McDonalds @ 20

THE CASE OF McDONALDS AT Rs.20 AN ECONOMIC ANALYSIS

For Prof. Debjani Ghose

LALIT MOHAN THAPAR SCHOOL OF MANAGEMENT,|

THAPAR UNIVERSITY, PATIALA. November 2008

THE CASE OF Mc DONALDS AT Rs.20 AN ECONOMIC ANALYSIS

By 50802013 Bhavdeep Singh Anand 50802015 Divya Sharma 50802019 Gurinder Singh 50802024 Harman Preet Singh 50802026 Hiten Gupta 50702506 Hema Mittal

For Prof. Debjani Ghose

LALIT MOHAN THAPAR SCHOOL OF MANAGEMENT,|

THAPAR UNIVERSITY, PATIALA.

November 2008

APPENDIX I

Introduction to McDonald In October 1996, McDonald’s opened its first Indian outlet in Basant Lok (Vasant Vihar), an affluent residential colony in India’s capital, New Delhi. As of November 2008, McDonald’s has opened a total of 132 restaurants. While McDonald’s opened 34 restaurants in five years (by 2001), it has added 98 more restaurants within seven years (by 2008). Although the initial scenes of crowds lining up for days outside the McDonald’s restaurants in Delhi and Mumbai are no longer seen, Indian consumer response to McDonald’s products still remains very strong.

McDonald has established close relationship with local suppliers who provide them with the highest quality, freshest ingredients to make their products. All of McDonald’s India products are prepared using the most current state-of-the-art cooking equipment to ensure quality and safety. On an average 20 different quality checks are carried out before any product is served to their customers.

The McDonald’s we visited in Chandigarh was packed with young people, children, and young parents enjoying ice creams, spicy potato wedges (instead of the usual french fries), and Happy Meals. Its growth is nevertheless impressive. How did McDonald’s do it? How did a hamburger chain become so prominent in a cultural zone dominated by non-beef, non-pork, vegetarian, and regional foods such as chola bhatura, kababs, bhaji, samosa, dosa, vada, sambar, bhelpuri, and rice? The answer to this question lies in McDonald’s carefully planned entry and expansion strategy in accordance with India’s changing political, economic, and cultural landscape in the 1990s.

Indian Market Spending Much of the McDonald’s growth in India can be attributed to its pricing strategy. Since, on an average, each household spends about 50% of income on food and beverages in India, food prices are always a sensitive issue. Even the Indian middle class, despite their much improved income level, remains very price sensitive. Accordingly, McDonald’s has pursued what Amit Jatia, the company’s managing director in the Western region, calls “purchasing power pricing” or the customer’s ability to pay. The adoption of such a pricing strategy in India offers a useful country-specific insight on possible price differences of the company’s products on the basis of purchasing power parity (PPP) calculations across countries. See Exhibit No.1.

APPENDIX – II

Exhibit No.1

MCDONALD’S IN INDIA Happy Price Menu @ Rs.20

Introduction The McAloo Tikki Burger

With an ambition to penetrate deeper into the new and existing markets, the forever young brand McDonald’s introduced ‘Happy Price Menu’ at Rs.20/- in the year 2004 in India. This ‘value for money’ proposition has been well accepted by the discerning customers. The communication towards this proposition has graduated over the years, but the Happy Price Menu platform has been consistent.

In the pursuit of reinforcing its value proposition, McDonald’s India has unveiled its new campaign titled “Aap ke Zamaane Mein, Baap Ke Zamaane Ke Daam” for its Happy Price Menu. The campaign led by the television commercials shot in three renditions showcase Bollywood’s famous dad-son duos where it accentuates the message of enjoying the tongue tingling taste of the Happy Price Menu comprising of following items, which is comparable to the yester years.

• McAloo Tikki™ Burger • Pizza McPuff™ • Ice Tea • Small Soft Serve

Irrespective of the variance in prices of its key ingredients, the Happy Price Menu has been retained at Rs.20/- price point for the last 4 years.

UTILITY Utility is the power to fulfill psychic satisfaction of a human want. Any good which has the power to satisfy the human want by its consumption is said to have utility. Thus utility is psychological concept.

Capitalists believe that utility though a psychological process was measureable. They proposed utility could be measured indirectly by finding out how much a man is able to sacrifice in order to get one unit of a certain thing. Thus utility could be measured either in:

• Money • Goods • Numbers

The Concept of Total and Marginal Utility Total utility obtained is measured as total satisfaction enjoyed from the consumption of burger. If we consider utility of multiple burgers i.e. a couple of burgers rather than a single burger then Total Utility will be total satisfaction obtained from the consumption of the burgers.

TU = Sum of satisfactions from each burger = ∑ S1 + S2 + S3 + . . . +Sn

Marginal Utility, on the other hand is the relative measure of the satisfaction on each consecutive consumption.

