3/16/2011

MCDONALD S

BREAKING INTO THE GOURMET COFFEE MARKET

MANA 4395.002 | Gloria Byrd, Troy Hillis, Marc Vestal

IntroductionAmerica s seemingly ever-increasing demand for premium coffee continues to drive U.S. coffee shop sales, and the market has not shown many signs of slowing down. Today, specialty coffee accounts for over $13 billion in sales, easily one-third of the nation s total coffee industry. Americans drank 146 billion cups of coffee in 2008 and while three out of every four cups are prepared at home, almost 90 percent of all dollars spent on coffee are spent on foodservice coffee. Fueled by the gigantic appetite Americans have shown for premium-priced coffee, coffee shop chains have expanded at breakneck speed. Consisting of nearly three-quarters of the market value, Starbucks is the clear market leader and is the driving force behind much of the growth in the premium coffee sector. Yet, despite the dominance of Starbucks, the coffee house frenzy has generated high enough demand for premium coffee that independent coffee shop sales have also had room to grow. Many seek out the locations where Starbucks is operating, because the ground work of establishing a coffee shop culture in the area has already been laid. While Starbucks may be growing the market, it also increasingly owns a larger market share. So Starbucks may afford some opportunities to others, it also prevents independents and smaller chains from growing the market on their own. Thus, these smaller chains are unlikely to ever present a threat to Starbucks. The real competition, however, comes from the giants such as McDonalds, which is much larger than the Starbucks chain, and is starting to jostle for a piece of the coffee shop action. As Americans already visit restaurants such as McDonalds on average seven times a month, McDonalds seems perfectly placed to offer a real alternative to Starbucks. The luxury coffee market, a market revolutionized by Starbucks Corporation, a new market that McDonald s is attempting to enter. McDonald s has already begun its infiltration by introducing an espresso drinks line, the aggressive addition has been aided by the increasing awareness of the economic recession and the ever-increasing demand for low cost food items. We know our customers are looking for those affordable luxuries, McDonald s spokeswoman Danya Proud said. We know our customers are visiting us, now more than ever, for many of our well known breakfast items, and we know our coffees continue to be a growing category. To meet the changing needs of our valued customers, we re testing a variety of beverage options, including specialty coffee. We re encouraged by what we re hearing from our customers. They re telling us they appreciate the added value, convenience, and selection. It is far too early, however, to speculate about test results or specific product offerings. No final decisions have been made. To speculate beyond this, or comment on rumors, would be irresponsible and inaccurate.

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BackgroundMcDonald sMcDonald s is a fast food franchise restaurant. It was started by Dick and Mac McDonald in 1940. McDonalds s first restaurant was a Bar-B-Que restaurant. After eight years they wanted a change, so they shut down for about three months and remodeled the restaurant. When they reopened it was known as McDonald s. They added nine menu items to the list: hamburger, cheeseburger, soft drinks, milk, coffee, potato chips, and a slice of pie. The price of a hamburger back then was only fifteen cents. In 1949: McDonald s came out with the French fries which took the place of potato chips. They had also added shakes to the menu at this time. Around 1954, the brothers wanted to go nationwide, a man named Ray Kroc was interested in the operations of McDonald s, and it happened that he was a nationwide agency. So Ray started the franchise of McDonald s in Des Plaines, Illinois. The first day sales of the restaurant were $366.12. By 1965, there would be over 700 McDonald s restaurants around the world. Ray Kroc hired a man named Fred Turner, who worked the counter sales, and then later became the head of McDonald s Operation in Des Plaines. By 1958, McDonald s had sold 100 million hamburgers. In 1959, McDonald s opened its 100th restaurant in Fond Du Lac, Wisconsin. In 1961, Fred Turner and Ray Kroc founded Hamburger University in a basement of a McDonald s in Elk Grove Village, Illinois. y On February 24, 1961, fourteen students has graduated from the University y As of today more than 5000 students attend Hamburger University y And since 1961, more than 80,000 restaurant managers, mid-managers and owner/operators have graduated from the facility. McDonald s was the first restaurant to start a global training center. Ray Kroc had said once if we are going to go anywhere, we ve got to have talent. And I m going to put my money in talent. i All the restaurants so far had not been built with inside seating, until 1962, they finally built a restaurant that customers could sit and enjoy their meals, in Denver, Colorado. In 1965, was the 10th anniversary of McDonald s and they celebrated it by the first public Stock offering at $22.50 per share. In 1966, Ronald McDonald made his first public appearance in the Macy s Thanksgiving parade, sitting high on a hamburger, which made Ronald McDonald an instant hit, especially with children. In 1967, McDonald s finally went International in Canada and Puerto Rico. There are McDonald s restaurants in 118 countries around the world. In 1968, McDonald s introduced the Big Mac, which Jim Delligatti of Pittsburgh, Pennsylvania started. In 1969, the company started redoing the Golden Arches of McDonald s, reconstructing them to a larger size.3|P ag e

