Starbucks vs. McDonald's

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.

Wall Street greeted this week's changing of the guard at Starbucks with cautious optimism; Bank of America, for one, upgraded the stock from "sell" to "neutral." For Schultz the "Starbucks experience"—that fuzzy feeling he hopes customers get when they bring a carefully crafted Starbucks drink to their lips while enveloped in a warm and comforting retail nest—is known to be something of a religion. Bringing him back could be key to reinvigorating a brand that in recent years has seemed more focused on keeping up with demand than ensuring a distinctive brand identity. "It is now more important than ever for Starbucks to justify the premium it charges customers for its coffee and other products," says John Owens, an analyst with Morningstar.

Mariel Rappaport agrees. With a daily latte habit and both a Starbucks and a McDonald's within walking distance of her office in Los Angeles, the administrative assistant, an avid Starbucks fan, says her business could be up for grabs if McDonald's version is tasty and less expensive. "By the end of my week, going to Starbucks really adds up," Rappaport says. "But I can't help it. Going is an important break in my day." Starbucks isn't yet going into detail about its plans to keep customers like Rappaport coming back. In a letter to Starbucks employees this week, Schultz, who declined to speak with NEWSWEEK, said the company would scale back domestic growth, introduce new menu items and store designs, close underperforming locations and expand overseas. "By focusing again on the Starbucks Experience we will create a renewed level of meaningful differentiation and separation in the market between us and others who are attempting to sell coffee," he wrote.

And there are plenty of others. Among the coffee stalwarts pouring marketing and product development resources into their own brews are 7-Eleven stores and Dunkin' Donuts, which began selling lattes and cappuccinos in 2003 and has been marketing itself as a coffee—rather than doughnut—destination. Frances Allen, Dunkin' Donuts' brand marketing officer, says the company views the heightened competition as "an opportunity to make sure we've got our A-game on." Allen says the chain will be announcing several new menu innovations in the next year, including a greater emphasis on food after the morning breakfast rush. "Our customers' habits are changing, and their eating times are changing," she says.

But there are limits. McDonald's is developing sugar-free flavorings, but don't look for them in restaurants anytime soon. And how about the increasingly popular soy latte or green tea chai? "Not yet," says McDonald's Frick. Starbucks, take note.

Starbucks vs. McDonald's | Business