The One Reason Why McDonald's Crazy Bagged Coffee Idea Makes Sense

Aug.23.14 | About: McDonald's Corporation (MCD)


McDonald's plans to start selling bagged coffee on supermarket shelves across the U.S. in 2015.

Even if they catch on with at-home coffee drinkers, the sales probably won't significantly raise the company's top or bottom line anytime soon.

Still, there's a good reason for McDonald's to make this move -- especially as it eyes a long-term plan to turn things around.

On the surface, the idea seems silly - selling McDonald's (NYSE:MCD) coffee by the bag on store shelves. After all, this is a restaurant chain best known for its burgers and fries, not its coffee. At least not the way Starbucks (NASDAQ:SBUX) or Dunkin' Brands' (NASDAQ:DNKN) Dunkin Donuts are.

McDonald's is also a chain with more than 35,000 locations around the globe - most of which have a drive-through. It's pretty easy to grab a cup of McCafe whenever you get a hankering as it is.

All that, no doubt, has lead some writers to question the plan - and others to poke a little fun at the Golden Arches. But there may be something behind this seemingly crazy plan that actually makes a lot of sense. And it just may work to give McDonald's a bit of a boost when it most needs it.

Struggles mount
Let's take a quick step back and put some things into perspective. McDonald's is struggling right now, more than it has in at least 10 years. U.S. same-store sales have been down, or at least flat, in every month dating back to late 2013. Domestic comps dropped a dismal 3.2% in July. What's more, same-store sales worldwide were down 2.5% for the month, the worst decline in more than a decade.

McDonald's faces stiff headwinds. Key among them are a slow economic recovery that had been harshest on the lower income levels, the rise of healthier, fast-casual rivals such as Chipotle Mexican Grill (NYSE:CMG), and a menu that has strayed from the core successful products in favor of clunkers like Mighty Wings.

Will selling coffee at the supermarket fix any of those woes? No. Will it make up for a lot of the lost revenue? No. Especially not in the short term.

Then why make the move that called a "full-tilt entrance into the $11 billion-plus U.S. retail coffee market"?

This is long-term thinking
Despite's assertion that "McDonald's could use a nice chunk of that market," that's not likely the Golden Arches' real aim here.

This move is about getting the McDonald's name in front of consumers for whom it's become increasingly easy to pass by the Golden Arches without even noticing that it's there. Some of those consumers may have abandoned McDonald's and its fast-food brethren for fast-casual chains like Chipotle and Panera Bread (NASDAQ:PNRA). Others may have abandoned eating out due to continuing financial constraints since the Great Recession.

Earlier this year, Bloomberg Businessweek reported that McDonald's strategy over the next three years puts a high priority on "coffee-driven visits."

"In a Jan. 28 memo, U.S. operations chief Jim Johannesen and U.S. brand chief Kevin Newell exhorted franchisees to deliver 'a gold-standard cup of coffee with every visit,' " the magazine reported.

But the ultimate goal of that is not selling coffee. It's getting diners to come back to McDonald's, where they will also buy burgers, fries, chicken sandwiches, and salads.

What's the retail market's potential?
Starbucks has a significant head start on McDonald's in supermarket sales. Yet its channel development segment - which includes not only bagged store coffee, but also single-serve cups, Tazo teas, and an assortment of ready-to-drink coffees, teas and juices - still made up less than 10% of its overall revenue in fiscal 2013. At roughly $1.4 billion for its entire channel development segment, it's unlikely Starbucks coffee makes up even 10% of that $11 billion retail coffee sales market referenced earlier - and maybe not even close to that.

With McDonald's store footprint nearly twice as large worldwide, it's hard to imagine store-bought bagged coffee will make up a significant amount of revenue any time soon - if ever.

Beverage Industry estimates that Starbucks, a company built on coffee, owns 13.7% of the overall retail coffee market. That's even more than Kraft, the company McDonald's is partnering with to get its McCafe beans on store shelves. What could McDonald's realistically expect to muster? Even at half of Starbucks' share -- a very optimistic number, even long term -- it would be looking at a roughly $700 million annual endeavor for a company that did $28.1 billion in revenue last year. That's small potatoes.

But the move as a means of marketing could be significant over time, as shoppers identify McCafe as a quality cup of coffee and become more likely to swing through the McD's drive-through.

By no means should investors take this coffee plan as a signal to buy. McDonald's is facing some strong headwinds right now. The rise of healthier fast-food outlets, the sluggish economy (especially among the lower and lower-middle class), and the possibility of rising wages in the U.S. are just a few. Those won't go away in a quarter or two. They're long-term issues.

Selling bagged coffee in stores won't fix any of those problems. But for patient investors looking to hold the stock, it's a sign that the company is thinking creatively about ways to appeal to customers.

Disclosure: The author is long CMG.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.