Competing as Starbucks

Starbucks is not often considered a fair player when it comes to how they conduct their business. However, they do take part in the perfectly competitive world market for coffee. The price of coffee beans is left up to the forces of supply and demand, so Starbucks is considered a price taker just like all of their competitors. Many people believe that Starbucks has a dominant presence in the world coffee market, but in fact their global demand for beans is only 2% (but 10% of the fair trade coffee bean market), which is hardly enough influence to control the price. Starbucks’s is merely another small buyer in a huge commodity market for an identical product, and they will purchase their beans from anyone who is selling them. They have the same information available as all other price-takers on the world market. Starbucks first store actually only sold beans, not beverages, when they first started their business.

Starbucks has been around since 1971, but anyone who was alive during the mid-nineties can recall the rapid expansion of Starbucks, which was ingeniously parodied on The Simpsons. Bart enters a mall, and passes multiple Starbucks stores, and by the time he leaves all of the stores in the mall have been converted to Starbucks stores, including the one he was just in. I grew up in Vancouver and remember a Starbucks across the street from another Starbucks.

Starbucks took great advantage of their economies of scale by doing such things as allowing customers to take used coffee grounds home to use in composting which would cut down the cost of Starbucks disposing of this byproduct. They also didn’t need to advertise, because they had saturated the market so much that it was impossible to not be aware of their presence. Litterbugs were also taking care of a lot of the advertising for them as well. Eventually they had taken full advantage of their economies of scale and were in a position where they were experiencing diseconomies of scale as their long run costs went up, likely due to bureaucratic inefficiencies. After all, it is the guys in suits that decided to keep expanding.

The unfortunate part of rapid expansion is that it is followed by rapid contraction. Starbucks was suddenly in a position where some of their stores were actually losing business to their own stores. So many outlets were running with excess capacity in the short run, rather than economic capacity where their average costs are at their minimum. They had lost sight of what worked for them in the first place, which was selling a unique coffee drinking experience, and were beginning to become a company that specialized in just rapid expansion. They were also beginning to sell a product that people were falling out of love with due to their once aroma rich stores no longer grinding the beans in-store. Consumer Reports had awarded McDonald’s with the best coffee title in 2007. This type of news was surely going to cut into Starbuck’s profits.

Downsizing is never easy, but a firm must do it in order to stay competitive. Starbucks was awarded with short term profits by innovatively expanding their business, but went too far, like Icarus flying too close to the sun. From Feb 2008 – Jan 2009 Starbucks closed 977 stores worldwide, and eliminated 18400 jobs in the US. This bold move would allow them to scale back to refocus on what actually works for them and their customers, and hopefully return to scale. They began doing such things as offering free Wi-Fi, started a loyalty program, and grinding their beans in the stores.

Personally, I brew my coffee at home or drink the free coffee at work because I feel the price of Starbucks coffee is too expensive. However, the long lines at most Starbucks will prove that the public is willing to pay the price that Starbucks charges, so they must be charging a little below the equilibrium price to create the long lineups. Perhaps the Starbucks cup is a status symbol, which would make it’s drinkers conspicuous consumers willing to pay more for what the brand symbolizes rather than the coffee itself. McDonalds does brew a comparable coffee for a lower price, but McDonald’s is….well…..it’s McDonald’s. If Starbucks lowered their prices, their product may be considered less of a status symbol and on par with the general vibe low cost outlets like McDonald’s receives. Without the high price, Starbucks would just be selling coffee.

Sources:

http://www.nytimes.com/2009/01/29/business/29sbux.html

http://askville.amazon.com/starbucks-beans/AnswerViewer.do?requestId=230804

http://www.catalogs.com/info/food/the-history-of-starbucks.html

http://www.marketingshift.com/2009/2/coffee-wars-mcdonalds-attacks-force.cfm

http://en.wikipedia.org/wiki/Starbucks

Long Run Costs and Economies of Scale

 I work for a large oil and gas company, and recently we held an event called the ‘Oil and Gas Board Game Day’. We have been holding this annual event for a number of years, and the event is so popular that there is always a waiting list of people who would like to take part. I think people enjoy these types of events, and companies can achieve benefits from the team building it encourages. The oil and gas board game people have built a fairly simple game that mimics the process of oil and gas exploration, drilling, and expansion. In a large company, we have such a division of labour that we really get caught up in the day to day operations of our own departments and we seldom get to interact with other departments. The board game forces members of many different departments (accounting, information systems, administration, drilling, engineering, etc) to come together and make decisions as a team.  I think what attracted a lot of people to the game was the presentation. The game is played out on a massive 10’x 10’ wooden box, which is actually the game board with a paper map of Alberta on top of it.  Teams must decide where they would like to run imaginary seismic surveys by using a battery powered studfinder over the paper map. The modular wooden box beneath hides the shapes of the oil and gas reservoirs and traps, and based on the surveys, teams can punch a hole in the paper with a long wooden stick  to mimic drilling a well. If the stick hits wood, it’s a dry hole, but if it stands up, you have struck oil. It’s a great interactive experience, and the 3D aspect adds a really fun dimension. Basically, they took the rulebook of an old boardgame, and turned it into a 3D experience so the player feels more like they are inside the game. 

