ECON 230: MILESTONE 2

Maria Plumb, Macroeconomics

ECON 230

Dr. Jeff Bajah

November 20, 2021

Although McDonald’s is one of the growing and successful fast-food chains globally, it is still susceptible to economic factors that can significantly impact its business operation. In addition, other transmission mechanisms such as the labor adjustment costs, network effects, and time bunching can affect McDonald’s profitability in both the United States and its key market, not to mention, its exclusive franchisees globally.

Inflation and Unemployment

Inflation and unemployment fluctuate based on different circumstance such as economic, political, environmental, and global pandemic factors. These factors can have hurt to McDonald’s profitability in U.S. and its key market, China.

What is inflation? “Inflation is an increase in the average level of prices” (Cowen & Tabarok, 2018, p. 649), which means that prices of products and services increase as consumer demands for goods and services increases due to “demands outpacing supplies” (Matthews, 2021, para. 2); rising in money supply, due to political factors can also cause inflation. In 2020, when coronavirus hit, it shut down most of the economy in the world, including the United States. The lockdowns caused people to lose their jobs, which contributed to an increase in unemployment. As the coronavirus slows down in 2021 and businesses became operational, demands for goods and services increase, as well as demands for labor and higher wages (Matthews, 2021). Inflation and unemployment have impacted McDonald’s profitability in its home base, as well as one of its largest consumers, China. According to Current US Inflation Rates: 2000-2021, the inflation rate in United States in 2021 went up to 6.2 percent, which is 4.8 percent than in the year 2020.

Per Statista Research Department (2021), inflation rate is higher than it was in the year 2020.

Per Statista Research Department (2021), unemployment rate in the last quarter of 2020 was 2.3 percent higher than the last quarter of 2021.

Monthly unemployment rate in the United States from October 2020 to October 2021

According to Textor, C. (Statista, 2021), based on the graph below, inflation in China was not as bad as in the United States in the year 2021, showing an inflation rate of 1.07 percent, which is down 1.37 percent from last year.

Inflation rate in China from 2010 to 2020 with forecasts until 2026

Unemployment rate in urban China from 2010 to 2020 with forecasts until 2026

The fluctuations in inflation and unemployment can easily affect McDonald’s profitability. According to McDonald’s Corporation – United States Securities and Exchange Commission (p.12), high inflation and unemployment rate can harm the company’s profitability as it causes “supply chain disruption” and affecting the supply and demand of McDonald’s products, which they outsource from all over the world. “Supply chain interruptions, including due to lack of supply or price increases” can negatively affect the company not just in the United States but its key market, China. The disruption in the business operation in China resulting from high inflation and unemployment can increase the cost of production, which would impact the prices on the menu and may also reduce revenue. In 2010, inflation in China resulted in price hike of most of the McDonald’s items such as the “hamburgers, chicken nuggets, French fries, as well as their combo meals ranging from 0.5 yuan to 2.5 yuan” (Lubin, 2011, para. 1-2). The increase in prices of the menu items is due to the cost of raw materials in manufacturing supply, as well, as “accelerating food inflation” (Kwok, para. 1). Amidst the coronavirus in 2020, McDonald’s shuts down several hundreds of restaurants in China and had a huge impact on McDonald’s China revenue.

In the United States high inflation and unemployment resulting from the coronavirus in 2020 resulted into the decline in revenue as “comparable sales, earnings, and store visits are all down year-over-year” (Krause Fund Research, 2020, p. 6). As the unemployment rate increased to 14.7 percent in February of 2020, which is 11.2 percent higher before the coronavirus impacted the U.S., sales declined as consumers refrained from eating out due to pandemic and loss of income (Krause Fund Research, 2020, p. 2). The pandemic negatively impacted McDonald’s revenue as business operational halted for months in 2020 and the beginning of 2021. This disruption resulted in a decline in McDonald’s “annual revenue of 19.034 billion dollars by the end of 2020 and is reduced by 9.79 percent and 16.07 percent in 2020. Out of which the net profit of the brand was 4.926 billion dollars, a decrease by 16.07 percent” (Shaw, 2020, p. 2). Economic factors such as high inflation and unemployment can affect McDonald’s its financial investment with its franchisees, specifically, China.

Aggregate Demand and Supply

As inflation and unemployment rises, it will affect McDonald’s productivity due to supply and demand. With labor shortages, production will slow down as business struggle to keep up with the demands for consumer goods and services. With high inflation, cost of labor increases and so are the price of manufacturing the products. In McDonald’s case, anything in the market associated with operating McDonald’s restaurants in the U.S. and China will impact McDonald’s operational, as demands for meat products to make hamburgers, chicken nuggets and fish-filet, as well as other items on McDonald’s menu, outpace supplies, and commodities, can influence production and profitability (LaMarco, 2018, pp. 6-7). With unemployment on the rise, there will also be labor shortages, affecting the productivity of goods and services. Demands for labor, raw materials, wages, and delivery (transportation) will also increase. An increase in demand is good, only if there is supply shortages or vice versa. A decline or rise in McDonald’s revenue could create a “real shock in the aggregate supply and demand” (Cowen & Tabarrok, 2018, p.). However, in 2007, McDonald’s China has been able to keep up with the aggregate supply and demand as “nearly 96 percent of the products sold in McDonald’s 770 restaurants in China are produced at 43 facilities there. Its supply chain is far larger than what those restaurants demand” (Groom, 2007, para. 7). McDonald’s globalization contributed to the “increasing demand of its supply” (UKEssays, 2018, para. 1) as the population continues to grow not just in U.S. and China, but other countries, as well; demands for this fast-food chain and its supply increases.

