The economy side of McDonald’s

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The economy side of McDonald’s

 

1.        History of the McDonald’s

 

The name of the McDonald’s comes from Richard and Maurice McDonald who owned and ran a hamburger restaurant in San Bernadino, California, in the 1950s. But the birth of the McDonald’s that are later known to the world begun with Raymond Albert Kroc who was managed to discover the fast growth of the fast food industry in the US and also the rest of the world and Raymond Albert Kroc was impressed by the McDonald brothers’ business by using the Multimixers to serve their customers. In 1955, Ray Kroc founded the McDonald’s Corporation and opened the first restaurant in Des Plaines, Illinois together with the brothers. And later in 1961, he bought out the McDonald brothers and after that the chain restaurant accelerated its pace to become the largest restaurant organization in the world (Mcdonalds.com.my 2011) bringing great value to the customers around the world in term of convenience, cost saving, delicious food though the health concern of the fast food has been increasingly focused in the nowadays.

 

2.        Organizational objectives

 

2.1    Profit maximization vs wealth maximization

 

The financial management comes from a long way to shift the focus of attention from traditional approach to modern approach about what the corporate goal should be for the business and it is considered that the modern approach focuses on wealth maximization rather than profit maximization and the latter is the concentration of the traditional approach.

 

 

2.1.1            Profit maximization

 

And in a traditional and economic perspective, making a profit is the primary goal of a business which is calculated as simple as the total revenue less the total costs (Boyes & Melvin 2008, p.531). To maximize the profit and find out the profit-maximizing quantity of the output, one useful method is to compare the marginal revenue and the marginal cost. As we know marginal cost refers to the additional cost of manufacturing one more unit of output while marginal revenue is the additional revenue that could be earned by selling that particular additional unit, and when marginal revenue is still greater than the marginal cost and according to the formula the profit will increase and so when the marginal cost equals to the marginal revenue then in a traditional and economic perspective the profit has been maximized until the conditions influencing the marginal cost and revenue change.

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Figure 1 Profit maximization when MR=MC

Source: Fisher & Waschik 2002

 

2.1.2            Wealth maximization

 

As mentioned above, as focus has been shifted from the traditional profit maximization to wealth creation and value creation, more and more companies now use the concept of wealth maximization rather than profit maximization due to there are a number of issues that could not by addressed by concentrating on the profit creation by balancing the marginal cost and marginal revenue. For example, making a profit of one million could not simply be said as good or bad for the business until it takes into consideration of many other factors to be compared with investment, sales and so on and what is more, duration of earning the profit is also important i.e. whether it is earned in short term or long term. And in the view of wealth maximization, the center of the target is no long the profit creation but the cash flow generation (Fabozzi & Drake 2009, p451). This corresponds with the claims that the value of the company today is the present value of all its future cash flows. And to measure the same, value of business is said to be a function of two factors, i.e. the earnings per share and capitalization rate. And the formula of measuring the value of the business is that: Value of business = EPS / Capitalization rate (Khan & Jain 2007). Though the wealth maximization is a modern approach as setting the organizational objective of a business but problems still exist such as the agency problem which arises as a result of the separation between the managers and the shareholders and the managers may make decisions that are not in line with the goal of maximizing the owners’ wealth and the cost associated with the agency problems is known as the agency costs (Shim & Siegel 1998, p.3).

 

2.2    Stakeholder oriented organizational objectives

 

A stakeholder is any person, group, organization, or system who affects or can be affected by an organization’s actions (Camarinha-Matos, Paraskakis & Afsarmanesh 2009, p.518). There is a view that organizations should define and prioritize the stakeholders such as politicians, citizens, customer, collaborators, suppliers, environment and the society with the collaborators and managers involved in term of setting vision, mission statement and long term strategic objectives to achieve the interests of the stakeholders rather than just the interest of the shareholders (Sobh 2010, p.131).

2.3    McDonald’s organizational objectives

 

McDonald’s define its organizational objectives through the setting of its mission statement, corporate vision and the core value of its business which involve the major stakeholders of the company. To the shareholders, organizational objective of McDonald’s is to grow the business profitably for all members of the system and the investors. And to the communities, McDonald’s organizational objective will be to take seriously the responsibilities that come with being a leader in the fast food industry. The company aims at helping the customers build better communities, support RMHC, and leverage our size, scope and resources to help make the world a better place. And also the company is committed to sustainable business practices and is determined to conduct our operations in a manner that does not compromise the ability of future generations to meet their needs. And to the employees, one of the core values would be to place the customer experience at the core of the business and the job content. And QSC&V (Quality, Service, Cleanliness & Value) for each customer for each single purchase is the company’s goal and promise to the customers. And to the employees, the company claims that the company will be committed to the people by creating a diverse team of well-trained individuals and provide opportunity, recognize talent, and develop leaders.

