McDonald's and other food giants are struggling in the inflation economy

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The inflation economy has come for Big Food. 

Inflation has fallen far from its 2022 peaks but remains elevated, frustrating the Federal Reserve's efforts and keeping interest rates high. Consumers are somewhat optimistic — but worried about that inflation. And the overall economy continues to grow steadily.

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But big fast food chains and other food companies have struggled to stop inflation anxiety from hitting sales. Executives say it's impacting pricing, foot traffic, and growth plans. A slew of quarterly earnings reports in recent weeks by some of the biggest food companies have shined a spotlight on higher menu prices, labor shortages, wage hikes, and turnaround efforts - some of which include leaning on AI technology.

"There's definitely some belt tightening," Jerry Sheldon, vice president of the market research firm IHL Group, said of inflation-weary customers. "What consumers are saying is 'woah, wait a minute.'"

Far from the food sector, even e-commerce giant Amazon sees consumers pulling back — and is adjusting how it sells food to compensate.

"Consumers are spending but they're just being really careful about what they spend on and how much they spend," Amazon CEO Andy Jassy told CNBC last week. "And so, wherever they can, they're trading down an average selling price. You see consumers wherever they could find a deal, they take the deal."

Retail's food and hospitality sectors, which include casual dining and grocery stores, are both grappling with the challenges. In earnings calls, executives said they could get customers back by focusing on lower prices, sales on their apps — and doing it all with fewer employees.

Fast food executives are acutely aware that consumers are stretching every dollar. At Wendy's, that means being cautious about pricing. The company faced a public relations debacle over the possibility that it would implement "surge pricing" — or "dynamic pricing," as Wendy's preferred to call it. The company backtracked amid an uproar.

Nick Villa, a Moody's economist, described that as a tipping point for consumers. It highlighted "the growing discontent among many Americans after years of seeing a discernible erosion in their purchasing power for goods and services," he said.

Despite Wendy's reporting a 2.6% increase in global sales growth during its first quarter this year, it missed Wall Street's earnings expectations last week. That was partly because consumers earning less than $75,000 a year pulled back, Gunther Plosch, Wendy's chief financial officer, said during the company's earnings call on Thursday. Plosch also said the company won't "get too greedy" when it comes to pricing.

Higher-earning consumers haven't been as spooked by higher prices. Chipotle, for instance, raised prices by 7% and still reported a 7% increase in sales during the first quarter of the year. That growth was driven partly by new restaurant openings and more sales. And digital sales — such as orders on its app — accounted for more than 36% of total food and beverage revenue.

Wingstop is treading similar waters. During the company's earnings call last Wednesday, Wingstop CEO Michael Skipworth said the chicken wing restaurant is "attracting a higher-income, mostly Gen Z and millennial demographic." He said customers are mainly those "who prefer digital engagement and tend to order boneless wings."

On the other hand, that Big Mac and fries at McDonald's isn't as attractive to lower-income consumers as it once was. The fast food giant is struggling in its competition with other chains for downscale customers, who continue to be scared away by inflation.

McDonald's raised menu prices by 10% in 2023. Since 2014, it has raised its menu prices by 100%, according to a study conducted by FinanceBuzz. The data firm noted that some items, including its McChicken sandwiches and medium-sized fries, have seen price increases of almost 200%.

Even so, McDonald's said this week that U.S. sales grew 2.5% during its first quarter. That was partly due to the higher menu prices, which boosted the average check size. But McDonald's overall sales in the quarter dropped year-over-year, due both to consumers in the U.S. tightening their wallets —and others staging boycotts related to the Israel-Hamas war.

The slowdown is a wakeup call, said McDonald's CEO Chris Kempczinski. He said " consumers are more discriminating with every dollar that they spend."

McDonald's isn't alone in struggling to reach consumers. Starbucks said this week that same-store sales fell 4% during its second quarter. And Yum Brands, which owns KFC, Pizza Hut and Taco Bell, said same-store sales worldwide declined 3% in its first quarter. Its KFC and Pizza Hut divisions declined 2% and 7%, respectively. Taco Bell sales increased 1%.

Some grocery stores might be the winner of the inflation domino effects — for now.

"What you tend to see when people peel back on restaurants, they'll often downsize to fast food, and if that starts to get really expensive, then they'll downsize into grocery stores," said Sheldon, the IHL Group analyst.

