Why McDonald's Is Taking On Starbucks Over Coffee

At the end of this month, Starbucks  (NASDAQ: SBUX  ) is likely to post a result that will draw little attention, but is intriguing for its larger implications: The company will overtake McDonald's  (NYSE: MCD  ) for the first time in pre-tax earnings in Japan.  McDonald's, of course, has struggled in Japan recently. Its 50-owned Japanese subsidiary recently announced that it was closing 74 stores, or about 2.3% of its total store count, due to declining customer demand. Starbucks' demand arc in Japan is quite another story -- the company has gone from zero to more than 1,000 stores in less than 20 years. 

The two businesses' trajectories in Japan are emblematic of a more global phenomenon. On nearly every continent, McDonald's is struggling to maintain its growth momentum, while Starbuck's has seemingly effortlessly posted a recent annual growth rate of 11.1%. McDonald's is dealing with a number of factors crimping its revenues, the most prominent of which is a sea change in consumer preferences, for higher-quality, fast-casual establishments over quick-service chains like McDonald's. Yet recently, the company has zeroed in on Starbucks as a threat to its business. Here's Chief Operating Officer Tim Fenton during the company's most recent earnings call, discussing the last quarter's problems and mentioning Starbucks but not by name:

... we lost some share based on our insights to non-traditional competitors, cafés, and bakeries."

As Bloomberg reported a few days after this call, internally, McDonald's has challenged its operators to protect its breakfast segment by winning what it deems a "coffee war" with Starbucks.

Will McDonald's wrench significant amounts of market share from Starbucks with this new push? It's doubtful. But CEO Donald Thompson understands that sometimes, to push forward a big strategic objective, you need to humanize the objective and create a villain that your troops can rally around to defeat.

The point of appearing to go to war
In this case, the strategic objective is simply to increase coffee-driven visits in the U.S., as such visits usually occur at breakfast, which accounts for 25% of company revenue. The strategy is likely informed by the chain's recent experience in Canada. In 2008, career McDonald's executive John Betts took over the company's Canadian division. Along with upgrading McDonald's Canadian locations to a more contemporary aesthetic, Betts implemented a plan to draw more Canadians into McDonald's outlets with coffee, because Canada, similar to the U.S., is a coffee culture. 

Most notably, McDonald's Canada began giving coffee away for free, first running this promotion in 2009. The emphasis on coffee won over skeptical Canadians, and since then, coffee sales in Canada have tripled, and breakfast has seen double-digit sales increases for the last five years. As Betts archly stated in 2012: "When you change someone's coffee habit, you have got them." 

In the U.S., McDonald's can't expect to triple its coffee sales in five years by giving away free coffee. When Starbucks was but a single crammed location in Pike Place Market in Seattle, and the company's global footprint existed only as a network of neurons in Howard Shultz's brain, McDonald's provided by default the most widely available retail cup of coffee in the country. Today, the landscape has changed irrevocably. What McDonald's can expect by pushing a "gold-standard cup of coffee with every visit" is to regain traction with wavering customers.

As CFO Pete Bensen stated during the company's most recent earnings conference call, "If we lose relevance in coffee, then we are going to lose the transaction which yields food purchase." In other words, if the company can direct more of the legions in need of a coffee fix through its arches during breakfast, the rest of the transaction will fall into place. It's interesting how well Woody Allen's famous quote that "80% of life is showing up" applies to a simple and well-reasoned corporate strategy like this one.

McDonald's coffee-led breakfast strategy in visual terms. Image courtesy McDonald's. 

Toward this goal, McDonald's has quietly laid the groundwork for increasing the quality, supply, and promotion of its coffee. Last year, the company announced that it was investing $6.5 million to assist more than 13,000 farmers in Guatemala and other South American countries, to scale up volume of high-grade arabica coffee beans, as well as to assist small-scale farmers with sustainable agricultural methods.

