Business Economics Analysis – Case study of McDonald’s Corp

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1.        Introduction

McDonald’s was the brainstorm of two brothers who opened a cheap burger restaurant in California in 1940. When they expanded their operations to Arizona, they began to use two year arches to make their building visible from blocks away. And after the takeover by Ray Kroc, an enterprising businessman, McDonald’s rapidly spread to all of the United States through standardizing the fast food business. By 1995, more than half of all McDonald’s restaurants were located outside the United States and by 2000, McDonald’s was already serving fifty million people a day (Duiker & Spielvogel 2010, p. 937). This study will concentrate on the analysis and evaluation of the market strucure, industrial environment and also the economy performance and also the strategy analysis of the McDonald’s Corp in order to provide some useful information to the various stakeholders such as the investors and potential franchisees who are interested to take up a lucrative investment.


2.        Strategic business objectives

Every business unit needs a broad strategic objective. The fundamental objective for every business unit is to maximise shareholder value. But such an objective is not actionable without more definitive guidelines. And a business unit and individual products or markets can be assigned one of the five objectives: divest, harvest, maintain, growth or enter (Doyle 2008). And the choice of the five objectives could be based on the current stage of a market sector in the industry product life cycle and also the nature of the market and products. Another view expressed by Malcolm McDonald and Peter Cheverton (2002, p. 9) is that there are four typical business objectives of: maximizing revenue (market share); maximizing profits; maximizing return on investment and minimizing cost. In the case of McDonald, as the company is the leading global food service retailer with more than 33,000 local restaurants serving more than 64 million people in 119 countries each day ( 2011), various strategic business objectives could be identified in different individual markets and in general they could be described in this way:

Market The five objectives (Doyle 2008) The four objectives (McDonald & Cheverton 2002, p. 9)
Existing markets: Developing countries (such as China & India) Growth Maximizing return on investment
Existing markets: Developed countries (such as EU and US) Maintain or Growth Maximizing revenue (market share)
Undeveloped markets Enter Maximizing revenue (market share) and Minimizing cost

Table 1 Strategic business objectives for McDonald’s major markets

Source: own conclusion


For example, McDonald’s Corp. is planning its biggest expansion to date in China, aiming to open 700 new stores by 2013 as the fast-food giant faces increasing challenges from competitors. The U.S.-based company plans to expand its Chinese operations to 2,000 stores by 2013, up from its current 1,300, and according to a McDonald’s spokeswoman, Betty Tian, the company in China will also hire 50,000 new employees, including 1,000 university graduates for management-training positions (Burkitt 2011). This shows a growth objective and maximizing revenue (market share) in the China market for McDonald’s Corp which has closed close relationship with the industry competitive environment. Below we will target at analyzing the nature of the products provided by the company and the general competitive environment in the global fast food industry to see how the industry environment could affect the strategic direction setting and how McDonald should achieve the maximization of the shareholder wealth in the long run rather than short term profits.


3.        Product of the company and the industry introduction


The major traditional types of fast food chains are still the hamburger chains, chicken houses, pizza/pasta parlors and Chinese food chains. However, other fast food chains are catching up like the donut chains, coffee shops, barbecue houses, bakeshops and Filipino food chains (Reyes 2011). While still based on hamburgers, today’s menu of the McDonald’s includes numerous other items that have been added through the years (Motz 2011). By looking at the standard menu provided by McDonald, the company provides five major categories of food products:


  • Burgers
  • Chicken, fish and pork
  • Other products
  • Breakfast
  • Beverages
  • Desserts


The menu of these products are highly standardized, for example, the burgers include Big Mac, Quarter Pounder, Double cheese burger, McFeast and so on which could be found in any of the McDonald’s outlets around the world. Besides the physical products, the company also provides related food services such as the food delivery service which would be done in 45 minutes or less.