In 1973, is when the Quarter Pounder and the Quarter Pounder with cheese was introduced to the menu. In 1974, the Ronald McDonald House was built in Philadelphia, Pennsylvania.

Ticker: Exchanges:

MCD NYSE FRA MXK LIM

Country: Major Industry:

UNITED STATES Recreation Restaurants & Fast Food Franchisers

Sub Industry:

2010 Sales

24,074,600,000 (Year Ending Jan 2011). U.S. Dollars December Common

Employees:

400,000

Currency: Fiscal Yr Ends: Share Type:

Market Cap: Shares Outstanding: Closely Held Shares:

78,508,245,310 1,043,298,941 176,182

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Coffee The general coffee service industry has been around for many years with few leader changes. Before Starbucks came to take over the coffee drinker world, most coffee service business were rather small and maintained their one area/region with little expansion and little competition. One aspect of the coffee service industry that helps companies from Starbucks down to the Ma & Pa shops is how the industry trend tends to stay the same from year to year. According to NCA, National Coffee Association, even with the economic downturn and challenging previous years, coffee consumption has stayed the same in which about 54% of adult population. This is due to the fact that consumers need coffee as a part of their everyday life whether it is to get going in the morning or a desert after dinner, the only change noticed due to the economy situation is the an alter in the coffee choices. The location where consumers drink their coffee changes each year. They are not drastic changes, usually a few percentage points, with recent results showing that more consumers are choosing at-home consumption over out-of-home consumption. As for the age groups of coffee consumers, the most play in the percentage points is with the 18-24. They tend to move with the economic situation, as its going down they consume less, until a lifestyle change makes coffee and integral part of everyday life. The 25-39 age groups and the 40-59 age groups usually remain the same from year to year at about 61%. Again this proves the loyalty of coffee consumers and how it is not as hard for the coffee service industry to survive economic downturns.Retail Sales of Coffee by Type: % Value Growth 2000-2005

Sales figures- the American Coffee Industry

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The coffee industry in a whole has been studied for years due to the fact that the coffee service industry and mainly the consumer are directly affected by certain factors in the industry as a whole. Recent years and many doctors are disproving the old idea of drinking coffee is bad for you or drinking too much of it can cause health problems. But according to doctors such as Tomas Depaulis, Overall, the research shows that coffee is far more healthful than it is harmful . Also other university studies have shown that drinking excessive amounts, like six or more cups, can actually reduce the risk of a consumer getting type two diabetes. Coffee service industry has the potential to strengthen with consumers learning more and more that drinking coffee is in fact not a bad habit. The opposite side of that is the potential weakness in the coffee industry. Coffee is a crop-based product, which means any bad growing seasons results in higher prices for coffee. This direct correlation is passed onto the consumer who may decide an expensive cup of coffee is not worth it, and in turn ultimately hurt the service part of the industry. As for coffee service opportunities in the industry, there are plenty due to the fact that over 400 million cups of coffee are consumed every day. Like, I mentioned before around 54% of the adult population drink coffee every day. Although there are many opportunities, the coffee service industry is highly developed and very competitive. The threats for the coffee service industry like all industries are sensitive to the economy, even though coffee shops don t take as big of a hit. During economic downturns companies may begin to do promotional activities that could potential draw customers away. Also, I like mentioned before the service part of the coffee industry is directly tied to the rising price of crops and even dairy products. The U.S. handles about 1/4 of global coffee imports (2.45 billion pounds). The U.S. specialty coffee industry is responsible for only approximately 17% of the total U.S. green coffee imports but its $7.8 billion sales represent approximately 40% of the $18.5 billion U.S. coffee market. Total U.S. retail sales of specialty coffee beverages were $5.3 billion in 2000 while retail sales of specialty coffee beans reached $2.5 billion. It is the only segment of the coffee industry that has shown consistent and notable growth and is the largest specialty coffee market in the world. According to the International Coffee Organization (ICO) and the SCAA, most potential specialty coffee markets are far from saturated. Specialty coffee sales continue to expand by 5% to 10% per year according to conservative estimates. The North American specialty market therefore represents one of the largest and most vibrant coffee markets in the world. Its ability to develop new trends and influence global consumption is well documented.

