Wendy's hikes prices: Here come falling sales

The fast-food chain can't live with dollar menu items, but perhaps it can't live without them either.

By InvestorPlace Jan 7, 2013 1:59PM

Image: Fastfood working copyright Creatas, PictureQuestBy Dan Burrows


iplogoThe fast-food industry has a dollar-menu addiction, one that's very bad for margins but almost impossible to give up because of how it juices sales.


So, don't be surprised if Wendy's (WEN) change to its value menu leads to a drop-off in revenue in the very near future. Worries about profit margins forced the chain to raise prices. But, as we've seen recently, messing with the dollar menu can be very bad for a fast-food chain's top-line results.


Wendy's said last week it was changing its value-menu offerings because selling stuff for only 99 cents was a money-loser amid rising costs for things like chicken, beef and cheese.


The fast-food chain known for square burgers and Frosty shakes is dumping its 99 cents value menu and launching a campaign called "Right Price Right Size," where items will range from 99 cents all the way up to $1.99.


That's all well and good for margins, but if McDonald's (MCD) recent experience is any guide, the price hike will punish sales none too soon.


Recall that back in October, McDonald's, the Dow component and world's biggest fast-food chain, posted its first monthly sales decline in nine years, largely because it futzed around with its own dollar menu.


The company blamed the shocking drop on pushing its so-called "Extra Value Menu" -- that is, trying to sell items priced higher than a dollar. McDonald's immediately reversed course, doubled-down on actual dollar-menu offerings and -- voila -- sales bounced back strongly the very next month.


Unfortunately for all concerned, the big players really have no choice but to have value-menu offerings. True, those foods may have little or no margin attached, but they pull traffic into restaurants, and then customers often buy other, more profitable items along with the 99-cent stuff.


Consumers, meanwhile, are as cost-conscious as they've ever been, meaning that if one chain has a dollar menu, all the others have to follow suit.


Competition among the fast-food companies has probably never been more intense. After all, they have never in their histories faced an economy this weak for this long or unemployment this high for this long. At the same time, the old-line outfits also face an onslaught from higher-quality upstarts like Chipotle Mexican Grill (CMG).


That puts Wendy's, in particular, in a very difficult position. It simply has to offer margin-killing value-menu items to keep customers coming in the doors, but at the same time it has almost no margin or profitability to speak off.


After all, Wendy's is coming off of two consecutive quarters of net losses, meaning it has a negative net profit margin. And there's little wonder how that came to pass, given how its profitability teeters on a very thin edge at the operational level. Indeed, the company's operating margin stands at just 6.6%.


McDonald's, by comparison, has an operating margin of 30% and a net profit margin of nearly 20%. Even struggling Burger King (BKW) has operating margins in excess of 20% and a net of more than 4%. Yum Brands (YUM), which owns Pizza Hut, KFC and Taco Bell, falls in the middle, with operating and net margins of 16% and 12%, respectively.


So, as an unprofitable chain with razor-thin margins, it seems Wendy's had no choice but to raise prices on its value menu. And the market certainly appeared to like the move, sending shares up more than 1% on the news.


But that reaction may be short-sighted and short-lived.


Wendy's revenue was forecast to grow just 3% to 4% in upcoming quarters. The company has almost no room for error in its margins -- but then it doesn't have much breathing space when it comes to top-line results, either.


As of this writing, Dan Burrows did not hold positions in any of the aforementioned securities.


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134Comments
Jan 7, 2013 10:55PM
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Thanks Obama. Now we can't afford to eat cheap fast food.

Jan 7, 2013 10:34PM
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Wendy"s used to be a have a great burger and fries. they to change it all and the burgers are bland and the fresh cut fries suck!!! I really used to like food from them but now my fast food choice is Culvers
Jan 7, 2013 9:48PM
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This is a real life example of how folks determine the value of a dollar. If the burger becomes more expensive and folks reject the purchase at the increased price point, the restaurant will either do without the sale or  drop the price and live with a declining profit. If everyone declined/ delayed purchases until the price was reduced, the dollar would increase in buying power. We will never do this as a population consistently. The government is now doing this for us by reducing our paychecks.
Jan 7, 2013 9:46PM
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raise as high as they want to maybe it will stop me from going to them to eat so much. I am to fat any ways ,so i could use to lose the pounds.

 

Their was a time in the Grate country of ours we did not go out to eat every day more like once or twice a mouth we would go out to eat. The rest of the time we would stay home an eat home cook meals so i say get rid of the dollar menu all together  

 

yes i know what you are thinking i am fat an i should excise i should just shut my hole well i do not care what you think. Just stop eating so much,

 

yes i do eat it to much just look at the back seat of my car the truth is there. Look in the back seat of your car look at how much junk food bags an cups you have back there

Jan 7, 2013 9:14PM
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I go to a Wendy's just across an alley from a busy Panera Bread in my southern Calif. hometown and I like the cheap specials.  A green McDs is one of the busiest eateries along with an Applebees after 5pm for happy hour.  My sister lives up US 395 in Lone Pine with great views of Mt. Whitney and the Sierra Range.  A McDs is on the southern end of town, a Carls Jr on the n. end and a Subway halfway at the sole stoplight. 
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couple hamburgers and a parfait...$23.00....you are lying or had more than what you said..
Jan 7, 2013 7:06PM
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I hardly ever go to Wendy's. Last week I had to meet some people and they said to meet at Wendy's so that was the first time in three years I ended up there. Like Jack n box, it was dirty, they had only one person at the counter and about seven people in line. They were very slow in everything the did, often confusing orders and laughing about it. The food wasn't any better then three years ago.  I use to like going to Wendy's, but not any more. One time in three years is enough. It will be at least another three years before I go again if ever.
Jan 7, 2013 4:42PM
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Gee, higher prices and fewer sales.  You'd think these people would have a clue.  Sounds like basic economics to be.  Maybe management never took an econ course.  They might want to take one.
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I just moved to an area where the only fast food place near me is a Wendy's. I went a couple of times and was astounded that a couple of hamburgers and fries and one parfait came to $23.00. Now I never get to Wendy's and instead stop at the grocery store and get the same items for about $8.00. Sure, I have to cook them but their prices are almost surreal in this economy and the "fresh cooked" that they've been touting for 30 years certainly doesn't apply to this franchisee down my street! Dave should  be turning over in his grave!
Jan 7, 2013 4:28PM
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