As for promotion, the company's well-publicized push into packaged coffee through its new partnership with Kraft might be construed as an attempt to compete with Starbucks in the retail grocery venue, but it's more immediately about heightening coffee brand perception. It is betting that U.S. incentives such as its "$1 any size coffee" at breakfast, coupled with McDonald's-branded coffee in grocery stores, will keep its coffee top of mind versus Starbucks and other competitors. If increased business at breakfast eventually leads to additional sales of packaged coffee, as well as more non-breakfast visits, the company will take it as a bonus.

Vegetable & Fontiago Breakfast Sandwich. Courtesy Starbucks.

A reaction from Seattle
How is Starbucks responding to McDonald's sudden pressure on the coffee front? By ramping up its new breakfast offerings, of course. This month, the company is introducing four new premium breakfast sandwiches, with enticing names including "Slow-Roasted Ham and Swiss" and "Vegetable & Fontiago." Tearing off a sheet from the McDonald's strategy notebook, Starbucks will offer a free Grande-sized brewed coffee with the purchase of a breakfast sandwich from March 12-14. Of course, Starbucks also has a larger strategy in mind, which is to generate a larger transaction per customer. Yet it speaks to the importance of the breakfast market that given a few more disappointing sales quarters from McDonald's, or any sign of Starbucks' vaunted growth slowing, and these two giants could be headed for confrontation after all.

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Read/Post Comments (26) | Recommend This Article (28)

Comments from our Foolish Readers

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  • Report this Comment On March 11, 2014, at 5:18 PM, cjoub wrote:

    The problem with Mc in my view is not the coffee it is the service help, all too often you stand at the serices counter only to watch a service person carry on a conversation about some thing they think is more important that the customer at the counter. Uniforms are not neat anymore and the focus has change from the customer. i may have to sell my position on this one!

  • Report this Comment On March 11, 2014, at 5:24 PM, plantoretire1day wrote:

    In down to earth terms, many of my friends do not like McDonalds. These are not super health conscious people. It is simple. The food generally does not taste good except for a few items (e.g. the stingy meat big mac and the parfait). My friends prefer other fast food businesses. It was not always like this or could it be that we are burned out from the flavors? One thing I have experienced, when McD presents a new item, it usually does not live up to their hype in flavor, with the exception of their new cold drink options in recent years. They have to get it together and test out their new food choices and obtain reliable data. Also it could be a regional thing in the US as what new item will be considered yummy and what isn't. You usually don't lose market share if you have a very good product that is priced right. They need to go from okay or semi good to great. It used to be a treat, now its worse than everyday, it's blah. This post is meant to help McD's if they see it by the way, not to harm. I'm still a weekly customer by the way.

  • Report this Comment On March 11, 2014, at 7:02 PM, hdweeks wrote:

    Having been involved in the early R&D by MCD for the roll out of it's coffee line I can tell you the quality of MCD's brewed coffee was far superior to that of SBUX.

    Both companies have tried to Americanize the specialty coffee business. Rather than learn for the Italian Masters of Specialty Coffee, both have tried and failed , in my opinion , in creating a quality, consistent coffee product line.

  • Report this Comment On March 11, 2014, at 7:17 PM, westhampnett wrote:

    To compete with Starbucks, McD's would have to vastly improve its coffee, and its pastries (offer variety and quality equal to Panera). More empty promises will be counter-productive.

    Doing both should be possible, but would require extraordinary management. The secret about Starbucks coffee is that its really not great -- just great hype.

    McD's Ambiance would have to change too, and that would be difficult.

    Since owners are no longer actively involved; and McD's managers almost certainly don't have the vision or daring-do of visionary entrepreneurers, McD's wil probably not suceed.

  • Report this Comment On March 11, 2014, at 7:40 PM, theeseer wrote:

    Mc Donald's has a nice busy store in the heart of the business district of Medellin Colombia and that is amazing considering competition from the local leader Juan Valdez and the soon to arrive Starbucks. The store is nicely laid out with high end coffee in a somewhat separated cafe area with a a patio and WIFI. Their other store in a mall has a less attractive cafe area and only does substantial food business. The lesson here is that store design counts and using real espresso machines also counts. To succeed they must also offer quality at a cut rate price to offset the "cache" of Starbucks.

