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Credit Crunch Takes Bite Out of McDonald's

Planned Coffee Rollout Hit by Banking Crisis That Is Restricting Loan Capital

By Published on . 2

CHICAGO (AdAge.com) -- The banking crisis is threatening to take a rather surprising hostage: McDonald's big-budget coffee rollout.

Tightening credit conditions, which are crimping plans for marketers as diverse as giant General Motors Corp. and relatively small household-products company Method, have prompted Bank of America to halt loans to McDonald's franchisees. They need the capital to frantically build coffee bars in the chain's 14,000 locations for what was planned to be an April coffee introduction.

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And although it won't derail the launch altogether, it is likely to delay it nearly into summer -- hardly optimal timing for a hot-beverage introduction. It also could force the company to postpone a huge marketing push it's been planning to support the java drive, as the company generally waits until 60% of its stores have been outfitted to undertake a national ad push. The fast feeder maintains that everything is on track.

According to an internal memo from McDonald's executive Cindy Fuller, Bank of America's franchisee-loan program, known as "Eagle," had reached funding limits faster than expected. She warned that market volatility was affecting the bank's ability to "fund additional growth."

"Please direct owner-operators to new lenders as quickly as possible for financing needed in the next several months," Ms. Fuller wrote.

Bank of America has since said it plans to honor all loans that have been promised to McDonald's franchisees. The bank did not immediately respond to inquiries about whether it would to make any more.

Cash on hand
Franchisees are spending about $100,000 per store to accommodate the "combined beverage business," which includes lattes and cappuccinos. Most are seeking loans for the build-out. "As money remains tight, it's going to be more difficult to get the loans to remodel for the combined beverage strategy," one franchisee said. "Obviously we don't know what the situation is going to be in another three to six months."

The corporate memo additionally advised that "now is not the time to be shopping for loans based on interest rates," or to refinance existing debt. It went on to suggest franchisees consider using cash on hand to cover new-equipment costs. Franchisees generally make more money in summer months, when kids are out of school and many of their customers are on vacation. The reserves often carry operators through winter months, when sales tend to be slower.

"I think it could very likely slow down the [rollout]," said Darren Tristano, exec VP of Technomic. "That plus the impact that Starbucks has seen in traffic and a decline in sales, I think it probably would be better to slow it down and continue to test it and see how the results are."

McDonald's spokesman Bill Whitman, however, said the beverage strategy is "on target and progressing as planned."

"There continues to be more than sufficient liquidity available to our franchisees to fund capital improvements in their restaurants," he said, adding that more than 50 national, regional and local lenders are providing financing to U.S. franchisees.

Backpedaling
Still, it seems clear that the company is backpedaling. In July, McDonald's was expecting the rollout to be completed by April. Earlier this month, Ralph Alvarez, chief operating officer, told analysts at a Bank of America conference that the specialty-coffee rollout should be complete by mid-2009.

Even if that date stays on track, the chain would likely miss the cold-weather window in which hot drinks are said to be the most popular. McDonald's has said that soft specialty-coffee sales in test markets this summer were a seasonal phenomenon. When bundled with iced- and brewed-coffee sales, McDonald's has boasted that its coffee business is doing better than expected.

Another problem will be what to do with the ad calendar. McDonalds' national advertising committee convenes each fall to approve the following year's budget. New products have generally been in at least 60% of stores before national efforts were undertaken.

"It would have an impact if everybody didn't have it in their restaurants," a franchisee said, adding that there is a mechanism for blocking off segments of the country if the rollout hasn't been completed in one region.

Specialty coffee is currently in about 20% of McDonald's U.S. locations, which represents an addition of about 900 stores since July. But it would be an uphill battle to add another 12,000 locations in seven months.

Even so, McDonald's is expected to go ahead and advertise the coffee business before a rollout is complete, or push franchisees harder for renovations. "My gut tells me that if McDonald's is counting on this for the second quarter, it's going to happen," another franchisee said. "They certainly have enough money and enough power to push their weight around."

Editor's note: Bank of America credit lines were not as forthcoming as usual for McDonald's franchisees. McDonald's own internal memo referred to loan demand "exceeding historical norms" and said Bank of America's announcement "last weekend of its intention to acquire an investment bank and the volatility in the debt markets, especially this past week, have impacted BofA's ability to get the quick solution originally anticipated." That does not mean that credit lines have been frozen, and we are pleased to clarify that point.
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