While obviously not as consequential as the war being waged in Iraq, there's a relatively insignificant but literally meatier battle brewing stateside.
In yet another contest pitting crowns against clowns, burger giants McDonald's (NYSE:MCD) and Burger King are engaged in a price war. With dollar menus as assault rifles loaded with rubber bullets, it's pretty apparent that the fast-food giants are starting to hurt when the buck stops here.
What more can you say when McDonald's finds itself trading at levels last seen nine years ago, and Burger King is so unloved that England's Diageo (NYSE:DEO) had to unload the second-largest burger outfit at a fire sale price of $1.5 billion just so it could focus on something more savory and less morally reprehensible: booze.
The Swiss miss
Playing a unique role is the sector's third-largest player, Wendy's (NYSE:WEN). In political terms, you can tap Wendy's in the neutral role of Switzerland. Or, better yet, cast it as Austria's Franz Ferdinand, given that Wendy's execution proved to be the catalyst of the burger war as we know it today.
The company had embraced the $0.99 price point well before its two larger rivals took to the limbo stick. The only difference is that there was a clear distinction between the chain's quality offerings and bargain-priced fare. So, Wendy's didn't lose a beat in executing the rollout of its off-price grub. If someone wanted a Wendy's Single or a chicken breast sandwich, the craving wouldn't be satisfied by a barren burger, a baked potato, or a side of chili.
Would any fast-food connoisseur out there like to elaborate on the various tiers of quality eats at McDonald's or even Burger King? I didn't think so. Even though the two burger giants have finally caught on and started producing quality salads as a beef and chicken parts alternative, they pale when compared to Wendy's Garden Sensations.
Yes, quality is subjective, but isn't a collection of subjective opinions rather objective if the sample is large enough? McDonald's has seen a slide in same-unit sales every single month over the past year -- and even before that, its financials were as uninspiring as a girl with a canker sore at a carnival's kissing booth.
Bucking the trend
The real problem with the dollar menu isn't that the crown and arches have resigned to playing to the cheap seats; it's that the chains never thought the ramifications through. By becoming essentially dollar stores with limited shelf-life inventory, they have betrayed logic by cheapening their already tarnished reputation for quality. The $0.99 and $1 price points are combo-meal killers -- and that's not good.
Growing up in the family business of frozen food distribution, I enjoyed the Western Frozen Food Convention that would send us out to California every February. You learned so much more just meeting with the industry vets over the course of a day or two than you could thumbing through dated trade publications. My father and brother-in-law came back from this year's show with an astounding nugget that was echoed by nearly every potato packer they met: french-fry sales at the two fast-food biggies were off by nearly 20%.
No, McDonald's and Burger King weren't taking a 20% hit at the register; it actually signifies something worse. Maybe the country woke up with a health-conscious conscience. Maybe it's the new oil at Mickey D's. Still, I think I know why this really happened. The new buck menu has been aiming at the pre-packaged, "order by number" combination meals of a sandwich, fries, and a soda. Instead of numbered orders, some folks are customizing their meals, slipping in a second burger, a side salad, or a new side dish over the fries and, quite possibly, skipping over the soda purchase, too.
That's where the dollar menu is really doing some serious damage, because fries and soda are where the fat margins really lie. Chains don't pay more than a dime for soda syrup or a serving of fries. If you think that a small dip in sales at the unit level isn't troublesome, just consider the hit margins are taking all the way down to produce a significant bottom-line shortcoming.
Last year, McDonald's expanded its way to produce a meager 2% gain in system-wide sales, but it came at the expense of a huge 45% decline in profitability. There was a time nearly a decade ago when McDonald's gave Microsoft (NASDAQ:MSFT) a run for its money, in terms of net margins. Now, those days of double-digit profit margins a few times over are a mere memory.
Walking through the ruins
How could a company like McDonald's, which serves more than 45 million hungry mouths on any given day through its global network of over 30,000 eateries, not realize the error of its ways?
Back in the 1990s, the burger giants faced down the threat of the cheap menu prices at the low-cost, frill-free, small-box drive-through burger chains, such as Checkers (NASDAQ:CHKR), Rally's (which eventually merged with Checkers), Whataburger, and In-N-Out. Bowing down to the dollar menu of its smaller rivals didn't make sense then, so McDonald's crafted the value meal. The value proposition of a basket of items that weighed out favorably on margins rocked. It worked. Why would a dollar menu make any more sense now than it did back then?
If McDonald's or Burger King claims that the sector is damaged, don't buy it. Sonic (NASDAQ:SONC) posted double-digit gains in earnings and revenue this past quarter. Carl's Jr. parent CKE Restaurants (NYSE:CKR) managed a small operating profit after posting losses since 1999. While Jack in the Box (NYSE:JBX) lowered its sales guidance for fiscal 2003 earlier this month, it actually raised bottom-line projections and is looking to earn roughly two bucks a share this year.
What can Jack in the Box get for two bucks? Well, it can hit the two-burger heavies and pick out an item at each dollar menu, before taxes, of course.
So that's the pickle for the burger war combatants that may be too proud to call a truce until the other party blinks. If other fast-food establishments have managed to thrive in an era in which Burger King rolls out tacos and McDonald's counters with yogurt parfaits, maybe a narrower focus is better than a wider menu.
While you won't find consumers complaining about getting more bang for their dining buck, shareholders obviously see the battle from a different perspective. In short, war is hell.
Rick Aristotle Munarriz is always up for a good meal, even if he has to order it from a window. Rick's stock holdings can be viewed online, as can the Fool's disclosure policy.
