Article Published in the August 2010 Issue of NACS Magazine

By Joe Bush

Fran Duskiewicz does not suffer lost margin dollars gladly. When he discusses them, you can hear him wince. Duskiewicz, senior executive vice president for Nice N Easy Grocery Shoppes, wrinkles his nose, too, when the subject is coffee’s performance in convenience stores in 2009. While sales dollars dropped slightly from 2008 to 2009, gross-profit margin dollars sunk more than $8,000 and gross margin percentage fell from 64.59 to 55.28, according to NACS State of the Industry data.

Rash Decisions

Convenience stores have two important advantages in the skirmish with drive-thru QSR coffee programs: a variety of blends and the condiment/mix¬ing area for customers to customize the taste of their purchase. When McDonald’s not only offered an improved cup of coffee but also a low price, many convenience retailers panicked, Duskiewicz said. All cup sizes for one price or simple price reductions were unfortunate choices in the heat of battle, he said.

“I think we reacted to a stiff challenge in absolutely the wrong way,” said Duskiewicz.

“All the work went down the chute.”

“The work” Duskiewicz refers to is the industry’s reformation of its coffee and foodservice image. Convenience store companies sought to capture the Starbucks-educated crowd by razing and rebuilding their coffee offer with theater, exotic blends, new equipment, more frequent brewing, increased condiments and most important, lower prices.

A great coffee business was a gateway to great breakfast business and helped customers see a convenience store as a viable place to find other good meals as well. Folks don’t mind paying for quality, and the margins on the category made the investment in upgrading worthwhile. Then, McDonald’s threw its weight behind a coffee upgrade of its own — combined with a low price point, an established breakfast offer and drive-thru ease — and it grabbed morning share from convenience stores.

Sound Advice

What was left for convenience stores to do? Hold the line, advised Duskiewicz and others.

“By making all sizes 79 cents, you are sending a very negative message,” said Jennie Jones, vice president of marketing for S&D Coffee, and chair¬man of the NACS Supplier Board. “It’s the worst tactic. That coffee is your brand.” Jones, Boyd Coffee Key Accounts Division Manager Vickie Grimes, Green Mountain Coffee Director of Customer Marketing Will Billings and Duskiewicz all agree that convenience stores have to put their faith in quality products that are brewed with the proper equipment and then creatively promoted and merchandised.

“They can’t lose focus on such a high-generating category, one with loyalty,” said Grimes.

“This is not the time to cut back on quality,” Jones cautioned.

Jones and Grimes each said that some retailers tried the price-slashing approach.

Duskiewicz said Nice N Easy did, too. Grimes’s client didn’t see a rise in units sold. Jones said one of her partners saw a double-digit boost in sales, but it was not enough volume to cover the loss per cup. Plus, there was little retention of the new customers gained from the limited-time price cut.

Nice N Easy tried a 99-cent all-size promotion, said Duskiewicz, and “we stopped it immediately.” “I could see huge amounts of margin dollars being sucked out,” he said. “It goes right to the bottom line. What expenses are you going to cut to make that up? We just have to be very careful not to be fast and loose with labor-free gross-margin dollars.”

Room for Growth

Bundling coffee with a breakfast meal is one of the tactics the experts suggest as an alternative to waging a price war. According to a new foodservice study by The NPD Group, which looked 10 years into the future, foodservice breakfast-sandwich servings per capita are expect¬ed to rise from 11 in 2004 to 19 in 2019.

The research firm says that from February 2005 to February 2010, servings of specialty coffee and breakfast sandwiches grew twice as fast as the industry.

“Currently only one out of 10 breakfast opportunities is satisfied by food-service, and there are more breakfasts skipped than served in restaurants, all of which means that breakfast is a significant growth opportunity for the foodservice industry,” said Bonnie Riggs, NPD restaurant industry analyst.

There are customers to be stolen, as well. NPD reported that in the year ending March 2010, there were more than 12 billion morning meals served at U.S. restaurants; 80 percent of them were from QSRs. In all, breakfast accounted for 60 percent of the restaurant industry’s traffic growth over the last five years. (For more on taking breakfast share from QSRs, read the June issue cover story, “Breakfast Brawl.”)

Stick to the Basics

In addition to offering an attractive breakfast, Jones said that retailers should stick to the basics: follow trends, both in taste and ethic (like organic or Fair Trade coffees); protect the quality and integrity of the coffee; bundle creatively; and establish or continue a rewards program. Jones is a fan of offering exotic blends from different regions, like Central America, Indonesia and Africa, and the more expensive Fair Trade, Rainforest Alliance or organic choices. “We’ve educated the consumer to look for these,” Jones said.

Billings said Green Mountain Coffee helps retailers by delivering rewards programs it has negotiated with companies like emusic and Minor League Baseball. Green Mountain also pushes seasonal coffees five times per year, and all suppliers have a hyper-caffeinated choice (extra caffeine comes from increased throw weight, basically more coffee in the brew). The experts can make consensus suggestions, but just as in politics, what matters is what’s local. Jim Tidwell is the director of merchandising for 40-store Reay’s Ranch of Tuscon, Arizona, a chain with mostly rural stores across the southern part of the state. Reay’s does not offer exotic blends or Fair Trade coffees because that doesn’t excite its customers, and the chain does not have much more to offer than Danishes and donuts. Tidwell said Reay’s tried a low-price promotion in a group of stores that had poor sales, but discontinued it when the results were not worth the lower margin.

“If you get too inexpensive, it will have an impact on your image,” said Tidwell. “Our strategy is to offer a quality product that’s consistent. Basics are a big key across the board in the convenience store industry. Do what you know how to do.”

Tidwell said he discounts a Danish or donuts or a granola bar with a full-price coffee because he thinks it’s more realistic in the current economy to keep existing customers than steal traffic from other retailers.

Duskiewicz said that Nice N Easy’s bundled discounts include a full-price coffee. “Coffee owns the transaction,” he said.

Again, each retailer’s story has details. Duskiewicz said that the industry average of 55 percent margin “wouldn’t be acceptable [at Nice N Easy].” Duskiewicz has one of the industry’s preeminent foodservice people in Jack Cushman, however, and as executive vice president of foodservices for the chain, Cushman shops for Nice N Easy’s coffee on the commodities exchange, where buying a contract means buying in bulk. Thus, Nice N Easy improves its margin on coffee by “being a better negotiator,” according to Duskiewicz, not by having any on-the-floor secrets. Nice N Easy also sends its coffee out for third-party tasting to ensure quality and consistency. In addition to his businessman’s revulsion at what amounts to surrender, Duskiewicz also wants his fellow retailers to adjust their way of thinking. He’s not overly optimistic that coffee in convenience stores has a much higher ceiling. McDonald’s finally found the right formula — quality, price, drive-thru — and isn’t going anywhere.

“Do I think we’ll see again the halcyon days of a couple years ago?” said Duskiewicz.

“I’m not sure.”