Burger Wars 2002 Case Simulation This Case Simulation was prepared by Edwin Hartnell ([email protected]) working with the Georgia Institute of Technology (www.gatech.edu).
Abstract— In 2002 a price war broke out between McDonald’s, Burger King, and other USA fast-food hamburger restaurants. This Case Simulation offers a case study of those market dynamics and suggests questions for class discussion. A software simulated replica of the 2002 fast-food hamburger market is then presented. Students are asked to use the provided data analytics tools to an- alyze the simulation and answer pertinent questions of interest to the business leaders involved. A final challenge asks students to extend the market simulation to test an outstanding hypothesis. 1 ABOUT CASE SIMULATIONS
1.1 Overview
Case Simulations are a combination of Case Studies and Market Simulations.
퐶푎푠푒 푆푖푚푢푙푎푡푖표푛 = 퐶푎푠푒 푆푡푢푑푦 + 푀푎푟푘푒푡 푆푖푚푢푙푎푡푖표푛
Case Simulations extend business and economics case studies by reproducing key market dynamics in a software simulation. Students can actively explore this simulated environment to analyze the problems presented in the case. Data ana- lytic tools are provided alongside the simulation to answer specific questions. Student solutions can be tested in software before recommendations are made.
1.2 Market Simulation Details
The software simulation runs an Agent-Based Model (ABM) built upon Main- stream Economics. Consumer Agents make Rational Decisions based upon their Willingness To Pay (WTP) and Consumer Surplus for goods and services. Ven- dor Agents can follow the rules of Game Theory to maximize profitability.
The simulation runs within a Data Analytics platform called KNIME. This plat- form, along with the Market Simulation extension, must first be installed by stu- dents before the Market Simulation workflow can be explored and analyzed.
2 CASE STUDY
Everybody blamed McDonald’s for starting the price war [i][ix].
Value menus and steep promotions were not new to fast-food. But what McDon- ald’s did in 2002 traumatized an industry already suffering from economic re- cession.
2.1 Background
The fast-food industry had seen phenomenal growth since McDonald’s was founded in 1948. By 2001, McDonald’s had reached 30,000 restaurants globally [xii]. But in 2002 the industry was hurting.
Figure 1: In 2002, McDonald's controlled 43% of the fast-food market. Second-place Burger King controlled 18.5%, and third- place Wendy's controlled 13.2% [vii].
Starting in 2000, McDonald’s store revenues had been declining at a quarterly rate of 0.4%. For an average store, that meant 35 fewer transactions and $155 less
in sales per day [iii]. Its “Made For You” strategy, designed to catch Burger King’s higher quality and faster speed, was failing to improve sales [xi].
The wider economy was suffering from a recession caused by higher gasoline prices [ii]. But McDonald’s blamed the slump on the a la cart segment. That is, on those customers who bought individual items off the menu rather than complete meals [iii].
By the middle of 2001, others in the industry were making big adjustments. Burger King’s slim profit margins and declining market share caused its parent company to put it up for sale [vii].
Wendy’s was the exception. By targeting adults and offering higher-quality, more nutritious food cooked to order [vii], Wendy’s was growing at about 3% annually [x]. Wendy's customers spent about $4.75 per visit, while McDonald’s customers spent $4.25, and Burger King customers spent $3.50 [viii].
"People pay more because it's a better burger," said John Glass, a financial analyst at CIBC World Markets. "They don't discount, never have and never will. They maintain their margin." [vii]
Wendy’s had established its 99-cent menu in 1989, though they had always been careful to exclude their high-end sandwiches [xii]. McDonald’s had a history of offering 99-cent promotions on its Big Mac [viii]. And Burger King had occasion- ally offered temporary promotions for its high-end Whopper, though by 2000 they had also decided to cease all discounting of their high-end products [viii].
2.2 Price War
In September 2001, Burger King temporarily cut the price of its Double Cheese- burger from $1.89 to 99-cents, along with ten other items, to reinvigorate sales. But following Wendy’s lead, Burger King deliberately excluded its flagship Whopper sandwich from the promotion [xi].
McDonald’s felt they were running out of options. Their Teenie Beanie Babies promotion was a huge hit with kids [xii], but that would not address the prob- lematic a la cart segment.
And McDonald’s had been historically slow to expand its menu. No new burgers had been introduced between 1972 and 1985, with subsequent offerings being mostly failures [iii].
The Big N’ Tasty, introduced in 1996, was a rare success. When critics accused it of being an imitation Whopper, McDonald’s responded by saying “Adding let- tuce and tomato to a hamburger is not rocket science.” [xv].
