Confidence in Coffee

McDonald's and Starbucks introduce new java drinks, eye increased sales

OAK BROOK, Ill., & SEATTLE -- As McDonald's reports a 15% increase in coffee sales since its introduction of Premium Joe, it is now experimenting with iced coffees and espresso-based drinks, even as industry leader Starbucks aims to return its attention to its coffee roots.

McDonald's is pushing quickly into the high-end coffee market, with its mouth-watering profit margins, according to a report from Reuters. "You can't get much better profit than adding water to beans," McDonald's USA president Don Thompson said at an investor conference [image-nocss] two weeks ago.

The burger chain, which has seen sales of cups of coffee rise 15% with the introduction of Premium Joe, is now experimenting with iced coffees and espresso-based drinks. "These beverages can be destination drivers, encouraging customers to stop by at different times of day, which is why we are pursuing this opportunity," Thompson said.

At the same time, Seattle-based Starbucks will launch its latest coffee treats on April 3, a pair of confections called Dulce de Leche Latte and Dulce de Leche Frappuccino, according to a separate report in Business Week. A 16-oz. grande latte has a robust 440 calories (about the same as two packages of M&M's) and costs about $4.50 in New York City, or about three times as much as McDonald's most expensive premium coffee.

The introductions are a small step in chairman Howard Schultz's mission to take his company back to its rootsand triple sales in the next five years to $23.3 billion. The company also plans to have 40,000 stores worldwide, up from 13,500 today, not long after that.

To hit its profit targets, Starbucks has become expert at something that's decidedly unromanticstreamlining operations. Over the past 10 years the company has redesigned the space behind the counter to boost barista efficiency. Automatic espresso machines speed the time it takes to serve up a shot. Coffee is vacuum-sealed, making it easier to ship over long distances.

To boost sales, the company sells everything from breath mints to CDs to notebooks. Add it up and you have an experience that's nothing like the worn wooden counters of the first store in Pike Place Market or an Italian espresso bar.

Somewhere along the way that disconnect began to gnaw at Schultz. Most recently it manifested itself in a note he wrote to his senior team. The Valentine's Day memo, which leaked to the Web, cut to the heart of what he sees as the company's dilemma. "We have had to make a series of decisions," Schultz wrote, "that, in retrospect, have led to the watering down of the Starbucks experience, and what some might call the commoditization of our brand."

Now, Schultz is asking his lieutenants to redouble their efforts to return to their roots. "We're constantlyI don't want to say battlingbut we don't want to be that big company that's corporate and slick," says Michelle Gass, senior vice-president and chief merchant for global products. "We don't. We still think about ourselves as a small entrepreneurial company." That's a tricky business when you have 150,000 employees in 39 countries.

According to the Specialty Coffee Association, the U.S. market for specialty coffees -- defined by the use of high-quality beans and roasting standards -- was worth $12.27 billion in 2006, up from $8.3 billion five years earlier.

Coffee importer and roaster Gavina supplies coffee to about 2,700 McDonald's restaurants in the western United States. The company's other U.S. coffee suppliers are S&D Coffee Inc. and Kraft Foods Inc.

Oak Brook, Ill.-based McDonald's success has invited speculation that the chain may be taking business away from coffee rivals Starbucks Corp. and Dunkin' Donuts. Thompson said at the J.P. Morgan conference that McDonald's hoped to take market share from specialty coffee retailers but declined to name names.

McDonald's specialty coffees are produced in machines that grind the beans individually for each drink but are quick enough to live up to the company's stringent speed requirements.

So far the world's largest coffee company, Starbucks, has not felt an impact from efforts by McDonald's and Dunkin' Donuts' to upgrade their coffee offerings, CFO Michael Casey told the same conference.

Dunkin' Donuts has been selling espresso beverages for three years, and those drinks now make up more than 5% of the chain's sales.

"More educated customers about high-quality coffee is good for all the participants in the business," Casey said.

One expert said demand for higher-quality coffee is so strong that McDonald's will probably see robust sales of specialty coffee drinks without making a dent at either Starbucks or Dunkin' Donuts.

"It will expand the market rather than impact Starbucks," said Bob Goldin of restaurant research firm Technomic Inc. "It's not the right experience (for Starbucks customers) ... the smell of french fries and ultra premium coffee drinks don't go together."

Still, the market has clearly become more competitive. Both Starbucks and Dunkin' Donuts this month gave away free coffee to customers, and McDonald's tells customers that its workers will add cream and sugar to drip coffee for them -- a direct attack at Starbucks, where customers add their own.

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