Coffee Gets Hotter at McDonald's

Adding specialty coffee stations to its restaurants could reap specialty profits. But adding such complexity to a simple system has its risks

by Judith Crown

McDonald's (MCD) is riding high, enjoying a resurgence fueled by new snacks and longer restaurant hours. But is it about to put the whole thing at risk by trying to take on Starbucks (SBUX)?

The burger giant plans to install specialty coffee stations in all its restaurants over the next 18 months. The stations, which are a scaled-down version of the format Starbucks uses, could deliver another $1 billion in sales to McDonald's $23.3 billion in annual systemwide sales, the company says. But restaurant experts say the change also could slow down operations and add to wait times. That conjures up memories of the troubled rollout of McDonald's "Made for You" cooking system in 1999, which was designed to let restaurants prepare burgers to order but initially slowed delivery times during the crucial lunch-hour crunch.

Drive-Through Luxury

"You're adding operating complexity in a system that's designed for simplicity," says Neil Stern, senior partner at retail consulting firm McMillan Doolittle in Chicago. Experts note that customers expect their order to be completed in 60 to 90 seconds and get cranky when service breaks down.

The key to fitting the new system into McDonald's highly regimented operation is that it will be simpler to operate than a Starbucks setup, the company says. Still, McDonald's plans to hire Starbucks-style baristas for the first time. Those baristas will man stations separate from the main counter to make sure concocting a latte doesn't slow down a Big Mac order. If coffee orders are slow, the baristas can always swing back to help bag burgers.

The chain already has some experience with specialty coffee service. It offers espresso-based drinks at 800 of its restaurants in Kansas City, Michigan, and the Pacific Northwest, using the same format that it plans to roll out nationally. Its goal will be a maximum wait time of 90 seconds. The tradeoff is that McDonald's won't be able to offer as many choices as Starbucks (you may have to go elsewhere for that cinnamon dolce frappuccino, for instance). About 60% of McDonald's new coffee drinks will be delivered through drive-through windows, the company expects, or about the same percentage as for the main menu offerings.

Even while charging an average of 60 cents less per drink than Starbucks, McDonald's is expected to make 30%-plus margins on the specialty coffees. Still, some McDonald's franchisees are apprehensive about the expected $50,000 per-store cost of the equipment and store retrofitting, which is about what Made for You cost, even though the parent company will help defray expenses. Also, the return on the special coffee drinks will depend on local competition. McDonald's is looking to wrest business not just from Starbucks, but convenience stores and rival Dunkin' Donuts.

More Versatile Staff

Another factor is whether the new equipment can even fit into some restaurants. Irwin Kruger, a 40-year franchisee who owns three New York City stores, worries whether he'll be able to wedge a coffee station into his 2,000-square-foot restaurant near Madison Square Garden.

"It is a big endeavor," says Fred Huebner, a North Carolina franchisee who is opening his 14th store in February and has been testing specialty coffees for a couple of years. He offers coffee in three locations, including a McCafe—an experimental format that includes desserts along with specialty coffees. Huebner likens the initiative to Made for You but says in this case the challenge will be designing the coffee station to fit the store layout in a way that doesn't disrupt the front counter. Store operators will have to fine-tune staffing, perhaps providing for counter workers to slide over to barista duty while making sure there are enough people on the main line to dispense hamburgers and salads.

Coffee isn't the only stretch that McDonald's has planned. Eventually, it plans to offer smoothies at its beverage stations, which will require still another class of blending equipment. "We're still working on that," says Huebner.

McDonald's points out that it has 18 months to iron out the kinks as it expands specialty coffee to all 14,000 U.S. locations. "We'll make sure we've done the training properly and that we're fully staffed," spokesman Bill Whitman says.

Stock on a High

Analysts largely applaud McDonald's strategy, saying that coffee will draw customers into restaurants during off-peak times and bring them in more frequently. "The beverage platform takes over where the dollar menu left off," says UBS Securities analyst David Palmer.

McDonald's says coffee would be its biggest product rollout since breakfast was added during the 1970s. The menu expansion extends a strategy launched in 2003 to drive traffic at existing stores, rather than to merely open more units, and to introduce snacks and beverages that can be consumed at all hours, not just during traditional meal times. McDonald's reduced its pace of annual store openings to around 300, compared with three times that number earlier this decade.

As a result, sales at stores open for at least a year have risen consistently since then. McDonald's stock closed Jan. 9 at $57.27, near a five-year high and up from $44 a year ago.

It's a strategy that McDonald's newfound competitor, Starbucks, appears ready to emulate. Newly appointed Starbucks CEO Howard Schultz sees fewer new store openings and the closing of some underperforming stores as a key to reviving his company's flagging fortunes.

Crown is a senior correspondent for BusinessWeek and BW Chicago.