In November 2002, McDonald’s decided to launch a national Dollar Menu and the price war began in earnest. The Dollar Menu covered 8 of its products, in- cluding three of its premium sandwiches: the Big N’ Tasty, the Double Cheese- burger, and the McChicken sandwich [iii].
The permanent price reduction of high-end sandwiches was something the in- dustry had not seen before. McDonald's said it intended to stick with its Dollar Menu for 18 months.[i]
In the weeks following the introduction of the Dollar Menu, the total number of transactions at McDonald’s increased. Sales of McDonald’s Big N’ Tasty sand- wich and the McChicken sandwich doubled [i].
McDonald's had hoped this momentum would result in a revenue surge. But the new menu also resulted in a 25% decline of Extra Value Meals sales [iii]. Total same-store revenues continued to slip [ii].
The bad news kept coming. In December 2002, McDonald’s warned investors that the company expected to report its first quarterly loss since going public 37 years earlier [iv].
Other fast-food chains were also hurting. Jack in the Box expected sales to drop by 2.7%. The Carl’s Jr. chain suffered a 5% sales drop [ix]. And Burger King slashed its selling price from $2.26 billion to $1.5 billion [iv].
"They've created a senseless price war," said Robert A. Doughty, a Burger King spokesman. "That has put a lot of competitive pressure on us and others, too." [i]
Larry Tripplett, who owned seven McDonald's stores, hoped the price-cutting would end soon. "There's no profit in selling a huge sandwich for a dollar," he said [ix].
i Kilman, S. (2002, November 8). Leading the News: Diageo Says Industry Price War Is Crimping Its Burger King Sale. Wall Street Journal, A.3. ii Business Brief—McDonald’s Corp.: Big N’ Tasty Will Be Pulled From Costly Promotion Plan. (2003, February 18). Wall Street Journal, A.18. iii Parry, M. (2004). McDonald’s: The Hamburger Price Wars. Darden Business Publish- ing, 13. iv Leung, S. (2002, December 18). Leading the News: McDonald’s to Serve Up First Loss— Reeling From Price Wars, Fast-Food Chain Warns Charges Could Increase. Wall Street Journal, A.3. v MacArthur, K. (2004, July 26). Rivals not lovin’ McD’s comeback. Advertising Age, 2. vi Vignali, C. (2001). McDonald’s: “think global, act local” - the marketing mix. British Food Journal; Bradford, 103(2), 97–111. http://dx.doi.org/10.1108/00070700110383154 vii Bertin, O. (2002, June 28). Wendy’s making minced meat out of McDonald’s. The Globe and Mail. https://go.openathens.net/redirec- tor/gatech.edu?url=https://search.proquest.com/docview/383967029?accountid=11107 viii Ballon, M. (2002, August 17). Wendy’s bucks the burger-price war: As McDonald’s dis- counts its Big Mac, the home of the square burger refuses to cut corners: [Final Edition]. The Gazette, C4. ix Peltz, J. (2002, December 22). Getting Deep-Fried in the Burger Wars; McDonald’s sales slow, profits fall as price cuts wreak havoc on a saturated market. Can management re- verse the slide?: [HOME EDITION]—ProQuest. Los Angeles Times. https://search.proquest.com/docview/421768273/E0F31E3C4580414BPQ/3?accountid=11 107 x Zuber, A. (2002). Discounting not a quick fix for fast feeders—ProQuest. Nation’s Res- taurant News, 36(47), 1,54+. xi Veiga, A. (2002a, December 25). Burger war leaves more casualties than victors. The Charleston Gazette; Charleston, W.V., 13A. xii Gereffi, G., & Christian, M. (n.d.). Food Production Systems, Trade, and Transnational Corporations: A Global Value Chains Approach to Consumption and Healthy Diets. 30. xiii Loose, C. (1998, June 8). ED-101 R13 Did Somebody Say Teenie Beanie Babies.pdf. The Washington Post, C01. xiv Gibson, R. (2001, November 27). McDonald’s in Southern California Hopes Cheap Food Will Revive Sales. Dow Jones Newswires. xv Bloomberg News. (1997, September 18). McDonald’s Has No Plan for New Burger. New York Times, D8.
3 DISCUSSION QUESTIONS
These questions can be prepared by students after reading the case and before an instructor-led class discussion.
1. What are the possible reasons sales were declining from the a la carte seg- ment? 2. Why were McDonald’s and Burger King suffering more than Wendy’s? 3. Should McDonald’s, Burger King, and Wendy’s change which customer segments they were targeting in 2002? 4. If Burger King were the first to introduce an extended 99-cent promotion of its Double Cheeseburger, was it fair to blame McDonald’s for starting the price war? 5. With falling sales, and pressure from franchisees and investors, what choices did McDonald’s have in November 2002? 6. What type of customers would be most attracted by a heavily promoted Big N’ Tasty sandwich? 7. A Burger King spokesman said that it was impossible for McDonald’s to sell their high-end sandwiches for $1 without losing money. Do you think this is true? 8. Why did sales of the Big N’ Tasty and McChicken sandwich double while Extra Value Meals (which included the discounted sandwiches and were also cheaper) decrease by so much? 9. How can the industry bring an end to the price war?
