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Starbucks, McDonald's Put the Squeeze on Dunkin' Donuts

Dunkin' Brands' (NASDAQ: DNKN) Dunkin' Donuts faces high-end competition from Starbucks (NASDAQ: SBUX) and lower-end, price-driven pressure from McDonald's (NYSE: MCD). That puts the company in an odd position. It's not the place to get the fanciest coffee nor is it the place to get the cheapest cup of joe. Dunkin' sort of sits in a weird middle ground. It has good-enough espresso-based drinks and reasonable prices, but it loses customers to Starbucks and McDonald's.

Dunkin's lack of a clear place in the market has put a squeeze on its sales. Its numbers are by no means awful -- comparable sales in its U.S. cafes rose by 0.6% in the third quarter -- but foot traffic dropped by 2%. The company expects only low single-digit same-store sales growth for the full year.

To energize its brand and return to faster growth, Dunkin' Donuts has tried everything from testing a name change (to just Dunkin') to simplifying its menu. Now, the chain has a new plan to lure customers away from Starbucks and McDonald's that takes a page out of the burger chain's playbook: discounting. 

Dunkin' Donuts is about more than doughnuts. Image source: Dunkin' Donuts.

What is Dunkin' doing?

McDonald's has been putting pressure on Dunkin' Donuts with its own aggressive efforts to grow its McCafe brand. To expose customers to its coffee lineup, the fast-food chain has been offering heavy discounts including the current offer of any small McCafe beverage for $2.

Dunkin' has not been shy about discounting itself. In Q3's earnings call, CFO David Hoffman cited discounts as driving sales and called offering its menu at a "compelling value," a core strength for the company. 

CEO Nigel Travis agrees with that and recently told Reuters the chain plans to increase its use of discounts to drive traffic and sales. "Our franchisees are now seeing the value of value and you will see a lot more in the future,"  Travis was quoted as saying. The CEO also cited the ability to use digital data gathered from its app to send customers personalized deals.

That's a tactic that Starbucks uses well. The higher-end chain offers deals designed to spur second visits in a day during non-peak times. It also uses digital data to market new menu items and reignite interest in less-popular choices.

It's a tough climate

In its most recent quarter, McDonald's reported that U.S. comparable-store sales rose by 4.1%. Starbucks' domestic same-store sales were even better, increasing by 5%.

The challenge for Dunkin' is that McDonald's has moved in on its turf as the low-cost alternative to Starbucks. The burger chain has also encroached on the coffee company's place as a blue collar/working man's establishment.

But discounting is a short-term solution. McDonald's, which like Dunkin' is a 100%-franchised business, has had to deal with franchisee anger over its now-defunct Dollar Menu driving traffic, but hurting margins. That's a problem that could easily take hold with Dunkin' Donuts owners if the company keeps leaning on low prices to drive traffic.

What should Dunkin' do?

The doughnut chain needs to forge an identity beyond being a less-fancy, cheaper answer to Starbucks. Perhaps it could improve its pastry lines to use those as a clear differentiator from its rivals. It could also find ways to innovate with its coffee rather than adding menu items and drinks like cold brew coffee after Starbucks creates a market for them.

The coffee space has become very crowded and small steps like the chain's effort to improve its frozen coffee line will help, but the brand needs to do more than offer discounts if it hopes to do more than barely keep its head above water.

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Daniel B. Kline has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool recommends Dunkin' Brands Group. The Motley Fool has a disclosure policy.