Assignment No 2

Module MBA 4643

PART-B: Managing during recession Due Date 24th April, 2011

Submitted by Munazza Tanveer Sijo Jose Kavitha Prabhakaran Jithin Vijayan Sanaa Aizaz Ajesh

M00338309 M00339404 M00334666 M00341655 M00339867 M00334324

Assessor Professor Ajit Karnik Word Count

Cover Page

Table of Contents
Executive Summary .............................................................................................. 1 The product .......................................................................................................... 2 Target Market ....................................................................................................... 4 Macroeconomic expectations 2nd half of 2011 ....................................................... 5 Costs of production ............................................................................................... 7 Change in Fixed costs ........................................................................................... 8 Change in Variable costs ....................................................................................... 8 Marginal Utility ..................................................................................................... 9 Law Of Diminishing Marginal Utility by Alfred Marshall .......... Error! Bookmark not defined. A psychological generalization that the perceived value of, or satisfaction gained from, a good to a consumer declines with each additional unit acquired or consumed. .............................................................. Error! Bookmark not defined. Market structure ................................................................................................. 10 Strategy with respect to competitors .................................................................... 10 Market segments..................................................... Error! Bookmark not defined. Pricing strategies................................................................................................. 12 Price and income elasticity of product. ................................................................ 12 Cross price elasticity with respect to substitute products .................................... 14 Developments in demand .................................................................................... 15 Effect of the recession on the demand for product ............................................... 15 Affect on demand - Government policies in different markets .............................. 16 Effect on the price competitiveness with respect to currency market. ................... 17 Bibliography ....................................................................................................... 18

Executive Summary

The product
McDonalds McCaf gives you an option to choose between several gourmet coffee choices: cappuccinos, latts, and iced and hot mochas. Theyre brewed with rich, bold espresso and made with real steamed milk, real chocolate and whipped cream. We searched the globe for exactly the right blends of gourmet coffee beans. Our Premium Roast coffee is a blend of Arabica coffee beans grown in Brazil and the mountains of Colombia, Guatemala and Costa Rica. Our McCaf specialty coffee blend comes from Brazil and the mountains of Sumatra, Guatemala and Costa Rica. The McCaf Espresso coffee beans come from Central and South America and the mountainous regions of Indonesia, while the Premium Drip Coffee blend comes from the mountains of Columbia, Guatemala and Costa Rica. Generally, the espresso is bolder, with a rich, roasted flavor and chocolaty notes, while the Premium blend is a little milder. If you look at similar gourmet coffees, and compare taste, size and price, we feel that McCaf specialty coffees offer convenience and wonderful quality at a great price!.i Economic downturn has led peoples to look from age old coffee houses like Starbucks, Costa Caf etc, to other in expensive options. McDonalds entrance to this market reflects its intention to fill a price gap and in cashing on the fact that people are less willing to pay $4 for a drink at Starbucks than in previous years. Consumers are reevaluating the value of the product they are purchasing and are looking for substitutes. Apart from targeting existing customers who are looking for other options, McCaf has also tried to portray there drink as much healthier in comparison to its competitor, below tables reflects the key ingredients and nutritional factor of one of its product in existing market.

McCaf Caramel Mocha

McCaf Latte

McCaf Cappuccino

McCaf Hot Chocolate

McCaf Iced Mocha

McCaf Iced Caramel Mocha

McCaf Iced Latte

Source: http://nutrition.mcdonalds.com

Further to existing markets like USA, UK, etc; McCaf intends to enter much competitive market of Middle East.

Target Market
Keeping the marketing strategies applied in United States of America (USA), by McDonalds, a similar concept will apply to the Middle East, after considering a gap analysis on socio-economic conditions prevailing in both markets, discussed here under:

Price: Coffee is normally served in specialized cafes, which sell coffee, roughly for US$ 4.50 and onwards, which is still out of price range of many prospective consumers. Weather: Weather plays another factor, a general perception is that, hot drinks are not preferred in summers, even though the supply of coffee remains unchanged irrespective of the season. Availability & tradition: Existing cafes are serving in locations like, affluent areas, shopping malls, hotel, etc. With its existing chain, McDonalds can easily reach to a wider customer base. Further, the local population is more inclined towards the traditional coffee brews, such as Turkish coffee or Arabic coffee. Considering the above factors, at the micro economic levels, a cup of coffee, if made available on an affordable price, around the clock, with specialized brew to cater local population at the widely available network of McDonalds will not only attract more customers, but also help establishing the culture of having coffee more frequently, as well. The idea behind McCaf is to essentially enter the luxury coffeehouse business most well exemplified by Starbucks. McCaf can be paired up with existing stores, either as a separate section or as a separate sales counter. Not only can the sales of the original restaurants be increased, but the restaurant may also benefit from a better reputation and increased popularity. This will definitely be true in the early stages of implementation of these stores, because people will get naturally curious. This is also when establishing McCaf as a worthy and cost-friendly substitute to current coffeehouses and dispelling a negative reputation as a low quality coffee brand will be important.

