A lot of you had some pretty good ideas about why McDonald's has adopted a strategy of charging the same price for all sizes of its soft drinks ($1.00), so I thought I would put up a few thoughts on the subject outside the blog.
First of all, I want to recommend an excellent book that addresses aspects of this case: David Friedman's Hidden Order: The Economics of Everday Life. This book offers many excellent observations and insights on why things are they are in our economic world.
Friedman points out a number of the same factors that many of you brought up:
1. Markups: It's difficult to get a reliable estimate, but it is likely that it costs McDonald's on margin about thirteen to nineteen cents to produce a soft drink, including syrup, container, water, ice, labor, electricity, product wastage, etc. McDonald's saves a lot of the cost of labor by letting customers serve themselves (Wendy's does not!), so they are making a hefty profit on each drink. But that still does not answer the question of why $1.00 for all sizes.
2. Psychology: McDonald's wants to win over as many of us as possible, and we all discriminate in some way when it comes to economic decisions. For some of us, the idea of getting a great bargain makes us choose McDonald's over Wendy's or another competitor. And, even though logic tells us that we can refill our cups as many times as we want at McDonald's, our emotions get the better side of teh argument: there's something really satisfying about getting so much MORE for the same price as getting less. Studies have shown that people who believe they are getting a bargain spend more on other products - aha! A number of you brought this up.
3. More psychology: It's all about incentives! Some people like the idea that they can start with a smaller size and, if they need to, get a refill. This creates a sense of self-control over the situation, which again creates a "warm and fuzzy" feeling toward McDonald's. If we did a study at our local McDonald's, we would probably find that some peeople get small drinks and refill them several times, while many others do not (drive through customers CANNOT). In the end, it all averages out to a certain amount of total soft drinks dispensed, divided by the number of customers... the marginal profit on the next serving is what matters, not how much has been dispensed totally. So, it is more important to keep cusomers feeling happy, empowered, and coming back than it is to worry about who is refilling and who is not. In the end, the restaurant who gets return customers is the one who wins, not the one who charges less. McDonald's strategy is much more about creating loyal and happy customers than it is about making a certain amount of profit.
4. Still more psychology: I have heard several times, while standing behind a customer at a fast food restaurant, the complaint "But I don't want that much... don't you have anything smaller?" Odd, isn't it? Some people actually discriminate that way. I mean, you can get a large, fill it, and simply drink only the amount you want to drink. But many people would find this wasteful, and such waste wouldcreate antipathy toward McDonald's... so, we retain the size choice to keep those who discriminate in that way happy. I have observed my own behavior: I tend to get a medium drink, and sometimes get a refill, but just as many times don't. I also use a lot of ice, so even if I get three refills, i probably am still leaving McDonald's a fifty cent or more profit on my drink... incredible! I feel good, they make money, and I keep coming back... everybody wins.
5. So, why not charge only 50cents a drink? Well, partly it's because some of the margin made from soda has to pay for loss leaders and pad the profits of low-margin products. There is not a lot of margin in the fast food industry on a per item basis; I recall reading at some point that Taco Bell made less than two cents profit on each food item. Additionally, accounting has to be done for those who actually buy a large, refill it twice in the restaurant, and fill it up again for the trip home... a few of those can destroy your profits pretty quickly. And, believe it or not, some people get suspicious when prices are too low. And, I suspect, someone has calculated the cost of making change if a drink sells for less than a dollar, too... there are many decisions that go into deciding what to charge for a drink, and McDonald's isn't about to start giving away its secrets.
Anyway, most folks did a pretty good job of this, although no one really rose to the 20-level. But then, that's what ECUs are for - right?