Tuesday, May 03, 2005

Espresso with your Big Mac and fries? McDonald’s roll-out of premium coffees to compete with Dunkin Donuts, 7-Eleven, and Starbucks

McDonald’s has recently introduced premium roast coffees into Michigan and Southern California test markets with national launches to 13,000 US stores expected later this year. While leaders of the $19 BN quick-service hamburger giant claim the new coffee line is a natural product extension and meets ever-evolving customer needs, others suggest McDonald’s is merely reacting to increasing competition for early morning business by Dunkin Donuts and 7-Eleven. Both have recently introduced their own premium branded coffees with great success. McDonald’s has also seen quick-service growth channeled to high-end coffee chains such as Tim Horton’s and Starbucks. Can McDonald’s simultaneously fend off Dunkin Donuts and 7-Eleven charges while capturing share from Starbucks and other high-end café’s?

The number of adults drinking premium coffee has nearly doubled in four years, growing to an $8.9 BN industry. McDonald’s first attempted to tap into this lucrative market in 1993 through Starbucks-modeled McCafes. With locations in the US, Asia Pacific, and Europe, McCafes offer premium coffees, teas, desserts, and sandwiches without McDonald’s mainstay burger and breakfast menu. While McCafes have been successful, McDonald’s has historically kept their higher-quality products and coffees out of their 30,000+ traditional quick-service restaurants. McDonald’s new strategy is to bring the product lines closer together. Some stores, such as the recently renovated Chicago flagship, include a second counter “Bistro” selling cappuccino, latte, and gelato. But the greater emphasis is providing better service (e.g., free Wi-Fi access), higher quality foods (e.g., new McGrill and salad products), and premium coffees to customers.

In the nineties, McDonald’s got away from their traditional family-based appeal and began to rely more and more on young males and lower income individuals for sales. High-quality coffees would appeal to middle and upper income individuals who are willing to pay a premium for better tasting beverages. A Convenience Store News article suggests that competitors are using premium coffee sales to take market share away from McDonald’s.

Domestically, McDonald’s move to offer premium coffee and fight back against donut and coffee shops makes sense. In fact, analysts say that the premium coffee market is one ripe for the picking for fast food chains. McDonald’s could achieve a first-mover advantage by being the first fast food chain to tap this market. Coffee sales of any type are highly profitable, and McDonald’s needs to defend its drive-to-work business. This new line of products may also attract more customers throughout the day to sip coffee during non-mealtimes – and push more food revenue sales in off-peak times. This move helps McDonald’s in their strategy to re-center their product offering and customer appeal to middle-America. While McDonald’s advantage vis-à-vis other quick-service players Burger King and Wendy’s will likely be short-lived, they will at least defend their turf against Dunkin Donuts and 7-Eleven in the competition for early morning caffeine.

We are more skeptical about Ronald McDonald & Co. competing with Starbucks in the US and Europe. Part of the obvious appeal Starbucks offers that core McDonald’s restaurants do not is atmosphere and service. Piping in jazz music and installing plush couches might work for Starbucks, but would likely alienate core McDonald’s customers and makes no sense in a fast food environment. From a service standpoint, Starbucks employees often recognize repeat customers and know exactly how to serve that customer’s favorite drink. Operationally, McDonald’s would face increasing complexity if they tried to offer the same wide variety of cappuccinos, lattes, mochas, and combinations thereof that Starbucks offers today. McDonald’s target is to deliver food within three minutes of a customer order. Unless a separate counter is setup in a traditional store, it would be extremely difficult and expensive to offer Starbuck’s product offering in a traditional McDonald’s store.

While we question whether McDonald’s premium coffees will fend off Starbucks in the US and Europe, the stage may be set for a more competitive showdown in other regions. In-store and McCafe premium coffee sales could act as a preemptive strike in emerging Asia and Latin America countries to Starbucks’ expansion – before Starbucks unilaterally defines and captures the high-end premium coffee markets. Generally McDonald’s is perceived as a higher-end product outside of North America and Western Europe already. With existing advantages in supply chain infrastructure and brand recognition, McDonald is well positioned to roll-out premium coffees and products to growth markets before Starbucks develops a US-like presence in Asia and Latin America. Operational issues will still exist, so careful vetting of product and service will need to be performed. The mini-café “bistro” approach (e.g., of the new Chicago flagship McDonald’s) would offer similar products to Starbucks and appeal where McDonald’s is still seen as a luxury good.

So McDonald’s does seem to know what they’re doing. In-store premium coffee sales will impede the likes of Dunkin Donuts and 7-Eleven and might even attract a few new customers that want higher quality dining. The more attractive market for Starbucks-styled premium coffee sales is probably Asia and Latin America. There, McDonald’s can take on Starbucks directly and become a leader in exporting over-priced coffee and canned McAmerican culture.

Carlos Atencio, David Michels, and Matt Sorenson

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