United States-McDonalds considering price hike.

UNITED STATES-McDONALDS RAISE PRICES.

A consulting firm that advises McDonald’s franchisees is recommending steeper increases this year than it has in the past, according to documents from a presentation to restaurant owners in February.

Price hikes have been a key driver of sales growth for the chain, and bigger boosts would bring some relief to franchisees squeezed by higher food costs and expenses associated with McDonald’s push into specialty coffees. But raising prices during a recession could send cost-conscious customers running to rivals.

To keep store traffic high during the downturn, Oak Brook-based McDonald’s Corp. has emphasized its Dollar Menu and rolled out a series of low-price promotions. It collects royalties based on total sales volume from franchisees, who bear the brunt of profit pressures from rising expenses and promotional pricing.

"Raising prices is a way to offset any tension with franchisees facing higher costs and lower profits," says David Bishop, a food consultant at Barrington-based Balvor LLC. "This way they can offer value on the Dollar Menu and still help franchisees make a profit."

OFF LIMITS

Price hikes are unlikely to affect the Dollar Menu or special promotions, which McDonald’s strongly urges franchisees to follow. McDonald’s 2,000-plus franchisees, who run about 80% of McDonald’s 14,000 U.S. locations, set their own prices, but the company strives to keep them similar across the country. A McDonald’s spokeswoman declines to comment on pricing strategy except to say that the company and franchisees work to offer customers value across its entire menu.

A franchisee group that works closely with company management is warning restaurant owners against precipitous price hikes.

"Raising prices as an immediate reaction to cost pressures will hurt, not help, your profits," the National Leadership Council said in a February message to franchisees. "We strongly recommend you use the scientific approach offered by RMS."

RMS is Revenue Management Solutions, which says it works with McDonald’s franchisees in 30 countries including the U.S. Its presentation materials say the firm’s strategies have boosted profits at 7,000 U.S. outlets in the past four years.

It’s hard to determine the extent to which McDonald’s management endorses the consultant’s recommendations, but the fact that it gives RMS access to franchisees implies tacit approval. RMS Chairman and CEO Thomas Kelly won’t discuss his firm’s relationship with corporate headquarters other than to say, "We are very good friends with the folks in Oak Brook."

Mr. Kelly says his firm develops pricing strategies for restaurants by looking at local demographics, competitors’ prices and demand for each item at different times. He says the primary goal is to adjust prices without losing customers.

CEILING RAISED

Tampa, Fla.-based RMS this year called for raising the maximum price increase to 30 cents per item from last year’s 20 cents, according to the presentation materials. It also recommended that price hikes match the government-estimated rate of inflation in restaurant prices, rather than trailing the index as the firm advised in previous years.

The U.S. Department of Agriculture’s "food away from home" index rose 4.4% in 2008 and is expected to climb 3.5% to 4.5% this year. McDonald’s executives have said costs increased 7% at the chain’s U.S. restaurants last year and predicted a rise of 5% to 5.5% this year.

McDonald’s outlets in the U.S. raised prices about 4.5% on average last year, according to Larry Miller, an analyst in Atlanta at RBC Capital Markets Corp. He figures price increases accounted for about half the 4% rise in sales last year at McDonald’s U.S. restaurants open at least 13 months.

But large price hikes could turn off budget-strapped customers or lead more to switch to the less profitable Dollar Menu.

"Most franchisees know if you raise prices too high or too quickly, you will lose customers," says consultant Dick Adams, a former McDonald’s executive and franchisee.

Still, franchisees want a break, says one restaurant owner: "All franchisees welcome price increases because of the cost pressures."