McDonalds vs. Starbucks- A Marketing Battle You Just Have To Love

Yesterday's Wall Street Journal featured an article on the marketing battle currently brewing (yes, I know- a bad pun) between McDonalds and Starbucks over upscale coffee.

The Journal article displayed a one-year stock price chart for the two companies. I prefer two other timeframes- two and five years.

The nearby two-year chart for McDonalds, Starbucks and the S&P500 Index clearly show Starbuck's recent decline. It was holding flat, even up a bit in mid-2006, then slumped monotonically beginning in October of that year, rising nearly without pause since then.

McDonalds' stock price over the same period is almost directly opposite. Its price was truly flat for mid-late 2006, then took off in September of that year.

The next, five-year price chart for the same entities reveals how Starbuck's decline is a serious departure from its prior, longterm trend. The red curve, depicting the coffee giant's price over time, enjoyed two years of growth which outstripped the S&P in 2003-4, then flattened in 2005-6, and began to fall.

McDonalds have been on a steady upward trajectory over the entire five year period.

With that backdrop, I found the article suggestive that McDonalds is about to take a major piece out of Starbucks' recently-earned volume growth. McDonalds' move into higher-end coffee is the next in a series of revitalizing moves that have turned around the formerly-ailing fast-food giant.

For Starbucks, however, as I've written in prior posts, here, here and here, their expansion strategy has brought new headaches, as they try to buck the natural limits to growth of their business model. To me, it seems a clear indication of Schumpeterian dynamics at work, signaling an end to Starbucks' salad days of growth and total return superiority.

Particularly worrisome, as was also voiced this morning on CNBC, is Howard Schultz' preoccupation with 'returning to the core' of Starbucks. For example, in this passage from his nearly year-ago internal memo, Schultz wrote,

"We desperately need to look into the mirror and realize it's time to get back to the core,"

Thus, this morning's announcement that Schultz forced out his CEO, Jim Donald, and is resuming that title and role at the coffee roasting titan.

However, McDonalds' push into coffee has more to do with raw market opportunity than simply competing with Starbucks. That is, as the Journal article notes,

"The confrontation between Starbucks Corp. and McDonald's Corp. once seemed improbable. Hailing from very different corners of the restaurant world, the two chains have gradually encroached on each other's turf. McDonald's upgraded its drip coffee and its interiors, while Starbucks added drive-through windows and hot breakfast sandwiches.

The growing overlap between the chains shows how convenience has become the dominant force shaping the food-service industry. Consumers who are unwilling to cross the street to get coffee or make a left turn to grab lunch have pushed all food purveyors to adapt the strategies of fast-food chains.

It also shows how the chains' efforts to adapt to a changing market have had drastically different results on their bottom lines. McDonald's is entering the sixth year of a successful turnaround, while Starbucks has begun struggling after years of strong earnings and stock growth.

McDonald's executives watching the growth of Starbucks at the beginning of this decade realized that they were missing out on the fastest-growing parts of the beverage business. Data showed that soda sales had flattened while sales of specialty coffee and smoothies were growing at a double-digit rate outside McDonald's. Customers were buying food at McDonald's, then going to convenience stores to get bottled energy drinks, sports drinks and tea, as well as sodas by Coke competitors."

The fact that McDonalds wasn't originally remotely considered a competitor of Starbucks makes this a fascinating marketing battle. It's like watching a football wide receiver and his defender both leap for a pass, each having an equal 'right' to catch the ball, neither having especially wanted to collide with the other. But the ball is in only one place, so there they all are- the receiver, defender, and the ball.

In this case, it's the fast food and drink consumer, McDonalds and Starbucks. If McDonalds had identified something else, such as upscale desserts, or pizze, or what have you, somebody else might be in their way. Or perhaps nobody.

But as it is, Starbucks moved so far downscale, and reprogrammed so much of America to drink better coffee, that they created a market too tempting for McDonalds to avoid. And Starbucks developed its business model to be perilously close to that of McDonalds, in terms of satisfying instant consumer demands for food and/or drink, but being less efficient in its provision.

Chance are good you can learn to make better coffee more easily than you can instill a new, faster service ethic in your sprawling employee base. For what its worth, I happened to have sampled McDonalds' upscale coffee salons in New Zealand several years ago, and found it every bit as acceptable as Starbucks or, for that matter, Dunkin' Donuts.

