McDonald’s McCafe To Face Stiff Competition In Canada

McDonald’s (NYSE:MCD) McCafe lovers in Canada, finally have a reason to cheer up, as the customers can now add McCafe coffee to their grocery lists to take home. On September 16, the fast food giant announced the introduction of McCafe ground coffee in Canadian grocery and retail stores. Roast ground coffee at retail stores, as well as coffee in single serve formats are expected to be available at major grocery retailers across Canada by the end of September. ^[1]

The competition among the fast food restaurants in the U.S. has intensified over the last decade, with the entrance of new fast food brands fighting for market share. Over the last three years, breakfast has become the highest grossing and fastest growing daypart for the quick service restaurants (QSR). The most popular breakfast item in western markets is coffee, which has been introduced as a major menu item in all the top quick service restaurants such as Starbucks Corporation (NASDAQ: SBUX), Burger King (NYSE: BKW) and Dunkin’ Brands (NASDAQ: DNKN). Most of the top QSRs have established themselves quite well in the U.S., their biggest market, and now are shifting their focus to the untested Canadian market.

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McCafe: Expansion & Its Probable Reasons

In August, McDonald’s and Kraft Foods Group (NASDAQ:KRFT), one of the largest consumer packaged food and beverage companies, announced a deal to expand the manufacture, marketing and distribution of McDonald’s McCafe brand in the U.S., with effect from early 2015. ^[2] Shortly after this deal, Kraft Foods entered into a  multi-year licensing, manufacturing and distribution deal with the Vermont based K-Cups maker, Keurig Green Mountain (NASDAQ:GMCR). Available for both at-home and away-from-home channels, the portion packs of Kraft’s coffee brands, including McCafe, will be offered in K-Cups format, K-Carafe packs and Keurig Bolt Packs. After its plans for introducing McCafe in the U.S., the company decided to expand the reach of its coffee product in Canada, which is its fifth largest market in terms of number of restaurants.

However, the company’s plan to expand its McCafe portfolio might be due to various factors:

• To Counter Tough Competition In the Breakfast Market

McDonald’s is going through a tough period, as it continues to face headwinds in its path for top line growth. From restaurant shutdowns in Russia to poor performance in China driven by the China meat scandal, the company is reporting sluggish growth in all its segments. To add to its woes, tough competitive activity in the industry for the breakfast share of the market has forced the company to further expand its customer base internationally. The company thinks that it has less than fair share of the coffee market; McCafe accounted for less than 13% of the U.S. market in 2013. However, considering the fact that McDonald’s coffee sales have increased 70% since the introduction of McCafe specialty coffees in 2009, McCafe is the company’s best bet to capture some breakfast market share, by attracting new customers in a country where retail prices are slightly higher. This in turn can give a boost to the company’s average spend per customer visit.

• Canada: A Coffee Loving Nation

In 2013, coffee retail value in Canada surged to reach $1.9 billion, an increase of 21% year-over-year (y-o-y). ^[3] Also, the per capita coffee consumption in Canada is one of the highest in the world, with a daily coffee consumption rate of 3.2 cups per day per person. ^[4] Canada takes the second spot among all the coffee drinking nations when it comes to percentage of coffee cups consumed away from home. ^[5] Coffee consumption patterns are very similar across the U.S. and Canada; however, there are differences in preparation. Reported single-cup brewer ownership is higher in Canada (20%) compared to the U.S. (12%). ^[6] The single-serve K-cups account for $750 million in annual sales in Canada.

Source: Coffee Association of Canada

Considering that the coffee market in Canada has potential for further growth, McDonald’s finds the region to be a lucrative market for expanding its coffee portfolio. McDonald’s launched the McCafe coffee brand in Canada in 2011, and since, the company has doubled its market share in coffee and tripled its coffee sales. Around 78% of the coffee consumption in Canada is through at-home format, and the company wants to capture this market through its retail coffee products. ^[7]

Strong Competition Might Hinder Desired Volume Growth

Canadian coffee market is dominated by some top retailer and coffee chain brands such as Kraft Foods Group, Tim Hortons (NYSE: THI) and Starbucks Corporation (NASDAQ: SBUX). Kraft Canada leads the overall retail coffee sales in Canada with a market share of 32%, as of December 2013. Moreover, Tim Hortons has more than double the number of McDonald’s restaurants in Canada, with better system-wide sales as well. ^[8] Also, the company has over 70% share of baked goods market in Canada and more than 75% of Canadian coffee market, much ahead of Starbucks and McDonald’s. ^[9] Interestingly, Canada is the world’s largest per-capita market for Starbucks. ^[10]

In such a market, where almost 95% market is dominated by well established brands, McCafe might find it difficult to penetrate the Canadian market to such an extent. Customers will need a strong reason to shift their coffee preferences from the likes of Starbucks and Tim Hortons to McCafe. This might create problems for McDonald’s to generate expected sales in the initial years. However, one of the most prominent reasons for people to shift to McDonald’s coffee is that McCafe is slightly cheaper compared to Starbucks’ coffee.

McCafe’s success in Canada might provide a huge boost to the company to expand its McCafe portfolio in its other major markets in Europe and Asia.

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