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The Competition Starbucks Starbucks, the world s number one coffee retailer, has over 13,000 coffee shops in more than 35 countries. The outlets offer coffee drinks, food items, beans, coffee accessories and teas. Starbucks owns about 17,500 of its shops, which are located in about 10 countries (mostly in the U.S.) while licensees and franchisees operate the remaining outlets. Starbucks does 78% of its store volume in beverages, with 12% in food, and 5% in whole beans. The company does not compete on price but rather on the complete experience customers get while visiting the coffee shop. Embracing its value beyond extraordinary coffee, Starbucks tries to make a business out of human connections, and celebration of diversity and culture. Starbucks focuses its retail selection on the best places in town and its outlets can be found in the center of almost every famous city in the world ranging from Cologne to Los Angeles. The firm focuses on high-traffic, high-visibility locations. While Starbucks selectively locates stores in shopping malls, it tries to focus on places that provide convenient access for pedestrians and drivers. Starbuck s overall goal is to establish its brand as one of the most recognized and respected ones in the world. Therefore the enterprise plans to continue the rapid expansion of its retail ~ and grow its specialty operations and to selectively pursue other opportunities to leverage the brand through the introduction of new products and the development of new channels of distribution. In continuance with its history of partnerships, Starbucks and Concord Music Group announced the formation of a new record label Hear Music which will distribute recordings at Starbucks locations. This partnership is another step in Starbucks entertainment strategy that links to the company s focus on atmosphere and image.7|P ag e

Addressing McDonald s attempts to lure customers away, Starbucks announced its plans to offer hot breakfast sandwiches in an appeal to fans of the Egg McMuffin and establish them also in the breakfast and afternoon snack segment. Dunkin Donuts Dunkin Donuts (founded 1950, headquarter in Canton, Massachusetts) is the world s largest coffee and baked goods chain, serving over 3 million customers a day. In 2006 the enterprise had revenues of $4.7bn ($4.3 bn in the U.S.). There are more than 7,000 shops worldwide (5,300 in the U.S.). The company is opening 700-1000 additional shops every year. Dunkin Donuts has forged an identity as a coffee destination with ample seating and a diverse menu that grows incrementally following its slogan: America runs on Dunkin . Already, 57% of the chain s sales, and the most profitable product group, are beverages. The company sells about 500 million cups of coffee a year for $1.65 each. Dunkin Donuts is pursuing the following key strategies: multi-branding concept development, Dunkin brand vitalization, product innovations, accelerated brand development, improved operational effectiveness and talent acquisition. Dunkin Donuts retail outlets are operated in a franchise format either through operating agreement, license agreement or joint venture. The company s current plans are to widen its specialty coffee offerings and offer them on a broader basis nationally. Therefore Procter & Gamble signed an agreement with Dunkin Brands on March 1st 2007, to launch Dunkin Donuts coffee at U.S. retailers (e.g. grocery stores, mass merchandisers, club stores). Additionally Dunkin Brands CEO Jon Luther emphasizes the company s strategy to be a faster, cheaper, user-friendlier alternative to Starbucks. He is convinced that there is a market opportunity especially among a younger audience that is enamored with Starbucks frothy beverage menu but daunted by its prices. Addressing this issue Dunkin Donuts installed espresso machines in prime locations, capable of delivering inexpensive coffee in 44 seconds. The company purposely leaves the fancy CD burning stations, mood lighting and comfortable chairs to the competition and focuses, instead, on speed. The company tries to reach a rate of one shop to every 15,000 - 20,000 people in their target markets. According to the CEO Dunkin Donuts coffee business industry is basically a game that relies on ubiquity. However, that is an important, but not the most critical, issue because high margins in the coffee business will allow the company to buy key sites. Additionally the enterprise aims at improving its level of service and cross shop consistency in service; a goal that is especially challenging because of the franchising structure. CEO Luther in 2003 to his 2700 franchisees: "We re changing this game, we re raising the stakes, if you don t like it, get out."