Network Effect

As new technology innovation arises and McDonald’s globalization spread through more than 120 countries, McDonalds invested almost $2 billion dollars to keep up with the technology beginning with modernizing its design, digitizing their menu, creating a “self-order kiosks”, and introducing this innovation to its more than 4,500 restaurants in 2017 (Symington, 2019, para. 1). By 2020, McDonald’s has led the way in defining a modern way to place an order through online application with the use of mobile apps to order and pay for food to either be pick-up or delivered at home, avoiding the crowd and wait time (Jones, 2020). These technologies incepted as the coronavirus pandemic put lockdown restrictions, preventing access to many McDonalds restaurant in its home-based, as well as its key market, China, and put a strain on McDonald’s profitability, as well, as their investment worldwide (McDonald’s Corporation, 2020).

According to CNN Business, the mobilization of digital ordering counteracts the effect of the restrictions. Although, “overall, McDonald's revenue fell about 2% in the quarter to $5.3 billion, missing Wall Street's expectations” (Wiener-Bronner, 2021, para. 4). The billions of dollars McDonalds invested to digitizing menus and ordering online paid off during coronavirus and made it possible for McDonald’s consumer to get food throughout the lockdown of McDonald’s restaurants in U.S. The innovation of creating online ordering, home delivery, and curbside pick-up kept McDonald’s restaurants business running (McDonald’s Corporation, 2020). On the other hand, even with the innovation, China shut down several hundreds of McDonald’s franchisees as a precaution for fear of the coronavirus, when it hit main China in the beginning of the year 2020 (Davies, 2020). During the early state of the pandemic, McDonald’s CEO and president, Chris Kempczinski, states that “roughly 9% of the company's restaurants are in China, but the country represents only about 4% to 5% of sales system wide” (Jones, 2020, para. 5). The CEO continued in indicating that even though the situation in China is on a critical stage, “it's actual impact on our business is going to be fairly small assuming (the virus) stays contained to China’’ (para. 5).

Labor Adjustment Costs

Labor shortages, inflation, and unemployment and other economic factors, as mentioned earlier can impact McDonald’s profitability and change labor cost. According to Statista, in 2020, McDonald’s spent $11.88 billion for its restaurants in United States to be fully operational paying for the cost and labor, which “includes employee’s wages and benefits, food and paper” products and with the most considerable expense comes from franchise-related costs, which amounted to $2.21 billion in the same year (Lock, 2020, para. 1). As of 2021, McDonald’s prices increased to almost 6 percent to make up for the higher cost of “labor and commodity” (Lucas, 2021, para. 2) as explained by CNBC to see customer’s willingness to pay for the increases in prices. The graph taken from Statista illustrates the decline in cost of labor in 2020 possibly due to the restrictions resulting from the pandemic, which also contributed to decrease in revenue.

McDonald's Corporation operating costs and expenses from 2009 to 2020, by type (in million U.S. dollars)

In 2018, inflation in China increased to 13.5 percent, which in turn contributed to the price increase of goods and services such as “food and fuel”. Inflation changes McDonald’s profitability in China, increasing the price of its menu item as previously explained to keep up with the high cost of labor to meet production and manufacturing of products. With China using price control to offset increase in consumer price, it passed on the extra expenses of labor cost to businesses, creating problems to workers and resulting in shortages of raw materials and supplies (LaMarco, 2018, p. 9).

Time Bunching

According to “The Biggest”, the busiest day for McDonalds are weekends, which starts on Friday with over “10 billion visits, followed by Saturday with 9.8 billion trips with the most active time are within the hours of early morning to mid-afternoon. This time frame could only mean that McDonald’s are more profitable on weekends (What is McDonald’s Busiest Day, 2021). As reported by McDonald’s, dinner time is where they get most of the sales (Waltrous, 2021, para. 2).

Even with the rise in inflation, unemployment and pandemic, McDonald’s remain operational and continued to lead the way as one of the most successful and innovational fast-food restaurant chains in the United States and its key market, China.

Reference

Cowen, T. & Tabarrok, A. (2018). Modern Principles of Economics. New York, NY. Worth Publishers

Current US Inflation Rates: 2000-2021. US Inflation Calculator. Retrieved from https://www.usinflationcalculator.com/inflation/current-inflation-rates/

Davies, R. (2020, January 29). McDonald's shuts 300 restaurants in China as coronavirus spreads. The Guardian. Retrieved from https://www.theguardian.com/world/2020/jan/29/mcdonalds-shuts-300-restaurants-in-china-as-coronavirus-spreads

Groom, N. (2007, January 7). McDonald's looks to China to supply restaurants. Retrieved from https://www.reuters.com/article/businesspro-leisure-mcdonalds-china-dc/mcdonalds-looks-to-china-to-supply-restaurants-idUSN1047786220061110

Kwok, D. (2010, November 10). McDonald's price rise points to inflation pressure. Retrieved from https://www.reuters.com/article/us-mcdonald-china/mcdonalds-price-rise-points-to-inflation-pressure-idUSTRE6AG10P20101117

Krause Fund Research (2020, November 16). Fall 2020 McDonald’s Corporation (NYSE: MCD). Consumer Discretionary. Retrieved from https://tippie.uiowa.edu/sites/tippie.uiowa.edu/files/documents/krause/f20_mcd.pdf

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Statista Research Department. (2021, November 11). Monthly unemployment rate in the United States from October 2020 to October 2021. Statista. Retrieved from https://www.statista.com/statistics/273909/seasonally-adjusted-monthly-unemployment-rate-in-the-us/

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Lucas, M. (2021 October 27). McDonald’s higher U.S. menu prices fuel earnings beat; chain raises sales forecast. CNBC. Retrieved from https://www.cnbc.com/2021/10/27/mcdonalds-mcd-q3-2021-earnings.html

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