 

3.        Industrial environment in fast food part

 

3.1    Labor force and labor relation

 

Fast food industry with its raise in the developed country and developing countries has not only shaped the local diets habit by persuading more people to focus on the efficiency of having meals and it also brings changes and impacts to the labor market. For example the American fast food companies have been anti-union by establishing an unskilled workforce of primarily young and often part-time workers who could be taught and replaced in a short time and minimize the people impact on the food preparation by using strictly controlled standardized production and serving procedures. And also in many countries, the fast food industry has led a negative impact in the labor market. Accordingly to a study done in the European Union countries warned that the fast food industry was actually accelerating a trend toward the replacement of labor-intensive craft-based food preparation with “industrialized mass production methods” leading to occupational structures with the features of “unskilled, low paid part time jobs with high rates of turnover” (Gottlieb & Joshi 2010, p.113).

 

3.2    Market structure

 

Market structureNumber of companiesEntry conditionsProduct type
Perfect competitionVery large in number EasyStandardized
MonopolyOneExtremely difficultOnly one product
Monopolistic competitionLarge numberEasyDifferentiated
OligopolyFewImpededStandardized or differentiated

Table 1 Characteristics of market structure

Source: Boyes & Melvin 2008, p.535

 

The market structure or market environment in which a company is running its business and selling its products is defined by three characteristics: (a) the number of firms it comprises; (b) the ease with which new firms may enter the market and start the business and (c) the degree to which the products produced by the firms are differentiated from each other. According to these three dimensions, traditionally four major market structures are distinguished which include Perfect competition, Monopoly, Monopolistic and Oligopoly competition (Mukherjee 2002, p.331). For example, perfect competition is characterized by a very big number of firms in the industry and homogeneous product and in an oligopolistic market there will be a small number of firms and the competition will be intense provided that there is not a collusive agreement and the table describes the differences between the four major market structures through the differences in the four characteristics. And for fast food industry, it is widely believed that it is a perfect example to monopolistic competition in a global scale and monopolistic competition refers to a market in which products are heterogeneous but which is otherwise the same as a market that is perfectly competitive and it is marked by large number of buyers and sellers, freedom of exist and entry, perfect information and heterogeneous products (Baumol & Blinder 2011, p.236). Below we will see the traits of the fast food using the market structure model by discussing the three characteristics of fast food industry in which the McDonald’s is running.

 

3.2.1            Number of competitors in fast food industry

 

In a global scale, we can see that McDonald’s, Burger King, Subway, KFC are the biggest players in the fast food industry that enjoy a large market share and also lead the market edge (Lopus, Morton, Reinke, Schug & Wentworth 2003, p.60). But there are also many smaller local competitors that could also have their proportion of market share and compete with the global big players in the given market in a country or in a regional market. For example, in Malaysia local fast food restaurant include Restoran Ali Maju, Restoran McCurry[1], Old Town White Coffee and other small scaled fast food restaurants. And in China, local fast food restaurants are greater in number and there are even different local competitors in different regions and provinces. For instance, in the capital of China, Beijing, local fast food restaurants with Chinese features include Kungfu Restaurant which is dedicated to the Chinese style rice fast foods, Big Thumb Restaurant and Quan Jude Peking Duck Restaurant and so on.

 

3.2.2            Product variety and product differentiation

 