  • Report this Comment On March 11, 2014, at 9:09 PM, sharpx2 wrote:

    Hey McDonalds . . . until I can just walk up to the counter and order a double shot, your coffee initiative is inadequate. Right now, the cost for a double shot varies from store to store, depending on the training of the staff and the manager. I have paid as little as $1.00 for "two extra shots" and as much as $3.00! Why? Because the program for your fancy coffee machines doesn't include the possibility that someone just wants espresso and not "an extra shot in that coffee." Starbucks has a much more nuanced approach to making coffee. As to the quality of both brews, I have found that both of them have a fairly decent product, but not as good as what I have at home every day. One problem is that the coffee is generally cooked to death and brewed with boiling water, which is about 10 degrees above the optimal temperature for coffee making. Starbucks Clover machines compensate for this, but their bulk-produced, brewed coffee does not. So I can believe that the MCD'S product could be superior. Doesn't matter until McDonald's can actually think like a café and not a fast food emporium. Just FYI, long in both SBUX and MCD

  • Report this Comment On March 11, 2014, at 10:53 PM, Daveoffv wrote:

    I go to McDonalds most mornings and order a senior coffee for 64 cents. I find a comfortable booth and read my newspaper in quiet, friendly atmosphere. My wait in line for service is not as long as Starbucks and I honestly feel the coffee is as good. There is a minimum of loud people on their cell phones whereas at Starbucks many people talk loudly on their phones to impress their fellow coffee drinkers. The people at McDonalds are interested in a good cup of coffee and don't have a need to impress their fellow coffee drinkers.

  • Report this Comment On March 12, 2014, at 12:48 AM, TMFfinosus wrote:

    cjoub, sometimes personal observation can help firm up your investment thesis; looks like you've seen enough!

    plantoretire1day, McDonald's is planning to sell sustainable beef by 2016. Maybe initiatives like this will increase the quality and taste of the food, let's see.

    hdweeks, interesting observations. Personally I'm more apt to buy a brewed coffee from MCD than SBUX -- it's a personal preference, but I think SBUX roasts are overly acidic, always towards an almost burnt profile. McDonalds knows how to serve up a high quality arabica bean at a temperature that brings out the bean's rounded taste. But my first choice is always good local cafes in the downtown of the city in which I live. Better beans, locally roasted, and a nicer, less homogeneous experience than either MCD or SBUX!

    westhampnett, I almost think MCD would have to buy a small coffee chain and expand it if their goal was truly to displace SBUX.

    Hey theeseer, all coffee chains will be extra careful to present themselves well in Columbia because as everyone knows, the coffee culture is very strong down there. By the way, Cartegenas de Indias is on my wish list for travel!

    sharpx2, I think MCD has given up on a full blown McCafe concept here in the states, and hence the training suffers. By the way, did you ever get a chance to try a coffee from a Clover machine before SBUX bought the company out? I had a few coffees from a Clover in Toronto several years ago, and I swear the product coming out of SBUX machines isn't as good for some reason. By the way, not bad to be long both MCD and SBUX!

    Daveoffv, valid points on the value. MCD got beat up in the press for the restaurant in Queens that was hostile to the senior crowd, but I don't think this is the norm. See my comments above on MCD versus SBUX taste.

    Thanks everyone for the comments!

    Best,

    Asit

  • Report this Comment On March 12, 2014, at 2:40 AM, mikiissexy wrote:

    Speaking strictly as a guy who drinks too much coffee. I have to say McDonald's coffee is pretty good. I was impressed when they rolled out their new but cheap coffee a few years back. But I haven't gone there for coffee in some time because I would keep getting a cup that tastes like it's been sitting around on the heating element for too long. I look forward to being able to huy a bag of their beans to put through my burr grinder and Moccamaster, so I don't have this problem. I hope it's really cheap, like their brewed foffee. I wonder what took them so long to come up with this. One of my first reactions when I tried their coffee was I wish I could buy a bag.

