McDonald's owners eye Starbucks with McCafe drinks

SAN DIEGO (Reuters) - The next phase of growth brewing for McDonald's Corp (MCD.N) is in the hands of franchisees like Ernie Sandoval, who is introducing McCafe espressos and cappuccinos to the restaurants he owns.

Sandoval is among the first in San Diego County to renovate his store and make room for the machine that, with a press of a button, turns out espresso-based drinks. Many of them can be served hot or cold and spiked with flavored syrups.

He owns 15 McDonald's restaurants in the area and plans to install the coffee stations at 9 of them, in what will be the newest front in a growing battle between the hamburger chain and Starbucks Corp (SBUX.O).

Sandoval's first restaurant to get the McCafe drinks is in Del Mar, California, in north San Diego County, and is located close to two other coffee shops.

"My first thought was that I'd like to take some of the business" from the neighboring cafes, Sandoval told Reuters. "We're seeing a lot of movement in the coffee with breakfast."

With McCafe drinks priced from $2.39 for a small to $3.29 for a large, they are still less expensive than the barista- prepared lattes and cappuccinos that made Starbucks a household name.

That could count for a lot in a weakened U.S. economy that has forced consumers to cut discretionary spending.

"It's got to taste as good or better than the competition. The flavor and quality has to be there or you're not going to get that customer back," Sandoval said.

Adding coffee also provides a draw for young adult customers, he said.

More than 2,500 McDonald's restaurants around the country are selling the new beverages and the chain plans to offer the drinks in the majority of its 14,000 U.S. restaurants by the middle of next year.

It expects the new beverage program to eventually add $1 billion to annual sales. Markets that are most penetrated include Kansas City, Missouri, as well as San Diego and Seattle -- Starbucks' home turf.

McDonald's and a host of other fast-food chains from Wendy's International Inc WEN.N to Jack in the Box Inc JBX.N and privately held Dunkin' Donuts are eyeing the fancy coffee market and trying to steal share as Starbucks retrenches after an overly aggressive expansion.

McDonald's executives want to make the chain's restaurants a place where people go for drinks as well as food. The company is adding high-profit beverages in markets around the world.

"Beverages have higher margins than food. Obviously fountain drinks are the highest of those, but coffees, espresso-based coffees and bottled drinks will have higher margins than the food items," Chief Operating Officer Ralph Alvarez said at an investor conference this week.

A second beverage wave set for mid-2009 through 2010 will add smoothies, frappes and bottle beverages, he said.

(Editing by Andre Grenon)