Macroeconomic expectations 2nd half of 2011

Q3 2010 is considered as the first full year of recovery from the Great Recession in the United States. Yet despite the fact that the economy has clocked in six straight quarters of positive economic growth, there seems to be little to celebrate. The only constant throughout 2010 was a very high uncertainty. Decision-making has been challenging owing to high inflation and borderline deflation. However 2011 has been promising now and a strong outlook is building towards to second half of 2011. The most recent survey shows BESI improving from its October value of 48.3 to 50.4 to in January of 2011, reflecting a cautiously optimistic sentiment among executives. Based on analysis of macroeconomic data and improved reading of BESI, in Q1 2011 we forecast economic growth at an annual rate of 3.7%, within one standard error interval of 2.7 to 4.6%. We expect the consumer price inflation rate to remain between 0% and 2%. Unemployment will likely remain between 9 and 10%, with much volatility due to changes in numbers of discouraged workers. In response to additional expansionary monetary policy, interest rates will remain low. The U.S. dollar will be subjected to opposing forces exerted by QE2 and accelerating growth, resulting in mild appreciation against currencies of major trading partners.ii

Source: www.cebviews.com. US Quarterly report Q1 2011.

Above graphs depicts a positive outlook for the second half of 2011. A strengthen macroeconomic policies will certainly ensure the upward movement of graph in respect to economical growth. 6

Costs of production
Law of Diminishing returns as stated by Alfred Marshall The law of diminishing returns states that in all productive processes, adding more of one factor of production, while holding all others constant, will at some point yield lower per-unit returns.

AC & MC curve
7 6 5 4 3 2 1 0 0 50 100 150 200 250 300 350 400 450 500 Sum of AC Sum of MC 1200 1000 800 600 400 200 0

TC, TVC & TFC curve

0 50 100 150 200 250 300 350 400 450 500

Sum of TFC Sum of TVC Sum of TC

Average cost per unit is minimized at a range of output between 350 and 400 units. Thereafter, because the marginal cost of production exceeds the previous average, so the average cost rises (for example the marginal cost of each extra unit between 450 and 500 is 4.8 and this increase in output has the effect of raising the cost per unit from 1.8 to 2.1). When diminishing returns set in (beyond output Q1) the marginal cost curve starts to rise. Average total cost continues to fall until output Q2 where the rise in average variable cost equates with the fall in average fixed cost. Output Q2 is the lowest point of the ATC curve for this business in the short run. This is known as the output of productive efficiency. Short run costs of production-If a marginal cost is below average cost then the average must be falling. Even if MC is rising, AC falls if MC<AC.For this reason MC curve intersect

Change in Fixed costs

A rise in the variable costs of production leads to an upward shift both in marginal and average total cost. The firm is not able to supply as much output at the same price. The effect is that of an inward shift in the supply curve of a business in a competitive market.

Change in Variable costs

An increase in fixed costs has no effect at all on variable costs of production. This means that only the average total cost curve shifts. There is no change at all on the marginal A rise in fixed costs has no effect on marginal cost; it simply causes an upward shift in the AC CURVE

Marginal Utility
Law Of Diminishing Marginal Utility-Marshal states the law The additional benefit which a person derives from a given increase of his stock of a thing diminishes with very increase in stock that he already has.
1 2 3 4 5 6 7 8 9 10

140 120 100 80 60 40 20 0 -20 -40 Sum of Total Mc Caf's utility Sum of Marginal Mc Caf's Utility

Market structure
At present, unlike USA, though coffee shops are not only available at every other corner of a residential block, instead a culture of having a cup of coffee in morning on the way to office is also going strong. The widely available coffee shops have provided equilibrium in supply and demand of coffee. The price of coffee cup in USA varies not because of coffee served, but due to the services provided along with it and the standard of caf where its being served. Whereas, in Middle East, most of the established cafes providing good coffee are the specialized cafes and bistros, such as Star Bucks, Caribou Coffee, Costa, etc. Due to their specialized nature, these cafes, keep price for a cup of coffee at minimum USD $ 4.50. Hence, there is huge gap in the market for supplier (having vast network of outlets) of coffee at affordable price. McDonalds vast network of restaurants, which is already serving a brand of coffee, will serve as an outlet for the special blend of coffee for local population, at an affordable price. These restaurants situated in shopping malls, almost all residential areas and even at gas stations, will serve as a perfect venue to offer coffee.