No.of Burgers

Total Utility

Marginal Utility

1 80 80 2 150 70 3 210 60 4 260 50 5 290 30 6 305 15 7 310 5 8 300 -10 9 290 -10

* Hypothetical assumption by presenters

Observations Here increasing Burgers will decrease the utile. Therefore as more and more commodities consumed continuously the utility derives steadily and monotonically decreasing. Therefore we have total greater amount of satisfaction. However with each burger consumed satisfaction derived is lesser and lesser.

DEMAND FUNCTIONS Demand is the variation in the purchasing of given commodity (or service) which consumers would buy in one market in a given period of time at various prices or at various incomes or at various prices related good.

Demand = Fn (price, consumer taste, hygiene, site, conduct)

Price With the same price since last 6yrs, it has contributed to the foot-fall to McDonald’s for Burger, the dedicated customers are still going to McDonald’s.

Consumer Taste McDonald’s has modified the taste of its products according to the Taste of the Indian Tongue.

Hygiene: Open Kitchen, Clean Surroundings, Frequent Cleaning, Gloved Hands & Cooking Masks are few to mention practices McDonald’s has incorporated to increase its head counts

LOCATION: It plays an important role in developing the business strategy. Apart from economically & logistically feasible location, possibility of Drive-Thru is a major advantage.

CONDUCT: A cheerful wish to the customer is their way of starting the business. Even the Drive-Thru has a trained executive for customer interaction. A delighted customer is a free promotion,

DEMAND w.r.t Price

Law of Demand When the price of a good rises, people buy less of a good. This is called the “law of demand” – higher prices lead to a lower quantity demanded, all else equal.

As per our survey among, we got figures as below:

* Presenter’s Data: survey results from 18 college going teenagers

Observations • As price falls more quantity is purchased because Burgers being cheaper. • At peak price only 7 will purchase burger out of 18.

Demand Curve

PRICE DEMAND 25 7

20 11

15 12

Presenters’ Data: Survey on 18 consumers.

To satisfy the law of demand the slope of the demand operation must be negative so that there is an inverse relationship between price and quantity demanded. This is negative relationship between price and rate of demand is known as Demand Function.

Factors of Demand: __ __ __ __ __ D = f (p, PS, PC, Y, T, W)

Where:

PS: - Price of Substitutes PC: - Price of Complements Y: - Income of the Consumer T: - Tastes of the Consumer W: - Wealth of the Consumer p :- Own price of the Good

As all functions except ‘price of our good’ are not under our control, hence, are ignored

Therefore D = f (p)

Elasticity of Demand Elasticity of demand measures by virtue by which demand stretches or contracts under the presence of the change in price. The term elasticity expresses the degree of correlation between demand and price. It is the rate at which Quantity demanded varies with change in price. The concept of elasticity is used to measure the responsiveness of demand to changing prices.

Elasticity of demand (ED) = - Percentage change in Quantity demand Percentage change in Price

Observations

• When the price falls from 20 to 15, when elasticity of demand = 0.2 Therefore, the demand is relatively inelastic.

• When the price increases from 20 to 25, when elasticity of demand = 0.8 the demand is relatively elastic

PRODUCTION FUNCTION McDonald’s purchases raw vegetables and other raw materials from its fixed, pre-defined suppliers only, therefore by increasing capital and labor, their production will increase proportionately.

Q = KaLb (Cobb-Douglas Production Function)

Where:

• K {Capital} • L {Labor} • a, b {Parameters of Production} • (a+b) = 1 {Constant Returns to Scale}

ECONOMY OF SCALE As the output from any fixed setup increases, it leads to reduction in the per unit cost of the product. Economy of Scales refers to the dealing in the bulk ordering / production.

Economies of Scale bring advantages to McDonald's.

McDonald’s offers relatively uniform menu that include well- recognized items such as the Big Mac, McAloo Tikki Burger, French Fries etc. These items are easily mass produced, so the cost of making each one is small. Consumers’ pervasive familiarity with these items also creates stability in sales, which ensures revenues are consistent year-round and it always sells a certain volume of its highest profile menu items.

PRODUCTION COMPARISON The scale of production provides McDonald’s a competitive edge. It enables the firm to enjoy the low Raw Material cost.

For the analysis, relative stats were taken from local market:

* Presenter’s Data: Average pricing of various burger joints across Patiala.

* Presenter’s Data: Approximate costing of the McDonalds Aloo Tikki Burger.

