Economics of Starbucks

Monopolistic Competition

Oligopoly

Globalization

• Although Starbucks is a chain brand, it offers different menus in other parts the world. There are more than 5,500 coffeehouses in over 50 countries.

• Starbucks is very unique, playing a part in a few very different markets.
• Starbucks is part of an oligopoly being one of a few large firms dominating the market for coffee and breakfast, competing with McDonald's and Dunkin Donuts ("medium" concentration ratio of 60%).
• All three have started to offer items such as hot breakfast sandwiches and pastries to compete with each other.
• Three Main Characteristics:

1) There are a small number of large firms that dominate the industry (DD, Starbucks, and McDonalds carry the principle market share)

2) Firms sell identical or differentiated products (While coffee itself can be considered similar, there are differences in the quality of coffee and the types of beverages offered at each location)

3) Barriers to entry are relatively high (people prefer these larger brands to small local coffee shops)

• The home coffee market also has oligopolistic characteristics, with primary competitors being Starbucks, Folgers, and Maxwell House.

• Starbucks plays a role in the market of a coffeehouse, a destination where people could go to sit, relax, read a newspaper, and drink higher quality coffee than the local diner or donut shop.
• Starbucks competes with three other principle firms in this specialty market: Cairbou Coffee, The Coffee Bean and Tea Leaf, and Peet's Coffee and Tea (concentration ratio of these four firms: 28%).
• They offer high end drinks and a relaxing atmosphere where customers can relax or complete work/study.
• These national brands are being supplanted by more local coffeehouses (such as Joe's in New York City).
• Three Main Characteristics:

1) Relatively low barriers to entry.

2) A large number of firms exist because of the variety of these local coffeehouses that currently exist.

3) Product differentiation exists, with the baked goods and coffee combinations at Starbucks different than the ones offered by its competitors.

• In conclusion, as opposed to the more oligopolistic nature of the "fast-food coffee market," the "coffeehouse" type market is one of monopolistic competition.

-For example: In Japan, there are drinks that

are offered such as Azuki Matcha Frappuccino

and the Apple Crumble Latte that are not offered

in the U.S. There is also a difference in the cost of the price. In Japan, prices start from 490 yen (~$6.29 US) for a tall size drink whereas in the U.S, tall size drinks start from $4.

Scale of Plant

• Logo Troubles- The siren of the logo was

deemed "morally-inappropriate" for

middle-eastern countries that were

predominantly Muslim. Since the siren is

inappropriate and offends the middle-

eastern people, Starbucks has replaced the siren with a crown swimming in the sea.

• Starbucks's Woodbury location is relatively smaller in size as compared to its stores, a reason for the frequent and relatively long line that seems to be present at all times.

• Starbucks has become a global brand through their costumer loyalty and 'word of mouth' communications.

• Approximately 4 employees can be behind the counter with 2 more that can fit in a storage room in the back.
• The store can fit about 16 people inside and 10 people outside with outdoor seating.
• With a smaller scale of plant than other locations, this locations output may be slightly lower than other locations.
• Customers may be discouraged due to the long line and relatively slow output.
• However, this location's advantage is its convenience for Woodbury and Huntington customers.

• Firms involved in oligopolies must

therefore consider the response of their competitors when making decisions (see Game Theory slide).

Substitute Products

Complementary Goods

• As with substitutes, Starbucks has attempted to offer products within its own stores to complement its central product: coffee.
• Starbucks's food selections exist to complement its coffee and include pastries, confections, and pre made foods (i.e. sandwiches and salads)
• Starbucks also offers retail complements to coffee such as mugs, tumblers, and coffeemakers.
• Additionally, goods that are involved in the delivery of Starbucks's final product, such as milk, cream, sugar, artificial sweeteners (such as Splenda), and syrups.

• Tea is the most direct substitute to coffee in terms of being another source of caffeine.

-To gain control of both fronts, Starbucks currently sells tea both in and out of its stores with its own brand, Tazo Tea.

• Alcoholic beverages can be considered a substitute due to the social aspect of drinking coffee.

-Starbucks is bringing the aforementioned "Starbucks Evenings" to many stores.

• More consumers given current economic conditions are starting to brew coffee at home at a fraction of the cost of going out.

-Starbucks has started its own brand of home coffee maker (Verisimo) and offers its own coffee beans and syrups to be shipped to homes.

• Starbucks makes K-cups to be used with Keurig makers.
• However concern still exists for other brands that attempt to offer high end coffee chains that focus on customer service and specialty drinks

-Peet's Coffee and Tea

-Caribou Coffee

Game Theory

• On May 10, Starbucks lowered the prices of coffee that were sold in grocery stores. The $1-per-bag discount represents a 10% discount on its eponymous beans which results 12.5% drop on its cheaper Seattle’s Best brand.

Market Power/Brand Image

• Starbucks maintains a high end brand image.

• Competitors such as McDonald's and

Dunkin' Donuts have a connotation of

being "cheap," unappealing to Starbucks's target market.

However, they are substitutes for

coffee.

• Since Starbucks is a company with a renown, high stature, this is a big deal. By lowering the price of each bag of coffee, it is making a profit of ~$2.55 per bag. Therefore, Starbucks would have to sell 65% more bags to book the same amount of profit.

-"Starbucks Evenings": Starbucks is planning to launch a program called "Starbucks Evenings" over the next few years, providing customers with bottled beer or wine, but, not cocktails

-Even though its input costs are lower due to economies of scale, Starbucks charges higher prices than it needs to to maintain the image of being high-end.

-Starbucks demonstrates a heavy sense of corporate social responsibility, with a goal to have 100% fair trade coffee, appealing to a young clientele that desires to change the world.

• Major retail growth has been, and will continue to be- at the low and the high ends of the socioeconomic scale.

Differentiation

• Since coffee prices have been low, major coffee brands such as Folgers, Dunkin' Donuts, and Maxwell House have also been cutting down their prices.

• Starbucks offers a wide range of drinks including freshly brewed coffee, frappuccino, smoothies, teas, refreshers, bottled beverages, and much more.

• “If you take all of our core beverages, multiply them by the modifiers and the customization options, you get more than 87,000 combinations.”

-Starbucks spokeswoman Lisa Passe

• Recently, Starbucks has unveiled a new logo and omitted the words "Starbucks" and "Coffee" in its logo. Although issuing a nameless logo was a risky action that infuriated many loyal customers, it did not hurt sales because most Starbucks customers are enthusiasts. Thus proving that Starbucks has gained high brand recognition over the past few decades. Also, its advertisements are high end just like its brand image.

Economies of Scale

• By committing to lower prices, Starbucks is serious about being in the low end of the market. Competitors such as Dunkin’ Donuts, Folgers, and Maxwell House can either trim their margins further or give up volume. But, either way, they lose.

• Starbucks’ founder and owner, Howard Schultz, stressed the idea of building and expanding business operations to the level of a store chain. This enabled him to gain the necessary strategic advantage over local competitors, in terms of size and volume, which was finally transformed into unrivaled brand status.

• Starbucks has created the idea that the customer is buying more then the coffee itself; they are buying the experience that comes with it.

• Due to its large size, Starbucks is able to take advantage of economies of scale.
• It pays less for input costs because it is able to buy products (such as dairy and paper goods) in bulk.
• Cheap inputs complemented with specialty drinks and many additional options allow Starbucks to benefit with high profits.
• Since there is no price cooperation in the coffee industry, Starbucks has the advantage of a lower input cost and the ability to price its products based on the elasticity of its consumers.

The Economics of Starbucks

-Alice Kim & Rohit Gupta