The 55-Cent Big Mac Bet

South China Morning Post

2nd March 1997

Press Index

IT might taste good to customers, but a price offensive announced by McDonald's could leave the fast-food industry in the United States feeling sick.

The giant company, increasingly bothered by an eroding market share, is placing its hopes on the introduction of the 55-cent Big Mac - the reigning monarch of the American hamburger.

Burger King, Wendy's and other major rivals have vowed to avoid the same kind of damaging price war that followed a massive price-slashing initiative by Pepsico's Taco Bell in the late 1980s.

But while analysts disagreed on the likely response to the McDonald's offensive, stockholders were united in their disapproval, sending shares in many major fast-food chains tumbling in the second half of the week.

It seems clear the move says much about McDonald's growing discomfort with recent trends in the domestic US market. Last year, it tried to correct its slide by focusing on product quality and betting heavily on the introduction of the Arch Deluxe, an adult-oriented hamburger. It was a disastrous move that saw its unit sales drop 3.3 per cent while Burger King's rose 2.6 points.

This time round, McDonald's, under the leadership of chairman and chief executive Michael Quinlan, is opting for a time-tested tactic: cut your price, tempt more customers into the store and let your rivals sweat.

The company, with its 12,000 US outlets still dominates the market with a 42 per cent share, more than double its nearest competitor, Burger King. Its US$32 billion worldwide sales last year also eclipsed Burger King's $9 billion. But it has seen its local performance slacken alarmingly, to the point where about 57 per cent of its profit comes from overseas.

Analysts believe it is also continuing to over-expand at a time when the industry's growth is sluggish. It opened 2,500 new stores in the US last year, even though revenues for the industry rose only about 3 per cent.

It has also experienced a quality-perception problem, with the public beginning to prefer Burger King and Wendy's products, particularly in the large breakfast sector.

And with the US market nearly saturated, the only way a company can expand its revenues is to steal another's market share.

But indulging in price-cutting, even for a cash-rich market-leader, was "an extraordinary gamble", said Damon Brundage, a NatWest Securities analyst.

"Anyone can get more customers in the door by essentially giving away the product. What the company needs to do is go back to the focus on the product and trying to differentiate themselves on the product."

Whether McDonald's is actually giving much away is open to question. The 55-cent Big Mac - a quarter of its current price - is only valid when purchased with french fries and a drink, high-profit items which help recoup the investment. Added up, the special offer represents a "combo meal" only 20 cents lower than currently offered. Ironically, the "combo meal" was itself a special offer tactic introduced during previous price wars.

But while the parent company will see higher royalties from pulling in large numbers of new customers, the franchisees who run the stores could see their profits drop and many of them have not yet agreed to the price cuts.

The company disputes that view. Memos circulated within the firm said its move was based on estimates that the strategy would boost revenues in the average store by $50,000 over 18 months.

Industry experts expect many smaller fast-food chains, who are already struggling to compete, to be badly hit by McDonald's aggressive move.

Rally's, a restaurant chain based largely in Ohio, recently reversed a loss-making price-cutting programme, and hopes McDonald's move will not force rivals to follow suit.

"Nobody knows the discount strategy better than Rally's, and it just doesn't work," said company president Jeff Roschman. "You buy customers until you end the deal, and then they stop coming."

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