The smartest person the author ever knew, a true scientist with PhDs in Physics and Mathematics, said something very profound once: “if it has ‘science’ in its title, it isn’t (Minnick).” This applies to the “dismal science” of economics. The problem with any social “science” is that it deals with human beings and using human beings in experiments is impossible. To be sure, actuaries can predict the actions of groups or demographic segments with a reasonable confidence. Individuals, however, are notoriously unpredictable. We are left, then, with observations which are converted into “laws.”
Chief among these laws in economics is the law of supply and demand. At its most basic, the law of supply and demand states that in a free market, where willing buyers and sellers interact with full knowledge and where there are no barriers to entry into the market, the supply and demand for any given good or service will reach an agreed market clearing price. This is the condition of market equilibrium.
For Starbucks, the supply can be considered as the number of outlets. The demand is, of course, the number of customers which converts directly to volume of sales. At this point the market clearing price is approximately $1.85 for the “tall” coffee. Prices range to over $5.00 a cup for various lattes or cappuccinos (Starbucks Prices). This is in line with the competition at the lower end when Dunkin’ Donuts, for example, charges $1.89 for the same cup of coffee (Dunkin’ Donuts Prices) but significantly higher than McDonald’s where that cup of coffee is $1.29 (McDonald’s Prices).
Thompson attributes this success to your well thought out plan based on Porter’s model. He explains that you have succeeded in the key component of that strategy, product differentiation. You have also been working on market penetration to consolidate your position. In both of these core strategies you have been successful (Thompson and Mind Tools Editorial Team).
What you have accomplished, better than your competition, is to generate brand loyalty. Your marketing has persuaded a significant segment of the market that Starbucks coffee is simply better. It is, in their view, worth paying the premium. In this you have managed to shift another important economic factor, elasticity of demand. When you think about it, coffee is a commodity. Very few coffee aficionados can actually tell the difference in blind taste tests. Nevertheless, a good piece of the market is willing to pay the premium price for Starbucks. You have lowered your customers’ elasticity of demand, something very few firms ever accomplish.
Starbucks has also made some smart partnerships. The arrangement with Barnes and Noble for example, was inspired. The bookstore, with its welcoming approach to browsing, brings in customers who become foot traffic for the associated Starbucks. What you are doing is working but we may be approaching market saturation. The most recent data show the growth slowing. From 2013-2014 the number of stores grew by 8.39%. This declined to 7.74% for the 2014-2015 period and then again to 5.79% for the 2015 - 2016 period (Trefis Team).
This slowdown certainly has not affected earnings. As shown in Exhibit No. 1 below, both income (adjusted net income) and profit margins continue to improve. Not only that, Starbucks is absolutely owning the coffee market. In 2014 Starbucks accounted for fully 42.4% of the American coffee market. The nearest competitor, Dunkin’ Brands, Inc. had 25.5% of the market with “all others” accounting for the balance (Market share of the leading coffee chains in the United States in 2014).
Starbucks has steadily expanded its menu as well. A Starbucks store may not be a full-service, sit down restaurant, but it sports an extensive menu of breakfast and deli food. Sandwiches dominate but a variety of salads are also available.
As of today, Starbucks is a model of efficiency. You have expanded from a basic “coffee shop” into a restaurant. Strong brand identity and, more importantly, brand loyalty keeps customers coming back.
At some point, though, Starbucks will inevitably reach market saturation. You are already into markets as small as Bedford, Indiana, population 13,413 (Find a store). It will not be long before you have reached the point where the supply and demand curve will catch up with you. As you increase the supply beyond equilibrium levels prices will be affected as illustrated in Exhibit No. 2. As the supply curve is moved from S1 to S2, to the right, the equilibrium price will fall from P1 to P2. This is inevitable.
Starbucks will be able to protect its income and profit, however, by expanding products and services available. You have squeezed about as much efficiency as you an out of the distribution systems and, as you know, transportation costs are a very significant part of your raw material costs. That is the answer to that classic question in any Economics 102 (Microeconomics) class - “Why are the best salads always found in the middle of cities, far from where the produce is grown?” The answer, of course, is because when transportation is such a large component of the final price there is no reason to not purchase the absolute best produce. Starbucks has already demonstrated a fine understanding of that key concept.
There are still opportunities for expanding the menu. Starbucks is not really competing with the classic “fast food” places such as McDonald’s or Arby’s. Nor is it a full service chain sit-down restaurant such as an Olive Garden or Red Lobster. Starbucks is unique and you must be careful as you add products or services to hold on to that uniqueness.
References
Cooke, J. (2010). Supply Chain Quarterly. Retrieved from http://www.supplychainquarterly.com/topics/Procurement/scq201004starbucks/
Dunkin’ Donuts Prices. (2016). Fast Food Menu Prices. Retrieved from http://www.fastfoodmenuprices.com/dunkin-donuts-prices/
Find a store. (2016). Starbucks.com. Retrieved from https://www.starbucks.com/store-locator?map=39.635307,-101.337891,5z
McDonald’s Prices. (2016). Fast Food Menu Prices. Retrieved from http://www.fastfoodmenuprices.com/mcdonalds-prices/
Market share of the leading coffee chains in the United States in 2014. (2014). Statista. Retrieved from https://www.statista.com/statistics/250166/market-share-of-major-us-coffee-shops/
Mind Tools Editorial Team. (n.d.). Mind Tools. Retrieved from https://www.mindtools.com/pages/article/newSTR_82.htm
Minnick, R. (Approximately June, 2014). Private conversation.
Starbucks Prices. (2016). Fast Food Menu Prices. Retrieved from http://www.fastfoodmenuprices.com/starbucks-prices/
Thompson, A. (23 June 2016). Starbucks Coffee’s Generic and Intensive Growth Strategies. Panmore Institute. Retrieved from http://panmore.com/starbucks-coffee-generic-strategy-intensive-growth-strategies
Trefis Team. (19 September 2016). Forbes. Retrieved from http://www.forbes.com/sites/greatspeculations/2016/09/19/lets-look-at-starbucks-growth-strategy/#1f311af77175
