You can practically hear Admiral Ackbar, the squid-like alien military commander from the Star Wars movies, yell "it's a trap" as McDonald's (NYSE:MCD), Wendy's (NASDAQ:WEN), and Restaurant Brands International's (NYSE:QSR) Burger King all announce dollar and sub-dollar menu deals.
The problem for the chains is that these low-priced offers, which were pioneered by McDonald's with its now-defunct Dollar Menu, lure customers in who often just stick to the cheap, low-margin offerings. These deals can essentially serve as loss leaders that fail to generate the additional sales that make those kinds of offer make sense.
In some ways, these super-cheap deals harken back to the old retail joke where a store says it will sell $20 bills for $19, but make up the loss on volume. Using teaser deals, sub-$1 items, and other pricing gimmicks might bring customers in the door, but that's only a good thing if they do more than purchase the deals.
What's happening now?
A new fast-food price war has taken shape despite the fact that fast-casual leaders including Chipotle (NYSE:CMG) and Panera Bread (NASDAQ:PNRA) have proven that consumers will pay more when a menu item has a higher perceived value. Neither Chipotle nor Panera regularly discounts or offers a value menu, but McDonald's, Wendy's, and Burger King have actually stepped up their discount efforts in recent weeks.
Here's a look at their latest Dollar Menu-like offers:
- McDonald's McPick 2 Menu: This is a pretty straightforward take on the dollar menu, except you pick two items for $2 from a short list including the McChicken, the McDouble, a small fries, or a three-piece order of mozzarella sticks.
- Wendy's 4 for $4: This one is exactly what it sounds like, it's four items -- a Jr. Bacon Cheeseburger, a 4-piece chicken nuggets, fries and a drink -- for $4. There is no choice or substitutions, but it's a fairly hearty cheap offering at Dollar Menu value.
- Burger King's 5 for $4 deal: This is pretty much exactly what Wendy's is offering: a bacon cheeseburger, chicken nuggets, a small fries, and a small drink, plus you get a chocolate chip cookie.
All the companies are offering $1 or less items, but there is less choice than on the old McDonald's Dollar Menu, and customers are forced to spend a little bit more money. These are still very low-cost offers that give people the option to fill up for less than $5.
Why is this a trap?
These new deals do solve one problem with the original Dollar Menu: sprawl. Instead of a long list of $1 choices, Wendy's and Burger King are offering specific meal deals, while McDonald's is offering a tightly focused set of choices. But, what the new offers do not address is that it's very hard to make money selling items for $1 or less.
McDonald's first introduced its Dollar Menu in 2002 to bring in customers during the recession. It worked, but franchisees had trouble making money with it. One of them, a former owner of two McDonald's locations, Al Jarvis, told Bloomberg that rising beef and commodity prices forced him to deviate from the company's script.
He raised prices of some dollar items to $1.10 and $1.20, which is allowed in the chain's franchise agreement, but he said he "got harassed about it" by the company. "We were just losing money," he said, noting that he still had to pay franchise royalties on the revenue even on items on which he lost money.
Jarvis was not alone. As far back as 2008, McDonald's franchises in New York and Texas were abandoning the Dollar Menu in favor of pushing higher-margin items, according to Ad Age. That article quoted franchise owner Ed Bailey calling the low-cost menu and the ad push behind it "reprehensible."
He noted that in a meeting with corporate officials, he was told that customers who buy dollar double cheeseburgers go on to buy three more items. He did not dispute that, but said since their average check was $4.42, "that means the other items they're buying are from the value menu."
That's the trap all three fast-food chains risk falling into. Cheap offers bring people in the doors, but it's a big challenge to get those customers to order pricier items. This type of deal can not only increase foot traffic from deal-seekers, it can also lower checks for existing customers.
Why is this happening?
The odd thing about this latest round of fast-food discounting is that all three chains know it represents false salvation. They also know, or at least they should know, that they are no longer competing just with each other, but also with fast-casual chains, including Chipotle and Panera. Those companies are almost certainly happy that their rivals are focusing on the bottom of the market -- customers not likely to spend $8-$10 or so for a burrito, fancy sandwich, or a fast-casual salad.
Instead of focusing on improving their food and earning more consumer spending -- something Panera and Chipotle have proven is possible -- McDonald's, Wendy's, and Burger King are returning to a discounting strategy that comes with huge risks. It's an easier play, and it could bump up short-term sales at the expense of profit margin, but it addresses none of the fundamental reasons fast-food burger joints have struggled against pricier rivals.
It's most certainly a trap, but there's still time to pull up and fight the longer battle that could actually result in victory.
Daniel Kline has no position in any stocks mentioned. He is open to creating a Star Wars-themed chain of coffeehouse "Ackbar's Snackbar." The Motley Fool owns shares of and recommends Chipotle Mexican Grill and Panera Bread. The Motley Fool recommends Coca-Cola. 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.