Perfect competition assumes that the products of different providers in the industry are identical, but the situation in a monopolistic competition the products differ from seller to seller in the dimensions of different quality, packaging, supplementary services provided (Baumol & Blinder 2011). But we need to notice that such differences in term of product variety and product differentiation are actually exist in customer perception and need not be in a substantial dimension that is in any objective or directly measurable sense. For example, the French fries that offered by McDonald’s and the monopolistic competitor KFC may be quite similar in the production procedure and technologies involved but so far as customers find out differences between the two French fries in term of different taste or may be contributed by different sources served then the two French fries are different. And having some product differentiation among the large number of monopolistic competitors in the fast food industry, it means that to a particular company, the other monopolistic competitors’ products will not be perfect substitutes. For example, let us say McDonald’s is doing a promotion that by purchasing any large size set meal together with chocolate Sundae or strawberry taste Sundae customers will be given a glass cup during the promotional period, then the KFC customers may be attracted to purchase the McDonald’s meal but due to the products that these two fast food restaurants offer are not perfect substitutes, only a proportion of the KFC customers will be lured away because there are still customers want to enjoy the KFC food. And this diversion effect may be less significant when similar case happen between McDonald’s and Subway because the two company products are more differentiated as perceived by the customers, the Subway food is more fresh and healthy while the McDonald food is better in value and taste. And obviously the larger the product differentiation is, the less direct competition will be between the two competitors.

 

3.2.3            Condition of entry in fast food industry

 

Due to the perfect information in the monopolistic competition, there is much freedom for entry in the fast food industry, potential players may enter into the fast food industry as they perceive that there is chance in the market by imitating the leaders’ business mode or creating a new model that has some new features in term of different food cuisines or different way of serving the food. And also because the little investment in opening up a fast food restaurant compared to registering a large company that requires large capital investment we can conclude that the entry in fast food industry has much freedom of market entry.

 

3.3    Porter’s Five Forces

 

Porter’s Five Forces model was developed by strategy expert Michael Porter which identifies five competitive forces that have influential impacts on the planning of the business strategies and these five forces are: the threat of new entrants, the threat of substitute products, rivalry among competitors, the bargaining power of buyers, and the bargaining power of suppliers (Kurtz, MacKenzie & Snow 2010, p.56). Porter’s ‘five forces’ model is a useful tool to highlight key factors that affect an industry and ultimately the market (Soffe 2005, p.317). And according to Porter (1998, p.5), the five forces will determinate the industry profitability because they influence the prices, cost, and the required investment of firms in an given industry or the elements of the return on investment and what’s more the strength of each of the five competitive forces is a function of industry structure or the underlying economic and technical characteristics of the given industry. For example, when we say that an industry will has smaller number of potential new entrants, it could imply that the potential new entrants are blocked by the cost or difficulties of entering the given market and these high cost and difficulties of entering the industry are actually the features and characteristics of the industry that like other features of the rest four competitive dimensions that together design the level of competition in the industry.

 

3.3.1            The threat of new entrants

 

As mentioned above that due to the perfect information in the monopolistic competition, there is much freedom for entry in the fast food industry; potential players may enter into the fast food industry as they perceive that there is chance of making a profit. So the threat of new entrants is strong thought McDonald’s as the leader in the fast food industry in the world with one of the most favorable brand that it would not be facing instant pressure from the new entrants.

 

3.3.2            The threat of substitute products

 

The substitute products for the fast-food industry are probably some of the most diverse in the world. One of the key issues with the various substitute products is that there is increasing number of alternative that could provide fast food to customers who need convenient fast food service and also these substitute products are already there available to customer causing much threat to McDonald’s. And another threat that besides the availability of the various substitute products is that people are now more and more engaging in a healthier lifestyle and healthier food that exclude the traditional McDonald’s that is known as with high calorie and low nutrition though McDonald’s already begun to introduce low-fact McLean Deluxe burger as early as in 1991 to capitalize on the public’s desire for healthier foods (Raju 2009, p.244). But still the promotion of the healthier lifestyle reduce customers’ possibility to purchase the meals from McDonald’s because there are other substitute products that are better positioned to be better for health.

 

3.3.3            Rivalry among competitors

 

The rivalry among competitors is high due to the existing competitors’ will the struggle for a larger market share and such rivalry is more significant in the developed where the market size has stopped growing and even decline to some extent. And in the new developing market such as China, such rivalry will be less fierce because the market is growing and the majority of the competitors would be able to enjoy the profit and market size growth.

 

3.3.4            The bargaining power of buyers

 

The bargaining power of buyers is in a middle level because of the two reasons. One is that the individual buyers in the fast food industry will have little bargaining power bargain with McDonald’s due to the large number of buyers and small purchasing each time. But the other reason that supports the bargaining power of buyers is the low cost of switching to competitors and substitute products.

 

3.3.5            The bargaining power of suppliers

 

Like Wal-Mart, McDonald’s as a super powerful buyer, it could expect and get cost-efficient service and quality control from its suppliers (Hirt, Block & Basu 2006, p.195). And such behavior and requirements would significantly restrict the prices that the suppliers could charge on the products though it does not necessarily means low profit because of the large volume of purchasing from McDonald’s which is also one of the key reasons that the suppliers would still want to cooperate with McDonald’s.

