Microeconomics Paper on Chipotle

Introduction

 The purpose of this paper is to conduct an analysis of the Chipotle Mexican Grill in relation to its production, demand, and supply of its product. The paper explores the supply and demand conditions of Chipotle’s products through evaluation of trends in demand over time and analyzing the information regarding supply and demand for Chipotle products. It also examines the price elasticity of demand for Chipotle’s products, analysis of various costs of production the Chipotle is facing including how the costs influence the company’s profitability and explore the overall fast-food industry, examining the characteristics of the market. The objective of this paper is to use the results of the market and the firm’s analysis to develop recommendations to the firm on how it can improve its productivity and manage marketing risks to sustain success.

Chipotle Mexican Grill

Chipotle Mexican Grill, Inc. (NYSE: CMG) is American fast-casual restaurants chain. The company operates in the United States, Canada, France, Germany, and the United Kingdom. Chipotle main products are tacos and mission-style burritos (Ernst & Young LLP, 2017). The name chipotle originates from a Nahuatl term which means smoked and dried jalapeno chili pepper .  The firm’s ticker under the New York Stock Exchange is CMG. Chipotle Mexican Grill was founded on July 13, 1993, by Steve Ells in Denver, Colorado. In 1998 when McDonald’s Corporation became a major investor, Chipotle already had 16 restaurants in Colorado (Grill, 2007).

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  The founder of Chipotle Mexican Grill, Steve Ells, began as a cook at Stars in San Francisco where he had observed how San Francisco burritos and taquerias were popular in the Mission District. Ells utilized the knowledge he acquired in San Francisco to open the first Chipotle Mexican in Denver, Colorado next to University of Denver campus. Ells’ main source of capital was the $85,000 loan which he received from his father. After a month of operation, Chipotle was supplying 1,000 burritos per day. Ells and his father used the revenue earned from the first store to establish another store in 1995, while the third one was funded by an SBA loan. The restaurant opened its first store outside Colorado in 1998 when it established a restaurant in Kansas City, Missouri. The firm has established itself as one of the best chains of fast –casual restaurants in the word.

 Chipotle Mexican Grill, Inc. operates Chipotle Mexican Grill restaurants whose menu mainly consists of burritos, salads, burrito bowls, and tacos prepared from fresh ingredients (Ernst & Young LLP, 2017).  As of December 31, 2017, the company had 2,363 operating restaurants in the United States and 37 international restaurants.  The firm’s main focus is to offer a safe and delicious food prepared with better ingredients. It offers a focused menu, wholesome food, quality assurance, and food safety, and has a close relationship with suppliers. Although the restaurant majorly focuses on tacos, burrito bowls, burrito, and salads, there are numerous other varieties customers can choose from including four types of meats, two different beans, tofu and others like queso, lettuce, salsas, guacamole, and shredded cheese (Ernst & Young LLP, 2017). These varieties of items offer Chipotle’s customers with a variety of choices to choose from.

Supply and Demand Conditions for Chipotle’s Products

The following table represents sales revenue data for the last eight quarters for the years ended 31st December 2017.

 

The data retrieved from https://www.sec.gov/Archives/edgar/data/1058090/000105809018000018/cmg-20171231x10k.htm?mod=article_inline

The graph below elaborates the trend in the Chipotle sales revenue for each quarter in 2016 and 2017.

The total sales revenue for Chipotle is lower during the first and the last quarters for both years. The changes in sales revenue are a result of fluctuations in the demand and supply of Chipotle’s products. One of the major factors influencing Chipotle’s demand and supply is seasonality factors. The lower values of sales revenue in the first and last quarter of every year is attributed to low demands during holiday seasons. Also, the first and last quarters are parts of the winter season. It is revealed that the number of people who eat out during winter seasons (periods of inclement weather lower as compared to the number eating out during mild or warm weather.

 Additionally, Chipotle’s restaurants which are located next to universities and colleges have more supply and demand during academic years, while the demand reduces once the institutions are closed for the holidays. Apart from seasonality, the supply of Chipotle’s products is largely influenced by the number of stores opened in each quarter. The number of operating stores available increases the firm’s efficiency in delivering services hence increases supply.  Thus, the number of restaurants opened in a quarter, net of relocations/closures has also led to changes in the company’s supply.

