Does Offering Keurig Coffee Make Subway a McDonald's Competitor?

The sandwich chain has found an inexpensive way to offer custom coffee.

Jun 14, 2014 at 8:32AM

Keurig Green Mountain (NASDAQ:GMCR) and Subway have partnered to bring Keurig's single-serve brewers to thousands of the restaurant brand's North American locations. 

Subway had quietly rolled out Keurig brewers in over half its stores in the United States and Canada but no formal deal had existed between the companies. Now, they have officially partnered to bring Keurig's K150 Commercial Brewing System to even more of the chain's North American locations. The K150 is a relatively small machine that takes up about as much counter space as a small microwave. 

By adding the K150 to its stores Subway can offer a diverse selection of coffee, teas, hot chocolate, and anything else offered in a K-Cup. That gives the sandwich chain the ability to offer a mini coffeehouse in each of its stores. That may not lure in customers seeking out a high-end coffee experience from Starbucks (NASDAQ:SBUX) but it could be bad news for McDonald's (NYSE:MCD), which has invested heavily in its McCafe brand.

As of 2012 Subway has 25,549 franchised stores in the United States (out of over 42,000 globally). That was significantly more than McDonald's and Starbucks, according to QSR Magazine.

Partnering with Keurig lets Subway bite off a piece of the coffee market without investing heavily in equipment or staff training beyond some basic cleaning and maintenance procedures.

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McDonald's spent big bucks

While Keurig does not list a price for the K150 on its website -- it's only available to qualified commercial accounts -- it can be found for sale on other sites for between $350 and $450. That's essentially no investment for franchisees, whereas McDonald's owners faced a huge tab to bring McCafe into their stores.

New McCafe coffee stations cost $100,000 to install and the corporation only covers $30,000 for franchisees, according to a 2011 Forbes article. Frozen drink machines added to some stores cost an additional $13,000. Those investments may payoff in the long-run but the short-term results have been mixed.

"While regular coffee sales are reported to be brisk, some franchisees have complained in surveys that sales of espresso drinks fall far short of covering the cost of the high-maintenance machines that crank out lattes and mochas with the press of a button," Reuters reported.

McDonald's did sell regular coffee before it launched McCafe but it made a heavy ad push about its upgrade to brewing the Newman's Own brand from its previous generic mix as it rolled out the cafes. The success of regular coffee while the espresso struggles suggests McDonald's might have been better off simply raising the quality of its normal coffee without introducing the coffee shop concept.

McCafe has clearly not turned around the chain's fortunes as it has seen consistently shrinking U.S. sales. That was true again in May as the world's largest restaurant company reported a 1% decline in sales for U.S. restaurants open at least 13 months.

Subway is making a morning push

Subway has not advertised the presence of Keurig machines in its stores even though over half have had them. The company has however periodically advertised its breakfast menu, which launched in 2010, though those ads have featured the Newman's Own coffee brand, not Keurig (which also partners with Newman's Own).

A call and an email to the Subway public relations department inquiring as to whether the company would be advertising the presence of Keurig machines in its stores was not returned. 

While the presence of Keurig coffee maker may enhance the company's breakfast appeal, coffee is an all-day offering that may bring in business during the quiet periods between the lunch and dinner rush. The holy grail for restaurants is luring customers in between meal periods when stores remain open and must be staffed but fewer customers are buying. An increased coffee offering gives Subway an all-day product, which should bump up sales during these slow times. How much depends upon what the company does to get the word out. 

Can they make money with it?

With so much money invested, the risk for McDonald's owners is high. Subway franchise owners are spending essentially nothing to open up a huge market. Even if they only sell a couple dozen cups of coffee a day the bottom line impact could be significant. Assume Subway franchisees can purchase K-Cups wholesale for around $0.25 each (about half of retail) and that they have another $0.25 in cost of delivery (the cup and labor). If they sell each cup for an average of $2 that means $1.50 in margin, $37.50 a day, $262.50 a week, and $13,650 a year. 

That's nothing for a McDonald's, which leads QSR Magazine's annual top 50 list of fast food restaurants with an average of $2.6 million in annual sales. But it's meaningful to Subway. The generally much smaller stores each do about $481,000 in annual revenue, so this would be a nearly 3% sales spike. 

If a franchise managed to move 100 cups of java a day -- remember, Subway is a high-volume business -- it would add an additional $54,600 in annual revenue, an 11.35% jump. Nearly any business would be happy to parlay $500 of capital investment that takes up very little real estate into gains even on the low end of that scale.

The best thing for Subway owners is that even if the numbers are lower, the machinery cost will be paid off after 300 or so cups of coffee sold. If it takes a year to do that, the Keurig deal is a failed (but cheap) experiment and the owner now has a very fancy coffee maker to take home.

McDonald's bets big

Subway allowed its franchisees to offer a reasonable coffee solution for a very modest investment. McDonald's made its franchise owners bet big on a grand plan that might be a huge overreach.

While McDonald's has failed to take share from Starbucks in espresso drinks, Subway may very well cut into the McCafe business. Coffee from a Keurig at a Subway may not be quite as good as the McDonald's offering but the differences are slight at best. It seems likely that if someone just wants coffee and is willing to buy it from a fast food chain, convenience will mean more than any small quality differences. McDonald's may lose share because its customers pass a Subway first.

Subway knows that Keurig is a good enough solution in a tiny package, not a complete answer to a coffee house. If its customers order more coffee, the chain can always look into adding single-serve espresso options (which Keurig also makes). Until then there is little risk with a lot of upside. 

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Daniel Kline has no position in any stocks mentioned. He was drinking coffee from a Keurig as he wrote this. The Motley Fool recommends Keurig Green Mountain, McDonald's, and Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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