Strategy with respect to competitors

Competitors who are selling only coffee with a selected and limited no. of confectionary items through their specialized items will be losing the edge to McDonalds on pricing and convenience of widely available locations. Other than this, all McDonalds, either on gas stations or in residential areas have a Drive Through service window. Serving coffee through drive through will be another break through concept, which will attract the customers on move. This will serve as an additional service to customer on the same lower price and will also save them from hassle of getting off from their vehicles and getting in queue at specialized shops to get one simple cup of coffee. 10

Because of the nature of McCaf, its target Our marketing strategy will focus on the pure market will ultimately price economics and convenience; these are the overlap significantly two important factors which will set McDonalds with Starbucks market. apart from its competitors in all areas, i.e., Price, If McDonalds is to open Profitability, lower overheads due to utilization of McCaf stores in the already available infrastructure/resources U.S. separate from its and existing consumer base which is McDonalds restaurants, increasing, day by day. success is not guaranteed because the coffee market is fairly saturated. Most profitable regions already have a plethora of Starbucks stores and other coffeehouses. Furthermore, its reputation as a low quality brand may discourage many coffee drinkers from trying McCaf. Although McCaf is its own brand, it is hard to separate it from its parent company because of the obvious similarities in name.

McDonalds vs. Starbucks Small/Tall Starbucks Latte McDonalds Latte Starbucks Caf Mocha McDonalds Mocha Starbucks Cappuccino McDonalds Cappuccino $2.70 $2.39 $3 $2.39 $2.70 $2.39 Medium/Grande $3.25 $2.89 $3.55 $2.89 $3.25 $2.89 Large/Venti $3.55 $3.29 $3.85 $3.29 $3.55 $3.29

Table 2. McDonalds vs. Starbucks Espresso Prices (prices taken in Anaheim, CA)

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Market Segments
The existing consumer base of McDonalds not only includes the affluent segment of market, but it also includes the middle as well as lower middle class. This is due to the economical prices and promotional pricing strategy which is based on most effective penetrating prices strategy in fast food industry, world over.

Pricing strategies
Considering the macro economic conditions of the Middle East region, where inflation is high due to which the purchase price index or in other word consumer purchasing power has either been declining or is stable, the coffee lovers will appreciate a good cup of coffee at an affordable price, available at convenient locations. The pricing of new coffee drink at McDonalds will be low comparing with other competitors in the market, since at McDonalds the cost of service will be shared with the other line of products.. There is no other cost in introducing new coffee drink, as infrastructure in terms of restaurants, locations and resources (employees), already exist.

The lower prices will attract additional consumers as well, Our primary target is the middle and lower who either due to higher middle class segment of the society. The prices of coffee at specialized secondary target is the affluent clientele which cafes or due to convenient of already have the taste for good coffee and will location were either not appreciate a good coffee at affordable price with inclined towards enjoying a convenience, which is not offered by the good cup of coffee or were competitor specialized during or start shying away from making it a habit to have cup of coffeecafes / bistros. of the day

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Price and Income elasticity of product.

Though McDonalds remains to be a relatively elastic firm due to high competition and so much physical base all across the US and the globe, we cannot study the specific elasticity of the Iced Mocha at Mc Donalds yet. Law of demand by Alfred Marshall: The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good. In other words, the higher the price, the lower the quantity demanded

Effect of Income on the Elasticity of Demand Though the demand for any regular coffee is usually the same as that of a normal good. The case is different for McCaf and McDonalds. As mentioned above, McDonalds was the only food retailer in the history of economic times, which not only survived, but made profits during the past economic depression. We classify McDonalds products line up, including the new Iced Mocha, as an Inferior Good one whose demand increases as incomes fall. This is because as the American culture is greatly attached to Coffee Drinking, the public will always opt for something cheaper than their usual preference in times of an Income drop. This concept is further elaborated using the cross elasticity of demand by substitutes further on. A negative income elasticity of demand is associated with inferior goods; an increase in income will lead to a fall in the demand and may lead to changes to more luxurious substitutes 13

Cross price elasticity with respect to substitute products

The above graph clearly depicts the effect any change in price of an Iced Mocha Frappacino at Starbucks, on the quantity demanded of the same drink at McDonalds Mc Caf. When Starbucks added a new variety to its Iced Mocha array of drinks in 2009, the new drinks cost almost $3 more, these immediately saw an increase in demand for the Iced Mochas available at McDonalds. Such a strong elastic relationship can only reveal a strong rivalry between existing competitors, this kind of competition is healthy yet at the same time can be fatal for certain market players too 14