    I think most coffee drinkers are too quick to dismiss Starbucks. Starbucks coffee really tastes like quality coffee to me. It is darker across it's entire selection, but coffee from no name brands or Dunkin Donuts just do not compare. It is bitter, but its medium roasts are rich and consistent. I feel like most who drink coffee just don't have a discerning palate, hence the popularity of Dunkin Donuts and Keurig.

    I have had coffee better than Starbucks, but those brands and single origins I like are much more expensive. When I'm outside, I'm gonna probably go to a Starbucks for coffee even though what I drink at home (Intelligentsia, Stumptown, Sightglass, Peet's, Mr. Espresso, or various Konas and Kau coffees) is better, lighter, or it's dark the roast is not as bitter. Unless I'm close to my favorite local coffeeshops, I like other chains' coffees even less than Starbucks's Pike Place roast.

  • Report this Comment On March 12, 2014, at 5:34 AM, GlobeTrttr wrote:

    The gap McD's would need to close to get close to beating Starbucks is perception of luxury and status - in EU the McCafe's are sophisticated outlets that get closer to the SB's feel - in the states showing up with McD's coffee is like having a Coach bag - while SB is Louis Vuitton. The principle that people will paya premium to associate their personality with a brand is well established -SB has nailed the perception at the top of the ladder while McD will have a climb to get there. The ruthless efficiency of SB getting folks in and out with their luxury coffee is another area where McD's will be challenged with spotty cleanliness and service efficiency. More likely they'll occupy closely stratified but separate niche's

  • Report this Comment On March 12, 2014, at 9:30 AM, RandyNC wrote:

    I've struggled with getting anything customized when ordering latte drinks from McD. It's gotten better over the last few months locally (in Raleigh, NC) and I think that some of that has to do with the fact that the McD's that I frequent are all owned by the same operator and I have provided quite a bit of feedback to that operator. Pricing is becoming more consistent, and I can see staff training getting better in terms of how to construct coffee drinks when a customer asks for something different than the standard program. As far as TASTE, to me, it's better than the latte drinks at SBucks and it's a bit cheaper as well. I don't mind going to McD for a latte but I want it made the way I want it made - not the way it typically comes out of the machine. They have some limits on what they can produce w/ the super-automatic machines and I realize that, but they can do easy things like add an extra shot, lower the standard amt of syrup shots added, etc, etc. Like I said, getting better overall, but still not quite where it needs to be to take on SBucks in terms of a customized drink delivery.

  • Report this Comment On March 12, 2014, at 10:15 AM, TMFfinosus wrote:

    mikiissexy,

    I hear you on the overconsumption brother. Good analysis on the relative merits of different brews. The Guatemala Cielo (?) coffee offered by SBUX once a year is quite good & reminds me of some of the smaller roasters' coffee you mention.

    GlobeTrttr,

    I wonder if MCD got its cafe edge in Europe from not having to deal with existing legacy restaurants in many locations, as is the case here. MCD in the states was/is dealing with restaurants in business for years/decades, so conversion to McCafes wasn't easy. Perceptive comments.

    RandyNC,

    I'm from Raleigh too. I think I know the operator you're talking about. They own some of the North Raleigh locations, say the corner of Falls of Neuse & Spring Forest, correct?

    I personally have been impressed by the brewed coffee at Lenoir Street and Peace Street locations, which are more urban but serve a more consistent cup than their wealthier cousins uptown. (IMHO!).

    I appreciate all the knowledgeable comments!

    Asit

  • Report this Comment On March 12, 2014, at 1:09 PM, PJSacchetta wrote:

    I can't read one article on this site without at least one shameful plug for some report or service at the end of it. There is a plug for a free trial even before the author's disclosures. Then there is a plug for the CEO's four stocks even before the comments begin.

    The article, disclosures and comments belong together. Ads or shameful plugs belong after the article or somewhere else on the page.

    If you want people to take fool.com seriously stop the incessant selling at every single turn, webpage or email. We know you sell reports and research. We are not stupid or ignorant.