Historically, Chipotle’s average daily restaurant sales as wells as net income are lower. The historical declination of the supply and demand of Chipotle’s products is attributed to many factors.  The perception of health hazards associated with fats foods and the Chipotle brand, in general, have adversely impacted the demand of Chipotle’s products. The company has been adversely affected by the actual or rumored food incidents as well as negative publicity. For instance, an article which reads “… We may continue to be negatively impacted by food safety incidents associated with our restaurants…“, have a great influence on customers’ perception about the products. Such publicities and campaigns about the safety of fast-foods and its health risks have made most people believe that fast-foods are bad for health. Therefore, the perception has decreased the overall demand for Chipotle’s products.

Another reason why Chipotle is experiencing a historical low demand and supply is the number of increasing competitors in the fast-casual industry. The number of fast-casual restaurants has increased in recent years with other company’s having strategies which overlap those of Chipotle. Consequently, the Chipotle market share has declined to result in the historic decline in the demand and supply. Some years ago, one could be assured that any vacant lot in a strip mall would be occupied by Chipotle, Moe’s, Qdoba, or any other well established fast-casual Mexican Grill. However, in recent times, made-to-order pizza joints have been involved in handling fast-casual baton. Some of the fastest-growing fast-casual chains include Blaze, Pieology, MOD, among many others. Chipotle-handled Burrito chains are no longer hot in the market. The increasing number of competitors has therefore contributed greatly to the historical fall of demands. Chipotle visitors have scattered to a variety of quick-service outlets.

Price Elasticity of Demand

Chipotle Mexican Grill completed the last phase of menu price increases in January 2018. For three month ended June 30, Chipotle’s revenues increased by 8.3%, while the restaurant sales increased by 3.3 %.  For the six months ended June 30, 2018, Chipotle had an increase of 7.9% in revenue as well as an increase in the comparable restaurant sales by 2.8% from 2016. The increase in sales revenue was mainly attributed to an increase in comparable sales as well as the opening of more stores. However, the company has experienced slow growth in sales since the addition of prices in 2017. Ever since it increased the prices of its product, Chipotle has had difficulties in increasing its sales.

 Competition in the fast-casual industry really increased in the past few years. Chipotle Mexican Grill no longer enjoys the large market share it used to have. Various competitors, as well as substitutes, have taken over the market. Companies such as McDonald’s, Blaze, Qdoba, Moe’s, MOD, Pie Five, and Pieology are fastest growing companies which are expanding their market shares in the fast-casual industry. Made-to-order pizza joints have recently ventured in the handling of fast-casual baton whereby pies are assembled on an assembly line then heated up for some minutes in quick-bake ovens. There have been numerous hot trends eating away the popularity of Chipotles’ products including the “better burger”. The availability of substitutes, as well as stiff market competition, greatly influenced the price elasticity of Chipotle’s products. Customers nowadays have got plenty of other fast-casual options to choose from besides the Chipotle’s products.

The price elasticity in the fast-casual industry is largely influenced by several factors. First, fast-casuals are considered luxuries; they are not perceived as basic foods. These are products consumers can do without when they become pocket unfriendly. Increasing the prices of these products will be too sensitive on their demand. Since they are not basic needs, there is a high possibility that an increase in the prices will reduce consumers demand for the product. Also, due to the availability of numerous substitutes for Chipotle’s fast-casual products, a slight increase in the prices will make customers consider affordable substitutes. In a perfect market, pricing strategy is very essential. Most companies in a perfect market lower their prices as a tool for luring customers. Consumers will always prefer more to less at a given price. Therefore, stiff competition in the fast-casual industry also contributes to the price elasticity of demand in the industry.

Price elasticity of demand in the fast-casual industry has really impacted Chipotle’s pricing decisions and revenue growth.  With high price elasticity of demand, Chipotle has had difficulties in maintaining a healthy margin. Labor costs, material costs, and other expenses have risen in the past few years due to rising inflation rates. Consequently, Chipotle has attempted to increase the price of its products in order to cover for the increasing costs/ reducing the margin. However, the high price elasticity in the fast food industry has made it difficult to successfully implement such decisions. As a result, the revenue growth rate has significantly decreased over the years.

Cost of Production

Chipotles incur various costs during production including food, beverage, and packaging costs, labor costs, occupancy costs, and other operating costs. Also, the company incurs general and administrative expenses, depreciation and amortization expenses, loss on disposal and impairment of assets, and income tax provision. Labor costs as a percentage of revenue were 26.9% for the year ended December 31, 2017, which was a decrease as compared to 28.3% in 2016. The decrease was attributed to an increase in menu prices, sales leverage, improved manager deployment, and lower promotional activities. The labor costs as a percentage of revenues are expected to rise in 2018 due to rising labor inflations. The current costs reduce revenues by 26.9%. Since labor cost is a variable cost, an increase in stores sales is associated with an increase in labor costs.

