Once in a while, an established corporate titan figures out a new trick and shocks the market. That's what McDonald's did when it realized that it could make a killing on fruit smoothies and cold frappes in the hot summer months. Yet, for a low-price fast food chain, such a strategy might have raised some eyebrows. But the company silenced critics when it reported July earnings. Its performance showed a 5.7% month-over-month increase -- the biggest since April 2009 -- due in large part to its new drink offerings. Why did it work? The success reflects simple microeconomics at work.

Low Pricing

Higher Profit Margin and Higher Volume?

The beverage business is very good money -- just ask Starbucks. Some perspicacious executive at McDonald's must have convinced others that the fast food chain could also profit by offering tasty frozen coffee and fruit drinks. In fact, even with lower prices than competitors, the company might be able to obtain a higher profit margin. Its clients also won't expect the same level of quality in their ingredients as trendy coffee and smoothie shops offer. McDonald's also has the scale to obtain those ingredients even more cheaply than many competitors. And it will sell plenty: in most of America, chances are good that there's a McDonald's closer than the nearest smoothie shop.

Lower Prices

The price point matters to McDonald's customers. They have to decide what to get as a beverage. They could get a soda or a smoothie for a little more. The smoothie is likely perceived as more satisfying and substantial. Indeed, some people would purchase one as a snack without food on a hot day. So if McDonald's charges $2-$3 for a smoothie, it has a distinct advantage over a smoothie shop like Jamba Juice which charges $3-$4. If you're likely to go to McDonald's in the first place, then you also probably aren't as willing to pay $5 for a frappe from a pricey coffeehouse to begin with.

Demand Capture

A Boiling Hot July

And that leads to the next point: most obvious reason why people would want cold drinks is the hotter-than-usual July weather. When you walk into McDonald's from near triple-digit temperatures, a drink made of blended ice will look more appealing than one merely cooled by ice. So this was partially luck, but the strategy probably would have succeeded even with regular summer weather -- just with more restrained results.

A Healthy Treat

You don't often hear McDonald's' clientele characterized as being very health coconscious. Yet when provided the option of having something perceived as healthy that is also tasty, the average person will consider the option. Think about the psychology involved: "Well, I know this Big Mac isn't very healthy, but if I get a smoothie, then that's some fruit to balance things out!" Of course, a 16 ounce smoothie actually has 73% more calories and 30% more sugar than a Coca-Cola of the same size. McDonald's also doesn't use as pure ingredients as some smoothie chains like Jamba Juice.* But perception is reality.

Of course, smoothie shop Jamba Juice had some fun mocking McDonald's going into the smoothie business with the following commercial. But it looks like the fast food giant's strategy worked.

*The ingredients in a McDonald's Strawberry Banana smoothie includes: Strawberry puree, banana puree, water, sugar, concentrated apple juice, contains less than 1% of the following: cellulose powder, natural (botanical source) and artificial flavors, xanthan gum, citric acid, colored with fruit and vegetable juice, pectin, ascorbic acid (preservative).

A similar Strawberries Wild smoothie from Jamba Juice includes: Apple Strawberry Juice Blend, Nonfat Frozen Vanilla Yogurt, Frozen Strawberries, Frozen Bananas, Ice.

Additional Note: As a former Jamba employee points out in the comments section, Jamba is vague on its website about the ingredients in its juice and yogurt. This could mean that its ingredients line up more closely to McDonald's smoothies after all.

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