McDonald's eyes coffee market, but some franchisees not happy

CHICAGO -- McDonald's Corp. executives came out swinging when they announced their assault on the comfy world of coffee shops.

After the success of its upgraded drip coffee -- which even managed to snag a thumbs-up from testers at Consumer Reports earlier this year -- the fast food chain known for supersize meals is gearing up for a massive expansion into the world of lattes.

"We want to move from beverages as an accompaniment to being a beverage destination," Don Thompson, president of McDonald's USA, said in a meeting with analysts Tuesday. "Our speed, our convenience, the value that we can afford to customers without quality comprise will make us a formidable player."

Restaurants will offer lattes, mochas, cappuccinos and espressos with a choice of different flavorings and milk. Industry watchers say the drinks cost about 50 cents less than at Starbucks.

But as it tries to cash in on the fast-growing specialty coffee market, the world's largest restaurant chain is already finding itself at odds with the unlikeliest of groups: Its own franchise owners.

"There's a real groundswell of resistance among the franchisees about this," said Richard Adams, a consultant for McDonald's franchise owners. He estimated the effort has a 50-50 chance of getting off the ground because of franchise opposition.

Store owners are balking at the plan's estimated $100,000 price tag to cover renovations and initial new equipment.

And many are concerned that little customer interest in McMochas means it could take years to recoup their investment, even on the famously high-margin coffee drinks.

"They're going to have whipped cream on their face," Adams said.

McDonald's said it's confident the new coffee will win over new customers and help individual stores boost annual revenue by about $125,000 once the coffee products, along with new bottled drinks, smoothies and other beverages are added to stores.

If McDonald's can persuade its franchisees to sign on, analysts say it can likely thrive in the growing $12 billion specialty coffee market, which includes both brewed coffee and beans.

About one in five Americans drinks some kind of espresso-based coffee each day, and the market is supposed to grow by at least 4 percent each year until 2011.

"With coffee gaining so much ground, McDonald's almost has to go there," said Sharon Zackfia, a restaurant and retail analyst with William Blair & Co. "The feeling that the coffee business is a single pie and everyone is fighting for different slices doesn't seem to acknowledge that the pie is growing."

In response, companies are scrambling to offer more steamy drinks and snacks.

Dunkin' Brands Inc. added espresso beverages to Dunkin' Donuts shops in 2003 and credits the full-line of coffee drinks with helping its aggressive growth plans.

And Canadian coffee chain Tim Hortons, which is expanding its U.S. presence, said customer demand for one-stop food and coffee shopping is growing.

"I think we're all now competing in the same space," said spokeswoman Rachel Douglas. "I think the lines are blurring, and I think consumers are demanding that."

A full-court press by McDonald's couldn't come at a worse time for Starbucks Corp., the world's largest chain of coffee houses, which is struggling with rising dairy prices, growing competition and flattening store traffic in the U.S.

In a conference call with analysts last week, executives with Seattle-based Starbucks said they welcomed the competition. Then they threw in a subtle jab.

"We understand all too well that we have built a very attractive business for others to look at and try and take away, whether it's 1 percent on the margin or big companies that are trying to take more," Starbucks chairman Howard Schultz said. "We are up for the defense and we are going to get on the offense."