Developments in demand
Population growth, currently averaging over 7% per annum Rising rates of private consumption expenditure which also have the effect of driving up Food-Service expenditures Three-quarters of the population are non-nationals, with a large percentage of this segment being male bachelors (in fact, males outnumber females two-to-one)Given the prevalent working lifestyle, most people are compelled to eat at least one meal per day while at work The impact of tourists visiting the country annually One single Hardees outlet sells 20,000 burgers per day Factors affecting the industry growth-The number of international tourists is expected to decline due to the global economy crisis 50% of the UAE population are low paid expatriate workers brought in to work in the booming hotel and real estate construction industry and are not relevant to the high value food service industry, or the modern retail supermarkets

http://www.scribd.com/doc/24763400/UAE-Restaurent-Analysis

http://www.mcafee.cc/Classes/BEM106/Papers/2009/McDonalds.pdf

Effect of the recession on the demand for product

Much has been written about McDonald's (MCD) being a recession-resistant stock. There is some truth to the thesis. After all, people still need to eat, so doesn't it make sense to be eating at an affordable place like McDonald's when times are tough. the McDonalds and the Wal-Marts are likely increasing their market share in these recession-ridden times. In conclusion, McDonald's is indeed a recession-resistant company. They are continuing to show positive same-store growth and appear to be taking a bigger market share from its competitors. Unfortunately, the strong dollar is depressing their financial results--due to exchange rates when results are reported in dollars--and they are feeling the pressure from their multinational business as many such corporations are experiencing today. Due to what appears to be brilliant management, this gigantic restaurant chain is reinventing itself, adding salads, healthier items and a coffee bar to many of its newly named 'Cafes'. Some of the reasons that MCD is flourishing in a downturn economy worldwide are: 15

1. In many countries McDonalds is a novelty and consumers want to give it a try. This is true in emerging market countries and also in some Eastern European countries. 2. As mentioned by the company, consumers prefer to eat something that is cheap. This is true in Europe as well, where local food prices could be high in traditional eateries. Though their food may not be of as good quality as other fast food restaurants, it is comparably cheaper. This is a huge draw among cash-strapped consumers. 3. McDonalds brand is very popular all over the world and it continues to take advantage of that with effective marketing. 4. The company positions its stores in some of the most strategic places around tourist locations, busy thoroughfares, near malls, etc. In countries such as Canada, they can be found inside huge malls right next to high-end fashion or jewelry stores. Some competitors havent fared as well. In mid-January, Atlanta-based Wendys/Arbys Group pulled the plug on breakfast in more than half its 850 units after items such as the Buttermilk Frescuit and Grande Breakfast Burrito failed to win over franchisers and customers. With one failed ad campaign following another, and none resonating with the clarity of McDonalds Im lovin it, Wendys seemed to lose its way after founder Dave Thomas died in 2002, about the same time both McDonalds and Burger King began to turn themselves around, Owens recalls.

Affect on demand - Government policies in different markets

On Wednesday April 6, 2011, 6:34 pm EDT A New York City councilman plans to introduce a bill that would ban toys and other giveaways for children from fast-food meals that don't meet certain nutritional guidelines. Meals would be required to be less than 500 calories, as well as low in fat and sodium. Any single food would have to be less than 200 calories, 16

and violators would initially be fined $200-$500. McDonald's (NYSE:MCD - News), which is known for its Happy Meal toys, edged up 0.2% to 76.72.

Effect on the price competitiveness with respect to currency market.

Macroeconomic policies Expansionary quantitative easing, referred to as QE2, was launched in November 2010. Its effect on the exchange rate of the U.S. Dollar seems to be smaller than the much more volatile impact of the European sovereign debt crisis. QE2 has, however, succeeded in stabilizing inflationary expectations. Worries about an imminent threat of inflation have not materialized the Feds growing balance sheet has so far translated into bloated excess reserves in the U.S. banking system, but not the money supply. With all standard measures of the money supply remaining essentially flat, inflation has been consistently below the Feds target. Slowly rising inflationary expectations are therefore good news.

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MCDONALDS CORP (MCD) Historical Prices

Bibliography
http://www.mcafee.cc/Classes/BEM106/Papers/2009/McDonalds.pdf

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The McDonalds. 2011. See What Were Made Of. [Online]. Available at: http://www.mcdonalds.com/us/en/food/food_quality/see_what_we_are_made_of/your_questions_answered/mccafe.html [accessed 22nd April 2011].
ii

CEB Views, 2011. Quarterly macroeconomic review. Available at: http://cebviews.com/uploads/2011/01/US-Quarterly-Report-Q1-2011.pdf [accessed on 19th April 2011].

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