2 Food service management company Kopitiam Group is branching into the fast food business.

It is bringing the
franchise of American fast food chain Wendy's back to Singapore after more than 10 years.
Source: Channel NewsAsia, December 2009

(a) Explain how a firm like Wendy’s is likely to determine its output and pricing decisions. [10]

(b) Discuss if product differentiation is the best way for firms in an industry like the fast food industry to
compete. [15]

Suggested answer:

a) Explain how a firm like Wendy’s is likely to determine its output and pricing decisions.

Intro:

Wendy’s belong to the fast food industry which is dominated by a few large players in S’pore ( eg.
MacDonald’s, KFC and Burger King), therefore the market structure in question is Oligopoly. (or any
other characteristics that is applicable)

Identify some characteristics of Oligopoly:

 Number of firms in the industry
 Nature of products
 Conditions of entry ( Barriers to entry)
 Degree of knowledge
 Interdependence of Firms
 Price rigidity and non-price competition

Body:

Explain how an oligopolistic firm determines its Price and Output decisions.

Here we assume they are not collusive oligopolists hence we employ the kinked demand curve model

The model makes the following assumptions:

- Firms do not collude
- Rivals will follow any price decrease but not a price increase.

Assume the price is at OP.

If an oligopolist was to raise price above P, its competitors will not raise price. So, the firm that raises price
will suffer much fall in quantity demanded for its goods. The demand curve above price P (AB portion) is
therefore more price elastic.

If the oligopolist was to lower price below P, competitors will do likewise to avoid losing customers. So,
each firm will not gain much rise in quantity demanded. The demand curve below price P (BC portion) is
less price elastic.

In addition, a price fall may lead to a price war.

Since the firm loses out when it raises prices while it gains little or nothing when it lowers price, it will be
better to leave price unchanged.
 Profit maximisation (Fig. 2)

The MR curve will lie below the demand curve. The kinked in the demand curve at point B implies
discontinuity in the MR curve of the firm.

$
Fig. 2: The equilibrium
B position of the oligopolist
P
MC1

W MC2
f
e
AR
Y

MR
Qty
0
Q

The oligopolist is at equilibrium position when MC = MR. If the MC curve is MC 1, equilibrium is at point f.
Output is at Q and price is P. If the MC curve is at MC 2, equilibrium is at point e while output and price
remain the same.

MC could rise or fall anywhere within the vertical portion (WY, Fig. 2) of the MR curve and yet leave price
and output unaffected since MC=MR. This is another explanation of price stability in an oligopoly.

Conclusion:
The output decision of Wendy’s is dependent on the starting price of OP (which is the industry’s market
price) and its output decision is based on its ability to produce which ever quantity (OQ) that
corresponds to the price

Recognition that a Wendy’s is an oligopolistic firm and is able to define oligopoly. Brief
L1 description of how an oligopolist determines its price and output. If the candidate were 1–4m
identify Wendy’s as an Monopolistic Competitive firm will have max 4m
Recognition that a Wendy’s is an oligopolistic firm and is able to define oligopoly and
L2 supporting why Wendy’s should belong to the market structure. Able to explain how 5–6m
prices and output are determined.
Recognition that a Wendy’s is an oligopolistic firm and is able to define oligopoly and
supporting why Wendy’s should belong to the market structure. Able to explain how
L3 7 –10m
prices and output are determined with aid of diagram. Able to explain that Price is
determined by industry but output is determined by firm.

b) Discuss if product differentiation is the best way for firms in an industry like the fast food industry to
compete.

Intro:
For Wendy’s survival into S’pore’s market depends on strategies employed – price and non price
Product differentiation is a form of non price competition and should not be the only form of
competition that it should apply.

Body:
Explain how product differentiation works:
By employing product differentiation Wendy’s is able to make the demand for its product more price
inelastic and also less substitutable with other forms of fast food thus ensuring a steady demand for its
products.
With PED being more inelastic, Wendy’s is able to increase price without losing a larger proportion of
qty dd for its product hence increasing its TR -> increase in profit (assuming cost remains constant)
With its products less substitutable, when Wendy’s increases its price or its competitors lower their
price. The switch from its product to its rivals will be minimised hence securing its own market share.

However product differentiation may not be the best way to compete in the fast food industry. This is
due to the fact that every fast food chain has its own unique set of products hence it may be difficult to
break into the market.

Alternative forms of competition that Wendy’s can employ:

Price Competition: lowering of price to increase quantity demand in an attempt to capture market share

Penetration pricing can also be used by oligopolists with differentiated products. This involves the firm
accepting a loss initially while achieving sampling of the product and the development of brand loyalty.
This may be carried out by differentiating the appearance of the product and offering it as an economy
model. This can be seen in the sale of electronic products. A new comer will have to achieve a certain
level of sales in order to break even.

Discount pricing tactics may also be used. This may be in the form of price reduction or some other
concession such as free gifts. Cash discounts may be granted to buyers for paying their bills within a
specified period of time. Quantity discounts may be offered to encourage consumers to buy in larger
amounts or to order more goods within a certain promotional period. The discounts are based on the
size of the purchase. Seasonal discounts are usually offered to encourage buyers to place orders during
the slack period.

Non Price Competition:

Bundling of products (Value Meals), by bundling its products Wendy’s is able to make its products more
inelastic as there has to be many components to replicate by its competitors in order to compete
Advertisements (to increase dd and make dd for own products more inelastic) would increase demand
for its products but there is a down side to this as advertisements are costly and it would have an impact
on TC and AC of the company. If competitors also employ advertisements as a form of competition thus
cancelling out the effects and the cost would just add on the operation costs without any gains.
Extra services (delivery) such as home delivery services would make its services more unique thus less
replaceable therefore less elastic.
Longer operating hours (to cater to different market segments) such as 24hr branches to cater to the
different markets segments. Morning for working adults, late nights for teens or undergraduates.

Conclusion
 In order for Wendy’s to compete, it should not just employ product differentiation but a whole
repertoire of competition gimmicks both price and non price competition strategies. This is to ensure
that its initial survivability and in the long run its profitability.

For a one-sided answer only mentioning product differentiation

without suggesting alternatives. The question has not been properly
L1 1–5m
grasped, and there is inadequate development of analysis and
application. Little/no examples given.
Able to provide explanation of product differentiation and
L2 6–8m
explanation of at least 2 alternative strategies
Able to provide explanation of product differentiation and
L3 explanation of at least 2 alternative strategies ( 1 price and 1 non 9 –11 m
price) with necessary examples to support strategy.
Unexplained judgment on why provide differentiation may not be
E1 feasible and hence rationale for and limitation of other forms of 1 – 2m
strategies
Analysis that is based on economic judgment on why provide
E2 differentiation may not be feasible and hence rationale for and 3 – 4m
limitation of other forms of strategies