  Occupancy costs are fixed costs which do not change over a given period of production. Occupancy costs as a percentage of revenues reduced from 7.5% in 2016 to 7.3% in 2017 as a result of sales leverage on a largely fixed-cost base. Other operating costs such as restaurant utilities and maintenance costs, marketing, and promotion costs, and other costs such as a percentage of revenue was 14.65% in 2017 as compared to 16.45% in 2016. The decrease was attributed to a reduction in expenditures on marketing and promotional activities, reduction in kitchen supply expenses, and an increase in the menu supply. Other expenses such as general and administrative expenses, depreciation and amortization, loss on disposal and impairment of assets, and income tax provision as a percentage of revenues also decreased. The general decrease in the operating costs as a percentage of revenues resulted in an increased in the company’s profit margins in 2017 as compared to2016. The menu prices increase in implemented in 2017 contributed to the general reduction o9f costs as a percentage of revenues leading to an overall revenue growth in 2017.

Market Share

Chipotle’s major competitors include Darden Restaurant, Inc., Starbucks Corp, Wendy’s Co, Yum Brands, Inc., McDonalds Corp, and Docasa, Inc.  As at 2018, Chipotle Mexican Grill Inc. had a market share of 2.4%, Darden Restaurant, Inc. has 3.33% market share, Starbucks Corp has 9.19% market share, Wendy’s Co has 0.92% market share, Yum Brands, Inc. has a market share of 5.78%, while McDonalds Corp has a market share of 13.07%. In the third quarter of 2018, Chipotle’s revenue growth was 8.59% which was low as compared to the average revenue growth of the competitors which is 10.14%. Also, its net margin of 3.12% was lower than that of competitors. The graphs below show the market comparison of Chipotle and its competitors.

The graphs were retrieved from https://csimarket.com/stocks/compet_glance.php?code=CMG

The fast-casual industry is very competitive in terms of food quality and taste, price, services offered, location, among others making it very difficult for a new firm to enter the market. Also, the established companies in the market enjoy economies of scale hence can reduce the price to push emerging firms out of the market. The stiff competition in this industry makes it very difficult for a new firm to enter the market and establish itself. A new firm might be forced to apply entry pricing strategy to lure more customers. This reduces the profit margins as well as the sustainability of the firm.

Chipotle’s marketing structure is divided into three segments: local marketing, top-of-mind advertising, and brand advertising. The current Chipotle’s market structure can no longer work since the crisis of food safety that occurred in 2016. In order to gain more market share in the highly competitive fast-casual market, Chipotle needs to adopt new strategies. What the company needs right now is building its reputation, after that is when they can apply the current market structure. Otherwise, Chipotle’s popularity will continue to decline.

Recommendations and Conclusion

Chipotle Mexican Grill has recently experienced a historical low in demand and supply of its products. The company’s revenue growth has declined in recent years. Recently, the company increased its menu prices to maintain a healthy profit margin due to the rising labor costs. However, this price increase might adversely affect the company in the future due to the high price elasticity of demand in the fast-casual industry; the company will lose most of its customers due to the availability of substitutes and stiff competitions. Currently, the firm’s percentage market share is low as compared to other competitors. The organization needs to establish strategies to help it gain more market share and increase demand.

First, Chipotle should consider building the reputation of its brand to eradicate the negative perception that Chipotle’s products are not safe. The company can engage in food safety campaigns, including its ingredients on food packages, rebrand its products, and assure its customers of the safety of their products. Additionally, the company should engage an efficient and highly committed workforce to increase the quality of services offered as well as the firm’s productivity. This will increase supply and customer loyalty. Also, the company should adopt the policy of putting the client first. The policy should emphasize customer safety and satisfaction. The policy will help the firm gain more market share by improving customer loyalty.

References

Ernst & Young LLP (2017). Chipotle Mexican Grill, Inc. Financial Report. Retrieved from: https://www.sec.gov/Archives/edgar/data/1058090/000105809018000018/cmg-20171231x10k.htm?mod=article_inline

Miller, M., & Alberini, A. (2016). Sensitivity of price elasticity of demand to aggregation, unobserved heterogeneity, price trends, and price endogeneity: Evidence from US Data. Energy Policy, 97, 235-249.

Grill, C. M. (2007). Food with integrity. Chipotle Mexican Grill.