McDonalds Cost Structures - Assignment Example

McDonald’s Cost Structures McDonalds being the largest fast food chain in the world, has an integrated finance and accounting department so as to meet adequately all the financial requirements and excel in financial performance in the highly competitive restaurant industry. Overview of McDonald’s Cost Structures Fixed Costs The major fixed costs that McDonalds has to pay for even in times of no sales are advertising and utilities expenses. Also, payrolls of employees and salaries of management levels are fixed. The royalty charges that franchises have to pay are also fixed for a certain length of time till they are entirely paid back. The franchises have to pay their own occupancy costs which consist of rent, property taxes, insurance and maintenance costs. Certain corporate general and administrative expenses are fixed too which comprise of office support costs in areas of training, legal, supply chain, finance, information technology and human resources. Variable costs Variable costs which vary with the level of sales include a major chunk of food and labor costs. Sales staff and counter men whose salaries are based on the number of customers they serve are also variable costs for the company.Also, packaging costs, the paper material, employee benefits, selling and general expenses are variable charges. Certain corporate general costs are variable such as training and restaurant operations. Factors influencing the costs As for the fixed costs the factors that affect them are mostly the market changes. McDonalds needs to spend more on advertising and promotion when they see that market competition is getting fiercer and bitter. Moreover, in order to retain the higher level experienced staff, they need to raise the salaries of their staff and hence payrolls and compensation of management level employees increase. However, in times of recession like the major financial crisis, all fixed costs also dwindled down. The royalty charges or franchise fee is mainly fixed at a certain percentage after a 25% down payment initially unless the franchisor wants to alter the fixed rate for some reason. The variable costs are more directly responsive to changes in the level of sales. The main factor affecting the variable costs is the demand and the number of sales that McDonalds has. The more people want to eat McDonalds, the higher will be the food supplies costs, the packaging and paper costs, the more the number of counter employees to serve the customers, the higher the selling expenses andother general expenses. Cost Trends overtime The average cost is within fluctuating parameters as costs experience some volatility between the normal courses of the business. Certain food costs such as chicken prices and beef prices are constantly in movement as in 2008, in US, chicken prices were up by 4-5%. The costs trends overtime have been that variable costs have been on the rise from year to year which include commodity prices, labor costs and certain utility expenses. However, considering the global McDonald’s business, cost rises in one country maybe offset by decline in costs in other regions. McDonald’sattempts to keep costs at the range of $40,000 to $50,000 per restaurant, but the actual costs are pretty much dependent on the organizational structure and the local conditions of the market. Elasticity Sensitivity to changes in the costs of inputs (using price elasticity of demand for inputs) Cost of inputs have been on the rise especially recently due to the global recession. Commodity prices such as beef, chicken, fish, spices and vegetables have risen almost in all regions by a greater margin in few or less in others. McDonalds like all restuarants is impacted by these changes in input prices. Demand for inputs is extremely price inelastic as such commodities are the key supplies for McDonalds without which the business would surely go down. Hence, when input prices rise, McDonalds has to face a great increase in its variable input costs. Sensitivity to changes in the firm's output prices (using price elasticity of supply) The products of McDonalds comprising of a wide range of burgers, salads and other delicacies are price elastic for a certain proportion of customers while inelastic for others. The idea behind being price elastic is that if McDonalds raises the prices of its burgers, a large portion of income-constrained people will cut down on their purchase of McDonalds and may move to competitors. However, brand loyal customers or those who absolutely love McDonalds will still have it at a much higher price. Hence, the characteristics of customers are the major determinant of the price elasticity of McDonalds. Short run vs. long run dynamics for your company Characteristics of a short run (timeline, nature of fixed costs) The short run for McDonalds is within three years. It is within this time frame that they decide plans for short term growth or think of giving away more franchises in different regions. E.g. McDonalds has been focusing on growth plans for the period 2008-2010 (Jim Skinners, CEO) inan attempt to further gain competitive advantage over rivals. Fixed costs in short run do fluctuate but not too significantly. Fixed costs such as maintenance, insurance, property taxes, legal costs and rent are fixed by nature but may change if the contact requires them to or if there are sudden changes that need to be done. Explain whether it is possible for your company to operate at a loss in the short run McDonalds is one of the largest food chains and hence, if they need to sacrifice short term profits for long term gains, they will certainly go ahead. However, McDonalds due to its sheer reputation will not suffer global losses because losses in one state will be offset by profits in other.McDonalds ensures that its costs remain lower than its revenuesand hence it has not suffered losses even once in the past ten years. As demand for its offerings are price inelastic for certain loyal customers and elastic for others, McDonalds is not due to loose out much as demand for it has been and will be there. McDonald’s ability to adjust to changing market conditions McDonalds is a global business and it knows how to adapt itself to changing local or global market conditions. Its experience over the years has taught it the importance of quick responsiveness to changing market conditions. McDonalds incorporates an adaptation strategy because it recognizes that people have different tastes and cultures which are continuously in the process of undergoing change. The world has seen McDonald’s immediate response to dislikes of beef in India leading to menu changes to include vegetable deals or the inclusion of beer in the menus of Netherlands and Austria. Hence, there is no doubt on McDonald’s capability to respond to local or global market changes as it would not have been such a global success if it did not have the ability to adapt to the needs of the time. References Finance at McDonalds (2009), Retrieved on January 20, 2010 from http://www.mcdonalds.co.uk/static/pdf/aboutus/education/mcd_finance.pdf Annual Report of McDonalds (2007), Retrieved on January 20, 2010 from http://aboutmcdonalds.com/etc/medialib/aboutMcDonalds/investors.Par.94194.File.dat/Downloadable_AR_final_4_8_08.pdf McDonald's Q2 2007 Earnings Call Transcript (2007), Seeking Alpha, Retrieved on January 20, 2010 from http://seekingalpha.com/article/42150-mcdonald-s-q2-2007-earnings-call-transcript McDonalds sees 4th Quarter Foreign Currency Hit (2007), Flex News, Retrieved on January 20, 2010 from http://www.flex-news-food.com/pages/20326/McDonald/mcdonalds-4th-quarter-foreign-currency-hit.html Read More