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.
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I really like your historical perspective on Starbucks. I'm aware of Starbucks, but since I don't drink coffee I'm not familiar with all the details. I agree that the price they charge is obviously not too high since people keep buying their coffee. I now people that don't bat an eye at spending $4 or $5 for a beverage, yet they complain about the cost of just about everything else! You accuse bureaucratic inefficiencies for the increase in long run costs due to their massive expansion, but do you think that the expansion was due to a misinterpretation of the actual size of their market or the competition's strategy of providing good coffee at reasonable prices? Do you think that Starbucks actual market is all coffee drinkers?
ReplyDeleteHey Glenn, I am a coffee drinker when it's FREE! I honestly can not taste the difference, and I just don't get the attraction of the Starbucks atmosphere. BUT, kudos to Starbucks charging the high prices if people are willing to buy them.
ReplyDeleteI think they misinterpreted the size of the market. I think they got a taste of success, and assumed that building more stores, even within close proximity to their own other shops, was going to keep the profits steady. I wouldn't be surprised if the slump in the economy in the past few years could also be to blame for the drop in sales.
Although Starbucks sells food items, they don't seem to be a big draw, so I think that Starbucks customers are mainly interested in just coffee. McDOnalds on the other hand now has the reputation of serving both good food and good coffee. This is a reputation that Tim Hortons has enjoyed for years.