Microeconomic Analysis of McDonalds

JT Smith
Over the course of this paper I will give a brief history of
McDonalds, what they do and who they are. I will address the three
current factors that are affecting their business. Those factors will also
include some reasoning with PEST (Political, Economic, Social, and
Technological) being the main explaining factors. I will specifically talk
about how fast casual dining is increasingly becoming a threat to
McDonalds. After that I will address three factors of supply and demand
and how they are affecting McDonalds. After that I will explore
McDonalds and the ripple effect it has over the Chicago-land area.
Finally I will address McDonalds perceived value especially how it is
perceived by my generation.
McDonalds has been a powerhouse in the fast food since its
founding on May 15th, 1940. Today it has grown to be one of the
worlds most recognizable brands. It employees over 1.8 million people
worldwide. . They served 70 million [people every day at about 75
burgers per second. McDonalds is also the worlds largest distributor of
toys. Have over 36,000 locations both domestic and international. It
also earns over $28 billion a year in revenue. McDonalds also has but
in the last few years they have seen a decline in sales, revenue,
popularity and food quality. There are many debated contributors but
we will focus on three. The first factor will be food shortages and food
scandals that mainly happened outside of the United States. The
second factor is issues with franchisees. The third and final issue that

Microeconomic Analysis of McDonalds

JT Smith
will be covered is their identity crisis and how they are trying to move
away from their tradition business model and copy other successful
companies within the food industry.
The first factor effecting McDonalds and their operations is food
shortages and food scandals that have hit McDonalds in recent years.
In the last two years there have been numerous food recalls and
scandals in McDonalds Asian markets. A year ago in July of 2014
McDonalds meat processing plant in China was caught using
contaminated chicken and beef. Mixing it in with god meat and sending
it to stores. This plant supplied meat to McDonalds China and
Japanese restaurants, which account to 10.5% of net revenue.
Specifically Japan has been hit very hard as of late. This year alone
they are expected to lose $210 million, which is 3 times more then last
year. You are probably asking yourself why. The reason is the reason is
food shortages and food scandals. The later being already touched on.
Another food shortage was the recent French fry shortage that effected
McDonalds all over the world. In December of last year McDonalds
Japan, which operates 3,100 restaurants, had to start rationing french
fries. The way this looked is that they had to remove medium and large
fries from their menus, they also had to lower the price of all meals to
reflect the lack of fries. This shortage will later be reflected upon in the
supply and demand section.

Microeconomic Analysis of McDonalds

JT Smith
The second issue is the immense issues with franchisees that
account for 80% of the companys restaurants worldwide. One big
issues it the menu. The McDonalds menu is so diverse that the cost to
buy all the ingredients hit the franchise owner. A more streamlined
menu is becoming commonplace in the industry. Most chains try to use
the same ingredients in as many different combinations as possible to
stay unique in the consumers mind but also cut back on costs of
buying and maintaining various foods. Streamlining your menu ties
into the microeconomic idea, cost of production. Streamlining reduces
these costs and can help a company become more profitable. Also the
cost of upgrading cooking equipment is completely put on franchise
owners and is mandatory. This cut into their operating costs and can
destroy a budget and completely change and usually increase sales
goals to impossible levels. Most recently the decision to raise the
minimum wage of employees has infuriated them. Even though the
pay raise only affects company owned employee which are
approximately 1/10 of the 14,000 restaurants in the United States and
about 10% of all employee of McDonalds in the United States.
Franchise owners feel betrayed. This move has put franchise owners in
a tough position in which they feel that they have to increase wages as
well. This is not feasible at some locations. Franchisees say that they
cant afford this because McDonalds Corporate is already is hurting
their revenue with fees, aggressive promotions and expensive

