Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / Why Stagflation Is Reshaping the Fast-Food Value Menu
Transcript
- Lucas: So McDonald's announced this week that they're extending their $5 Meal Deal through the end of the year. Wendy's and Burger King have already matched with similar offers. And the interesting thing is that this is happening in an environment where their own costs are still going up. Luna: Right — the value menu was supposed to be a temporary summer promotion, and now it's become a permanent fixture. What changed? Lucas: Well, look at the macro picture. The latest CPI reading from May came in at 334.0, up from 332.4 in April. Core CPI, which strips out food and energy, is even higher at 336.1. So inflation is still running hot, even if it's off the peaks. Luna: And yet the jobs report last week showed payrolls grew by only 57,000 in June. That's way below expectations. So we've got sticky inflation and cooling employment. Lucas: Exactly — that's the stagflation pattern. And for fast-food chains, it creates a real tension. Their customers are feeling squeezed: real wages are barely keeping up — average hourly earnings are $37.60, up maybe three percent year-over-year, but inflation is eating into that. So people are trading down. Luna: Trading down from casual dining to fast food, or from a combo meal to just the sandwich. Lucas: Right. And McDonald's saw that traffic was slipping in the first quarter. Same-store sales in the U.S. grew only 1.5 percent, and that was entirely from higher prices, not more customers. So they needed a traffic driver. The $5 Meal Deal brought people back — early data showed a double-digit lift in visits. Luna: But here's the catch: the deal is basically at cost, or even a loss leader. McDonald's franchisees were reportedly pushing back because their margins are already thin. Food costs, labor costs — they're all up. Lucas: Yeah, franchisees operate on razor-thin margins. The National Owners Association, which represents McDonald's franchisees in the U.S., sent a letter earlier this year saying that the average cash flow for a franchisee had dropped to about $150,000 per store, down from $250,000 a few years ago. So every discount promotion squeezes them further. Luna: And yet McDonald's corporate is pushing the value message because they need the traffic to keep their overall system sales up. It's a classic prisoner's dilemma — if you don't offer value, you lose customers to the guy who does. Lucas: Exactly. And the interesting thing is that this isn't just a McDonald's story. Wendy's launched a $3 breakfast combo, Burger King has its $5 Your Way Meal. Even higher-end fast-casual chains like Chipotle are feeling pressure — they've been running more promotions than usual, even though they've historically avoided discounts. Luna: So the whole industry is locked into a value war. But can it sustain itself if inflation doesn't ease? Because the cost inputs aren't coming down. Lucas: That's the billion-dollar question. Let's look at the numbers. The producer price index for food services — which measures what restaurants pay for ingredients — has been rising at about three to four percent annually. Minimum wages have gone up in several states. And the unemployment rate is still at 4.2 percent, so labor markets are tight enough that you can't just cut staffing. Luna: We talked about labor force participation in a previous episode — it dropped to the lowest in 50 years outside of COVID. That means fewer available workers, which pushes wages up. Lucas: Right, so the cost structure of running a fast-food restaurant is higher than it was pre-pandemic, and it's not coming back down. The only way to maintain margins is to raise prices. But if you raise prices, you risk losing the traffic you just fought to get back. Luna: And that's the stagflation trap: consumers are sensitive to price because their real incomes are squeezed, but businesses can't absorb costs either. Lucas: Yeah. And there's another layer here. The data shows that even though traffic is up for chains offering value deals, the average check size is down. People are buying the deal and nothing else. So the revenue per customer actually drops. McDonald's same-store sales in the second quarter might actually be flat or down even with more visits. Luna: If today's conversation made something click about the economics of your lunch break, the way these episodes stay ad-free is listener support. You can find us at buy me a coffee dot com slash fexingo. Lucas: Yeah, it genuinely helps. And it keeps us independent — no sponsors, no pressure. So if the show's been useful, that's the place. Luna: Back to the value war. So we've got this tension where McDonald's is betting that the $5 deal will build loyalty and eventually lead to fuller orders. But is there any evidence that works? Lucas: Historically, yes. McDonald's has used value menus to drive traffic during downturns — think the Dollar Menu in the late 2000s. But the difference now is that the Dollar Menu was profitable because costs were lower. Today, a $5 meal deal probably has a food cost of close to $4.50. So the margin is essentially zero. Luna: Zero margin, but you hope the customer adds a drink or a pie. But in this environment, people are price-sensitive enough that they often don't. Lucas: Right. And the franchisees feel that directly because they're the ones buying the ingredients and paying the staff. Corporate can afford to run national ads for the deal, but the franchisee is the one making the sandwich at a loss. Luna: So what happens if inflation stays at these levels — say CPI hovering around 3.5 to 4 percent — for another year? Does the value war break? Lucas: I think we see consolidation. Some franchisees will sell their stores back to the corporation. Some smaller chains won't be able to compete and will close. We're already seeing that — the number of independent fast-food restaurants has declined about five percent over the last two years. Luna: And the big chains get bigger because they can absorb the losses on value for longer. Lucas: Exactly. McDonald's had over $25 billion in revenue last year. They can afford to subsidize a value menu for a while. A mom and pop burger joint can't. So what looks like a discount war is really a market-share grab funded by corporate balance sheets. Luna: One thing I find interesting is that this is happening even as the stock market is near all-time highs. The S&P 500 is at 7,495. So the economy is bifurcated: asset owners are doing well, but wage earners are still feeling the pinch. Lucas: That's a really good point. The wealth effect from rising stock portfolios hasn't trickled down to the typical fast-food customer. In fact, the top ten percent of earners account for the bulk of the market gains. For the bottom half, real net worth has barely budged. Luna: So the value menu is a symptom of a broader inequality story wrapped in stagflation. Lucas: Yeah. And I think that's why the Fed is in such a tough spot. Core PCE is still at 130.1, up from 129.67 last month. The ten-year breakeven inflation rate is at 2.24 percent — that's above the Fed's target. But if they keep rates high to fight inflation, they risk tipping the labor market into a recession. Luna: And a recession would just accelerate the value war. People would trade down even more. Lucas: Right. So the fast-food industry is a real-time indicator of how the consumer is doing. If the value menu starts expanding — more items, lower prices — that's a sign the consumer is in trouble. If it starts shrinking, that means chains think they have pricing power again. Luna: What are you watching for the rest of the year? Lucas: I'm watching the franchisee margins. If we see more franchisee lawsuits or public disputes over promotions, that tells me the tension is reaching a breaking point. Also, keep an eye on the JOLTS data — job openings were at 7.594 million in May, still elevated. If that starts dropping quickly, it means demand is softening, and that will hit fast food first. Luna: Good angle. So the next time you grab that $5 meal deal, you're actually participating in a pretty massive economic experiment. Lucas: Exactly. And the results are still being written.