Olha in Economy: Starbucks market success

⁷⁾Hi Everyone!

Today I would like analyse Starbucks in the light of perfect competition market. The world market for coffee companies contains thousands of them and there is the possibility of easy entrance and exit in that market. There are millions of consumers around the world who enjoys coffee. Another feature of perfect competition is that the single coffee company doesn’t have an influence on the price for coffee beverages. The information about the coffee producers and different recipes are ready available to the public.

That is true as the truth is the fact that it is very difficult for Starbucks to compete with low prices for coffee in other companies. That is when now we can see that Starbucks is not actually part of perfect competition. Why? Simple answer is that because Starbucks works hard on developing its brand name it requires the customers to show their preferences to the company. To prove that I would like to provide the words of Howard Schultz, CEO as a response on fast international growth: “We overlooked the fact that we would remove much of the romance and theatre that was in play. One of the results has been stores that no longer have the soul of the past and reflect a chain of stores vs. the warm feeling of a neighbourhood store... Push for innovation and do the things necessary to once again differentiate Starbucks from all others. We source and buy the highest quality coffee. We have built the most trusted brand in coffee in the world, and we have an enormous responsibility to both the people who have come before us and the 150,000 partners and their families who are relying on our stewardship.”²

That shows the following video about the brand

Some of the methods Starbucks have used to expand and maintain their dominant market position, including buying out competitors' leases, intentionally operating at a loss, and clustering several locations in a small geographical area have been labelled anti-competitive by critics.¹⁾

The decision to expand was part of economies of scale and it seems that it was too quick and not all aspects were taken into consideration. Among them were lowered requirements for new stores, struggling economy during the recession when people prefer inferior products like fast-food over the normal. The result was slowdown in sales and drop in the stock prices to 60 percent below its price in the fall of 2006.³⁾

In the attempt to save the brand the company decided to close 600 of its stores. Starbucks estimated $8 million US in severance costs and in total, the company forecast up to $348 million US in charges related to the closures.⁴⁾ Closing the stores was very tough decision but it paid off. One of the reasons for this decision was to bring the prices for the shares from $15 in 2007 to $35 they were trading in 2006. When we look at the stock prices for the shares we can see that when the stores started to close the price for shares fell to $8 in the first half of 2009. However over the next three years the prices jumped 6 times up and now the shares are trading at $50.⁵⁾

That decision lead to huge losses in short-run but in the long-run there was healthier company developed. The basic principles of the company to be different on the market got further as we can see from the video:

As part of its image as a high quality company that cares about customers Starbucks maintains tight control of production processes by communicating directly with farmers to secure beans, roasting its own beans, and managing distribution to all retail locations. Additionally, Starbucks’ Coffee and Farmer Equity Practises require suppliers to inform Starbucks what portion of wholesale prices paid reaches farmers. And Starbucks have also made strides in recycling with their paper cups and supplies.⁶⁾

All this helps the company to compete on the market despite quite high prices. In fact, I prefer their coffee over Tim Horton’s.

Now let’s look at the situation when Starbucks would want to lower prices. At the graph below I showed a D1 and S1 curves as the current equilibrium for the company. Decision to lower prices from P1 to P2 would require lowering costs and increasing supply from S1 to S2. Lowering costs would lead to worst quality and cut-outs of extras in attempts to save the profit. That is exactly what happened when the company wanted to expand quickly in 2006. As a result the quantity sold would increase from Q1 to Q2 for some time but the old customers (like me) would be turned out to another chains simply because they would lost the pleasant feelings. That would lead to decrease in demand to D2 and decrease in supply to S1 as a result and decrease in quantity to Q3 and revenue. That proves the following real life example:” While the current state of affairs for the most part is self-induced, that has led to competitors of all kinds, small and large coffee companies, fast food operators, and mom and pops, to position themselves in a way that creates awareness, trial and loyalty of people who previously have been Starbucks customers”²⁾