Microeconomic Analysis of McDonalds

JT Smith
upgrades. Also the fact that restaurant sales are slowing isnt helping
these non-company owned restaurants out. Franchisees have to pay
for advertising, rent, and many other expenses which company owned
restaurants are exempt from. The newest program being released by
McDonalds is the Create Your Taste. This program includes the
customer customizing their burger and really making it their own
through more expensive ingredients then found on a normal burger
already on the menu. The equipment for this program is said to cost
from $120,000 to $160,000. Again this cost is not optional, it is
mandatory. Many analysts and franchise owners say that McDonalds
has irreversibly damaged their relationships with their operators.
Corporate is becoming more and more disillusioned with the problems
facing a majority of their restaurants. They are advertising something
they have always promised the consumer, a quick meal and a low
price. Then they turn around and add more expensive ingredients and
complex items that take significantly longer to make.
The third issue is and internal identity crisis. In McDonalds we are
seeing menus that show custom sirloin burgers and high quality
chicken sandwiches right next to a dollar menu. McDonalds is trying to
be all things to all people and this is killing them. McDonalds is trying
to copy their competition. Mainly Burger King, Chick-Fil-A and the fast
casual sector, which will be addressed soon. Starting with Burger King
there are 3 reasons why McDonalds is losing to them. The first is their

Microeconomic Analysis of McDonalds

JT Smith
common sense promotions and discounting. They have introduced a
very successful two sandwiches for $5 deal and now sells 10 chicken
nuggets for $1.49. The items that McDonalds offers in comparison are
at least twice the price. Second is a simplified menu. The strategy
Burger King went with is to have fewer and impactful products. This
increases speed and efficiency in the kitchen while also saving owners
money on ingredients. The third reason is faster renovations. Burger
King will have about 40% of their restaurants renovated by the end of
2015 that is reported to boost sales as high as 10%. The second
company being copied by McDonalds is Chick-Fil-A. Last year Chick-FilA surpassed KFC in being the countries #1 chicken chain in the United
States. In response McDonalds has begun to upgrade its chicken
products. It has started creating a new chicken recipe and returned
chicken selects to its menu at a reduced cost then before.
The newest challenge to McDonalds is the rise of fast casual
restaurants. A fast casual restaurant is one that does not offer full
tableside service but does offer higher quality items and less frozen
and processed foods. This encompasses restaurants like Chipotle, Five
Guys, Culvers and Starbucks. The average meal costs from $8 to $15.
Composed of more complex flavors and made to order fresh. To tackle
this problem McDonalds in a way is leaving its past image behind. By
increasing ingredients and prices they are trying to combat fast casual
dining. They are alienating their already loyal customers. This big

Microeconomic Analysis of McDonalds

JT Smith
change has been fueled by millennials and how they have different
eating habits then their parents. The following statics and graphs have
been found on businessinsider.com We eat out more. 53% go out to eat
once a week compered to 43% of the total population. Our definition of
healthy is different. We are highly prone to believe fresh means
healthy.

Microeconomic Analysis of McDonalds

JT Smith
The graph above shows different perceptions of healthy and how
each generation responds to it. My generation also has developed an
affinity with ethically produced food. This is one reason behind the
success of Chipotle, which uses all natural and locally sourced foods.
Fast food is also perceived as embarrassing. This does not mean that
we do not go to these restaurants; we just dont want people to know.
Finally and maybe the most obvious reason is that fast casual makes
more sense with how we interact socially. It has the food we like and
the atmosphere we desire. You cant take a group of people to
McDonalds and hang out. But you can get a group to meet at a
Chipotle and hang out as a precursor to other social events. The
Washington Post reported that fast casual dining has increased by
550% since 1999. This is more then ten times the growth seen in the
fast food sector over the same period of time.
The French fry shortage scandal in Japan is a perfect example of
supply, demand, and equilibrium. McDonalds did not prepare for any
supply line interruptions. Hence the shortage. In response they had to
change menu prices and only allow purchasing of the small size of
fries. They also had to use planes instead of cargo ships to get flash
frozen potatoes into Japan. Japan is also the biggest market for
American French fries, importing $336 million tons of potato products
last year. The graph bellow is not completely accurate in terms of
numbers but visually shows you how the Japanese market was not

Microeconomic Analysis of McDonalds

JT Smith
being satisfied with the demand it needed of french fries.

