Why Are Burger King, McDonald's Chasing a Failed Breakfast Strategy?

Justin Rohrlich August 11, 2010 3:35 PM|

       It didn't work the first time because of high unemployment. And nothing's changed.

In February, fast-food restaurants across the board saw breakfast sales plummet due to the high unemployment rate.

"Typically, if you're unemployed, you're not getting up at six and not going through the drive-thru," Jeffrey Bernstein, an analyst at Barclays Capital, told the Washington Post in an article titled "Fast Food Breakfast Sales Decline As Fewer Head to Work." "There is a direct correlation between unemployment and breakfast sales."

The Post explained:

Breakfast sales had grown at a ravenous pace during the boom years as busy workers scarfed down sausage biscuits on the way to the office, fueling a $57 billion business and accounting for as much as a quarter of sales at some fast-food chains. Chains opened earlier and expanded their morning menus to accommodate the traffic as lunch and dinner sales flatlined. In the five years before the recession hit, breakfast sales jumped 64%, according to NPD Group, a consumer behavior research firm, making it one of the fastest-growing sectors in the industry. But traffic slowed as the economy tanked and the ranks of the jobless soared. By the time unemployment hit 10% in the fall, breakfast traffic was down 4%.

But a report released yesterday by Intellaprice, a restaurant pricing advisory firm, says the big chains are once again diving headlong into the breakfast “daypart.”

“There’s so much focus on this daypart because there’s so much growth potential. Most recently, Subway and Quiznos joined the party, as has Taco Bell (YUM) -- they want a piece of the pie. And the old standbys are stepping up innovation so they can maintain their stronghold,” Leslie Kerr, president and founder of Intellaprice says. “That’s why we see healthy options like egg white flatbreads at Dunkin’ Donuts, brunch at Burger King (BKC), and frappés at McDonald’s (MCD).”

However, that "growth potential" exists because breakfast was hammered so hard, they have nowhere else to go but up. However, adding to the pressure on increasing breakfast visits for the companies concerned, is that prices are also up -- by extremely small amounts, but up, nonetheless. Intellaprice’s 2010 breakfast study finds that the cost of fast food is up 1.3% vs. 2009.

While that may not be enough of an increase to drive existing customers away on its own, the unemployment rate -- which, as noted, was responsible for driving down breakfast sales in the first place -- has decreased so little to make it statistically insignificant. In June 2010, it stood at 9.6%. In June 2009, it was 9.7%.

In addition, input costs have risen. According to the Chicago Sun-Times:

* Coffee futures are up 21% since a year ago, and up 25% since the rally started in late June, and wholesale coffee prices hit a 12-year high last week.

* Orange juice futures are up 80% from a year ago, when the price rally began.

* Wheat futures are up 23% since a year ago.

* Pork has increased 24% in a year.

The “pass through” value (the amount of the rise in commodity costs that gets passed along to the consumer) must be considered, as well; Wendy’s (WEN), for example, is “phasing out a cheaper bacon in favor of a higher-priced Applewood-smoked, center-cut bacon.”

So, what’s changed since February? Why the big push back into breakfast? Does the fast food industry know something about the unemployment outlook we don’t?

Not exactly.

The major reason why McDonald’s same-store sales increased 5.7% in July is because fruit smoothies, frappés, and other cold drinks have sold extremely well.

Money manager Shawn Hackett, founder and president of Hackett Financial Advisors, a firm with a focus on agricultural commodities, tells Minyanville that it takes $0.35 worth of coffee at retail prices to brew a cup. McDonald’s charges $3.29 for a large frappé.

“That’s a pretty good margin even if coffee prices doubled,” he says. “And remember -- that’s what you or I buy it for in the supermarket. McDonald’s has such a good hedging program and buys in such volume, their inputs are probably as low as you’ll find anywhere.”

On the other hand, Jack in the Box Inc. (JACK) hasn't been as lucky, as joblessness continues to hurt its earnings. The company reported last week that its adjusted quarterly profit missed market expectations due to “high unemployment in…key customer demographics.”

"Our sales outlook remains cautious and largely reliant upon improvement in the economy," Chief Executive Linda Lang said in a statement. Yet, Jack in the Box is still expanding its breakfast menu.

Michael Catalano, co-founder of Krueger & Catalano Capital Partners, has a similar theory to Hackett’s as to why breakfast continues to beguile fast-food chains.

“If I were McDonald’s, and I thought breakfast could get even 100 more people to walk in that door and buy a drink, I’d give them the food for free,” he tells Minyanville. “That’s almost pure profit. It’s like when HP (HPQ) said “We’re going to give the printers away (the Egg McMuffin, in this case) and sell the ink (the coffee)."

So, is breakfast back? The jury’s still out on this one. Memories are short, and if the same strategy that failed seven months ago is being trotted out once again in the hopes that something is somehow different this time, it may be important to remember that even Starbucks (SBUX) doesn't hang its hat solely on java sales.