4 SIMULATION QUESTIONS
A Market Simulation has been prepared that mimics the dynamics of the Fast- Food Hamburger Industry in 2002. You may think of this as an Agent-Based Model (ABM) of a busy street corner with a McDonalds, Burger King, and Wendy’s. The sales of each corner store restaurant are representative of the broader franchises.
The Willingness To Pay (WTP) of all the customer “agents” in this simulation have already been measured and are provided. The product costs assume a roughly 80% gross margin on just the food and paper (labor costs have not been considered).
Using this Market Simulation, along with the data analytics tools provided, an- swer the following questions. Note that some of this data analysis may be demonstrated by your instructor.
Create a spreadsheet to collect your answers.
4.1 Exploring the Market
This section requires you to conduct basic statistical analysis of the products in the market.
For this section, you may conduct some of your analysis in the spreadsheet you created to collect your answers. But note this will not always be possible in future sections as you will need to modify and run the simulation to generate results.
1. Find the Product Array table in the Market Simulation. What is the total Quantity sold, Revenue, and Profitability of McDonald’s, Burger King, and Wendy’s? Fill in the following table by finding the totals for each franchise.
Hint: The simulation’s GroupBy node can be helpful.
Franchise Total Quantity Total Revenue Total Profit
McDonald’s
Burger King
Wendy’s
2. Calculate the market share (by Quantity) for each of the franchises. Do they align with the relative market shares listed in the case?
Hint: Remember that this market simulation only includes three fran- chises so the market shares found in the case will have to be adjusted to exclude “Others”. This calculation can be done in the Market Simulator, but it is much easier to do it in Excel.
3. Find the WTP Matrix table in the Market Simulation. How many custom- ers have been included in the sample set? How many products are in- cluded in the simulation?
How many Customers in the WTP Matrix?
How many Products in the WTP Matrix?
4. Look more closely at the WTP Matrix and note the zero (0) values some of the customers have for some of the products. This indicates that the customer is not even aware of the product and the product is not within the customer’s “consideration set”.
For the first five customers, count the number of products each is consid- ering vs. the number of products outside of their consideration set.
Hint: Do not try and do this question in the Market Simulator unless you are an advanced user. It is much easier to just count out the answers by hand.
Customer # Products Considering # Not Considering
C00001
C00002
C00003
C00004
C00005
5. Using the first row of the WTP Matrix, rank the top eight sandwich pref- erences for the first Customer (C00001) by their Willingness To Pay.
Preference Sandwich
First
Second
Third
Fourth
Fifth
Sixth
Seventh
Eighth
6. Using the WTP Matrix, find the minimum, maximum, and average Will- ingness To Pay customers have for the sandwich listed in the table below.
Hint: The Statistics node can be helpful.
Sandwich Min WTP Max WTP Average WTP
Big Mac
Whopper
Big Classic
7. Using the WTP Matrix, find the sandwich that customers (on average) believe is the closest substitute to each of the sandwiches below.
Hint: The Linear Correlation node can be helpful.
Sandwich Closest Sandwich Substitute
Big N’ Tasty
Whopper
Big Classic
8. Using the WTP Matrix, generate a histogram for the Big N’ Tasty sand- wich showing the range of the customers’ Willingness To Pay. How would you describe this customer distribution?
Hint: The Row Filter node can remove the Customers who are not con- sidering the sandwich (and have a 0.0 WTP). The Histogram Chart (JFreeChart) node can generate the histogram.
9. Connect the Product Array and the WTP Matrix to a “Simulate Market” node and run it using the green arrowed button. Find the “Output Prod- uct Array”. How many customers in the simulation bought sandwiches? How many customers did not buy a sandwich? If these are the only cus- tomers in the simulation, how much can sales in the market grow (as a percentage)?
10. From the Simulate Market node added above, find the Output Ranked Products List. Rank the sandwich preferences for the first Customer (C00001) by their Consumer Surplus. Highlight the product they pur- chased.
Preference Sandwich
First
Second
Third
Fourth
Fifth
Sixth
Seventh
Eighth
4.2 Analyzing Price Discounts
In this section, students are required to change the price of a single product and analyze how customers in the market react to change.
Continue collecting answers in your spreadsheet, but most of this analysis must be conducted in the market simulation.