Their game is loosely based on the rules of the game ‘Oil Power’, released in 1982.

http://boardgamegeek.com/boardgame/2269/oil-power

If I was to start a business, I would like to do something similar using large scale interactive variations of different boardgames. I think that kids would enjoy coming into school and presented with a massive 20 foot tall and fully interactive inflatable vertical Snakes and Ladders board, or have their soccer field converted to a giant Monopoly board. Obviously I would have trouble securing the rights to brand name games, but there is room for similar rule-sets to many popular games. I think this idea could be used during such events as kids’ birthday parties, work functions, high school assemblies, and exhibitions such as the Calgary Stampede on the PNE. I think the output units would be measured in the number of people who attend an event and are able take part in full game session. Different games would be able to include different amounts of players, so I would need to figure out how to balance a desire to include lots of people in a session against keeping the game fun. Testing the game would make it possible to measure the marginal amount of fun each player experiences as new players are added.   My fixed input would be the board game itself, and the variables would be the labor involved in running the game, as well as the players who will hopefully enjoy their time.  Testing would determine the optimal amount of laborers needed.

This type of business would have to start small, until I could assess the demand for such a business, or how I’d like to expand it, or scale it back once I know my average costs.  I think a business like this could handle a market the size of the city of Calgary, and possibly the outlying towns once I have a handle on the cost of fuel.  This type of business would probably have trouble in a rural community because it would need a large market population to exist or else the costs may not allow me to achieve minimum economic scale. If successful, I could see it prospering into a firm with a small office,  a space for testing games, and an area for storing/maintaining/manufacturing the games. I would probably employ an expert carpenter (salary) and perhaps a journeyman or two (paid an hourly wage),  a graphic artist, an office manager, and a few general laborers. I’d also need some sort of master of ceremonies to be the announcer of the games.  I would probably outsource such work as accounting, and marketing/advertising.

The costs would include:

Sunk Costs	Fixed Costs	Variable Costs
-          Initial testing and market research -          Research into legalities of game rules / IP / copyrights -          Consultations with experts (graphic artists, carpenters, lawyers, etc)	-          Actual large gameboards and related parts -          A van or truck to transport game boards -          Tools to maintain games -          Salaries of crucial staff -          Rent for storage facility and office space -          Any costs for legalities (copyrights, etc)	-          Wages of hourly employees -          Maintenance of gameboards (cleaning products, paint, etc) -          Custom features requested by customer (banners, custom game pieces, etc) -          Fuel / transportation

There is a similar company in Australia (Yardparty) that already provides a similar service.

http://www.yardparty.com.au/

Ultimately, I would love to turn these games into large scale 3D versions of themselves:

http://boardgamegeek.com/boardgame/44163/power-grid-factory-manager

http://boardgamegeek.com/boardgame/29368/last-night-on-earth-the-zombie-game

Law of Diminishing Returns

If you want to influence someone’s behavior, one of the most effective ways to do it is through incentives. Incentives are the proverbial carrot on the stick that keep people motivated and moving toward the goal.  Most people are raised with incentives, however large or small. A small bargain with a young child, such as giving them a piece of candy in exchange for cleaning their room teaches them an important lesson that will motivate them for the rest of their life. Generally, incentives will work for people who want the most of life, but what about the people who don’t care much about life?

In Pierre Lemieux’s article ‘The Diminishing Returns of Tobacco Legislation’ published to his website May 19^th 2001, he makes some interesting points about the subject of the attempts that have been made by the government to persuade people to stop smoking. He touches on some of the tactics, such as the pictures of diseased lungs put on the packages, and sin taxes. The fact that the price consumers paid for cigarettes rose by 48% between 1995 – 1999,  but the change in demand was only 11% shows just how inelastic the cross elasticity of demand for tobacco actually is (the coefficient of 11% / 48% = 0.23).The vast majority of the increased price are sin taxes, and when the demand for a product is inelastic, then the vast majority of these taxes are paid by the consumer. This will equate to straight up tax revenue to the government. How can smokers be so willing to continue in the face of such large disincentives?  An interesting point that Mr Lemieux has uncovered is that between 1985 – 1995 there was also a rise in the price of cigarettes to the tune of 52%, with an 18% drop in quantity demanded, which resulted in a cross elasticity demand coefficient of  0.35. Clearly, as time has gone on, the effectiveness of the price increases has become victim of the law of diminishing returns. The people have spoken, and have shown that they have accepted the high prices.

