McDONALD'S Corp.'s decision to slash in half the price of its Big Mac and other signature
sandwiches in the United States is the latest incarnation of a daring and risky strategy.
The move by the dominant fast-food chain is aimed directly at competitors such as Wendy's and Burger King, which have been aggressively discounting fast-food fare, analysts say.
McDonald's pre-emptive strike - code-named Campaign 55, for its 55-cent (U.S.) Big Macs - is an approach that countless companies, from airlines to movie houses, have used to try to defend market share and/or bury the competition.
But it's a move that can easily backfire. Pulling it off takes deep pockets, lots of planning and sheer guts.
"To be successful, you typically need to be a strong price leader like a McDonald's," says Bob Bougie, a partner at management consultant Deloitte & Touche in Toronto. "(It must be) someone who can handle the margin squeeze that comes from dramatically discounting prices."
History is filled with examples of price wars that have blown up in the instigators' faces. In the mid-eighties, for instance, full-service airlines in the United States were scrambling to match cut-rate fares offered by People Express Airlines. A few years later, People Express was neck-deep in losses and forced into a rescue merger.
Price-war strategies usually fail, Mr. Bougie says, because companies forget to calculate the inherent risks.
"You have to stay focused and have a good understanding of the impact on your bottom line," he says. "If you're going to take two points off your margin, and you anticipate the war will last six to eight months, you better have a good idea of the kind of volumes you need to generate to make up for the lost margin dollars."
But what if a company can't make up the difference? Mr. Bougie warns it then has to determine whether it has "the financial wherewithal to weather the decrease in margin dollars over the long term."
He cites the case of retailers - big and small - that underestimated the longevity of the various price wars that erupted during peak Christmas selling periods in the early nineties.
"We didn't see so much of it this year at Christmas, but in the previous four years, retailers blew their brains out by starting a price war, and every year it seemed to get earlier and earlier ... so Boxing Day was in mid-November."
Mr. Bougie says weaker retailers - who might earn 30 to 40 per cent of annual sales during Christmas - couldn't handle the drop in margins and fell by the wayside.
Retail industry pundits say companies that want to stay on top in price wars should consider the following principles:
The jury's still out on whether an all-out price war will erupt over McDonald's Campaign 55. Both Wendy's and Burger King would not say yesterday whether they'll hike beef-patty prices, and McDonald's price cutting is so far limited to the United States.
Still, Mr. Vandenbosch sees McDonald's move as an attempt to reassert itself as the "low-price leader."
To be an effective price leader, a company has to react quickly. "The more competitors cut prices, the quicker you have to act. Here's McDonald's trying to exercise some control - to teach its rivals a lesson. It's consistent with their role in the market."
Len Kubas, a marketing research consultant in Toronto, says fast-food retailers have been backed into a corner by consumers who "are addicted to getting deals and bargains.
"Retailers and marketers have been sharpening their pencils and trying to figure out ways to lower their prices without losing their shirts," he says.
With Campaign 55, Mr. Kubas believes McDonald's is playing it safe.
"The company seems to run best when it's operating at full tilt. It's better off being a volume-driven organization, even though they might not get the same gross margin for every item."