Dunkin' Brands (NASDAQ:DNKN) didn't drop "Donuts" from its namesake chain's name because it wanted a shorter moniker. It did so to better focus its branding around its real core product -- coffee.
The move's designed to subtly change how people think about the company, encouraging consumers to equate Dunkin' with coffeehouse rivals such as Starbucks (NASDAQ:SBUX). The change may seem minor, but it's entirely on point: The company admitted in its 2017 annual report that hot and iced coffees were its most valuable products, not the baked goods it once built its business around.
The name change also comes at a time when McDonald's (NYSE:MCD) and JAB Holdings -- the privately held conglomerate that owns Panera Bread, Peet's Coffee & Tea, Caribou Coffee, and Stumptown Coffee Roasters -- are also in the midst of concerted drives to attract more coffee drinkers. In this crowded playing field, consumers have a lot of choices when it comes to price point, quality, and experience.
In general, restaurants' food costs land in the range of 25% to 35% of sales. Those are considered healthy margins. But coffee generally offers much more robust profits, with the cost of ingredients to produce a cup often sitting below 10% of its menu price.
"The actual coffee in a grande Starbucks Cappuccino costs roughly 31 cents," wrote AZ Central's. "The drink itself [sold] for around $3.65, in 2014."
That's a 91.5% profit margin on the coffee alone. (The cost of the cup they hand it to you in cuts into that a bit.) And the numbers have changed a little since 2014. Moreover, even McDonald's, Dunkin' and JAB may not quite have the buying power of Starbucks, but profit ratios for coffee make the beverage a highly attractive item for restaurants to promote.
Coffee is also in high demand. In a given week, 42% of global consumers visit a coffee shop for coffee, tea, or other drinks, according to a recent GlobalData report. That percentage sinks slightly to 40% in North America, but that's still a huge number of people.
In the fierce competition for those customers, Dunkin' occupies a sort of middle ground between the true "coffeehouse" players led by Starbucks, and the fast-food chains that have been upping their coffee games, a group led by McDonald's.
What wins customers?
The question for those companies is what they can do to gain an edge. Given that 48% of those surveyed by GlobalData cited "quick preparation" as something they value, one answer is obvious. And speed of service is something Dunkin' generally does well, though perhaps not as well as McDonald's, which built its entire business model around rapid turnaround.
Starbucks has also become a model company when it comes to getting drinks out fast, aided by its push into mobile ordering and payment systems. Dunkin' and McDonald's have expanded their use of those technologies as well, though neither has the mobile app user base of Starbucks, nor the experience it has built as a leader in that arena.
What's perhaps most interesting is that price has generally not been much of a driving factor in this competition. The bargain beverages at McDonald's may entice its customers to add coffees to their orders, but those purchases are likely additive to the category, rather than sales made at the expense of Starbucks or Dunkin'.
Good to the last drop
Given coffee low costs, high margins, and purveyors' ability to position (and price) some variants as premium experiences, it's clear that the the competition won't cool off any time soon. Dunkin' wants consumers to view it fully as a coffee shop -- a positions Starbucks already occupies -- while McDonald's primarily wants to incrementally grow the checks of its existing customers, while maybe siphoning away some cost-conscious sippers from its rivals. JAB Holdings just wants a bigger share of the carafe as it puts together its own java-selling empire.
Brewing coffee is simply a better business model than baking doughnuts, flipping burgers, or selling pretty much any other food item. So expect those companies that are already popular in the niche to focus on the beverage even more in the years ahead -- and look for other eateries in pursuit of fatter margins to join the party.
Daniel B. Kline has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool recommends Dunkin' Brands Group. The Motley Fool has a disclosure policy.