Firms and Decisions Essay Question and Answers

Representatives from the food and beverage (F&B) industry have called on the Singapore government to provide more help, saying businesses have been hard hit by the COVID-19 restrictions such as the ban on dine-in customers. Border closures has also thwarted firms from recruiting foreign employees. Meanwhile many F&B firms have turned to digital platforms for online orders.

a. Explain how the COVID-19 restrictions have adversely affected the profits of an F&B firm. (10)

b. Discuss whether smaller F&B firms like hawker stalls or larger F&B firms like restaurants are more likely to survive the pandemic. (15)


Part (a)

Introduction

Profits are the result of the interplay between a firm's revenues and costs. Therefore, to understand how COVID-19 restrictions have affected the profits of an F&B firm, we must scrutinize both the revenue and cost aspects.

Impact of Border Closures

Border closures due to COVID-19 have severely curtailed the hiring of foreign employees. In many cases, this has compelled firms to hire local workers, who often command higher wages. This has led to an increase in the cost of production, as shown by an upward shift in average and marginal cost curves from AC0/MC0 to AC1/MC1. Concurrently, a fall in the number of tourists – a key customer base for many F&B firms – has shrunk the market size, causing a fall in demand for restaurant food and a subsequent leftward shift of both demand and marginal revenue curves.

Note for students: Remember, border closures have both direct (through increased labor costs) and indirect (through reduced demand) effects on profits. Make sure to address both in your answer.

Adoption of Digital Platforms

Many F&B firms have turned to digital platforms to accept online orders, a shift that brings both benefits and challenges. On one hand, the adoption of such platforms may increase the market size by attracting more takeaway orders, leading to a rightward shift in the demand and marginal revenue curves. On the other hand, this digital shift also imposes additional costs – such as employee training and software maintenance – that can lead to an upward shift in the average and marginal cost curves from AC0/MC0 to AC1/MC1.

Note for students: When discussing the adoption of digital platforms, don't forget to consider both the potential revenue increase and the additional costs involved. It's this balance that will ultimately determine the impact on profits.

Restrictions on Dine-in Customers

The ban on dine-in customers – a direct response to the pandemic – has led to a decrease in the market size. Furthermore, changes in consumer behavior, driven by an increased risk aversion to eating out, have also led to a decrease in the demand for restaurant food, causing a leftward shift in both demand and marginal revenue curves.

Note for students: Here, the key is to link the specific COVID-19 restriction (i.e., the ban on dine-in customers) with its impact on market size and demand. Remember to consider any changes in consumer behavior as a result of the restrictions.

Cumulative Impact on Profits

The overall impact of these factors is likely a net decrease in demand and an increase in costs. This would lead to a leftward shift in demand and marginal revenue curves, and an upward shift in average and marginal cost curves, respectively. Consequently, profits would fall.

Note for students: This is your opportunity to summarize the various impacts you've discussed and show their combined effect on profits. Make sure to draw a diagram and reiterate the changes in demand, revenue, and costs, and how these changes have ultimately led to a decrease in profits.

Part (b)

Question dissection:

1. Identify 3-4 factors to compare across smaller F&B firms vs larger F&B firms

2. Factors should be based on revenue advantages and costs advantages

Ability to Trim Costs

    1. Explanation: Smaller F&B firms, such as hawker stalls, have the advantage of flexible labor arrangements. These often involve family members or flexible contracts, which allow them to swiftly adjust labor costs in response to changes in business conditions. This ability can lead to a downward shift in their Average Cost (AC) and Marginal Cost (MC) curves, which can help to offset the fall in Average Revenue (AR) and Marginal Revenue (MR) during challenging times like a pandemic. By contrast, larger F&B firms tend to have more rigid cost structures due to higher fixed costs, including long-term employment contracts and rental costs. This rigidity makes their AC and MC curves more inflexible, making it harder for them to adjust costs to balance the fall in AR and MR.

    2. Link to survival: As smaller F&B firms can adjust their costs more flexibly, they can maintain their profit levels better in the face of falling revenues, thereby enhancing their chances of survival during the pandemic.

Note for students: In economic downturns, the flexibility to adjust costs can be a significant survival factor for firms. This ability allows firms to mitigate the impact of reduced revenues, making them more resilient to economic shocks.

