McD thirsts for $1B in new beverage sales

QSR leader reportedly poised to take on coffeehouses with chainwide espresso rollout

Eyeing $1 billion in incremental sales that would be siphoned largely from the Starbucks-dominated coffee-house sector, McDonald’s is poised to pursue a massive espresso beverage rollout requiring chainwide remodelings and equipment upgrades, according to a published report quoting internal planning documents.

However, until meetings scheduled for later this month, McDonald’s Corp. isn’t expected to clarify its role in helping finance what could be $100,000 in typical per-location overhaul costs for the mostly franchised chain of nearly 14,000 U.S. units, the report in Crain’s Chicago Business stated.

The nearly $1.3 billion price tag, for a rollout that McDonald’s reportedly wants to complete by late 2008, apparently would pay for more than automated espresso machines. The plan to tap what McDonald’s estimates is a $60 billion market in beverages also entails drive-thru modifications and installations of smoothie machines and wall-mounted refrigerators to sell bottled beverages and energy drinks, the planning memos are said to indicate.

The chain already has taken aim at Starbucks Coffee and other espresso specialists by test marketing such drinks as hazelnut caramel lattes and cappuccinos at hundreds of McDonald’s units in at least six states. Those tests were launched after the chain scored a 15-percent surge in coffee sales following an upgrade of its standard brew to a darker, richer beverage.

The Crain’s report said leaked McDonald’s memos envision sales of specialty beverages growing by 90 percent in the next five years to an average of $125,000 annually per location, yielding per-store profit ranging from $15,000 to $60,000.

Some 1,500 McDonald’s outlets reportedly would get the espresso makeovers by the end of 2007.

However, a McDonald’s spokeswoman denied that the company had decided to broaden its current beverage testing, which also includes bottled drinks being sold at some locations. Though the company has said it is eyeing a possible launch of smoothies, it would not comment on the leaked memos’ purported reference to energy drinks—presumably like those sold at Jamba Juice and other smoothie chains.

“We’re testing a variety of beverage options, including specialty coffee,” spokeswoman Danya Proud said. “It is far too early, however, to speculate about test results or specific product offerings. No final decisions have been made.”

Nonetheless, analysts say McDonald’s could easily take market share away from the burgeoning coffeehouse sector, especially by targeting consumers who are seeking lower-priced beverage alternatives.

“McDonald’s will steal value customers away from Starbucks,” said Darren Tristano, a vice president of Chicago-based restaurant consulting firm Technomic Inc. “In the past, Starbucks hadn’t perceived QSR to be competition. They may have to now.”

There is a proven market for specialty coffee in QSR,” said Dennis Lombardi, a foodservice consultant with WD Partners in Columbus, Ohio. “Dunkin’ Donuts has proved that, and McDonald’s will make that happen.”

Dunkin’ Donuts has sold lattes and other espresso-based drinks since 2004.

Each item from McDonald’s espresso menu would be “another snack for the growing snack day-part, and it will build morning sales,” Lombardi observed.

“It also will complement the Wi-Fi stoppers who may not be hungry enough to get a sandwich,” Lombardi said, referring to laptop-toting users of wireless-Internet services who frequent the thousands of McDonald’s that offer Web access.

Coffee has grown to 11.4 percent of all snack occasions so far this year, from 10.9 percent in 2006, said Harry Balzer, vice president of the consumer research firm the NPD Group of Port Washington, N.Y. He credited increased convenience and novelty for the surge.

The number of consumers who buy a coffee drink during a quick-service visit has jumped to 6.6 percent so far this year, from 3.5 percent for 2006, according to the latest Quick-Track consumer survey from Sandelman & Associates of San Clemente, Calif. In the third quarter of 2007 ended Sept. 30, that percentage was 8.9 percent, the Sandelman group said.

McDonald’s tests of espressos, cappuccinos, lattes, mochas, hot chocolate, iced coffees and sweet tea have spread to include the markets of Grand Rapids, Mich.; California’s Central Coast; Kansas City, Mo.; and parts of Georgia, North Carolina and Texas.

McDonald’s franchisee John Jelinek of Kansas City said sales have surged “like gangbusters” since two of his three restaurants began selling the specialty coffee items a few months ago. Most of the additional sales are in the morning, he said.

Jelinek expects to add an extra employee in each restaurant, primarily to handle the coffee service. Making the new beverages “does take more time,” he said.

However, a manager for a five-unit McDonald’s franchisee in the Grand Rapids, Mich., area that has been testing specialty coffees for the past year said most of the preparation process is automated, except for stirring in optional syrup toward the end. Now that crew members are used to the procedure, it has become second nature, she said.

Prices for the hot or iced lattes, cappuccinos, and mochas range from about $2 to $3, depending on size. Customers can choose whole, nonfat or 2-percent milk, and can opt for vanilla, chocolate, caramel and other syrup flavors.

Jelinek said he is not testing bottled soft drinks, as are some other franchisees, and he does not know of anyone in the chain currently testing smoothies. So far, he said, McDonald’s has not charged him anything for the new coffee equipment.

Whatever the cost, “there will be a payback later,” the 25-year franchisee said. “Nobody knows what it will be. McDonald’s has always been very reasonable.”

Crain’s said notes from an August meeting of McDonald’s operators indicated that one franchisee who had installed new beverage gear had pegged the cost of revamping an individual location at $100,000. Crain’s also noted that some franchisees had been angered when the chain’s last major equipment overhaul, the Made For You kitchen upgrades begun in the late 1990s, exceeded the estimated $25,000 per-location cost, of which McDonald’s had agreed to pay half.