Fast-Food Face-Off

The scandal started out as a CEO's worst nightmare. Three months ago, a Nevada woman named Anna Ayala claimed to have found a severed finger in a bowl of chili she ordered at a Wendy's restaurant in San Jose, Calif. The fast-food chain became the butt of every late-night comedian's jokes, and its CEO, Jack Schuessler, faced an embarrassing lawsuit and more than $15 million in lost business, thanks to the unwelcome publicity. Then things took an even more bizarre twist. Authorities in San Jose turned their attention to Ayala, alleging that she fabricated the story and that the finger belonged to an associate of her husband's. Ayala dropped her lawsuit against Wendy's, and the company was exonerated. CEO Schuessler can almost laugh about the "finger incident" now, but he says it taught him that "no matter how good you do your job, one person can really throw a company's life out of balance." The only thing that kept customers in the stores, he says, was the company's good reputation.

Reputation alone may not get Wendy's through its current slump. Well before the recent troubles, sales at Wendy's restaurants had been stalled for two years, budging just 0.9% in 2003 and 2.9% last year, far below the pace set by its competitors. The culprit? A sudden burst of creativity from the big guns in the fast-food wars, McDonald's and Burger King, as well as some smart plays by smaller chains like Hardee's and KFC. For years, McDonald's and Burger King had relied on their size to generate growth, opening hundreds of new stores every year to pump up sales. Meanwhile, Wendy's had some very lucrative ground to itself. It is only one-fifth the size of McDonald's in terms of sales, but Wendy's kept growing and generated healthy profits by pulling people into its stores with a steady stream of carefully tested new ideas and products, like the 99¢ value menu, salads and high-quality chicken sandwiches.

Over the past two years, its competitors wised up and realized that they too could goose up sales by adding some variety to the menu. In some cases they copied many of Wendy's most successful products. "That never happened before," says Janice Meyer, a fast-food-industry analyst for Credit Suisse First Boston (CSFB). "It took them out of their game." McDonald's launched a line of salads, preaching a newfound concern for health. Burger King and Hardee's took the low road, heavily promoting gut-busting sandwiches like the Enormous Omelet and the Monster Thickburger--names that only hint at the fat and calorie content between their buttered buns. Burger King also upgraded its chicken sandwich, a move McDonald's will make this summer. KFC has added a 99¢ chicken sandwich. The situation got so bad that Wendy's had to launch its latest innovation, an entrée-size fruit salad, in February--not exactly when most people are yearning for a slice of cantaloupe--because it knew that McDonald's was launching an apple-and-walnut salad in May. Even Schuessler concedes that archrival McDonald's strategy has been a success. "I give them a lot of credit," he says. "They've really improved the quality of their food."