Mr Lemieux seems to support a move toward gentle prohibition. In a way, this has already happened, as most businesses now do not allow smoking within 10 feet of their building. The heated indoor smoking lounges at airports have become a thing of the past. However, this may be a bad idea, as it may lead people to hide and smoke in dangerous places, such as in alleyways, where their cigarettes could start a fire if improperly extinguished. The ashtrays that used to be available in public areas have mostly been removed.

The fact remains that cigarettes are addictive, so it’s likely that as people are desensitizing to the pictures on the packs, they are buying more packs. Some people are just going to smoke, even though you have to live under a rock to not know that they are deadly at this point. Some people just have less interest in self-preservation, so a picture of a diseased lung has no effect on them. Anyone who was offended by a picture of a diseased lung gave up smoking long ago. In Quebec, entrepreneurs have even come out with ironic warnings and pleasant pictures to satirize the government’s efforts at panic warnings, so these warnings are just a joke to some. The point of diminishing returns may have kicked in the moment that these serious warnings became satirical. Although the sin taxes don’t make a huge difference, and the evidence of the diminishing returns, they do make a solid dent in demand, and if smokers are willing to pay them, then it may just be a necessary evil that can have positive effects. Perhaps some sort of tax on cigarettes that goes directly into a fund to research cancer may actually have a positive outcome in the end. Maybe smokers should be forced to swipe a card when they purchase cigarettes to track their personal consumption, and tax them individually based on their personal consumption. More smokes = more taxes.

Citations:
Pierre Lemieux ‘The Diminishing Returns of Tobacco Legislation’ published to his website May 19^th 2001
http://www.pierrelemieux.org/artdiminish.html

State of the Oil Industry in Alberta

Cars run on gas. Even staunch environmentalists must reconcile with that fact when they drive across the country to protest a proposed oil pipeline.  However, the game is changing. More Albertans are ditching their gas guzzling cars in exchange for hybrids because they are cheaper on fuel. The extreme people are ditching gasoline completely and now exclusively riding bikes, and buying up complementary products such as helmets. We still need cars in Alberta, but our demand for them has become far more elastic due to the passage of time and the substitutes now available to us. The City of Calgary’s Transportation Plan outlines our future plans to reduce the amount of cars on the road. One LRT can replace numerous cars on the road per trip, and we will continue to make the entire city more accessible by bicycle. This will naturally reduce our demand for gasoline powered cars.  Let’s face it – the price of gasoline is always going to go up, which is going to drive up demand for bikes. Our preferences are also changing, and it is more hip to carpool or bike to work than to admit you are the sole occupant of your Escalade on your daily commute.  In the future we will actually be able to do a cross-elasticity calculation to see just how much demand for bikes was affected by the price change of gas, by dividing the percentage change in demand for bikes by the percentage price change for gasoline.

Alberta’s oil industry can only stand to gain from the province’s own demand for cars becoming more elastic in the long term, because it frees up more of the oil we produce to export.  The demand for oil is much higher and more inelastic in the American and Chinese markets due to their larger populations and lifestyles. This will translate into a rise in income for Albertans, which will shift our demand for luxury items to the right. We can measure this by dividing the percent change in the quantity demanded for a luxury item by the % change in our income.

All in all, the oil and gas industry in Alberta is doing fine, and the future looks bright. Our continued policies of building cities less reliant on gasoline will lower our demand for oil, meaning we can export more. The Keystone XL Pipeline may have to cross some hurdles before it is built, but the Enbridge Gateway from Alberta to the coast of BC seems on track, and will increase exports to China and the Pacific Coast of the United States by 2017.  

Citations

The City of Calgary (author unknown), 2011, ‘Calgary Transportation Plan Explained’

Retrieved from City of Calgary Official Website, Dec 3^rd 2011

http://www.calgary.ca/Transportation/TP/Pages/Planning/Calgary-Transportation-Plan/Calgary-Transportation-Plan-Explained.aspx

City of Calgary – Transportation Department – Calgary Transit, ‘Bus Rapid Transit (BRT)’

Retrieved from  Calgary Transit Official Website, Dec 3^rd 2011

http://www.calgarytransit.com/html/brt.html

ssimpson@vancouversun.com,                 Vancouver Sun,  Nov 13^th 2008, ‘Enbridge Gateway Pipeline Back on Track in B.C.’

