McDonald's demand-based pricing in working-class Australian areas

¶ … McDonalds lifting prices in working-class areas in demand-based pricing scheme impacted on its revenue in Australia, particularly total revenue, marginal revenue and average revenue

A change in the pricing strategy in any organization is based on considerations such as the level of demand, former pricing patterns for the respective product or service, the lifecycle of the product etc. When making such a strategic decision, the company is taking into account, primarily, the way that this is likely to affect the revenues of the company, as well as future profits, but also its market share, an analysis that is done based on the market structure, on market surveys to identify the potential reaction of customers etc.

The decision by McDonald's Australia to increase the price of its products in area considered to have a low socioeconomic score was translated by many as an instrument of increasing revenues for the company, given the fact that evaluations had shown a lower price elasticity to demand in these areas. This paper will aim to examine, both from a theoretical and practical perspective, to what degree such an assumption is correct.

In order to achieve this, this paper will analyze the structure of the restaurant industry in Australia, as well as the particularities of the fast food segment. At the same time, it will analyze the results of a survey made in areas with low socioeconomic scores in order to determine the purchasing reaction of these communities to the increase in prices for McDonald's prices. The conclusion will draw on the findings and explain the results, and it will also connect the theoretical and practical levels for a thorough conclusion on why the proposed hypothesis is actually supported both by the statistical data and the survey findings.

2. The restaurant industry profile and market structure in Australia.

Despite the economic turndown that Australia experienced due to the global recession, 2008 and 2009 were still good years for the restaurant industry in Australia. Results showed an increase with 5.5% of turnover in the cafe, restaurants and fast foods sector of the market, with the cafe and restaurant sector amounting to a $1.28 billion turnover, as of January 2009. Despite these positive outcomes in the turnover segment, an overall increasing level of costs reduced the profits in the industry, with as much as 5% from the previous year (the reported profits averaged 3.8%)

The restaurant industry in Australia is dominated by cafes and restaurants, which amount for 69.9% of the total income, as well as 88% of the total business

. At the same time, it is the small businesses that have the largest proportion of the market, if the number of employees is considered: 63.4% of the total number of businesses have fewer than ten employees, but only account for 20.6% if the total industry income. 33% of the industry's income is generated by large businesses, with over 50 employees. Other characteristics of the industry include the fact that the general assessment of the operators in the industry point to a low quality, both of services and business practices, and the fact that there are occasional skills and labor shortages.

In terms of the market structure, following the information provided in the previous paragraphs, one can conclude that there are two different levels that would need to be analyzed. First of all, the discussion will revolve around the overall restaurant industry, while subsequently, one will investigate the particularities of the market structure in the case of the fast food sector alone, which has some characteristics apart from the general trends of the industry.

The restaurant industry in Australia is characterized by a large volume of sellers, concomitant with a large volume of buyer, making this a monopolistic competition. The products that are being sold on this market (basically, food) are substitutes, but the differences between them are not that great (similar food types, what differentiates then is the way these foods are prepared, the brand -- in the case of fast food outlets -- and the reputation of the restaurant or cafe). It is not however a perfect monopolistic competition, the main element missing is the fact that prices for products do vary significantly, especially determined by socioeconomic variables and conditions.

The fast food industry in Australia, however, is an oligopoly, which significantly changes the facts that determine this analysis, including the impact that a demand-based pricing strategy can have on the revenues that McDonald's Australia is generating. The oligopoly in the fast food industry in Australia means that the industry is dominated by a small number of players, one of which is McDonald's. The relevancy of such a conclusion is great, because, theoretically, there is a lower level of product substitution than within the entire restaurant industry.

This means that the customers will have greater difficulties in switching from one fast food product to another and, at the same time, the interdependence between the companies in the industry may ensure that this does not occur. Such a conclusion may support the hypothesis according to which the demand-based pricing strategy increased revenues at McDonald's Australia.

3. Evaluating the nature of the scheme

In late 2008, a document was leaked by McDonald's Australia, in which a new strategy that the fast food giant had conceived was being promoted around the country. Referred to as a "demand-based" pricing scheme, the scheme proposed increasing the price of food at specific McDonald's locations throughout the country, in direct correlation with socioeconomic behavior noticed in those particular areas. Before further evaluating the nature and results of the scheme, one will need to briefly discuss the concept of "demand-based" pricing and analyze how this was implemented with McDonald's Australia.

A demand-based pricing strategy relies exclusively on "changes in consumer demand for a product"

. As opposed to past-price strategies, which examine the way that price has evolved in the past in order to make a decision on future pricing, the demand-based pricing will examine demand patterns and create the price based on these. In a very simplified format, if the demand for a product increases, then the price is likely to increase as well.

