7/5/2011 4:35 PM ET|
McDonald's or Starbucks: Who wins?
The purveyor of burgers is going upscale, treading on turf that the coffee titan has trolled for years. Which company will prevail? And what's the effect on consumers?
Would you like some fries with that cinnamon dolce latte?
OK, you probably won't hear that question any time soon. But in an odd twist in the evolutionary path of quick-serve eateries, McDonald's (MCD, news) and Starbucks (SBUX, news) are looking more alike every day.
It's a trend that's going to continue, for a few simple reasons.
With a McDonald's or a Starbucks just about everywhere you look, both companies are running out of room to roam.
Starbucks was once expanding so rapidly that comedians joked it would be opening new coffee shops inside the bathrooms of existing outlets. The Seattle company plans to launch just 100 U.S. stores this year, though.
And in the cutthroat world of fast food, McDonald's needs to distance itself from powerful rivals like Burger King and Subway.
This competitive dynamic has the queen of premium coffee and the king of fast food poaching each others' customers in a low-key but persistent battle. Each is taking ideas from the other's playbook on how to please customers and boost the bottom line.
Call it the battle of the fries versus Frappuccinos. The double cheeseburger versus the double espresso. Or the Golden Arches versus the green siren. Whatever you name it, it's real, even if neither company admits it, and even if it's more a series of limited campaigns than an outright food fight.
I'll show you why, in a minute, since you might not believe it because these companies are so different.
After all, Starbucks and McDonald's have distinct customer bases -- one more affluent, the other more price sensitive. Each fan base is loyal, so there are limits to how much tinkering either of these iconic eateries can get away with. But there's plenty of middle ground -- occupied by a customer who is happy to frequent these two chains and all kinds of other fast-food joints.
So who is going to win?
It would seem that McDonald's has the most to gain. And it's easier for it to become more like Starbucks without damaging its brand than vice versa. Plus, profit margins are higher for coffee than for burgers and fries. So, the benefit to the bottom line in any victory in the coffee wars favors McDonald's, points out Pat Dorsey, the director of research and strategy at Sanibel Captiva Trust.
Make no mistake, though; Starbucks has a lot to gain as it imitates what works at McDonald's.
The other big winner just might be the consumer -- who gets higher-quality food and drinks and new amenities at McDonald's, and a bigger variety of quality food to nosh on while surfing the Internet at Starbucks.
Here's a closer look at the battle between these quick-serve giants.
The coffee wars
Early on, burgers and fries, and later breakfast meals were strengths for McDonad's. Drinks were an afterthought. It took a while, but the chain noticed the big profits Starbucks was raking in from coffee sales. McDonald's knew it could never get away with $5 coffee drinks. Well aware of its customer base, McDonald's is "always keeping an ever-vigilant eye on everyday affordability, which is the most important thing for our consumers," CEO Jim Skinner said during the company's most recent conference call with shareholders. "They get pinched everywhere," Skinner added. "They should not suffer the same fate at McDonald's."
But, taking a page from the Starbucks playbook, McDonald's has rolled out premium coffee. It's been a big hit, and it is growing by leaps and bounds. During the first quarter, sales of "specialty coffees" increased 17% from a year earlier. "We believe McDonald's could evolve into Starbucks' fiercest rival in the specialty coffee segment," says analyst R.J. Hottovy, who covers both companies for Morningstar.
This puts Starbucks in a quandary. It's got to be careful not to cheapen its brand, yet it needs to respond to this challenge from McDonald's. So far, Starbucks has finessed the matter well. It went after McDonald's coffee customers with a rollout of its premium coffee brand Seattle's Best Coffee at more than 30,000 quick-service competitors of McDonald's, such as Subway. This gives the company exposure to this space without putting the Starbucks name into the fray.
By stealthily moving into this part of the market, Starbucks looks more like McDonald's, at least behind the scenes, without diluting the premium aspects of its name in the eyes of the public. Job well done.
The food fight
Starbucks' strength at the outset, of course, was good coffee. That and plenty of opportunities for coffee lovers to customize their joe; the company says it offers 70,000 combinations of coffees, flavors and toppings.
Sure, the coffee chain has always sold basic foods, like the kinds of pastries you can enjoy in the typical Italian coffee bar that Starbucks tries to emulate. Now though, Starbucks is on an obvious campaign to offer more food, and in a ways a McDonald's customer might recognize.
Mornings are peak business time at Starbucks, and its breakfast menu now features sandwiches strikingly similar to an Egg McMuffin. And why not? This has been a popular mainstay at McDonald's for years.
Starbucks will likely never have a full kitchen -- its lunch offerings are prewrapped. But it is rolling out mini-ovens in all stores, so it can serve warm food. And it's in the process of beefing up its lunch offerings to compete midday, as well.
Starbucks, of course, would argue that its food is not at all like what's offered by McDonald's -- it is free of trans fats, artificial flavorings and other unhealthy stuff. It has a point, one that translates to sales as consumers become more health-conscious.