The McDonald’s operates as a fast food restaurant in the fast food market which sells quick prepared meals. The fast food market is defined as the sale of food and drinks for immediate consumption either on the premises or in designated eating areas shared with other food service operators, or for consumption elsewhere (Lux 2010, p. 21). The fast food business is driven by standardized meals and services. As suggested by Andrews (2007), fast food operations have a great impact on the food service industry. And it could be dated back to the 1920s and 1930s when A&W Root Beer and Howard Johnson’s franchise some of their units. After almost 90 years from the sale of the first hamburger and root beer, the global fast food market has grown to over US$201 billion in total revenues in 2009, with growth of 3.1 percent, according to Datamonitor (Reyes 2011). The fast food business is growing steadily and it is expected that in 2014, the global fast food market is forecast to have a value of $239.7 billion, an increase of 19.2% since 2009 ( 2011).  In the next session, we will examine into the industrial structure and economics of the fast food industry.


4.        Industry structure


4.1    Number of players


The global fast food industry is a highly competitive market with thousands of large scale players operating in it and competes for a larger market share. And with the raise of the emerging economies, the global fast food industry seems to be picking up the growth pace again since its fast growing in the middle and late of 20 century.





4.2    Competitive structure in the fast food industry


Figure 1 Porter (1998)’s five forces model

Source: Porter (1998)


In order to analyze the key structures and main forces within the fast food industry in a structured way, Porter (1998)’s so called five forces model will be applied here. In this competitive model, industrial competitiveness is not only determined by rivalry among the existing companies but also driven by the threat of substitutes, the bargaining power of suppliers, the threat of new entrants and the bargaining power of buyers. The Porter’s model and framework for competitive strategy is widely used for structured industry analysis, competitors’ analysis and competitive positioning (Rave 2009, p. 23).

4.2.1            Rivalry among the existing companies – high

Of all the five forces, rivalry among existing players is nearly always the most important in determining the attractiveness and potential profitability of an industry. The intensity of competition within an industry is determined by the market growth, cost structure, barriers to exit, product switching, and product and business diversity (Bensoussan & Fleisher 2008, p. 99). The rivalry among the existing companies in the global fast food industry is intense because of the large number of fast food restaurants and their competition to gain more market share to achieve a better economy of scale. Two major competitors are enough to bring strong competition in the global fast food industry to the McDonald’s. The first is the Subway. Though many researchers still shows that McDonald’s is the No.1 most favorite fast food chain, the Subway sandwich chain has surpassed McDonald’s Corp as the world’s largest restaurant chain, in terms of units. At the end of last year, Subway had 33,749 restaurants worldwide, compared to McDonald’s 32,737. The burger giant disclosed its year-end store count in a Securities and Exchange Commission filing late in April ( 2011). The second is the Yum! Brands which is the world’s largest restaurant company with more than 36,000 restaurants in over 110 countries and territories and more than 1 million associates. It is a company that owns several food chains world-wide. Four of their restaurant brands are the global leaders of the chicken, pizza, and Mexican-style food. The restaurants are Kentucky Fried Chicken, Pizza hut, and Taco Bell. The Yum! System includes three operating segments: United States, International, and China Division which includes mainland China, Thailand and KFC Taiwan ( 2011). For example, in the China market, KFC seems to beat McDonald in the competition by running more than 3600 thousand outlets which are almost three times as of that of McDonald’s. And the accomplishment made by the company is striking in a country where foreign companies often stumbled and ran into roadblocks in the past. The secret to the success of KFC’s parent company, Louisville, Kentucky-based Yum! Brands Inc., can be traced to its use of local ingredients – both in its management team and on its menus. In the 24 years it has been operating in China, Yum has hired Chinese managers to build partnerships with local companies in its expansion drive and used their expertise to offer an array of regional dishes that appeal to domestic tastes ( 2011). Hence we can see that there is intense competition among the established competitors, and McDonald has been challenged in term of both number of outlets and also customers loyalty.