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Caribou Coffee Caribou Coffee was founded in 1993 and its headquarters is located in Minneapolis (Minnesota). Today it is the second largest specialty coffee company in the U.S. with 416 outlets (2005) in 18 states and the District of Columbia. The revenue in 2005 totaled $198 million. Caribou s cafes feature mountain-lodge-style decor with exposed beam ceilings, leather chairs, and roaring fireplaces. The company s motto is "Life is short. Stay awake for it." Caribou Coffee successfully competed against the omnipresent Starbucks in a number of U.S. states. The company emphasizes the quality and freshness of their products (Coffee is packaged immediately after roasting, and it is not sold more than 21 days after roasting or more than seven days after the opening of the package). Caribou competes by offering a slightly different roast of coffee and a warmer, more relaxing in-store environment compared to the Starbucks shops with a rather sleek, urban atmosphere. The Middle East is the first region Caribou Coffee is seeking to expand internationally. The company believes that there is a small but growing market for American branded coffee houses. Another strategic approach has been to develop partnerships with other retailers, such as Eatzi s, or building stores next to Bruegger s Bagels, Blockbuster Video and Border s Books. The company also sells its coffee in upscale grocery stores, such as Lund s and Byerly s in the Twin Cities and Heinin s in Cleveland. Furthermore, Frontier and Maxjet airlines serve Caribou coffee, and the company recently inked a deal with Life Time Fitness. Coffee Bean & Tea Leaf Coffee Bean & Tea Leaf was founded in 1963, with its headquarter is located in Los Angeles. In 2005 the company had 400 outlets and revenues of $150 million. The strategy of Coffee Bean is Keep Innovating . The company is known for its extensive selection of coffees and teas, as well as its reputation for innovation, e.g. the ice-blended coffee drink and the chai latte. Coffee Bean has also made a push overseas, finding niches in Starbucks-free markets such as Israel. With nearly all of its drinks certified as kosher, the company has opened several locations in that area. Peet s Coffee Peet s Coffee, whose headquarter is situated in Emeryville, California, was founded in 1996. In 2005 the company had 120 outlets and revenue of $175 million. Peet s strength is the taste of its coffee, which appeals to java connoisseurs. The company roasts its beans in small batches, replaces brewed coffee every 30 minutes, and never re-steams milk. " Peetniks" often drink Peet s at home too, and about half the company s sales come from whole beans, which carry higher margins. Peet s beans are also sold in more than 4,000 grocery stores.

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It Begins With the Customers While the iconic Golden Arches are a sign of convenience to many consumers, McDonald s has attempted to be more than a quick and value-priced item with the introduction of its Premium Roast Coffee. The Oak Brook, Illinois-based restaurant chain is using this new beverage portfolio to make it more contemporary and relevant - planning on giving other beverage-focused retailers a run for their money. Customers beverage tastes have evolved over the last few years. It s clear to us, with those change in tastes, there s an opportunity for us to meet more of their needs, says the man behind the move, John Betts. As McDonald s vice president, Betts led the team that rolled out the beverage business. He has since been promoted to president of McDonald s Restaurants of Canada Ltd. Don Thompson, the president of McDonald s USA, emphasized beverages changing role with the company in one analyst meeting: We want to move from beverages as an accompaniment to being a beverage destination. That s a promising statement for beverages from the world s largest restaurant chain. Currently McDonald s operates over 31,000 restaurants in 118 different countries, with almost 14,000 of those within the United States. Reaching almost 56 million customers every day, McDonald s revenues attained a record high of $22.8 billion on global comparable sales in 2007. In fourth-quarter reporting, Jim Skinner, McDonald s Corp. s CEO, raved about McDonald s performance. For the quarter, the United States business generated solid comparable sales growth of 3.3 percent and increased operating income by 6 percent by staying in tune with growing consumer demand around breakfast, beverages and everyday value, he said. With the economy having slowed down and the challenges of rising food costs, McDonald s thinks that a strong beverage menu, including the introduction of specialty coffee drinks, gives the restaurant a huge opportunity to increase revenue. In addition to the new beverage lineup, the company has had a makeover. McDonald s restaurants have been redesigned to become more contemporary, with some locations featuring leather chairs, high-top tables, flat-screen TVs and even fireplaces. Many restaurants now offer a wireless connection for customer convenience. And with convenience always a concern, McDonald s are now opening earlier nearly 80 percent are open at 5 a.m. and staying open later or not even closing at all.

