Starbucks, McDonald's carve coffee niches

When the dust from the great coffee war that wasn't settles, McDonald's and Starbucks will find that each plays on a slightly shifted field, but neither side has captured the spoils -- the other's customers.

Legal secretary Krishna Anderson, 35, started her coffee habit three years ago at Starbucks and continues to buy a caramel macchiato from the coffee chain every day.
She occasionally visits other cafes and tried McDonald's new premium coffee when the hamburger chain gave out free samples. Anderson said she didn't like the taste of the coffee, and the smell of French fries in the morning turned her off.

"I'm one of those people that if I go to Taco Bell, I want a taco," Anderson said. "If I go to McDonald's, I want a hamburger. If I go to a coffee place, I want coffee. That crossing over -- it doesn't do it for me."

McDonald's Corp (MCD.N) officially launched its McCafe line of premium coffee drinks with an advertising blitz earlier this year, sparking investor worries that its aggressive push would hammer sales at Starbucks Corp (SBUX.O), the more upscale chain that acquainted mainstream America with fancy coffee drinks like lattes and cappuccinos.

While Starbucks sales did decline in the most recent quarter, the drop was less steep than in the prior period.

Chief Executive Howard Schultz attributed that result to economic factors rather than to competition from McDonald's. He said the buzz generated by McCafe promotions "created unprecedented awareness for the coffee category overall and has actually had a positive result on Starbucks' business."

Jefferies & Co analyst Jeff Farmer and other analysts had a somewhat different take. Farmer said Starbucks intensified marketing efforts, with high-profile value promotions like $1.95 for a grande (medium) iced coffee; and easier comparisons with the year-earlier quarter's weak sales "did most of the work."

Research from YouGov Plc's (YOU.L) BrandIndex shows that McDonald's is the hands-down winner on value perception while Starbucks has a substantial lead in quality perception.

PRICE VS QUALITY

Servings of traditional coffee at quick-service chains like Starbucks and McDonald's fell 7 percent in the May quarter, compared with a year earlier, market research firm NPD Group said. Servings of lattes, mochas and other specialty coffee drinks were down 3 percent in the same period, NPD said.

Unemployment is responsible for much of that decline, since fewer people are eating breakfast in quick-service chains, NPD restaurant industry analyst Bonnie Riggs said.
Still, some hamburger and doughnut chains are serving up more Joe this year.

More than anything, Riggs said those chains are expanding the overall category by introducing new fancy coffee drinks like the pricier mochas and lattes popularized by gourmet coffee chains like Starbucks and Peet's Coffee & Tea Inc (PEET.O).
"They've attracted people to the specialty coffee market that probably would not be there," Riggs said.

"It's two completely different customers. There aren't too many people who meet for business meetings in McDonald's," said William Smead, chief investment officer at Smead Capital Management in Seattle, which owns about 325,000 shares of Starbucks and 60,000 shares of McDonald's across all accounts.

MCCAFE BREWS UP SALES

McDonald's President Ralph Alvarez recently said that in the last 24 months the fast-food chain's coffee business has grown from 2 percent of sales to 5 percent of sales.

Some of that has come from people like Teresa Roman, who said she switched from Starbucks iced coffee to McDonald's after the chain swayed her with its value and taste.

"Even on the weekend, I'll go to McDonald's," said Roman, a banker, who was drinking a large McDonald's iced vanilla coffee when she talked to Reuters.

Starbucks' large iced coffee sells for $2.65 in downtown Los Angeles. The one from McDonald's is slightly bigger and sells for $2.19.