In 2008 and the beginning of 2009, McDonald's Australia began to heavily implement a pricing strategy based on demand that relied mostly on a 1.8% to 3.3% increase in prices for most products

. The respective increase varied depending on the location of the fast food and the socioeconomic characteristics of the neighborhood it was part of, as some claimed, despite the company officially denying this aspect. Company management, in fact, emphasized that the increase was not relying on socioeconomic arguments, but rather that this new pricing strategy was determined by other variables, notably the operational costs that certain neighborhoods implied. In other words, company management states that the new pricing strategy is not a demand-based pricing approach.

Explanation of survey

The first three categories of questions plan to associate the socioeconomic status of the participants in the survey. Most of the respondents had an income of at most $25,000 a month and usually just a high school education. On the other hand, question 4 was used to determine both the preference for fast food and, in particular, for McDonald's among all the other fast food outlets. Questions 5 and 6 in the survey were used to determine the price sensitivity of the McDonald's products, notably that of the most representative product, as well as the price elasticity to demand.

Results

Out of the total of 45 people that were included in the survey, 80% were included in the first two categories of income, which is important to determine the structure of the surveyed group from a socioeconomic perspective. At the same time, 74% mentioned eating at the local McDonald's at least 4 times a week, showing that the group is relevant from the point-of-view of the subject of the survey. The most important question for the purpose of the survey, question 6, had 81% of the respondents point out that their purchasing preference was not influenced by the increase in the product price or by any change to McDonald's pricing strategy, as described. This 81% are important to the final conclusions on the impact of a demand-based pricing strategy on the revenues at McDonald's.

Limitations of survey

The survey is limited because of the reasonably low number of respondents. Despite the fact that most of them belong to the same socioeconomic category and that their answers show that the increase in the price of McDonald's products did not affect their purchasing preferences (both in terms of turning to other fast food companies or other food products in general), the survey was done, because of the material and technical constraints, on a limited number of people. Around 1,500-2,000 would have probably been a volume that would have reduced such limitations. At the same time, the survey was also limited geographically: although this is most likely not the case, it is possible that other Australian communities with low socioeconomic scores have different results for the survey, namely that demand in those areas has been more affected by the new pricing strategy that McDonald's has implemented.

4. Conclusion.

The theoretical analysis, which included an analysis of the available statistical information, of the market structure in the restaurant industry in Australia, as well as of the financial results of the company following the implementation of the new pricing strategy, as well as the results of the survey supported the initial hypothesis that was proposed at the beginning of the 3rd part of this paper. Basically, the conclusion can be split into two different parts, (1) the new demand-based pricing strategy had no impact on the consumption habits of the analyzed community and (2) because of a similar level of demand, the overall and marginal revenue levels at McDonald's Australia increased, as the statistical data also showed (although the source used in this paper provided a different explanation, namely the fact that many of the restaurants were refurbished and new, healthier options were included on the McDonald's menus throughout the country).

When drawing the conclusions, there are several important things worth pointing out, as well as reemphasized. The first is that the market structure plays an important role in the final outcome of the impact of the demand-based pricing strategy on the revenue levels at McDonald's. As such, while the restaurant industry in its entirety is a monopolistic competition, with a large number of sellers and buyers, the fast food sector of this industry is a particular oligopoly, with few sellers, very undifferentiated products and a low price elasticity to demand.

With the conclusions related to the nature of the market structure in mind, the paper was able to initially conclude that, given the market structure and the mentioned particularities, it is less probable for the consumption preferences to be affected by a slight increase in prices. There is less of an incentive to switch to a different brand of a fast food product that in other sectors of the industry or, in fact, in other industries. In theory, the consumers will accept an increase in price because they cannot switch out of the food segment they are in (because of their socioeconomic status) and because there is not a sufficiently significant difference between the fast food brands to induce the change.

A very important element that was emphasized in the paper is the fact that the marginal cost that the consumer associates with a daily purchase of a fast food meal after the new pricing strategy was adopted is remarkably small. The estimate was of about $0.15, in the case of a Big Mac, which means that the increase in the price that the client will pay is not likely to be significant enough to induce a change in consumer preference.

The socioeconomic factor is obviously essential in the analysis. The low socioeconomic scores in the areas that are being analyzed (along with the low income and low educational levels that were also indicated by the survey) propose the fact that the pricing strategy was adapted to these areas, relying on the fact that consumer preference is not likely to change. The reason is quite simple: the poverty in these areas means that people will be paying the additional $0.20 for a Big Mac because they cannot afford anything else.

The results of the survey confirmed many of the theoretical conclusions that were drawn beforehand, notably the fact that consumers are not likely to change their preference of food products based on the new pricing strategy that McDonald's has implemented. The socioeconomic score does contribute to this in a good deal.

As a result, with demand (and, as such, quantity) remaining the same and the prices slightly increasing due to the new pricing strategy, the overall and marginal revenues at McDonald's Australia increased throughout 2009, the year after the period when the company implement the demand-based pricing strategy. This was translated in the financial report as well, although the explanations that the analysts gave relied on different conclusions on the elements that affected this change. One cannot evaluate to what degree the pricing strategy influenced the increase in revenues, but it certainly had an important contribution to it.