Big Mac Fights Subway Shrimp in Russia Fast-Food Fracas

More than two decades after McDonald’s Corp. (MCD)’s outlet on Moscow’s Pushkin Square began offering a golden-arched alternative to grey communist eateries, the fast-food pioneer is on the defensive.

McDonald’s, which virtually created the market for burgers and fries in the country and convinced Russians it’s OK to eat with their hands, must fend off a growing challenge from rivals Burger King Worldwide Inc. (BKW), Subway Restaurants, Yum! Brands Inc. (YUM) and Wendy’s Co. (WEN)

“A huge number of Subways have appeared in Moscow in recent years, I pass about five of them on my way home,” said Dmitry Mikhailov, a 30-year-old consultant. McDonald’s “is crowded -- it’s just for pigging out quickly and running away.”

To fend off rivals, McDonald’s this year will turn to franchising, a model it uses in more than 80 percent of its outlets worldwide but has shied from in Russia. The company has chosen OAO Rosinter Restaurant Holding, which runs local chains Il Patio and Planet Sushi as well as foreign franchises such as T.G.I. Friday’s, to operate outlets in airports and train stations. McDonald’s also plans to work with franchisees for a push into Siberia and other far-flung areas.

“Russia is a priority market for McDonald’s,” said Khamzat Khasbulatov, who heads the company’s operations in the country. “And franchisees will play a significant role in our success.”

Staying ahead in Russia is crucial to McDonald’s in Europe, which accounts for two-fifths of its global revenue. The company’s revenue in the region dropped in fiscal 2012 despite growth in Russia, where it’s the top chain with 43 percent of the market.

Siberian Franchises

Subway has opened 432 outlets in the past three years, for a total of 514, working with almost 200 franchisees. It sells shrimp sandwiches and other specialties created especially for Russia, as well as beer--which McDonald’s doesn’t offer. Subway’s sales more than doubled in 2011, the most recent data available, according to researcher Euromonitor.

Since arriving in Russia in 2010, Burger King has opened 86 restaurants there, and it’s targeting Siberia, which accounts for two-thirds of the country’s territory and is home to 26 million people. Burger King relies on franchises run with state-run bank VTB Capital, and its sales jumped 151 percent last year to about $266 million, Euromonitor estimates.

Yum has 196 KFC restaurants in Russia and says the country was its fastest-growing market in 2012, with same-store sales up 46 percent. In 2010 Yum bought out partner Rosinter -- the company now working with McDonald’s -- from a joint venture with KFC, and it’s seeking to double its outlets by the end of 2015. That would push sales to $1 billion, five times their 2011 level.

Increasing Competition

“People don’t go specifically to McDonald’s, they stop by the nearest fast-food place, and the competition is growing,” said Andrei Sterlin, head of researcher Business Analitica in Moscow.

Yum gets more than half its revenue in China, which has helped push its price-to-earnings ratio above that of McDonald’s.

McDonald’s fell 1.2 percent to $98.49 at 11:10 a.m. in New York. Yum declined 1.5 percent, while Burger King slid 1.1 percent.

McDonald’s shares are up 12 percent this year after plunging to a 15-month low in November, when the company replaced U.S. chief Jan Fields amid falling same-store sales. Yum has climbed 4.1 percent after tumbling late last year on news of an investigation of its chicken suppliers in China. Burger King is up 14 percent.

Rye Burger

Russians spend $106 per person a year in restaurants, less than half what the Chinese do and about a sixth of the average for Germany, according to Euromonitor, so there’s plenty of potential. After increasing 18 percent last year, Russia’s fast food market is set to expand 7 percent annually through 2016, outpacing the broader economy, Euromonitor predicts.

With its Big Macs, fries, and local offerings such as Beef a la Russ (a burger served on rye bread), McDonald’s saw its Russian revenue advance more than 10 percent last year, according to Khasbulatov. Euromonitor estimates the company’s 2011 Russia sales at $1.4 billion.

Despite McDonald’s storied path in Russia -- the Pushkin Square location, its first in Russia, attracted lines that were blocks long -- management shied away from franchisees there for fear of losing control of quality.

“Our first restaurant had queues for four years after opening,” said Khasbulatov, who headed that outlet before moving into management. “People were surprised how personnel could smile and thank customers for coming in.”

Empty Shelves

Part of the company’s reluctance to partner lies in its success in going it alone. When McDonald’s opened in Russia in 1990, grocers had trouble stocking shelves and shoppers often waited hours for scarce products. To guarantee a steady supply of everything from burgers to buns to special sauce, the company built a production plant near Moscow to process beef, bake bread, and make milkshake mix and sauces.

With the advance of the market economy in Russia, supplies are no longer such a pressing issue. Today, the company relies on outsiders for many ingredients, according to Khasbulatov.

After opening transport hubs with Rosinter, McDonald’s will push on to remote regions such as sparsely populated Siberia and Kaliningrad, a Russian enclave squeezed between Poland and Lithuania, Khasbulatov said. In Siberia alone, McDonald’s franchisees may open dozens of restaurants, he said, declining to give details.

McDonald’s also plans to hasten the pace at which it builds company-owned outlets. It took 23 years to reach its current 356 restaurants -- an average of 16 openings annually. In the next three years, McDonald’s expects to add 150 company-owned restaurants in addition to the new franchises, Khasbulatov said.

“People who live in cities where there are no places to go out or no drive-ins will eat at home,” Khasbulatov said. “That’s how many Russians live outside of Moscow, and it’s an unplowed field where we can grow for years to come.”

To contact the reporter on this story: Ilya Khrennikov in Moscow at ikhrennikov@bloomberg.net

To contact the editors responsible for this story: Kenneth Wong at kwong11@bloomberg.net; Celeste Perri at cperri@bloomberg.net

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