INGREDIENTS Price (in Rs. per burger)

Bread Buns 2.50

Potato Patties 7.50

Mayonnaise 1.50

Salad 0.50

Paper Wrap, Napkin 1.00

Ketchup Pouch 1.00

Total ~14.00

SUPPLY Keeping the price competitive, McDonald’s is planning to extend its supplier base to the local areas. During their launch in India, there were limited distant suppliers, as per the demand. Advancing in time, the demand rise, so did the procurement costs. It was pretty desired to develop suppliers’ base to the nearest local markets.

Sources of Basic Ingredients:

Buns: Shah Bector & Sons, Khopoli, Maharashtra and Cremica, Ludhiana

Veg. Patty: Kitran Foods, Tajola, Maharashtra

(fresh peas, carrots, green beans, red capsicum, potatoes and rice)

Spl. Sauce: Quaker Cremica, Phillaur, Punjab

(special vegetarian eggless sauce)

Veg. Salad: State Markets

COSTING Opportunity Costs: The initial openings of McDonald’s outlets in Delhi and Mumbai were driven by affordability and brand recognition factors. Given the metropolitan culture and wide Western exposure of these two large cities, where most of India’s rich and upper middle-class population live and are aware of McDonald’s foods, it was logical for the company to open its initial outlets in these two cities. Besides, the inhabitants of both Mumbai and Delhi love to experiment with a wide variety of foods. In addition, McDonald’s has two large distribution centers in these two Metros and later the brand became known in every part of the country. Thus the opportunity costs in expansion were very less.

There are quite a few terms relating to cost. We will consider the following seven terms:

• Marginal Cost • Total Cost • Fixed Cost • Total Variable Cost • Average Total Cost • Average Fixed Cost • Average Variable Cost

To compute these seven figures, the required data is written below in tabular form:

Q TC MC T/FC TVC ATC AFC AVC 0 130 0 130 0 0 0 0 1 250 120 130 120 250 130 120 2 390 140 130 260 195 65 130 3 600 210 130 470 200 43.33 156.67 4 840 240 130 710 210 32.5 177.50 5 1200 360 130 1070 240 26 214

* Presenter’s Data (hypothetical)

Marginal Cost Marginal Cost is the cost a company incurs when producing one more good. Suppose we're producing two goods, and we would like to know how much costs would increase if we increase production to three goods. This difference is the marginal cost of going from two to three. It can be calculated by:

Marginal Cost (2 to 3) = Total Cost of Producing 3 – Total Cost of Producing 2.

Total Cost The total cost is simply all the costs incurred in producing a certain number of goods.

Fixed Cost Fixed costs are the costs that are independent of the number of goods you produce, or more simply the costs you incur when you do not produce any goods.

Total Variable Costs These are just the opposite of fixed costs; these are the costs that do change when we produce more. These

Average Total Costs Our average total cost is our fixed costs over the number of units we produce.

Average Fixed Costs Our average fixed cost is our fixed costs over the number of units we produce, given by the formula:

Average Fixed Cost = Fixed Costs / Number of Units

Average Variable Costs Formula for average variable costs is:

Average Variable Cost = Total Variable Costs / Number of Units

Explicit Cost Function: These costs fall under actual business costs that are entered in the books of business.\

Explicit Cost Factors are:

• Wages / Salaries • Raw Materials • Electricity & Water bills • Equipments

All the raw material for buns is ordered and supplied in bulk (economy of scales), to reduce the company overheads.

Implicit Cost Function These costs do not take the form of cash outlays nor do they appear in accounting system.

Implicit Cost Factors are:

• Risk involved in forecasting the Demand • Costs involved in preventing the legal action against foul product / service. • Employees’ consumption • Food Scraped / Spoiled

PRODUCT LIFECYCLE Customers’ requirements change over time. What is fashionable and attractive today may be discarded tomorrow. In order to meet these changes, McDonald’s has introduced new products and phased out old ones, and will continue to do so.

Demand of McAloo Tikki Burger would not be same for all the time. Therefore, they introduced another product in the same range, Veg. Pizza McPuff.

Care is taken not to adversely affect the sales of one choice by introduced a new choice. McDonald’s knows that items on its menu will vary in popularity. Their ability to generate profits will vary at different points in their life cycle.

Products go through a life cycle, which is illustrated below:

PRICING DECISIONS For each country, there is a rigorous pricing process that is used to determine the price for that particular market. The process, as described by Vignali et al. (1999) [14] is listed below:

• Selecting the Price Objective • Determining demand • Estimation costs • Analyzing competitors' Costs, Prices and Offers • Selecting a Final Price

Cost to Price Model

P = f (O,D,Ce,Cc,R)

Where:

• O = objective • R = raw material • D = demand • Ce = cost estimates • Cc = compietitors cost price

McDonald's overall pricing objective is to increase market share. They look at the demand for their product as a barometer for setting price. To measure demand and to look after their raw material supply they started their franchised operation.