4.2.2            The threat of substitutes – low


The threat from substitutes will depend on the number available and how readily they can be substituted for the product in question. When there are few close substitutes for a product the level of competition will be reduced. And the degree of competition from substitutes will depend on how they meet the specific customer need, how they are priced relatively and the willingness of buyer to substitute (Stonehouse & Campbel 2003, p. 120). In the global fast-food industry there are numbers of substitutes that fast-food industry faces as competitive forces. Fine dining, hot and spicy foods, smoothies, wraps and pitas, salads, and espresso and specialty coffees (Zimmerman 2010). These products could not bring obvious threat as substitutes to the popular fast food for the following reasons: firstly, fast food products are served in a fast speed and when people especially those who are rushing would not have time to choose other way of dinning and fast food which could be taken away in minutes of time seems to be the only choice; secondly, fast food are usually priced in a low price witch the most said substitute could not provide; thirdly, as many fast food brands such as McDonald, KFC and Pizza Hut, they have become favourite restaurants for many customers and earn their loyalty and hence even they have spare time and they would still choose to dine in these fast food restaurants. As a result, the threat of substitute in the global fast food industry is low.


4.2.3            The bargaining power of suppliers – low


The bargaining power of suppliers results with higher independence from suppliers in the industry. Powerful suppliers are able to generate more of the value for themselves when setting up higher prices and reducing the quality or services. Often the supplier group has differentiated products or switching costs are high for the customer. Moreover, the supplier will have switching cost as well which will limit their power (Roy 2009, p. 27). In the global fast food industry, the bargaining power is usually in a low level for three major reasons. First of all, fast food firms are usually critical customers to the various suppliers and their buying makes up a large proportion of the sale revenue and thus the profit because they would purchase frequently and also in a large volume; secondly, there is usually intense competition in the suppliers’ industries to establish long term cooperation relationship with the fast food companies, in particular those of large scale because the major fast food firms’ buying represent a huge market share. For example, coca cola is in a cooperation contract with McDonald but if the contract ends, Pepsi would be more than willing to take over the order from coca cola because this change of supplier would create a large demand of its soft drink and also provides a great chance for promoting its brand among the  64 million people in 119 countries in each day; thirdly, many supplied products are coming from the local medium and small suppliers such as the the chicken, these suppliers are heavily relying on the orders from a particular cooperative fast food chain, and also because of the switching cost, it also means business failure to these small suppliers if the supplying relationship ends.


4.2.4            The threat of new entrants – high

Identifying new entrants is important because they can threaten the market share of existing competitors. One reason new entrants pose such a threat is that they bring additional production capacity to the market and unless the demand for a good or service is increasing, additional capacity holds the consumers’ cost down resulting in less revenue and lower returns for competing firms (Hoskisson, Hitt & Ireland 2008). In the recent years Global Fast-food market has shown tremendous results and the growing demand for fast food has been attracting many players. Market is full with players like McDonald’s, Wendy’s, Burger King, Subway, Pizza hut, KFC, and many other local players. Few other players are also looking to extract profit from this market. Even few local players are also looking to enter into the global arena ( 2010). These new comers are expected to radically alter the industry structure with their technology.

4.2.5            The bargaining power of buyer – middle level


The bargaining power of buyers could be understood as the customers’ power to argue down the price and request for the specific qualities of the products. The bargaining power in the fast food industry is in a middle level for three major reasons. Firstly, in most buying scenarios, buyers are individual buyers who purchase in small volume and their each buying would not have important effects over the business operations of the company; Secondly, the individual could also choose to have their lunches and dinners in other competitors’ restaurants which are also a show case of the customers’ bargaining power.


5.        Analysis of the economic performance of McDonald’s Corp (at least 3 years)


5.1    Stock price trend

Chart 1
  McDonald’s five year stock price trend


In the past five years according to the historical data, the stock price of the McDonald’s has grown more than double of what it was priced in 2007 in the stock market. Though there were some fluctuations in 2009, most probably due to the global financial crisis, still the increasing of the stock price is apparent and it is good news to the investors.