In this passage, the Journal piece provides a wonderful insight into how McDonalds used classic, grass roots market research to unearth the opportunity they are developing,

"McDonald's researchers contacted customers of Starbucks and other coffee purveyors and conducted three-hour interviews where they videotaped the customers talking about their coffee-buying habits. The researchers got in the cars of the customers and drove with them to their favorite coffee place, then took them to McDonald's and had them try the espresso drinks.
"There was a surprise factor," says Patrick Roney, a director of U.S. consumer and business insights at McDonald's. "The people who were on the fence...there was an opportunity to get those." "

And McDonalds is using some of its classic strengths- ubiquity and reasonable prices, to move into the upscale coffee product/market, as seen from this passage,

"Heather Pelis, a 19-year-old babysitter from Rayville, Mo., says she didn't like the McDonald's vanilla latte when she tried it. "It was a little syrupy tasting," Ms. Pelis said recently while drinking a drip coffee at a McDonald's in Liberty, Mo. But she says she'd be willing to try another espresso drink because they are cheaper than the caramel macchiatos she buys at Starbucks, and because McDonald's is more conveniently located. The nearest Starbucks is a 30-minute drive from her, she says.

McDonald's franchisees say they think the new coffee drinks will be particularly helpful in drawing young consumers who prefer them to drip coffee. Gary Granader, a Detroit-area McDonald's franchisee, has started seeing groups of teenagers at some of his restaurants after school since he added espresso drinks a year ago. Mr. Thompson says McDonald's also is considering adding some type of music-downloading service at its locations."

Toward the end of the Journal article, it discusses Starbucks' reaction to its current dilemma,

"Starbucks executives have attributed the slowdown in sales growth and store traffic in the U.S. to the weak economy.

Mr. Schultz has said that new competition actually helps Starbucks by expanding the specialty-coffee category. "Those consumers over time are going to trade up," he told investors in November. "They're going to trade up because they are not going to be satisfied with the commoditized experience or the flavor." He has emphasized that Starbucks's baristas, who are instructed to memorize customers' drink orders and make genuine conversation with patrons, will continue to set the chain apart.

But some Starbucks baristas say that the chain's push into food and drive-through service has made that a lot more difficult. Some workers say their managers instruct them to ask customers whether they want a breakfast sandwich with their coffee -- a selling technique that feels unnatural when they know the customer doesn't want one.

"The more and more business they get in the store, the more it seems like another fast-food job," says Joe Tessone, a Chicago barista who has worked at Starbucks for three years."

To me, having followed this building story for nearly a year, Schultz' and Starbucks' logic and expectations are wrong. They expanded into more price-sensitive, lower-income segments, and are now struggling to make that business more constant. But it will be precisely those customers who are vulnerable to McDonalds and Dunkin' Donuts. Further, the changes in its product strategies is causing confusion and morale problems among Starbucks' workforce.

In today's article on Schultz takeover of the CEO spot, they write,

"Mr. Schultz wouldn't specifically address the coming competition from McDonald's but said he will work to make the experience at Starbucks more distinctive. "We have to be able to restore that in a way that significantly differentiates us from everyone else," he said."

Clearly, this makes sense. It's simple, basic marketing- provide a clearly differentiated offering if you have different price points than your competitors. Doing that, however, after having lost the magic, is a pretty tall, or is that venti or grande, order. However, they also quoted from Schultz' recent internal letter to employees,

"Some of Mr. Schultz's objectives stated in the letter, such as "re-igniting the emotional attachment with customers," are so difficult to measure that it may be hard for investors to know whether they are happening."

Maybe it's me, but I don't really want an emotional attachment to my coffee purveyor, when I do buy coffee from a retailer. I guess that's why I've been a Dunkin' Donuts guy up until now. I only buy whole espresso beans from Starbucks, although my children will sometimes ask to buy a drink when I stop to do that.

Of course, I'm only one coffee drinker, albeit a fussy one. The outcome of this battle royale between two retail food giants, Starbucks and McDonalds, with Dunkin' Donuts also roaming the same terrain, will be fun to watch. If you ever wanted to view a classic marketing struggle between two fairly well-matched firms in a clearly-defined market, this is your chance.