According to the articles, McDonalds has been on a steady decline over the last

Question

According to the articles, McDonalds has been on a steady decline over the last few years, especially among millennials. McDonalds’ menu items appear to be losing ground, especially among millennials, to alternative menu items at so-called “fast-casual” chains that offer customization and healthier/organic/non-GMO/earth-friendly food (e.g., Chipotle, which uses free-range proteins (chicken, beef, pork) and organic produce and allows customers create their own combination of proteins, salsas, rice, and accoutrements).

The fairly new CEO of McDonalds has stated that he is intent on shifting part of their menu away from traditional offerings to more fast-casual items to cater to the wants of millennials. These changes will likely increase the cost of goods sold by McDonalds and require an upfront investment in capital (e.g., they would likely need different processing facilities to handle the more perishable and tender organic raw materials) and menu design, as well as on-going increased sales and general administrative expenses associated with marketing and re-branding a segment of their product line. They will also have to incur some additional expenses associated with allowing for more customization (for example, they will need to reconfigure the kitchen space to allow some menu items to be built by hand).   

The following information provides estimates of some potentially relevant variables associated with a plan to introduce fast-casual menu items only in the United State (where the demand for fast-casual among millennials is likely the highest). Based on this information, what do you recommend McDonalds should do regarding creating a new product line geared toward millennials?

An estimate of McDonalds’ revenue from sales at company-owned stores (i.e., total sales excluding sales at franchised stores) in the United States is $4.5 billion last year. Assuming that 25% of these sales come from the target customer base for this strategy, then $1.125 billion in revenue was from this target customer last year. The article indicates that sales from customers aged 19 to 21 years has fallen approximately 13 percent since 2011 while sales to those between 22 and 37 year is flat. It also indicates that sales at fast-casual competitors have been steadily increasing by 2.3 to 5.2 percent per year. Assume that if McDonalds does not develop any fast-casual menu items, that the revenue from sales to the target group will fall by 2% each year for the next 7 years, staying flat thereafter. However, if McDonalds develops some fast-casual menu items the demand from at least some millennials will increase sales revenue by the percentages given below.

Estimates indicate that the variable cost associated with producing revenue from the current menu items is approximately 85% of revenue. That is, it costs .85*$1.125 billion = $.95625 billion in variable costs to produce $1.125 in sales revenue currently. With the new product line, the variable costs will be higher; the costs of the raw materials will be higher (organic and non-GMO raw material is more expensive than conventionally raised raw material and there is likely to be more spoilage/waste). Assume that variable costs will rise to 90% of revenue for the new menu items. On sales of the old menu items, assume the variable cost remains at 85%. Also assume that, given these new menu items, the fraction of revenue that comes from sales of the new menu items to the target group will be as follows:  

Based on these estimates, what is the incremental change in the cost of goods sold associated with the decision to sell fast-casual menu items? To see how to do this consider the first year with the new items. With the new items, revenue is predicted to be $1.13625 billion. Then, 25% of this is from sales of the new products; that is, .25*$1.13625 billion = $.2840625 billion is from the new products. The cost of goods sold for these is then .9 * $.2840625B = $.2499609375 B. The revenue from sales of traditional products is .75 * $1.13625 B = $.8521875B. The cost of these goods sold is then .85*$.8521875B = $.72435375B. Thus, in the first year with the new menu items, the revenue is $1.13625 and the cost of goods sold is $.2499609375 B + $.72435375B = $.9743203125B.

Using this approach calculate a prediction of the incremental gross profit from introducing the new menu items.

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Time (Years) 1 2 3 4 5 6 7 8 And Beyond 1% 2% 3% 5% 5% 5% 2% 0%

Explanation / Answer

Answer:

In$ Macdonalds's revenue last year 4,50,00,00,000 Revenue from traget cutomers 25% year Original sales prediction Cost of goods sold Fall of 2% every year 85% of sales 0 1125000000 956250000 1 1102500000 937125000 2 1080450000 918382500 3 1058841000 900014850 4 1037664180 882014553 5 1016910896 864374261.9 6 996572678.5 847086776.7 7 976641224.9 830145041.2 8 957108400.4 813542140.3

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