    Right now it's a battle between Forbes and Fool as to which product is more annoying. If I'm a paid subscriber to one of your products I don't need to sold at every turn. Be professional. Annoyed people don't return to the site as often. Common sense folks!

  • Report this Comment On March 12, 2014, at 2:14 PM, TMFfinosus wrote:

    PJSacchetta,

    Thanks for the feedback, I'll pass it on. Sure, we try very hard to catch the eye of new potential subscribers, but as you can probably tell from this article (http://goo.gl/VpPK1t) we believe we have a superior track record on advisory, and at the end of the day, we want to continue to make a profit to keep providing solid analysis and advice. Plus, when you read one of our articles from our site or a news feed, you're essentially getting our reasoned analysis for free, so I hope that encountering the copy aimed at new subscribers is a small trade for value.

    Regards,

    Asit

  • Report this Comment On March 12, 2014, at 8:45 PM, MfromG wrote:

    Until McDonald's coffee quits tasting like hot cat piss I don't think SBUX has anything to worry about on the coffee front.

  • Report this Comment On March 12, 2014, at 11:01 PM, TMFfinosus wrote:

    MfromG,

    Dude, a first: you just offended me *and* Ronald McDonald in the same comment.

    Asit

  • Report this Comment On March 13, 2014, at 9:30 AM, taloft wrote:

    I have to agree, the clown makes bad coffee. Maybe it is just the franchise near where I work but, the coffee is always too acidic. It taste like it has been sitting around all day.

    SBUX on the other hand is consistently good across all the stores I visit.

    You get what you pay for.

  • Report this Comment On March 13, 2014, at 2:09 PM, FoolishLonghorn wrote:

    "You get what you pay for. "

    I am a coffee addict, but a frugal coffee addict. I never go to Starbucks other than with family or friends who insist on going there.

    I also rarely set foot in a McDonalds. But the few times I have purchased coffee there, it tested fine.

    With Starbucks, it's really not about the quality of the coffee. If I want a quality cup of coffee, there are many places where I can get one for far less money.

    For friends and family who like to go to Starbucks, it's about the atmosphere, the variety, and the service. Something which Mickey D's is very unlikely to match.

    Most of those who have negative comments about McDonalds coffee rarely, if ever, go there.

  • Report this Comment On March 13, 2014, at 3:07 PM, damilkman wrote:

    Overlooked in this entire discussion is the margins. Come on folks, we all know that the secret is the more beverage you sell the better your margins are. Think about it. People are willing to spend triple the base cost of the food to eat out. But they will pay TWENTY times the cost to DRINK OUT!!!!!

    That is the punch line why McDonalds wants to make inroads in the beverage business. People are paying up to 5 dollars for something that if they made it at home would cost a quarter. I can buy an entire combo meal at McDonalds for 5 dollars which is what I see people paying for one specialty beverage.

  • Report this Comment On March 14, 2014, at 9:15 AM, TMFfinosus wrote:

    damilkman, I think you have a valid point. I've often discussed margin as a driver for both SBUX & MCD in my coverage of their business decisions -- not so much in this article. To your point, if I'm not mistaken, not only does breakfast account for 25% of MCD's U.S. revenues, it's also the company's most profitable meal. Good insights in your comments.

    taloft, that's funny, as in my experience SBUX coffee is the more acidic of the two. I have to agree with FoolishLonghorn (see comment right after yours): it tests fine.

    FoolishLonghorn -- yup, MCD will have trouble matching the SBUX experience here in the U.S. But in Europe I believe it still has the ability to go mano or mano.

    Any one have thoughts on McCafe in Europe?

    Thanks,

    Asit

  • Report this Comment On March 14, 2014, at 2:59 PM, marbleskies wrote:

    Reality.....

    1) SBUX w Drive thrus obtain 70% of their business via the DT. So the SBUX experience for the majority of SBUX DT customers is within their car and what is in the cup.

    2) In 2006 SBUX switched to the Varisimo (sic) coffee maker which is a one button operation. Hence the art of expresso making was reduced to the art of programming and pushing a button. The footprint of the machine is two square feet.