5.2    Revenue, profit, cost of goods sold and EBT

Chart 2
 Total revenue of McDonald’s Corp (Dec 31 2007 to Dec 31 2010) (Currency in Millions of U.S. Dollars)

Chart 3
 Cost of Goods Sold of McDonald’s Corp (Dec 31 2007 to Dec 31 2010) (Currency in Millions of U.S. Dollars)

Chart 4
 GROSS PROFIT of McDonald’s Corp (Dec 31 2007 to Dec 31 2010) (Currency in Millions of U.S. Dollars)


Chart 5
 EBT, EXCLUDING UNUSUAL ITEMS of McDonald’s Corp (Dec 31 2007 to Dec 31 2010) (Currency in Millions of U.S. Dollars)


In term of total revenues, from the end of 2007 to the end of 2010, it has increased gradually from 22,786 millions of U.S. dollar to 24,074 millions of U.S. dollar, but the cost of goods sold was controlled well and even drop from 14,881.4 millions of U.S. dollar to 14,437.3 millions of U.S. dollar during the same period, this resulted in a better performance in the profit generation which increased from 7,905.2 millions of U.S. dollar to 9,637.3 millions of U.S. dollar which is good news to the stock holders. After the deduction of other expenses and addition of the other incomes, the earning before expense also witnesses a steady growth from 5,346.9 millions of U.S. dollar to 6,995.5 millions of U.S. dollar with a year on year growth rate of 9.37 per cent.


5.3    Ratio analysis

  Dec 31, 2010 Dec 31, 2009 Dec 31, 2008 Dec 31, 2007 Dec 31, 2006
Turnover Ratios          
Inventory turnover 219.06 214.17 210.96 181.86 144.88
Receivables turnover 20.42 21.45 25.26 21.62 23.87
Payables turnover 25.51 35.76 37.91 36.51 25.88
Working capital turnover 69.76 42.87 55.70 41.06 98.52
Average No. of Days          
Average inventory processing period 2 2 2 2 3
Add: Average receivable collection period 18 17 14 17 15
Operating cycle 20 19 16 19 18
Less: Average payables payment period -14 -10 -10 -10 -14
Cash conversion cycle 5 9 7 9 4

Table 2 Major financial ratio of McDonald’s Corp

Source: Based on data from McDonald’s Corp. Annual Reports


The major financial ratios show that the financial side of the company is healthy. In term of inventory turnover, which is calculated as revenue divided by inventory, it increased steadily within the five years from 2006 to 2010 indicating that the company has been improving its performance in managing the stocks and utilize them to generate revenue. But the working capital turnover decreased dramatically from 98.52 to 41.06 but improved in the later few years though still can not match up with the performance in 2006. In term of the operating cycle, the total of the inventory processing period and average receivable collection period increased from 15 days to 18 days suggesting that the operating cycles was prolonged.


Comparing McDonald and the industry

Figure 2
 Major finncial ratio compared with the industry average

Source: 2011


In term of profitability, the company is leading the industry but the margain analysis shows differentiated results which the SG&A margin is in a low level but the EBITDA margin is high in the industry. And the various growth ratios show the company is recovering and growing faster than the industry average in 2011.


7.        Strategic analysis


7.1    Strict control strategies

According to Mark Graham Brown (2006, p. 258), McDonald’s is a company that is a master at controlling processes dependent upon human behaviors. They have automated where they can, but something just can’t be automated yet. McDonald’s control strategies consist of thorough training, clear and precise procedures and work rules, constant monitoring, feedback and consequences. Also employees are rewarded for desired behaviors and acting in accordance with the process rules and punished for the failure to conform to the standards.

7.2    Product and operating procedure standardization


As proposed by Charles Hill and Gareth Jones (2010, p. 74), the competitive advantage of McDonald’s comes from efficiency, reliable quality and customer responsiveness. And McDonald’s efficiency is obviously the critical success factor of the business, and it comes from the company’s standardized processes, which boosts employee productivity, and its economies of scale in purchasing and both of which lower costs. Also the standardized processes and menu also help to ensure the reliable quality because the ways the products are made is standard and menu is relatively simple which means that the company focuses on the certain products in a longer term.

8.        Recommendations


As mentioned above, the secret under the success of Yum! Group in the China market is that it localizes it menu as well as localizing its management teams in managing the operations and decisions making regarding the china market, therefore one major recommendation  offered to the McDonald is that it could differentiate its offering in the local markets especially those that have quite different food culture and customer preference from the US style one by adding the local inputs in term of local favor and internal restaurant design that is more in consistent with the particular national culture background.


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