Deep discounts offered by restaurant chains may prove more detrimental

The deep discounts that restaurant chains have been offering to lure cash-strapped customers out of their kitchens are coming back to bite them.

Restaurant chains ranging from Denny's to Applebee's this year have been giving away food or offering deals to boost traffic slowed by the recession.

But as several chains prepare to report second quarter earnings in coming weeks, Wall Street is bracing for news that price cuts not only ate into profits but failed to bring in as many customers as hoped.

Yum Brands Inc., whose Taco Bell and Pizza Hut brands have been emphasizing low-priced fare, reported Tuesday that earnings in its fiscal second-quarter ended June 13 rose 10%, excluding an acquisition-related gain. But same-store sales in the U.S. declined 1% due to an 8% decline at Pizza Hut, which has been offering discounts for online pizza orders and other deals.

"We've been hearing from a lot of restaurant management teams that discounting wasn't driving the traffic they hoped for," said Jeffrey Bernstein, an analyst at Barclays Capital.

Despite heavy discounts across the retail industry -- prices have been slashed on everything from food to clothing -- consumers have been stubbornly reluctant to open their wallets.

Some bigger chains including McDonald's Corp. and Starbucks Corp. have avoided offering deep price cuts. But even they are boosting promotions. Starbucks has lowered prices on some drinks and McDonald's on Monday began a promotion called "Mocha Mondays," in which customers can get a free sample of iced or hot mocha from 7 a.m. to 7 p.m. every Monday until Aug. 3.

When Darden Restaurants Inc. reported earnings last month, the owner of Red Lobster, Olive Garden and The Capital Grille said it avoided the kinds of discounts and giveaways that many of its peers were engaging in.

We don't know that a lot of folks who did discounting got much for it from a traffic perspective," Darden Chief Executive Clarence Otis then said.

Some chains have tried to turn up the heat in the price wars but have failed to win over franchisees, who see the discounts hurting their profit margins.

Burger King Holdings Inc. wanted to sell its double cheeseburger nationally for $1 for a four-month period, but franchisees last Wednesday voted down the proposal. Prices vary by city, but at a Chicago Burger King, the double cheeseburger sells for $2.69. The chain instead proposed offering the $1 offer for just six weeks, but franchisees on Friday rejected that idea, too.

On Tuesday, the chain said it would mail coupons to 80 million households allowing them to buy the sandwich for $1.

Quiznos has taken a different approach. Rather than just cutting prices of existing menu items, the Denver-based sandwich chain has designed new, lower-priced menu items.

In March, Quiznos introduced the Toasty Torpedo, a 13-inch sandwich on ciabatta bread, for $4. After hearing from consumers who liked it but didn't want so much sandwich, Quiznos on Monday introduced an 8-inch version called the Toasty Bullet, for $3.

In the second week of the Torpedo's launch, sales increased 26%. It will remain on the menu.

"It was a product designed to be sold at $4, which is different than taking an existing menu item and discounting it down," Quiznos Chief Executive Rick Schaden said in an interview. "Discounting items that weren't designed to be sold at lower prices isn't sustainable and will hurt earnings."