Retrieved from Canada.com Dec 3^rd 2011

http://www.canada.com/vancouversun/news/business/story.html?id=480d1db9-0216-4c11-97eb-067ffbf2eff7

photobucket user g_major7, ‘Calgary Bike Path Photos’

Retrieved from Google Dec 4^th 2011

http://media.photobucket.com/image/calgary%20bike%20paths/g_major7/RingBikePath.jpg

South Fraser Blog, 2009, Calgary LRT Video

Retrieved from Google Dec 4^th 2011

http://www.southfraser.net/2009/02/calgary-lrt-video.html

Northern Gateway Pipelines, About Us

Retrieved from Official Enbridge Website Dec 4^th 2011

http://www.northerngateway.ca/project-info/about-us

Bar Graph - Oil Consumption>Energy Statistics

Retrieved from Nationmaster.com (customizable search engine of statistics)

http://www.nationmaster.com/index.php

Elasticity and Revenue

Anyone who has ever rode anywhere on a Greyhound bus will tell you it’s no fun. I’ve travelled from Vancouver to Calgary, and it was 14 hours. The scenic vistas of our majestic Rocky Mountains is overshadowed by the lack of feeling in the rider’s  ass after sitting in one uncomfortable seat for hours on end. I got past it by thinking about my dear mom, who I was on my way to visit, and who had also paid for my ticket as a gift.  I think most people who have rode the bus would much rather take ANY other form of transportation to get where they’re going. However, some people begrudgingly ride that bus because it works for them. I would say the demand for Greyhound Bus tickets is fairly elastic, since there are numerous alternatives, such as driving yourself, flying, or even hitchhiking, which are all comparable in price. The elastic demand of Greyhound tickets would cause a rise in price to result in a drop in total revenue.

Greyhound recently decided to add a fee they cleverly called a ‘gift fee’. Sounds charming! I love gifts!! This fee was about $20 on top of the cost of a ticket for the purpose of protecting a credit card holder from fraud when they purchase a ticket for someone other than themselves as a gift. Naturally consumers were not happy, but it is in fact Greyhound who should be even less happy about the fee because it will cost them revenue. Hypothetically, let’s say the demand curve for Greyhound tickets looks like this. It’s shallow, indicating it’s elastic.

I recall the ticket price my mom was charged  to be about $80, and at that price I would estimate the market demand to be about 8 tickets a year for the average family taking a trip. If Greyhound were to add a surcharge of $20 onto each ticket, the quantity demanded is going to drop considerably. Less tickets purchased, means less revenue. This can be proven by calculating that the Ep = % Chg Qd / % Chg Price. In this case, it works out to 46.15% / 22.22%, which gives us an elasticity coefficient of 2.07. This means that a 1% change in price will result in a 2.07% change in quantity demanded. More importantly, it means that Greyhound will be selling 5 tickets per year to each family who were purchasing 8 previously, all because of the higher price. This works out to revenue of just $500, down from $640 from each family per year.  Greyhound has to consider the elasticity of their customer’s demand when making changes to their price. Elastic demand means that a rise in price will result in a drop in revenue.

Hypothetically, if an international airline were to add a surcharge (and they loooove to do that) to the price of their tickets, they would actually make revenue despite selling less tickets. As per the graph below, the reason for this is because the demand is inelastic, or steeper.

I estimate the demand for international flight to be roughly 8 tickets per year per family at around $350 each (which you will win back on a slot machine immediately when you get to Las Vegas). If the airport added a $50 airport improvement tax to the price of the tickets, it doesn’t leave the consumer with a lot of options. There’s not a lot of substitutes for long distance air travel. You could drive to Mexico, but it’d take the entire week you booked off of work to get there. If you’re a business traveler, you need to go wherever you need to be in order to keep your job, even if that means a flight across the Atlantic. Good luck driving to England from Calgary. The inelasticity of the demand for long distance air travel is such that a rise in price will actually result in a rise in revenue, despite the lower quantity demanded.  In this example, Ep = 6.45% / 13.33%, which gives us a elasticity coefficient of 0.48. A 1% change in price will result in a 0.48% change in quantity demanded. Revenue will increase from $2800 per family of travelers per year to $3000, all in spite of a drop in quantity demanded.

http://delicious.com/pollockm#

Citations

David Lazarus. (2010, September 14). Bus ticket fee is an $18 gift for Greyhound

LA Times, Online. Retrieved December 1, 2011, from Google

http://articles.latimes.com/2010/sep/14/business/la-fi-lazarus-20100914