But McDonald's has noticed this as well. In the past year or so, it's rolled out its own version of wraps, healthier salads, premium burgers made from Angus beef and "real fruit" drinks that are a lot like Starbucks smoothies.
As a coup de grace, McDonald's has launched what a lot of old-timers probably thought they'd never see at a burger joint: fruit and maple oatmeal. I doubt it's coincidental that oatmeal has long been one of Starbucks' more popular food offerings.
"McDonald's is going through a major reinvention, with healthier food, the fancier coffees, the fruit smoothies, salads and now oatmeal," says Howard Davidowitz of Davidowitz & Associates, a retail consulting and investment banking firm. "They're trying to distance themselves from Burger King. That's not easy to do, and I think they've done a great job."
A big advantage for Starbucks is that its stores are comfortable places to hang out. I doubt many people have viewed McDonald's, with its harsh lighting and hard plastic seats, the same way.
But this is changing, too. With a nod to Starbucks, McDonald's is remodeling its restaurants to make them cooler places to spend time. "The remodeled McDonald's are more aesthetically pleasing. They have a European feel, with more art and free-standing furniture," says Hottovy.
And McDonald's is rolling out free Wi-Fi internet access, which as of Dec. 31 was available in about 12,000 of the chain's 32,737 outlets worldwide.
McDonald's has the cash -- $6.3 billion, as of the end of last year -- to get this done. It plans to remodel 2,200 restaurants this year. "We continue to see the desired results from our re-imaging, with improved perceptions of our brand and higher sales," Skinner said during the conference call.
Of course, there are limits to how closely McDonald's can resemble Starbucks. The fast-food chain will never match the "unique Starbucks experience" the coffee chain boasts about. And the remodeling won't generate Starbucks-style pricing on food and beverages: Skinner has cast cold water on the notion that upgraded restaurants will allow the chain to raise prices.
Another big difference: Starbucks is aggressively branching into new distribution channels like warehouse stores and grocery stores -- where it offers Tazo Tea, Seattle's Best Coffee, Torrefazione Italia coffee and Starbucks Via Ready Brew instant coffee. Starbucks also has a partnership with Green Mountain Coffee Roasters (GMCR, news) to supply K-Cup single-serve coffee and tea packs for use in the company's Keurig single-cup brewing system. McDonald's, surprisingly, still doesn't capitalize on its powerful brand in this way.
And the winner is . . .
So who's the winner? In one sense, Starbucks seems to be coming out ahead, hands down. Since the beginning of 2010, it has been posting sales growth of 7% at stores open more than a year, compared with growth of between 2% and 5% at McDonald's, said Jharonne Martis, the director of consumer research at Thomson Reuters.
But this contrast is a little deceiving. For one thing, sales growth of around 3%, the most recent number for McDonald's is quite healthy, says Martis, especially for such a big company. McDonald's had annual revenue of $24 billion last year, compared with $10.7 billion at Starbucks. McDonald's employs about 400,000 workers in about 32,700 stores in 117 countries. Starbucks has 137,000 employees in about 16,900 stores in 55 countries.
That size difference means it's tougher for McDonald's to post big sales gains. But it also means it has more strength in negotiating prices with suppliers. Plus, McDonald's employs a franchise system, for the most part, while Starbucks owns and operates most of its locations. This pushes a lot of the costs at McDonald's onto franchise operators -- boosting profit margins at the parent company. The upshot: McDonald's has operating profit margins of 31%, compared with 13.5% at Starbucks.
So more incremental gains in its coffee wars and food fights with Starbucks fall to McDonald's bottom line.
Right now, the market seems to fully recognize the potential of each company. Neither stock is a bargain. But over the long term, both should reward investors as they boost sales by borrowing what works best from each other. Just don't expect to see $12 burgers at McDonald's or to order chicken nuggets with your iced cinnamon dolce latte at Starbucks. Not that you would want to.
At the time of publication, Michael Brush did not own or control shares of any company mentioned in this column.
Michael Brush is the editor of Brush Up on Stocks, an investment newsletter. Click here to find Brush's most recent articles and blog posts.
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McDonalds wins for price conscience consumers - McCafe Coffee is pretty darn good.
if you are a coffee snob and like paying double almost triple then starbucks is your choice. The allure of carrying a starbucks cup and 2.49 coffee is gone for most of us. But different strokes for different folks that what makes this country great.
I have yet to see a McDonalds with atmosphere even close to Starbucks! Many of them are dirty and messy and all have kids screaming and running around.
I will say their coffee is good. But, who said the blended coffee drinks are cheap?! NOT!
Every Starbucks has a high-quality water filtration system that makes the mineral content of their water uniform throughout all of their stores, which is why a latte at SBUX tastes the same if you're in Paris or in Minneapolis.
Once McDonalds implements some more uniform training and production standards and cleans up their water, there really won't be much of a difference...minus the price. But don't fool yourself into thinking that the beans are raised better, shipped better, roasted better or brewed better at Starbucks over McDonalds.
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