Retained Supernormal Profits

    1. Explanation: Larger F&B firms generally have more retained supernormal profits due to their scale of operations. These accumulated profits can serve as a financial cushion, allowing them to sustain losses over a longer period without shutting down. On the other hand, smaller F&B firms like hawker stalls might lack such retained profits, making them vulnerable to prolonged periods of losses. This could potentially lead to them exiting the market if the pandemic continues for an extended period.

    2. Link to survival: Larger F&B firms with significant retained supernormal profits are better positioned to weather the storm of the pandemic, even in the face of sustained losses. Thus, they may have a higher probability of surviving the pandemic compared to smaller F&B firms.

Note for students: Retained supernormal profits are essential for firms to weather economic downturns. They provide a buffer that allows firms to sustain losses temporarily while they adjust their business strategies.

Ability to Switch to Online Platforms

    1. Explanation: Switching to online platforms is a critical strategy for F&B firms during the pandemic, as it allows them to reach customers who prefer to stay home. However, the switch comes with costs, such as commission fees for delivery platforms, which are typically between 25-35% of the order price. For smaller F&B firms that already operate on slim profit margins, these additional costs can cause their Average Cost (AC) and Marginal Cost (MC) curves to rise significantly, potentially leading to losses if their Average Revenue (AR) and Marginal Revenue (MR) do not increase proportionately. Conversely, larger F&B firms with higher profit margins may be able to absorb these costs more readily, thus mitigating the impact on their profits.

    2. Link to survival: Larger F&B firms that can absorb the costs of switching to online platforms have a higher chance of survival during the pandemic. They can continue to generate revenue and maintain their profitability despite the challenging circumstances. Conversely, smaller F&B firms may struggle to sustain this transition due to their thin profit margins, making survival more challenging.

Note for students: The ability to pivot and adapt to new business models, such as online delivery, is crucial in times of crisis. However, the feasibility and effectiveness of such a switch depend on the firm's cost structure and profit margins. In this case, higher profit margins provide larger firms with a competitive advantage.


Evaluative Conclusion 

The survival of F&B firms during the pandemic, be it smaller entities like hawker stalls or larger ones like restaurants, hinges primarily on their ability to pivot in response to the changing business environment, and their capacity to effectively manage their costs.

Pivoting and Increasing Revenues: F&B firms that can shift their business model to align with the new norms, such as by maximizing the use of online delivery platforms or leveraging social media for marketing, stand a higher chance of survival. This is because such pivots can help to drive revenues during a period where traditional dine-in services are severely impacted. For instance, large restaurant chains like McDonald's and KFC were able to quickly adapt to the situation by reinforcing their existing online delivery systems, thereby maintaining a steady stream of revenue despite the drop in dine-in customers. However, it's important to note that the ability to make this shift is not evenly distributed across all F&B firms. Smaller hawker stalls, on the other hand, may find it more challenging to pivot due to their thin profit margins and lack of digital infrastructure.


Note for Students: Remember, the ability to pivot and adapt to new business models is a critical survival skill in times of crisis. However, the effectiveness of such shifts will be influenced by the firm's cost structure and profit margins.

Managing and Cutting Costs: Equally crucial is the firm's ability to manage and reduce costs. For example, smaller F&B firms like hawker stalls have been able to adapt by limiting their menu options to reduce food wastage costs or renegotiating rental terms with landlords. These strategies have allowed them to adjust costs more flexibly in response to changing business conditions. Larger F&B firms, however, have more fixed costs that are harder to adjust, which could present a challenge. But some, like Starbucks, have been able to renegotiate their leases or close underperforming outlets to reduce costs.


Note for Students: Cost management is vital in ensuring survival during tough times. A firm's ability to adjust its costs in response to changes in demand and market conditions can be a significant factor in determining its survival.

In conclusion, the question of which type of F&B firm is more likely to survive the pandemic is complex and multifaceted. While smaller F&B firms have a leaner cost structure that could provide some advantages, larger firms' ability to absorb the costs of pivoting to new business models might give them an edge. Ultimately, the specific circumstances and strategic decisions of individual firms will play a significant role in determining their survival during the pandemic.




The ETG Team