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Becoming a Specialty Mcdonald s started its beverage expansion in 2006 with the launch of its Premium Roast drip coffee. The intent was to really contemporize and take our blend to the next level based on consumer changing taste preferences and desire for more sophisticated coffee drinks, says Danielle Paris, menu management food innovation and development for McDonald s USA. Once we did that, it really helped us establish credibility in the coffee industry. Premium Roast Coffee sales increased 30 percent during 2007, reported Jan Fields, McDonald s USA s executive vice president. The idea for Premium Roast Coffee began in McDonald s Michigan restaurants. Betts, who has 38 years of experience and has been a McDonald s general manager in three U.S. regions, served four years as the Michigan region s general manager. It was there that much of the work with Premium Roast Coffee began. We recognized that we had a business opportunity in the area of breakfast, Betts said. In the morning, coffee is the primary motivator for customers. The coffee offering we had was good, but it wasn t resonating. The richer, bolder, robust Premium Roast Coffee hit a nerve with customers, according to Betts. We enjoyed a great deal of feedback from them and certainly enjoyed the changes in our business around the coffee, he says. We discovered that they wanted even more. The next step for McDonald s was making its premium coffee more convenient for customers. Most of our coffee goes through the Drive-Thu, and listening to customers, something that was important to them was saving a little time, Betts explains. Serving nearly 26 million U.S. customers a day, two-thirds of those patrons go through the Drive-Thru, thus McDonald s instituted coffee customization. Instead of customers having to stop, pull over and put cream and sugar in the cup and stir, employees add sugar and cream to the coffee to the customer s specification. McDonald s continued its big plans for beverages with the launch of McCafe Specialty Coffee drinks, traditional favorites lattes, cappuccinos and mochas, and specialty menu items including Regular, Vanilla and Caramel Lattes and Cappuccinos, Mocha, Iced Vanilla Latte and Iced Mocha. Customers are offered the choice of whole and non-fat milk for the drinks, and McDonald s also offered a sugar-free vanilla syrup. We want to stay relevant and reached out to customers for them to tell us what their needs are, Paris says. The milk choice and also having a sugar-free syrup available are two things that we ve done to address customers needs. To be able to provide authentic espresso for customers, McDonald s needed the right technology to deliver premium coffee at a convenient speed, Paris says. The drinks are made with a one-step machine that grinds the espresso beans, brews the espresso and steams the11 | P a g e

