A Tale of Two Companies

McDonald’s kicked ass last year and all indicators are pointing to another solid performance this year. The analysis that people just want cheap food is wrong though, people want value, which is a lot more complex than just having a low price tag, and McDonald’s delivers it in spades. The Mini Meals menu items that they are running right now are about as good as it gets for a full meal in a reduced portion size for $3.

US fast-food giant McDonald’s said Monday its 2008 net profit soared 80 percent from a year, lifted by growing demand from consumers seeking low-cost meals in a deepening global recession.

[From McDonald’s posts sizzling 80% profit rise in 2008]

The team at McDonald’s read the cards correctly and put in place several initiatives that are paying returns, the value menu being just one of them. They embarked on an ambitious program to renovate retail stores, which feature comfortable sitting areas, televisions, and a new color palette that is pleasing and warm. New menu items like salads and chicken sandwiches satisfy a broad range of tastes and desires.

On the coffee front they, like Dunkin Donuts, doubled down on plain old drip coffee while adding espresso drinks, which put them squarely in competition with Starbucks, although with a far better array of assets to compete with then Starbucks could muster. In retrospect I think it’s fair to say that drip coffee is a bigger sales driver than many observers would suggest and it is most certainly the case that the quality of the coffee is far more important than other attributes… my purchase decision is not based on whether it’s fair trade or not, but how it tastes and Starbucks drip coffee just doesn’t taste that good.

Starbucks announced that they are making another 1,000 job cuts. This is a classic example of a company that lost it’s way by forgetting that the core competency they had to deliver on was good coffee and not just a lifestyle brand. Starbucks rather spectacularly miscalculated that people went to Starbucks for the atmosphere and the lifestyle brand could be leveraged for (bad) food, music, hardware and appliances, and even extended to the grocery store shelves. As it turned out, Starbucks is one of those disposable brands that you can do without.

On top of the dilution that occurred as they expanded into (bad) food and mediocre baked goods, the retail stores started to look dated and tired. As I wrote above, Starbucks lost their way and with so many things going wrong for them at the moment it is difficult to imagine a scenario where they emerge intact.

Their stock has lost $21b of market cap in a few short years, which puts massive pressure on employee morale, among other things, and their balance sheet is not particularly strong. What is most troubling is their cash flow, which is negative and largely driven by necessary capital expenditures. It’s hard to speculate on whether or not they would be an acquisition target; while the vast majority of the stock is held by institutional investors it really comes down to who would acquire them in this environment with the problems they are confronting.

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