1. Lower the price of just the Big N’ Tasty by 10-cents to $2.19. What is the change in the Quantity of customers who buy this sandwich? Is the Big N’ Tasty more profitable than before the discount?
Hint: Copy the “Product Array” Table Creator node to another part of the simulation workflow. Manually change the price of the Big N’ Tasty to $2.19. Connect both this new Product Array and the unchanged WTP Ma- trix to a Simulate Market node and run it.
2. Raise the price of just the Big N’ Tasty by 10-cents to $2.39. What is the change in the Quantity of customers who buy this sandwich? Is the Big N’ Tasty more profitable than before the price increase?
Hint: Keep this calculation separate from your calculation in question 1 as you will need to repeat it.
3. Using your results from above, what is the Price Elasticity of Demand for the Big N’ Tasty? Do this in your spreadsheet using the formula:
∆푄푢푎푛푡푖푡푦 ∆푃푟푖푐푒 푃푟푖푐푒 퐸푙푎푠푡푖푐푖푡푦 표푓 퐷푒푚푎푛푑 = / 푄푢푎푛푡푖푡푦 푃푟푖푐푒
4. Would you describe the demand for the Big N’ Tasty as being elastic or inelastic? Based upon just this calculation, could you make a recommen- dation to either increase or decrease the price?
5. Repeat the calculations in questions 1 and 2 by substituting Quantity with Revenue. What is the Price Elasticity of the Big N’ Tasty with respect to Revenue?
6. Repeat the calculations in questions 1 and 2 by substituting Quantity with Profit. What is the Price Elasticity of the Big N’ Tasty with respect to Profit? Based upon this calculation alone, would you recommend raising or lowering the price of the Big N’ Tasty?
7. Analyze those customers who switched to the Big N’ Tasty when it was discounted. Create a table and chart in your Excel answers spreadsheet showing the source of these new customers? What did most customers buy before the discount?
Hint: Use the “Purchased” column from the original Simulate Market node Output WTP Matrix to compare what customers purchased before and after the price change.
8. Repeat the calculations in questions 1 and 2 by substituting Quantity with total Store Profit. Calculating Store Profit takes an extra step (Hint: the GroupBy node can help). What is the Price Elasticity of the Big N’ Tasty with respect to Store Profit? Based upon this calculation alone, would you recommend raising or lowering the price of the Big N’ Tasty?
4.3 Competitive Reaction
In this section, students are required to consider competitive reaction and change the price of many products to analyze how customers react to change.
The McDonald’s Dollar Menu set the following prices:
Sandwich Price
Big Mac $2.39 (no change)
Big N’ Tasty $1.00
McDouble Cheeseburger $1.00
McChicken $1.00
Given the market dynamics as described in the Case Study, management at McDonald’s would have already had a pretty good idea of how Burger King and Wendy’s would react to their new Dollar Menu.
1. Set new prices for all three competitors based upon the McDonald’s Dol- lar Menu and those discounts management may have expected by Burger King and Wendy’s. Justify your price decisions and describe what hap- pened.
2. McDonald’s may have been wondering if it was a good idea to include the Big N’ Tasty in the Dollar Menu. Re-run your results from this sec- tion’s question 1 by excluding the Big N’ Tasty and adjusting your ex- pected competitor reaction.
3. Did this Price War have a winner? Who performed best out of all three competitors? Why do you think so?
4.4 Extra Value Meal (advanced)
After the Dollar Menu was introduced, sales of McDonald’s Big N’ Tasty sand- wich doubled while Extra Value Meals (which included the discounted Big N’ Tasty) declined by 25%.
One hypothesis is that more customers started buying two Big N’ Tasty sand- wiches instead of one Extra Value Meal.
1. Describe, in words, how you might simulate this phenomenon.
2. Create a simulation of just the Big N’ Tasty related products. Exclude the other two competitors and all other sandwiches, and assume customers can only choose between:
1. One Big N’ Tasty 2. Two Big N’ Tastys 3. Big N’ Tasty Extra Value Meal
Start with the Willingness To Pay (WTP) column for the single Big N’ Tasty and create two new columns in the WTP Matrix for the other two sandwich choices. Hint: filtering out the other WTP columns will keep your model clean.
You may assume that customers who want to buy two Big N’ Tastys will ran- domly find the second sandwich to be between 0% and 50% as satisfying as the first.
You may also assume that the Extra Value Meal randomly adds between $0 and $3 in value to each customer’s WTP for $2 extra price and $0.50 extra cost.
Compare the number of customers who buy each sandwich before and after the introduction of the Dollar Menu. Test the hypothesis that more customers prefer buying two Big N’ Tastys instead of the Extra Value Meal when prices were dis- counted. Describe what you find.
Hint: The Math Formula node with the rand() function is helpful.