3,000
2,500
2,000
Supply (Tons)

1,500

Column1
1,000
500
0
October

September

November

December

The second issue is employee raises and how that affects

franchisee and there operating costs. This issue ties in with the
microeconomic game theory. Game theory is the planning and

Microeconomic Analysis of McDonalds

JT Smith
forecasting of how a business model interacts with changing variable
and different economic agents. As I described earlier the cost of
operating a McDonalds is very expensive. With the mandatory costs of
upgrades profits are lessening and it is becoming increasingly more
and more expensive for the owner. Some even say it may become
economically impossible to operate a franchise and McDonalds may
need to scale back on its number of restaurants.

Sales

Overhead Cost
New Equipment
Misc. Cost
Profit

The third and final issue was McDonalds copying its competition.
This is a tactic that many companies who are in a perfect competition
market. Perfect competition consist of low to no barriers of entry and
unlimited consumers and producers. I think if you look at the current
landscape of the fast food industry you would agree this is the case. In
America there are approximately 50,000 fast food restaurants, globally
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Microeconomic Analysis of McDonalds

JT Smith
there are more then 500,000. That equals about 1 fast food restaurant
per 14 people. McDonalds have always tried to be the one restaurant
for everybody. They have tried to copy their competitors many times
mostly ending in failure. They have tried everything from pizza to tacos
and always end up back where they started. I think in some industries
its smart to diversify your product offering. But in the current food
market we are seeing more and more restaurants keeping a
specialization and they are doing very well.
The biggest effect that I see McDonalds having on the
Chicagoland area is the pay increase. Wage rates have always been a
contested. McDonalds is one of the biggest and most influential
employers in the Chicagoland area, especially since their headquarters
are in Oak Brook. McDonalds already has a bad relationship with their
operators. This employee wage raise will most likely strain them even
more. Maybe even to the breaking point. The breaking point being the
shutdown of restaurants and loss of jobs in the area. The retirement
of their CEO is most likely a signal to the market that McDonalds is
about to be changing things very soon.
I think the fact that McDonalds revenue dropped 4% in February
alone shows its perceived value especially to my generation. As I
showed earlier millennials are a driving force in all food markets due to
our rate of eating out and the higher average will to be spent. If
McDonalds is going to keep growing they will need to adapt to the
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Microeconomic Analysis of McDonalds

JT Smith
changing environment. I think they need to stick to what they know.
Fast and cheap food. They need to work with heir suppliers and source
more ethical food. With the immense buying power that they have they
can lower the prices of ingredient costs. They need to be more willing
to work with their operators. I can see McDonalds positioning
themselves somewhere close to Five Guys and Shake Shack but they
need to do it slowly and strategically.

Sources
http://www.theatlantic.com/entertainment/archive/2015/02/the-end-ofthe-big-mac/386129/?utm_source=SFFB
http://www.vice.com/read/why-is-mcdonalds-losing-money-everywherebut-australia?source=vice_iphone_app
http://www.forbes.com/sites/greatspeculations/2014/09/11/mcdonaldsfaces-declining-sales-in-asia-after-china-food-scandal/
http://www.businessinsider.com/12-facts-about-mcdonalds-that-willblow-your-mind-2015-4
http://qz.com/384962/french-fry-shortages-and-food-scandals-take-abig-bite-out-of-mcdonalds-japan/
http://www.businessinsider.com/mcdonalds-franchisees-against-payraise-2015-4
http://www.businessinsider.com/mcdonalds-franchisees-are-furious2015-4
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Microeconomic Analysis of McDonalds

JT Smith
http://www.businessinsider.com/mcdonalds-is-copying-chick-fil-a-20154
http://www.businessinsider.com/millennials-dining-habits-are-different2015-3
http://www.washingtonpost.com/blogs/wonkblog/wp/2015/02/02/thechipotle-effect-why-america-is-obsessed-with-fast-casual-food/

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