Question

(Related to Solved Problem 13.3 on page 461 ) In recent years, McDonald's has faced increased competition from other fast-food restaurants. In an attempt to differentiate itself from fast-food competitors, McDonald's has responded by remodeling some restaurants to include kiosks that customers can use to pay for their orders and to request table service. Remodeling a restaurant can cost as much as \(\$ 60,000 .\) McDonald's expects that customers will spend more on food when they order with kiosks. Suppose McDonald's begins to earn an economic profit in the restaurants offering table service and kiosks. a. How are other fast-food restaurants likely to respond? b. Is this new strategy likely to enable McDonald's to earn an economic profit in the long run? Briefly explain.

Short answer

a. Other fast-food restaurants are likely to respond by also remodeling their restaurants and introducing similar services to stay competitive. b. In the long run, it's not likely that this new strategy will enable McDonald's to earn an economic profit. This is because competitors will likely adopt similar strategies, negating McDonald's advantage and making the market return to its competitive nature, where firms only make normal profit.

Step-by-step solution

Evaluate the likely responses of competitors

Considering the fast-food market is highly competitive, when one company introduces a successful innovative service, competitors are likely to respond by adopting similar technologies or services. They may thus also remodel their own restaurants, introducing kiosks and table service. They do this to retain their customers and not lose them to the competitor who has advanced their service.

Assess the long-term profitability of the strategy

While the introduction of kiosks and table service may initially give McDonald's an advantage and help them earn economic profit, this might not remain the case in the long run. As competitors adopt similar modifications due to competitive pressures and to protect their market share, McDonald's may lose its edge. This is in line with the economic principle that in a perfect competition market structure, firms can't earn economic profit in the long run. They only make normal profit because any initial economic profit is eroded by the entry of new firms or expansion of existing firms in the market, which drives down prices.

Key concepts

Competition in the Fast-Food Industry

The fast-food industry is a classic example of a competitive market where many sellers offer similar products. McDonald's, being one of the market giants, strives to maintain its market share through innovative strategies such as introducing ordering kiosks and table service. These features are designed to enhance the customer experience and, consequently, to potentially increase spending per visit.

When McDonald's implements such innovations, the immediate effect can be seen in the form of increased customer satisfaction and higher economic profit. However, this change instigates a ripple effect among competitors. Chains like Burger King, Wendy's, and Subway, noticing the success of these enhancements, might implement similar technologies, leading to a homogenization of the customer experience across the industry. This indicates a dynamic and responsive competitive environment, where firms continuously monitor competitors' strategies and react accordingly.

To sustain its competitive advantage, McDonald's might need to regularly innovate beyond service delivery modifications. This could involve menu diversification, loyalty programs, and sustainability practices which are harder for competitors to replicate quickly. As the industry thrives on service speed and cost efficiency, innovations that manage to strike a balance between these factors while enhancing the overall customer experience tend to set the new standard that others in the market aim to follow.

Innovation in Service Delivery

Innovation in service delivery, particularly in highly competitive sectors like fast-food, can be a significant differentiator. McDonald's introduction of kiosks and the request for table service is an excellent example of leveraging technology to improve the consumer experience. In doing so, McDonald's has aimed to reduce wait times, increase order accuracy, and ultimately encourage customers to browse the menu longer, which can lead to more substantial orders and repeat business.

In hindsight, this type of innovation requires substantial capital investment. The cost of remodeling a restaurant to integrate kiosks, as mentioned, can be up to $60,000. For substantial chains, this is a significant but manageable expense, given their larger economies of scale. However, it could be a barrier for smaller competitors to match instantly. This creates a window of opportunity for McDonald's to capitalize on their innovation and potentially enjoy a period of increased economic profit before the market reacts.

The ripple effect of this innovation is not limited to direct competitors alone. It also sets new consumer expectations for technology integration within the service experience, challenging the entire industry to keep pace. A successful innovation in a single entity can spark a new trend within the industry, leading to an evolution of service delivery standards across the board.

Market Structure and Profitability

Understanding the correlation between market structure and profitability is essential when discussing innovations in the fast-food industry. The fast-food market can be described as monopolistically competitive, where many firms sell differentiated but similar products. In this market, firms like McDonald's are price makers to a certain extent due to brand loyalty and product differentiation; yet, they still face fierce competition.

In the economic model of perfect competition, it is suggested that firms can only earn a normal profit in the long run, as any economic profit will attract new entrants or prompt existing competitors to adapt, thus driving profits down. McDonald's earning an economic profit from their new service delivery innovation signifies a departure from normal profit levels. However, the exercise of economic profit is expected to be temporary. As competitors emulate the kiosk and table service model, the innovation's novelty wanes, and market prices adjust. The ensuing increased competition among the existing firms leads to a situation where economic profits are competed away, bringing profits back to normal levels.

In the end, to sustain profitability, firms must continually innovate while managing costs. Success lies in achieving not only short-term economic profit but also establishing brand loyalty and a differentiated position that can withstand the competitive pressures over the long run. Continued innovation, alongside wise investment decisions, are key factors that enable firms to maintain a lead in a monopolistically competitive market such as the fast-food industry.