But not all grocery stores are benefiting in the same way. Some, such as Kroger, Aldi, and retail giant Walmart, are faring better than others in the inflation era.

Kroger, for instance, captured more than 18% of total grocery store foot traffic in 2023, according to Placer.ai, making it the most frequented grocery store in the U.S. Walmart and Aldi got 8% and 9% of foot traffic, respectively.

R.J. Hottovy, Placer.ai's head of analytical research, said heightened competition among discounted food retailers is likely to continue.

"Many chains are looking to accelerate store openings this year — especially in higher-growth markets in the south and southeastern U.S. — but we're seeing increased competition for the most attractive sites," Hottovy said.

The discount grocery chain Aldi could be in a particularly good position to grow. Visits to the German-owned grocer's locations have continued to rise, according to an April report by Placer.ai. Aldi attracts the median U.S. grocery shopper, who earns almost $67,000 a year, according to Placer.ai.

Aldi also has an aggressive U.S. expansion plan. The company plans to invest more than $9 billion to open 800 new stores nationwide over the next five years. Aldi has approximately 2,400 U.S. locations.

Meanwhile, Walmart last week launched its own new food brand called Bettergoods to compete with offerings at Trader Joe's and Whole Foods. The brand will include 300 new grocery items priced between $2 and $15.

And for Amazon, reaching customers means giving them value in another way: a low cost subscription delivery service. Its new grocery delivery program, announced last month, is for Prime members and customers who use government-sponsored EBT cards.

Packaged goods companies also have their hands (and inventory) full, as shoppers cut back on purchasing higher-priced items. Some, such as ketchup maker Kraft Heinz, lean on lower-income demographics. But those consumers often rely on government support such as the Supplemental Nutrition Assistance Program (SNAP). And because they're on the hunt for deals, some items don't make the grocery list.

That's been Kraft Heinz's fate. The company last week missed Wall Street's earnings expectations for its first-quarter, reporting a 1.2% sales drop. Kraft Heinz pointed to inflation-weary consumers as the culprit in its sales miss. The company said consumers have been avoiding higher-priced branded items — such as its lunch combos, mac and cheese, and cold cuts.

Beneath it all is the reality that consumers are still worried about prices. Annual inflation has fallen to 3.5%, a big decline from the 9.1% peak in June 2022 — but still stubbornly above the Fed's target of 2%. And in states like California, a tighter labor force is affecting both workers and employers.

A new state law, which went into effect on April 1, increased the minimum wage from $16 to $20 per hour. That 25% pay hike applies to fast food restaurants that have more than 60 locations across the U.S. The wage hike has already impacted prices across fast food chains such as McDonald's and Chipotle.

"There will be ripple effects across the labor market," said Sara Senatore, Bank of America's senior analyst for restaurants. Senatore said the restaurant labor market was tight even before the pandemic, and "we've certainly seen wage inflation" because of it.

While workers in California celebrated the wage increase, businesses are bracing for higher costs. That could mean continuing to raise prices, cut staff hours, or lay off employees.

It could also mean more competition for workers.

"The labor pool for large chains is likely to compete with smaller limited service restaurants, or convenience stores, or even retailers," Senatore said.

One solution to the sector's labor and price challenges may ultimately lie in technology.

Chipotle said in March that it began testing its Autocado robot last July — essentially a robot that could cut, core, and peel avocados. Chipotle CEO Brian Niccol said last month that the company has "prototypes in'' and is "feeling really good about getting those into a restaurant." Chipotle plans to deploy some of the robots at its busier locations as early as this year, he added.

McDonald's has been testing digital kiosks since 2003, but those efforts could ramp up as it looks to cut down on labor costs. And with customers getting more comfortable making digital orders, the investment could be worth it.

"If labor costs are twice or three times of that investment, maybe it pays for itself," Senatore said.

Food giants like McDonald's, Chipotle, and even Wingstop may be poised to succeed in this environment — so long as they lean on their digital strategies. Wingstop, for example, said digital sales accounted for 68% of its total sales during the first quarter.

Sheldon, of IHL Group, said that leaning on technology is one way companies can not only win customers back, but also reduce costs. "Technology speeds up table-turn and reduces labor costs," he said.

"Things like kiosks always ask you to upsize your order," Sheldon added. "You don't have to pay kiosk benefits."