McDonald's customers are 'exploiting' the company with a troubling new habit

The popularity of McDonald's all-day breakfast menu and McPick 2 promotions is having an unintended consequence that's bad for business.

McDonald's introduced all-day breakfast and McPick 2, which allows customers to choose two items for $5, to drive up traffic to its restaurants.

The strategy has worked: McDonald's US same-stores sales rose 5.4% in the first quarter of the year, marking its best quarterly performance in more than four years.

But now comparable sales growth is slowing, falling to 1.8% in the second quarter, as customers increasingly "exploit" the promotions to trade down to cheaper menu items, according to Conlumino CEO Neil Saunders.

"Average transaction values for lunch and dinner have fallen as a consequence, something that has put a dampener on overall sales growth, even if it has been helpful to volumes," Saunders wrote in a research note Tuesday. "In most markets the pricing differential between breakfast items and lunch and dinner items is fairly pronounced, and this may be something McDonald's needs to assess over the next six months to see if there is any way to remedy the down-trading trend without losing customers."

Franchisees have warned that customers are trading down to cheaper breakfast menu items during lunch and dinner, now that breakfast is available all day.

"All-day breakfast is a non-starter. We are trading customers down from regular menu to lower-priced breakfast items. Not generating new traffic," one franchisee wrote last fall in response to a survey by Nomura analyst Mark Kalinowski.

Operators have also complained about the impact of McPick 2 on their profit margins.

"We are discounting heavily, against my will, so sales should be up and profits down," a franchisee wrote in response to a more recent survey by Nomura.

Another wrote, "I am very alarmed about the discounting push. I have never seen the corporation be so aggressive with discounts. The regional marketing teams are adding numerous other discounts to the McPick 2, primarily breakfast items. They are encouraging, quite literally, everything being on sale. This is a very hard cultural adjustment for me."

Saunders said McDonald's needs to invest more in automation to lower labor costs and offset the impact of customers buying cheaper food.

"The solution to all of this [is] in more automation - something that McDonald's has started but is still a long way off perfecting," Saunders wrote. "If McDonald's is to deliver its changes profitably it needs to forge ahead with this model so that it can simultaneously keep a cap on labor costs at its restaurants while delivering superior products, service and growth."

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