely in place, including smoothies and other drinks, restaurants could each generate $125,000 in additional annual revenue, McDonald's has said.

Getting there entails big investments by franchisees, who own about 85 percent of the firm's U.S. restaurants. Beverage equipment costs about $25,000 per restaurant, while building renovations to create a "cell" to house the equipment could run up to $75,000 per outlet. McDonald's says it will pay up to 40 percent of renovation costs.

In the Chicago area, only two restaurants have beverage cells installed and serving specialty coffees. McDonald's says a company-owned store in Wheaton has been selling 450 to 500 espresso-based coffee items per week, a brisker pace than in test markets recently.

Franchisees "are very excited" about the beverage blitz, said Don Armstrong, head of the national association representing McDonald's owner-operators. "If there is any frustration at all, it is the energy, effort and time it takes to get the [beverage] cells built."

Still, some franchisees have shown apprehension over the beverage build-out in a series of surveys, albeit unscientific ones, by restaurant industry analyst Mark Kalinowski. An April survey of 32 U.S. franchisees representing about 240 restaurants included several comments from franchisees fearing that the beverage program's cost might outweigh its rewards. "The majority of operators can't afford it if the sales do not meet expectations," said one anonymous franchisee.

Source: Mike Hughlett, chicagotribune.com

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