4.        McDonald’s performance in achieving the organizational objectives

 

Chart 1 Cash Dividend History

Source: Aboutmcdonalds.com 2011

 

To the investors, we can see from the above chart that the McDonald’s has kept its promised to pay back the investors with as increasing in term of cash dividend which keeps increase for the past 30 years (sees appendix 1). And to the customers, McDonald’s always tries to satisfy customers’ curiosity by introducing new taste of food such as the GCB burger that provides new chicken experience combined with many delicious ingredients and McFlurry (new taste Sundae) and also by regular promotion, the customers do enjoy benefit and quality purchasing experience from McDonald’s. And to the society and the local community, the company has also contributed its effort to build up a better world. For example, in 2009, the company introduced the Global Best of Green, a catalogue of environmental best practices from across the McDonald’s System. And this year, the company again added the Global Best of Sustainable Supply to the picture of the business and by providing a source of innovation in the company’s system, the suppliers will be able to innovate and keep advancing on the road to sustainability.

Reference

 

Aboutmcdonalds.com 2011. Cash Dividend History. Viewed on 1 July 2011, Link: http://www.aboutmcdonalds.com/mcd/investors/stocks_and_dividends/dividend_and_split_information/cash_dividend_history.html

 

Baumol, W. J. & Blinder, A. S. 2011, Economics: Principles and Policy. 12th edition, Mason, OH: South-Western Cengage Learning. p.236

 

Boyes, W. & Melvin, M. 2008, Economics. Boston, MA: Houghton Mifflin Company. p.531

 

Camarinha-Matos, L. M., Paraskakis, I. & Afsarmanesh, H. 2009, Leveraging Knowledge for Innovation in Collaborative Networks: 10th IFIP WG 5.5 Working Conference on Virtual Enterprises, PRO-Ve 2009, New York: Springer Berlin Heidelberg. p.518

 

Fabozzi, F. J. & Drake, P. P. 2009, Finance: capital markets, financial management, and investment management. San Francisco: John Wiley & Sons. p451

 

Fisher, T. C. G. & Waschik, R. G. 2002. Managerial economics: a game theoretic approach. New York: Routledge

 

Gottlieb, R. & Joshi, A. 2010, Food Justice. Massachusetts: Massachusetts Institute of Technology. p.113

 

Hirt, G. A., Block, S. B. & Basu, S. 2006, Investment planning for financial professionals. New York: McGraw-Hill Companies, Inc. p.195

 

Khan, M. Y. & Jain, P. K. 2007. Financial Management. New Delhi: Tata McGraw – Hill Publishing Company Limited.

 

Kurtz, D. K., MacKenzie, H. F. & Snow, K. 2010, Contemporary Marketing. 2nd edition, Toronto: Nelson Education Ltd, p.56

 

Lopus, J. S., Morton, J. S., Reinke, R., Schug, M. C. & Wentworth, D. R. 2003, Capstone: Exemplary Lessons for High School Economics – Student Activities. New York: National Council on Economic Education, p.60

 

Mcdonalds.com.my 2011, History: The McDonald’s story. Viewed on 1 July 2011, Link: http://www.mcdonalds.com.my/abtus/corpinfo/history.asp

 

Mukherjee, S. 2002, Modern Economic Theory. 1st edition, New Delhi: New Age International (P) Ltd, p.331

 

Porter, M. E. 1998, Competitive advantage: creating and sustaining superior performance : with a new introduction, New York: The Free Press. p.5

 

Raju, M. S. 2009, Marketing Management. 2nd edition, New Delhi: Tata McGraw – Hill education Private Limited. p.244

 

Shim, J. K. & Siegel, J. G. 1998, Schaum’s outline of theory and problems of financial management. 2nd edition, New York: McGraw-Hill Companies, Inc. p.3

 

Sobh, T. 2010, Innovations in Computing Sciences and Software Engineering. London: Springer Science and Business Media B. V. p.131

 

Soffe, R. J. 2005, The countryside notebook. Oxford: Blackwell Publishing Ltd. p.317

Appendix 1 Cash Dividend History

 

 

 

 

 



[1] McDonald’s even lost an eight-year trademark battle in Malaysia to prevent the restaurant McCurry from using the “Mc” prefix

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