FOOL PLATE SPECIAL
McDonald's Opens McCafe

McDonald's is opening its first "McCafe" in the United States later this week, and it's definitely a new direction for the company. While McDonald's needs the diversification, it seems unlikely that its brand will be effective in this market.

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By Chris Rugaber (TMF Chris)
April 30, 2001

If you've grown tired of the typical McDonald's (NYSE: MCD) offerings -- Big Mac, fries, and a Coke, yawn -- then never fear, you may soon be in for more variety than you ever expected. Just imagine a nice McDonald's tiramisu, or a hot, frothy cappuccino. Yum!

Unfortunately for most of us, such possibilities are still probably several years away. However, as reported in today's USA Today, should the company's new concept -- a Starbucks (Nasdaq: SBUX)-style coffeehouse called "McCafe" -- fare well in its first test run in downtown Chicago, we should expect to see perhaps 100 to 200 more McCafes in the U.S. over the next year. No word on whether the cappuccinos will be referred to as "McCappuccinos."

The McCafe is new only in the U.S. The first opened in Australia way back in 1993, and there are now about 300 in other countries around the world. While the company has released few details about them, presumably they've done well if the concept is going to be introduced here.

Diversification makes sense for the fast-food company, given that growth is clearly slowing for its core McDonald's franchise. Whether the company can tackle the upscale coffee market, however, is another question. It should prove a fascinating test of how brand identity works. Will the choice of the "McCafe" name help or hurt?

A necessary move
While the concept sounds unlikely, McDonald's does need new sources of growth, as it is probably reaching a saturation point with its core restaurants. There are now 27,871 McDonald's restaurants worldwide, as of March 31st, almost double the total seven years ago. Most of this growth has been overseas, since the company is running out of room in the U.S. As of the first quarter of this year, McDonald's increased its U.S. restaurants only 1.5% year-over-year, to 12,811, while international McDonald's units increased 10.7%, to 15,060.

Nevertheless, all these new restaurants are reaching the point of diminished returns, both in the U.S. and abroad. Revenue growth is sputtering worldwide, not just in Europe, where various cow diseases have spooked the population.

In the U.S., comparable-store sales -- for those restaurants open at least a year -- eked out a 1% gain last year, while comp-store sales declined 2% in both Europe and Asia, and dropped 7% in Latin America. These figures are in local currencies, so they do not include the negative effects of the strong dollar.

Other restaurants
As international growth slows, the company is showing better results from its "other brands" category, which reported $225.6 million in sales for the first quarter of 2001, as opposed to only $47.4 million in last year's first quarter. This increase is largely due to the company's purchase last year of the Boston Market chain, but McDonald's also owns or has stakes in several other growing franchises, including Chipotle Mexican Grill, Donatos Pizza, and Pret A Manger in the U.K.

As Fool analyst Todd Lebor pointed out in February, McDonald's is not the only fast food -- or "quick serve," as the industy prefers -- company moving in this direction. Wendy's (NYSE: WEN), in particular, is looking for other food concepts to boost its sales and earnings growth. However, it may be tough for McCafe to significantly contribute to McDonald's bottom line.

Poetry slams at McCafe?
According to a press release from McDonald's Chicago regional office, the McCafe -- which will open in downtown Chicago on Wednesday, after a ribbon-cutting tomorrow morning -- will serve "high-end cakes and pastries, gourmet coffee ... premium teas ... Viva Tiramisu [and] New York Style Cheesecake. ... Food and beverages will be served in fine china along with stainless steel flat ware. The warm decor consists of leather couches, chairs and bistro style tables with accents of mahogany, granite, lace curtains and French vintage posters."

That's a long way from formica tables and Happy Meals! This raises an obvious question: Who is the target McCafe customer? Let's face it, most consumers -- even those (like myself) who are happy to patronize both McDonald's and Starbucks -- may have a problem with a combination of the two. Does the company expect snooty gourmet coffee drinkers to flock to something called McCafe, or does it expect people who might not otherwise like upscale coffee and pastries to be attracted by the McDonald's brand?

We shall see. Personally, I enjoyed visiting a Pret A Manger during a trip to London two years ago, and had no idea I was visiting anything associated with McDonald's. Not that this necessarily would have discouraged me, but there are times I'm just not in a McDonald's mood. The company's other restaurant concepts don't carry the McDonald's name, so it's interesting to see them try it with this one. I doubt the brand will help, though, and wouldn't be surprised to see a name change somewhere down the road.

Chris Rugaber, he got a dog named "Blue," and he'll betcha five dollars he's a good dog, too. His stock holdings can be viewed online, as can the Fool's disclosure policy.