    3) In 2007 McD commenced testing their McCafe concept which has now become their main footprint for new builds and retrofits.

    4) To ramp up competing w/ SBUX McD needed to only convert two square feet of existing space to install a "like kind" Varisimo coffee maker.

    5) In 2006 SBUX attempted a chain wide installation of "warmers" to expand their food offering with a focus upon breakfast entrees. The attempt was a massive failure due to: lack of room within their existing already compact preparation area, an unappealing offering of breakfast product, lack of effective marketing to DT customers and failure to implement a dish/table clean up program within their dining room area.

    6) In 2007 SBUX hit the wall of too rapid growth without strategic and market planning initiatives. At the time the leader of SBUX, Howard had stepped aside, was a former Walmart guru.

    7) In 2008 Howard took back the controls, made significant business decisions that cut expenses w/ vastly reduced payrolls and took a deep pause on new store development.

    8) Today McD is on the move by recognizing the need to improve the quality of their coffee product which is not that difficult to do. When the coffee maker is push button dumb then what goes into the coffee maker becomes critical.

    9) In terms of marketing, store operations handling food prep and speed of service McD has the advantage.

    10) However, I am hanging onto my SBUX stock and not buying McD as SBUX has a vast brand advantage with customer loyalty (especially among women - whom I have seen almost turn their cars onto two wheels in a fast u-turn motion to get back to a SBUX DT location).

    11) So while McD should be able to increase their coffee sales it is yet to be proven these sales will come at the expense of sales transfer from the key SBUX customer segments.

  • Report this Comment On March 14, 2014, at 4:46 PM, oshuneer wrote:

    McD's coffee isn't bad and the price is right but it's silly in thinking it competes with SBUX. McD's sells generic food and quantity, SBUX sells atmosphere and quality. The two just aren't the same.

  • Report this Comment On March 14, 2014, at 4:49 PM, cmalek wrote:

    To compare Micky D's and Starbucks head to head is silly. Each caters to a different demographic and their focus is on different type of food. Most MCD customers would not go to Starbucks and most SBUX customers would not be caught dead at MCD. A more accurate comparison would be MCD to Dunkin Donuts, and SBUX to Panera. I think Asit is trying to create controversy where none exists.

    In my personal opinion, coffee at any chain provider, be it MCD, SBUX, Panera, Dunkin Donuts, etc. does not measure up to what can be brewed at home. As someone said above, it sits around too long and that is why I go out of my way to avoid drinking coffee out. But then some people will drink anything, as long as it provides them with the caffeine kick.

  • Report this Comment On March 15, 2014, at 10:00 AM, TMFfinosus wrote:

    Hey marbleskies, nice recap of events. As per your point #9, I'm curious how the new high density tables will affect food prep and the food customization MCD is experimenting with.

    cmalek,

    How's it going? We never seem to agree, but here I don't think you read my article very carefully. It's not silly to compare MCD to SBUX at all: that's exactly what MCD is doing when it tells its franchisees that it's "going to war with Starbucks." That's not a figment of my imagination, but from an internal memo reported on by Bloomberg. I do grant that MCD to DNKN is more appropriate, but this article analyses the strategy MCD itself is putting forward.

    Yes, home brewed coffee is best when you have the time. I love my Bialetti stovetop espresso maker and my Hario "one-cup" device, but as someone who's out and about quite a bit, I seem to sample coffee from every place imaginable. I'm not addicted, am I?

    Best,

    A

  • Report this Comment On March 16, 2014, at 3:43 PM, stockdissector wrote:

    Good stuff Asit.

  • Report this Comment On March 25, 2014, at 10:30 AM, mbushman wrote:

    McDonalds - you want to win me as a customer on coffee? Offer me milk to put in it (not crappy little hard to open non-dairy creamer capsules).

    Seriously, I pay 2x the price for Starbucks not because it is better coffee, but because they give me real milk to put in my coffee (and the cinnamon and cocoa etc is a nice bonus).

    Simple, inexpensive, and I'll bet a reason foor more than just me.

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