McDonald’s Corp.’s ambitious plans to serve up fancy coffee drinks and smoothies at its U.S. restaurants are sparking worries among its legion of franchisees, who must foot a big part of the bill for the beverage offensive.
Oak Brook-based McDonald’s last month unveiled a full-scale move into upscale coffee drinks, after testing the concept at about 800 U.S. outlets. It is a bold move intended to make McDonald’s a beverage destination, but restaurant franchisees must invest up to $100,000 to accommodate the plan.
And it comes at a time where franchisees’ profit margins are under pressure from rising labor and commodity costs. McDonald’s relations with its franchisees, who own about 85 percent of the company’s nearly 14,000 U.S. restaurants, have been good for the past few years, and there’s no sign that is fundamentally changing.
But many franchisees are “taken aback” by the rollout, said Richard Adams, a San Diego-based consultant to McDonald’s owner-operators.
“‘Don’t force us to remodel for some pie-in-the-sky vision,’ I hear that constantly,” he said.
Meanwhile, an unscientific survey of McDonald’s franchisees this fall showed worries over whether the potential reward of the beverage offensive is worth the risk.
“We are putting a lot of faith” in it with “only a hope of a return,” one franchisee responded to a survey done by restaurant industry analyst Mark Kalinowski.
McDonald’s believes the beverage initiative will have a big payoff for franchisees, estimating an additional $125,000 in annual sales per restaurant when it is fully implemented. The National Leadership Council, which represents McDonald’s franchisees, is on board, the company said.
“From the franchisee leadership, which has been part of this every step of the way, there has been enthusiasm and collaboration,” said Bill Whitman, a McDonald’s spokesman. Don Armstrong, head of the National Leadership Council, didn’t return calls for comment.
Franchisee relations is always an important issue for any big restaurant company. And that relationship has had serious strains in the past for McDonald’s.
In the late 1990s, franchisees complained loudly that the company’s U.S. expansion was cannibalizing sales at their restaurants. That tiff was followed by rancor over a new kitchen system mandated by McDonald’s. Adams said relations hit a low point in 2002, but began improving the next year as McDonald’s started a big turnaround.
Sustaining momentum
Whitman said McDonald’s began testing specialty coffees as early as 2005 and ramped up the trials this year to 800 restaurants. The national rollout will take considerable time given the investments required and isn’t expected to have an impact on McDonald’s sales nationally until mid-2009.
Many analysts say McDonald’s move into the land of mocha and frappe is a logical next step. Its premium coffee, introduced in 2006, has been a runaway hit, boosting McDonald’s vital breakfast trade and winning accolades for taste and value from Consumer Reports. The chain’s iced coffee offering this year also has been a success.
“McDonald’s has the credibility to launch specialty coffees,” said John Owens, a stock analyst at Morningstar Inc. Specialty coffees, as well as smoothies and frappes, will be an important part of McDonald’s efforts to keep its streak of solid results going, he said.
The company has posted monthly sales gains for 4 1/2 years and many quarters of solid profit, with its stock tripling since mid-2003. To help keep that momentum going, McDonald’s is aiming to get more customers into stores between meal times. That’s where smoothies and fancy coffee drinks come in.
McDonald’s caramel cappuccino, vanilla latte and cafe mocha should have high profit margins, Owens said.
“I think these beverages are liquid gold,” he said, but “the cost for the franchisee is significant.”
The equipment alone will cost franchisees about $25,000 per restaurant. Plus, they are being asked to invest considerably more to retool their stores to better handle the specialty coffee and other new beverages, from sweet tea to smoothies to energy drinks.
Essentially, plans call for a “beverage cell” to be built into the front counter, with easy access to the drive-through window. It would house specialty-beverage equipment and any workers who would make lattes and frappes.
McDonald’s executives have said remodeling costs could vary greatly by location but could be as high as $75,000 per restaurant. The company says it will share some of those costs with franchisees but has declined to say how much.
Adams said that for franchisees, the beverage offensive likely will amount to the costliest new-product launch ever. Irwin Kruger, who owns five McDonald’s in New York City, concurred. “This is a really aggressive plan,” said Kruger, who’s been a McDonald’s franchisee for 40 years.
It comes at a time, too, when some McDonald’s franchisees are, or soon will be, sinking money into their grills in order to handle a new burger, the Angus Third Pounder. McDonald’s this year introduced the burger in test markets, including California and New York.
But some older grills can’t handle the Angus’ thicker patty. For instance, Kruger said he had to upgrade grills in three of his restaurants at $12,000 a pop. Adams said other franchisees have done similar upgrades.
Kruger said the Angus burger has been a particularly popular item at his midtown Manhattan store. As for specialty coffee, he’s holding judgment until he sees more financial details from McDonald’s.
“I haven’t seen a business case for this program other than that McDonald’s feels there is a big market for it,” he said. However, in the franchisee community, “there is concern about the additional capital investment,” he added.
That was evident in the latest survey of McDonald’s franchisees by restaurant industry analyst Kalinowski. He’s been doing such surveys, up to six per year, for about four years. The most recent one was done in late September and polled 27 U.S. franchisees who together represent 196 restaurants.
More testing wanted
Beyond the cost, the survey showed some franchisees were concerned that specialty coffees are going to be rolled out nationally before being proven viable in test markets, Kalinowski said.
Adams said he’s heard similar concerns.
“The history of McDonald’s is that every new product line is extensively tested and proven to be a good seller,” he said. “But coffee is an Oak Brook vision that hasn’t been fully tested.”
Whitman said any franchisee worries may be because McDonald’s has communicated facts about the plan primarily through the National Leadership Council, not the entire franchisee system.
“There is, as to be expected, some questions because they have not seen the full picture yet,” he said.
The specialty-beverage rollout comes at a time when McDonald’s franchisees, like McDonald’s itself, is under increasing pressure from rising labor and food input costs.
“It’s bad timing,” said Adams.
The federal minimum wage rose 70 cents, to $5.85 an hour, last summer. Perhaps more important, several states, including Illinois, have raised their minimum wages.
Meanwhile, chicken and dairy costs in particular have been rising this year. McDonald’s noted in its third-quarter-earnings conference call that its own U.S. dairy costs, including cheese, are expected to soar 14 percent to 20 percent this year.
Part of the profit-margin pressure on franchisees comes from McDonald’s popular dollar menu, said Adams and Kruger.
As commodity prices rise, margins thin, since dollar menu items entail a revenue cap of sorts. Plus, if franchisees raise prices on the main menu, they risk that customers will trade down from a Big Mac to a dollar menu double cheeseburger.
“Margins are under pressure for a lot of franchisees,” Kruger said. “That will always be an impediment to capital investment.”
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mhughlett@tribune.com
