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Who’s losing in the McDonald’s-Taco Bell breakfast battle

The battle between Taco Bell and McDonald's that's been playing out on your TV screen and across social media — you've heard all about Ronald McDonald's new look and newly active role on Twitter — isn't just about a Chihuahua taking on a spiffed-up clown for bragging rights. By some estimates, what is at stake is a $30-plus billion fast food breakfast market, one that the industry hopes may be staggering back to life as the job market recovers.

Budget breakfasts have always been appealing to some consumers, but a 2011 survey showed that almost half of consumers dropped by some kind of quick service restaurant — whether a McDonald's or an upscale Starbucks — for a breakfast-type meal that year, up from only a third in 2009. And restaurants responded by adding more menu items — and competing more ferociously for the attention and dollars of potential patrons. The result: a full-out, no-holds-barred fast-food breakfast fight.

Taco Bell's waffle taco.
Source: Taco Bell
Taco Bell's waffle taco.

For most of us, what has followed has been tremendously entertaining and even profitable, as the rivals have scrambled to offer better deals and even freebies, like the occasional cup of coffee. In one corner is the veteran, McDonald's, whose Egg McMuffins have been fueling some early risers and travelers for decades. In the other, upstart Yum! Brands, whose restaurants thus far have had almost no presence in the breakfast market. It is now trying to make a virtue of a combination of an established brand name and fresh and unusual menu items, resulting in high drama in advertising primetime.

For the chains themselves, it's serious business. That's because their corner of the fast food business has been stuck in slow-growth mode for some time. Both Yum's network of chains — which includes not only Taco Bell but also Pizza Hut and KFC's fried chicken restaurants — and McDonald's have to do battle with each other but also with upstarts intent on siphoning away their business. Many of these offer newer concepts — think Chipotle Mexican Grill or Noodles & Co.

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The two chains certainly have great slogans to offer. In its corner, McDonald's is brandishing "Wake up and taste the free coffee!" Meanwhile, Yum! Brands and Taco Bell insist that "there will be breakfast envy…" But spending on costly television campaigns promoting low-priced items like a $1.99 breakfast waffle or a $1.39 Egg McMuffin is going to have to pay off big in order to boost Taco Bell and McDonald's businesses. There's little evidence so far that either Taco Bell or McDonald's will emerge victorious.

The earnings figures for both companies suggest that the loser in the breakfast wars, so far, may be the shareholders. Overall, competition is eating into McDonald's revenues and profits — and not just at breakfast time — with the result being that the company posted not only disappointing same-store sales figures but disappointing earnings.

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Same-store sales in the U.S. have fallen short of expectations for eight months in a row, and posted a 0.6 percent decline in March, the fifth consecutive month in which the chain witnessed a year-over-year drop in sales. (True, the March figures were the smallest drop in those five months.) First quarter profits slipped from $1.26 a share a year ago to $1.21 a share for the just-ended quarter.

McDonald's CEO Don Thompson told analysts last week that the Golden Arches hadn't seen any impact from the "most recent competitor" in the breakfast fight, but he pledged his firm will embark on a new marketing initiative. And yes, it will revolve around breakfast. They don't just microwave, the CEO would like the world to know: "we crack fresh eggs, grill sausage and bacon."

When it comes to Yum! Brands, sales in China rather than sales of breakfast sandwiches have a much greater impact on the company's bottom line. While the earnings figures were healthy — 87 cents a share, up 24 percent from year-ago levels, and 3 cents better than analysts had expected — Yum! could still do with a bit of a boost even from a waffle taco or two. That's because while its profits beat expectations, its revenues came up short: $2.72 billion, rather than the $2.81 billion that analysts had been anticipating.

For both fast-food chains, the biggest competitive threat, ironically, isn't the snazzy slogans and snarky ad campaigns, but the big push from the group of restaurants referred to as "fast casual" — those like Chipotle and Panera — that boast of offering fresh ingredients and healthier food choices than the burger/fried chicken/pizza joints of yore. Ultimately, it might not matter how many guys named Ronald McDonald Taco Bell can convince to eat waffle tacos if the rest of the world turns up their noses at the idea and heads off for a gluten-free muffin at their local coffee shop instead.

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If you're an investor, however, the hullabaloo is likely to end up distracting you from what really matters. In the case of McDonald's, that is whether the chain as a whole can reinvigorate sales of all its products (and not just breakfast sandwiches) while riding out any commodity price pressures over the course of the summer. For Yum!, the biggest headwind remains, as always, what lies ahead for the chain's China stores: Are its poultry supplies safe in reality and in the eyes of its consumers? And how resilient are those consumers going to be if China's economy succumbs to a fit of the hiccups?

Squabbling over who gets the right to charge you a few bucks for your morning fast food may seem like small potatoes. But set against a backdrop of weak economic growth and lackluster or even declining sales, finding a new way to woo consumers may prove crucial. Eventually, that is.

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For now, the breakfast wars make for great entertainment for those of us on the sidelines. An investor in either of these companies may well wonder just how lavish a marketing budget he's going to end up financing — and whether it will be worth that high price.

—By Suzanne McGee The Fiscal Times

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