milk, all in one process. The additional flavors Vanilla, Caramel, and Mocha are added by the barista. We have selected a piece of equipment which is very sophisticated, but it s also very flexible, says Paris. It will allow us to make a number of different beverages at a speed which is really required to make our speed of service, but it is done without sacrificing quality. The most important thing is we want to be able to provide our customers with authentic specialty coffee beverages, very high quality at the convenience of McDonald s. McDonald s is taking an in-depth approach to training employees on the use of the machine and about the coffee. This isn t about just pouring coffee into a cup and putting a lid on it, says Betts. This is about them understanding a whole new business, a whole new culture, a whole new way of providing great-tasting coffee and more of a beverage experience in our restaurants than in the past. Training begins with the managers education inside a training restaurant. Managers learn about the origin of coffee and coffee culture in the classroom, and spend a large amount of time on the floor learning how to create the products. The most important thing that we emphasize with the crew is the freshness of the coffee, maintaining that high quality at all times, Paris says. We ve also developed a very extensive training program where we re educating our crew on not only how to operate the equipment, but the important sensory attributes of the drink There are visual characteristics. There are taste characteristics, and that s all a part of our comprehensive training program. Implementation The Specialty Coffee rollout was not easy, even with the easy-to-use equipment and customer appeal. Restaurants had to be redesigned or updated to include a coffee bar, which is a substantial investment for the new beverage launches. McDonald s was financially assisting its franchisees by paying up to 40 percent of the beverage build-out. The business case was built understanding the economics, and we re very comfortable with the opportunity that we have to get a great return on our investment and to be able to enter this business profitable from the start, Don Armstrong, chairman of McDonald s USA s National Leadership Council, says. The NLC is a group of 37 McDonald s franchisees, representing more than 2,400 franchisees, who independently own and operate more than 11,000 McDonald s restaurants in the United States. Restaurant owners had bright hopes for the potential profits; they expected the beverage business to add $1 billion to the company s sales by 2009. The ever-increasing popularity of specialty coffee drinks and the chance for a return on the beverage investment has owners excited about the expansion, Armstrong says. We ve had upwards of 400 operators who have been a part of helping to develop it, says the chairman. It really is something that has not been done in a casual way. We believe that we have developed the right program for our customers and that we have the right program for the economics of this

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and that we have the right program to be able to deliver on this operationally within our restaurants.

Tasting is Believing

Marketing in a services industry is becoming an increasingly complex challenge. Theparadigms of service marketing demand a passionate understanding of customer expectationsand perceptions, and linking them to product design & delivery as well as operationalplanning. This is where McDonald s has excelled due to its ability to successfully integratethe customer s perspective in its products and operations in a comprehensive manner. Therevamped menu in India is an example of McDonald s strategy of integrating the customer sperspective in its products. And, the operational integration is evident from McDonald semphasis on its suppliers as its customers as well as its treatment of its consumers as co-producers of services. Having the new specialty coffee isn t enough though; educating the customers begins with owners, managers and employees. Sampling of the new drinks also played a vital role in customer education. Generating trial, getting product in the hand of the customer is a very intricate part of helping them understand what the offerings are, says Donna Kemp, an operations consultant. Sampling done right makes a big difference, she continues. We found that on the busiest day of the week, Friday, sampling throughout the day really captures new customers that have not tried the product. The marketing strategy includes TV commercials, billboards and sampling at college events, because many of the specialty coffee drinks appeal to young adults, Betts says. But these are not targeted at just one specific consumer, he adds. While the drip coffee appeals to older consumers and males, the specialty coffee drinks attract more females. Iced drinks draw in the younger customers. Everybody is going to be able to find two or three things out of our new beverage offerings that are going to resonate.

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Since staring its beverage expansion, restaurants already are seeing new traffic at breakfast time. But this increased traffic is not limited to breakfast time only, Betts says. In addition to the new flavors appeal and the convenience, the new beverages are priced competitively. Depending on the market, the drinks are 30 to 80 cents cheaper than competitors. They are a great value the way we have them positioned today, Betts says. Conclusion McDonald s new focus on high-end coffee is consistent with an overall strategic shift away from the traditional burger-and-fries offering towards a more upscale food, such as chicken and salad. Although it appears McDonald s is competing directly with Starbucks, the target market does vary slightly, for instance the new offerings will provide the perfect complement to current menu items and satisfy parents who bring their kids to McDonald s. The use of the automated espresso machines will not increase average serving time or require baristas, thus keeping in line with the principles of efficiency and consistency that McDonald s is proud of.

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www.aboutmcdonalds.com/hamburgeruniversity

http://www.fastcasual.com/article/98104/McDonald-s-not-pulling-from-Starbucks-customer-base http://www.msnbc.msn.com/id/21837962/ns/business-consumer_news/ http://www.neeley.tcu.edu/WorkArea/linkit.aspx?LinkIdentifier=id&ItemID=9771 http://www.ncausa.org/custom/headlines/headlinedetails.cfm?id=667&returnto=171 http://money.cnn.com/magazines/business2/business2_archive/2006/10/01/8387114/index.htm

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