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.

More from InvestorPlace

Jan 8, 2013 8:20AM
For the price now of 2 Big Mac meals or 2 Wendy's No1 Combos you can get 4 pork chops,potatoes,salad and green beans or corn and cook them yourself and feed a family of 4. I do that with myself and my 3 kids.Sometimes chicken strips or a big stew and rice meal w/cornbread.

 Point is you can cook a good or decent meal for a family of 4 for what 2 fast food(?)meals cost. And not be hungry an hour later.
anyone else noticed that the Big Mac is a lot smaller than it use to be twenty years ago??
Jan 8, 2013 1:46AM
wendys is way better than mcdonalds.   mcdonalds hamburgers taste like cardboard with pink slime

Jan 8, 2013 12:55AM







Jan 7, 2013 11:35PM
I've always liked Wendy's, and continue to do so.  I don't know where all you people live and go eat, but I've never been in a dirty Wendy's.  Granted they're a franchise, but they do maintain standards.   If there's a Wendys aroung, I'll take it over McD every time.   I'm a real cheapskate.  I don't buy drinks there  (it's just flavored sugar water to me ) which is what they want, as they make money on those.  But if they want to go up a bit on a good burger, I'll pay the extra.
Jan 8, 2013 2:34AM
Great input here  - how about going back and serving "" QUALITY "" AGAIN   Its not the price of the burger that makes or breaks your bottom line, but if its bad quality, no repeat business. Consumers need to be placed first, then your investors. Keep your consumers happier, and your investors will be wealthier.
Jan 8, 2013 12:05AM
The dollar menu is about all I can afford.  However, service has gotten so sloppy that I would rather keep my dollar in my pocket! Nothing worse then a cold fast food burger...dollar or not.
Jan 8, 2013 9:17AM

The problem with the economy is that stock holders are greedy. Profit margins that pad the rich mans pockets are the very thing that pushes the consumer away from their products. The bigger their profit the less the people can afford. Why not lower prices and encourage spending? Another gripe of mine is, WHAT EVER HAPPENED TO GALLONS AND HALF GALLONS OF ICE CREAM? Does the marketing world have to rip off the public by reconfiguring their containers to make us believe the 48 oz. of ice cream is still a half gallon? They remove 25% of the product and raise the price. I say we boycott Ice Cream Purchases until they figure it out.


Jan 8, 2013 9:49AM
Wendys really needs to stop putting people with no English on the drive thru speaker.  Those things are hard enough to hear w/o a heavy accent and someone who doesn't understand my order.  If I have to repeat it a third time, then I leave.  And I leave Wendys often, yet do not have this issue at McD or BK.
Jan 8, 2013 11:23AM
The reason these restaurants don't make money.....they have so many people running them that don't have a clue about, #1- Hiring, Training, and Managing people to be efficient and productive.  #2- Have no idea haw to manage costs in the restaurant ----paper, food, maintenance, etc.  #3-The very people that are running these restaurants at store level are extremely underpaid, and the hourly employees don't even make near poverty level wages.  They are allowed to run these restaurants because of that reason, to keep employee labor percentages down and all the  while keeping morale down also. They need to train their existing  entry level management, on everything from making a sandwich to cleaning, to cost.  Give some real attainable goals to meet, reward them for reaching them.  Try to RETAIN their people.  Productive, knowledgeable people are the key to making a profit in these types of places.
Jan 7, 2013 4:42PM
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.
Jan 7, 2013 11:37PM
We used to go to Wendy's a lot but they raised prices so high and give you less then McDonalds. You can almost see through their small burgers now. If they raise prices they need to provide a better, larger burger. Giving less and charging more does't work anymore.
Jan 8, 2013 6:50AM
If Im gonna buy a burger for as much as fast food chains charge nowadays its gonna be a damn good burger from Redmill or Five Guys.
couple hamburgers and a parfait...$23.00....you are lying or had more than what you said..
Jan 8, 2013 2:52AM
Out here on the West Coast....McD's....Wendys...Burger King they all know how to get a 20 dollar bill out of you. Its nothing for a burger and fries and a small drink for three or four people to be 20 or 25 dollars real quick. The crazy thing is the burgers are getting smaller...the frys taste like a cheaper oil....the shakes get loaded with all these fillers ..its like you are drinking whip cream......the soda is the only sure thing except when they are unloading a lot of ICE on you.........and the KICKER when did a small soda turn into an EXTRA LARGE, overnight?.....Ask for an Extra Large and they bring you this Gas Tank for 7 cents more...........ROFL!
Jan 7, 2013 11:56PM
I like the taste of their hamburgers, but their new fries are not nearly as good as their old ones. But they are still way too expensive ! Where I live in Southern California there is an "In n Out" restaurant, and Arbys and a Wendy's right next to each other and the Wendy's seems to never have any business at all. The Arby's doesn't fare much better. 
Jan 7, 2013 10:34PM
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
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 7:06PM
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.
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