In New Delhi, India, McDonald's was looking at market penetration in October 1996, and set price through looking at Nirula's, a local food chain. They used this local example as a guideline to what the Indian would perceive as an acceptable price and hence what they should charge.

MARKET Is it Oligopoly or Monopoly type? The theory of monopolistic competition has elements of both monopoly and perfect competition. After much consideration our team agreed it to be monopolistic competition. McDonalds has control over price because of their products are differentiated & this advantage pushes them far ahead of others.

Rarely Homogeneous In the markets with a large number of sellers, the products of individual firms are rarely homogenous. There are many Burger Points in India like KFC, Nirula’s, Local burger points and McDonalds but whenever we hear the word Burger the only name came in our mind is of McDonalds. Which is highly differentiated McDonalds in the mind of consumers

Product Differentiation This product differentiation may reflect materials and workmanship of the good sold in a particular store, or it may be the result of effective advertisement. The manner in which the store displays the good can be another source of product differentiation. McDonalds introduced McAllu Tikki Burger where as KFC introduced Student Burger. Here both sellers are selling the same product with different ingredients. McDonald’s's offers drive-through service while KFC doesn't.

Product differentiation is the key to survival. Least costly branded burger from McDonald’s is capable to beat even the local fast-food joints. Though they are not entirely homogeneous among producers, as McDonald’s McAllu Tikki Burger is 99% the same quality food, but the ingredient selection makes it largest selling among the segment.

To survive, there is increasing need for Ads and promotional activities. Aggressive ads, inducing ‘affordable’ ‘economical’ like terms, are suited best to lure Indian consumers, away from Hot Millions, KFC, Mr.Burger Nirula’s and various other well established Fast Food joints.

Location Location is another source of product differentiation. Sellers in a nearby will be more likely to obtain a consumer’s business than stores on the other side of town. McDonalds and KFC are not adjacent to each other they are far away from each other same in the case with the local burger points and with McDonalds.

Perfect Competition It assumes that there are a large number of small sellers like local Burger points. Thus the actions of any single seller do not have a significant effect on the other

sellers in the market. Also there are many numbers of buyers and that resources can be easily be transferred into and out of the industry.

Monopoly The monopolistic competition resembles the monopoly models in that products of individual firms are considered to be slightly differentiated. That is, the product of one firm is assumed to be a close, but not a perfect, substitute for that of other firms. The result is that each firm faces a demand curve with a slight downward slope implying the individual firm has some control over price. Although increasing its price will cause the firm to lose sales, some consumers will be willing to buy at the higher price because the product is highly differentiated from that of the competitors. Like McDonalds is selling their burger at Rs 20 where as KFC is selling its burger at Rs 25.

• Number and size distribution of sellers • Number and size distribution of Buyers • Product differentiation • Conditions of early and exit

OBJECTIVES Long-Term Plans...

In a business when a number of brains are working together, there are always different views on a certain aspect, therefore aims and objectives are used to help them focus on one view on the aspect which either seems right or is right. Aims and Objectives help an organization grow; it is used as a guideline, a plan and a goal. What the organization is heading for and how it is heading there and where it is heading? All the answers for these questions are answered by Aims & Objectives.

The Main Objectives of McDonald’s Business are: - Sales – Sales revenue is the total amount of money a company has earned by

providing their service or selling their stock.

Growth – An increase in the Business capacity to produce more stock or provide better or greater service.

Profit – Residual value gained from business operations after cutting out expenses such as stock cost etc.

Customer Satisfaction – Providing service to customers to their satisfaction level such as hygienically clean place or high quality food.

S M A R T

Before a business can set objectives it is important that they follow the SMART criteria.

• Specific – Detailed and Exact

• Measurable – Targets should be measurable

• Achievable – Something that can be achieved

• Realistic – Targets must be realistic, so that they can be met

• Time Specific – That can be achieved by a deadline

“It’s What I Eat And What I Do…I’m Lovin’ It”

PLAN – Their plan is to deepen their connection with the customer by providing great service ad experience “in every restaurant, every time.” Their usage of different activities allows McDonald’s and the Customers to have a relation between them.

REFERENCES

Mr. Kastoori Ram

Owner, Burger Joint, Patiala

McDonalds India website:

http://www.mcdonaldsindia.com/

Encyclopedia:

www.wikipedia.org

www.britannica.com

encarta.msn.com

Research Papers:

www.scribd.com

Search Engines:

www.altavista.com

www.google.com

Others:

www.financialexpress.com/news/mcdonalds-plans-more-eateries-franchise-model/109889/

www.rediff.com/money/2001/apr/10mac.htm

www.thehindubusinessline.com/2006/04/20/stories/2006042004621200.htm

www.icmrindia.org/casestudies/catalogue/Business%20Strategy2/BSTR142.htm