The Latte Wars

Obama and Clinton. McCain and Romney. Call them the great contests of the week, if you must. But pound for (finely ground) pound, a more heated battle has been steadily percolating. It's morning in America, and that's steamed milk you hear. A latte war is brewing. The prize: venti-size profits in a U.S. specialty coffee market valued at $11 billion and growing.

On one side is Starbucks Corp., the Seattle-based coffee giant responsible for the democratization of the $3-$4 hot beverage. In hopes of reinvigorating a stock price that has floundered in recent years—this week it hovered around $20, about 40 percent less than the $36.60 it was trading at a year ago—Starbucks ousted its CEO, Jim Donald, this week, replacing him with Howard Schultz, the company's longtime chairman and the executive credited with making it the ubiquitous brand it is today. On the other side is McDonald's Corp., the Oakbrook, Ill.-based burger behemoth that feeds more people every day than any other restaurant brand in the world. The company announced a national rollout of the type of made-to-order coffee drinks that Starbucks brought to the fore.

It's an interesting shift for two companies that less than a decade ago seemed worlds apart. In his quest to make Starbucks a global powerhouse Schultz, as recently as 2000, declared that Starbucks sought to be the McDonald's of coffee. He's come close. In the last decade the coffee chain has grown from 100 stores to more than 15,000 worldwide. Meanwhile, McDonald's top executives enviously eyed the $4 consumers seemed more than willing to pony up for a caramel macchiato, while at the same time demanding that Big Macs stay priced at 99 cents.

Taking a cue from Starbucks, McDonald's three years ago switched to richer-flavored "premium roast" coffee. Consumers swallowed it up, and the burger chain's coffee sales growth bubbled up into "the double digits," says Lisa Frick, director of McDonald's U.S. combined beverage business. After years of slumping stock prices and supersized bad press, McDonald's is now in the midst of a turnaround and is counting on high-margin lattes and cappuccinos to get regulars to spend more and attract new customers, a difficult but necessary endeavor for any established fast-food brand. "We were hearing loud and clear from our customers that they were ready for this," says Frick, adding that in test markets about half the customers who purchased frothy concoctions were new faces, and particularly young women.

Starbucks has primed the American drinking public well. According to Frick, McDonald's mixed coffee drinks have profit margins that rival even its regular cup of drip, an appetizing prospect in a week when shares of McDonald's fell more than 7 percent on reports of slow December sales. The company is betting its new drinks, which will be priced lower than equivalent Starbucks offerings, will also drive between-meal traffic into McDonald's restaurants.

None of which is good news for Starbucks. McDonald's, with more than 14,000 restaurants in the U.S. alone (there are no plans yet to broadly introduce lattes abroad) could be formidable competition for Starbucks, particularly as cost-conscious consumers start recalculating the price of a gallon of gas vs. a grande cappuccino.