Aroma Therapy

It is unlikely that the cool urbanites frequenting Soho coffee shops would feel completely comfortable asking for a McLatte or Macuccino. But the idea is not beyond the realm of possibility. Two weeks ago fast-food giant McDonald’s bought the 23-strong London-based Aroma café chain – which specialises in takeaway and eat-in coffee and sandwiches – for about 10m.

But the move represents a change in strategy for McDonald’s, heralding one of the first tentative steps down the road of diversification.

The company took a minority stake in Mexican food chain Chipotle in February last year. But the purchase of Aroma is the first full-scale acquisition McDonald’s has made outside its own brand in its 40-year history and shows that the company wants, or, moreover needs, to diversify.

“It’s a highly unusual move for McDonald’s because it has traditionally grown by franchising one brand,” says Luke Johnson, founder of Pizza Express and chairman of the Belgo Group. “It tells me it’s scraping around for new avenues and it must be under pressure from the likes of Starbucks. It smacks of desperation.”

Given the 80 per cent mark-up on coffee purchases through coffee bars and the fact that it is a market where consumers are not particularly price sensitive, clearly there is money to be made in coffee as the likes of Starbucks and Coffee Republic have demonstrated.

Research specialists Euromonitor predict that the UK market alone will grow exponentially and suggest that there is room in the market for up to 1,500 outlets. Currently there are fewer than 300.

Even if McDonald’s keeps a relatively small foothold in this market, Aroma will give it an important insight into the way competitors are making their money. But if, as is widely expected, it cranks up the operation and builds it into an international brand, McDonald’s could leverage all kinds of cost savings. As a result of purchasing power and reduced overhead costs, its margins on coffee would be greater than for existing players.

“It’s not a surprise McDonald’s is getting into this market,” says Stuart Price, brewing and restaurants analyst with Credit Suisse First Boston. “Some of the margins are well over 80 per cent. If you look at the rate of growth in the UK fast-food market and the coffee market it’s no wonder it is looking to diversify. And it is good that it is doing this sooner rather than later.”

He adds: “Most people have flagged the coffee market as an area of major growth. But I am sceptical for two reasons. This is primarily a morning offering and, secondly, the barriers to entry in this market are extremely low.”

But some observers are asking whether the gold is flaking off McDonald’s arches.

Pressure is being brought to bear on the company in its home market where US sales per-store are flat. In its last quarter, after-tax profit slipped to $348.9m (209m) from $410.9m (246m) and McDonald’s also faces increasing pressure from Diageo-owned number two Burger King.

The top US marketing post – senior vice-president marketing for McDonald’s – was vacant for ten months until Larry Zwain took up the position at the end of January. Top marketers were said to be fighting shy of taking the role, because it has become increasingly difficult to make the brand stand out in the slowing and competitive US market.

In the UK, other issues have affected McDonald’s reputation. In January, a two-for-one promotion backfired and was dubbed McBungle after McDonald’s underestimated the scale of take-up for its Big Mac offer. McDonald’s had to run newspaper advertisements to apologise.

And the 314-day McLibel trial, the longest in English legal history, has been a thorn in the side of McDonald’s for the past three years. The case involved two environmental activists, Helen Steel and David Morris, who were found guilty of defaming the company in allegations about its food safety and treatment of its employees. The issue hit the headlines again last week after Steel and Morris succeeded in having damages reduced from 60,000 to 40,000.

It is questionable what McDonald’s could do with the Aroma concept as it currently stands. Critics point out that Aroma does not have a single, clear concept and offers snacks, sandwiches and coffee, rather than leading in one particular area. By contrast Starbucks and Coffee Republic are primarily coffee houses with food attached, while upmarket fast-food outlet Pret Manger specialises in the sandwich with coffee as an optional extra.

Aroma chief executive and chairman Finlay Scott concedes: “Yes, you could say that [we don’t have a specific single offering]. But the advantage is that we are not reliant on any particular day part. That is, people will come to us in the morning for patisseries and coffee, at lunch-time for a sandwich and coke and in the evening for cake and latte or tea.” Scott will act as consultant for McDonald’s for the next year and will have input into the strategic direction of the brand, while his partner Michael Zue Szpiro will increase his involvement with brand consultancy Wolff Olins, where he is a partner.

Other critics have pointed to the fact that a move outside McDonald’s traditional sector may be something of a challenge.

“It’s a different market – and deliberately so,” says the spokeswoman. “There is no risk of one business having an impact on the other. McDonald’s is aimed at the family and Aroma is aimed at the adult market. And I don’t believe this is a limiting factor. It’s not fair to say that just because we have been marketing McDonald’s it doesn’t mean to say that we can’t market anything else.”

But the company is coy about how far it plans to take the brand. “This is our first venture into diversification and it is really too early to talk about strategy,” adds the spokeswoman. “We haven’t put any numbers on it and we’re not going to get into specifics.”

Whether café society will accept Big Mac culture is debatable. If McDonald’s is to succeed in this venture it will need to be subtle – a characteristic with which it is not normally associated. And although Starbucks and other coffee houses believe the coffee phenomenon is here to stay, the jury is out on whether coffee has the staying power of fast food.

But a tried and tested format, even with a five-year life span, could significantly boost McDonald’s profits. And experimentation and diver- sification into new areas for short-term gain may be the key to success in a fickle and increasingly fragmented market.

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