McDonald's, Wendy's and Burger King compete for low-income diners

Subway began phasing out its $5 12-inch sandwiches a decade ago, but other fast-food chains have now brought back the $5 price tag in hopes of winning over customers who have cut back on spending.

As many restaurant companies prepare to report their second-quarter results, investors expect to hear that diners are visiting their locations less frequently and that sales have slowed, with few exceptions such as ChipotleHoping to improve their results for the next quarter, chains such as McDonald'sTaco Bell, Burger King and From Wendy They have introduced or revived meal deals priced at $5.

McDonald's said it is seeing an increase in traffic as a result, although Wall Street does not expect a big increase in sales from the promotions.

Fast food generally fares better than the rest of the industry during economic downturns, but price increases in recent years have led many consumers to conclude that fast food is no longer a good option. More than 60% of respondents in a recent LendingTree survey said they had cut back on spending on fast food because it was too expensive.

Uncontrolled menu prices have scared away many fast food customers, including those with low incomes who make up a considerable part of the sector's customer base. Sensing the negative reaction of diners towards fast food, players such as Brinker International Chili's has used its marketing to highlight its own value relative to the cost of a fast food meal. Casual restaurant chains have gained market share in the fast food sector. Darden Restaurants CEO Rick Cardenas said in June.

“It's a war for less affluent customers,” said Robert Byrne, senior director of consumer research at Technomic, a restaurant market research firm.

That shift in consumer behavior has also spooked Wall Street. Shares of McDonald's and Burger King's parent company International restaurant brands and Wendy's have fallen double digits this year. Taco Bell owner Yum Brands is down more than 1% in 2024. Meanwhile, the S&P 500 is up 14%.

“The feeling among investors is that the second quarter will probably be one to forget: many major chains are likely to miss consensus. [estimates]”KeyBanc analyst Eric Gonzalez told CNBC.

McDonald's is expected to report second-quarter results on Monday, while Wendy's is scheduled to announce its results on Wednesday. Restaurant Brands and Yum Brands are expected to report their quarterly results the following week.

In general, fast-food chains tend to concentrate their discounts and value menus in the first quarter, when consumers are trying to save money after the holiday season and keep their New Year's resolutions. As temperatures rise, so do restaurant sales, and operators typically don't need to rely on deals to attract customers.

But this summer is different. Fast food chains need discounts to drive traffic and sales growth.

“The fact is that restaurants are running out of room to put more prices on their menus,” Byrne said.

But value meals aren't just about driving traffic.

“It's also about converting the bargain-seeking consumer into a higher-value consumer by introducing other add-ons or other things they could do,” Byrne said. “The risk is that they don't.”

If customers aren't persuaded to add a milkshake or other entree to their order, discounts eat into profits and become unsustainable in the long run. That's a big concern for investors, who are already skeptical that chains won't see the traffic boost they expect.

“The low-price menus were launched towards the end of the quarter. There is a fear that it will not improve and that there will be a race to the bottom,” Gonzalez said.

Subway’s $5 price tag is a cautionary tale. While the deal was popular with customers, it lasted longer than was acceptable to operators, eroding their profits and exacerbating other brand problems, such as sales cannibalization due to its outsized footprint. That led to restaurant closures, angry operators and years of searching for a new way to win back customers.

Investors aren't the only ones skeptical of promotions: franchisees are also skeptical, often resisting discounts because they hurt their bottom lines.

In recent years, franchisees have also gained more power to resist the negotiating strategies of parent companies. Today, many franchisees are larger, have more restaurants and sometimes even private equity money.

At McDonald's, franchisees banded together to form the National Owners Association in 2018, rebelling against the burger giant's unpopular discounting and store renovation plans. Since then, the chain's operators have pushed back even more against management's plans.

An initial proposal for a $5 McDonald's menu was not approved, so Coca Cola Coca-Cola provided marketing funds to make the deal more attractive to operators. Coca-Cola Chief Executive James Quincey said on Tuesday's earnings call that the beverage giant has seen weaker out-of-home sales in the U.S. as fast-food restaurants struggle. To boost demand, Coca-Cola is partnering with food-service customers to market combined food-and-beverage menus, according to Quincey.

On Monday, McDonald's extended its value menu offering beyond its initial four-week window. Ninety-three percent of its restaurants voted in favor of the extension, executives wrote in a memo to the U.S. system seen by CNBC.

The promotion is drawing customers back to its restaurants, according to executives and foot traffic data. June 25, the day McDonald’s launched its $5 meal, drew 8% more visits than the average Tuesday in 2024 so far, according to a report from Placer.ai. The pattern repeated itself in the days that followed, as the chain beat its year-to-date daily visit averages. Placer.ai also found that the discounts helped drive traffic to Buffalo Wild Wings, Starbucks and Chili’s.

In his quarterly survey of more than 20 McDonald's franchisees, analyst Mark Kalinowski of Kalinowski Equity Research asked respondents what percentage of their sales were boosted by the $5 meal offer. The average response was 1.3%.

“These responses may suggest that the $5 meal deal should be viewed as an initiative that can help keep some customers from going elsewhere, rather than a major sales driver,” Kalinowski wrote Wednesday in a research note on the survey results.