Starbucks

Starbucks started their first store in Seattle’s historic Pike Place Market back in 1971. The name Starbucks comes from a classic American novel name Moby Dick from Herman Melville about the 19th century whaling industry. Howard Schultz, the Starbucks chairman, president and chief executive officer joins Starbucks in 1983 he was inspired by the famous espresso bar in Milan and started to expand Starbucks worldwide since the 1990s. Today, with more than 18,000 stores in 62 countries, Starbucks is the premier roaster and retailer of specialty coffee in the world. (Starbucks Coffee Company, 2013)
Starbucks is in a restaurant industry, Starbucks is well known for their high quality coffee. Starbucks serve many types of beverage like ice coffee, bottled drink, brewed coffee, chocolate beverages, espresso beverages, frappuccino blended beverages, tea, smoothies and also kids’ drinks. Besides, Starbucks serve food like sandwiches, paninis, salads, muffins, cakes, cookies, croissant, yogurt and fruits as well.(Starbucks Coffee Company, 2013)

Price Elasticity of Demand

Price elasticity of demand measures the extent to which the quantity of demand of good changes when the price of good changes. In order to determine price elasticity of demand we compared the change in quantity demanded with change in price.

McCafe had spread and reached almost 70% of McDonald's outlets now offer specialty coffee had caused Starbucks to face a decrease in demand. This is proven as McCafe expands its reach, Starbucks is moving in the opposite direction, closing 200 U.S. stores is year 2009. (GLOVER, 2013) McCafe is a close substitute to Starbucks which puts Starbucks is in an elastic demand category. If Starbucks were to increase its price of a latte, while McDonalds remain their prices unchanged, Starbucks consumers will change their consuming choice as both Starbucks and McDonalds offers coffee, they are of a close substitute. Starbucks coffee has an elastic demand, some consumer may be addicted to coffee but Starbucks coffee is a luxury not a necessity. The demand for Starbucks coffee will decrease if prices grow because of the huge market of competitor we have that offers the same good and at a cheaper price. For example, when McDonalds and Dunkin’ Donuts is offering their coffee at three to four dollars less where the price is lower than the coffee at Starbucks.

Starbucks is measured on luxurious good both high quality and high price.  Consumers are thinking more about necessity versus luxury. Necessity tends to have inelastic demand and it is unresponsive price change. Whereas luxuries have more elastic demands quantity demand is more responsive to price change and Starbucks coffee is elastic.

Elasticity of Supply

The elasticity of supply measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain the same.

Colombia the second-largest producer of mild arabica coffee bought by companies such as Starbucks Corp. (SBUX) , said consumers will have to get used to higher prices because of reduce in supply. In Colombia, storms last year that damaged flowering likely will cut the second-quarter crop by about 10 percent to about 2 million bags, according to Munoz. Worldwide, producing nations’ stocks are at “precarious” levels and won’t make a sustained recovery, partly because of adverse weather, it has been raining for 2 years. (Walsh, 2013) Such nature disaster causes Starbucks to have lesser source of raw materials to produce coffee. Hence, the firm is unable to respond to the increase in demand and puts Starbucks in an inelastic supply category.  If supply is elastic, Pes>1, producers can increase their output without a rise in cost. However, if the supply is inelastic, Pes<1,the firms will find it hard to change production in a given period of time. When Pes=0, this means that supply is perfectly inelastic. In this situation, crop is unable to grow to its original amount as the rain continues. Therefore, Starbucks is categories under perfectly inelastic supply.

Market Equilibrium

Market equilibrium is a situation in which supply and demand balances each other. Equilibrium in a market occurs when the price balances the plans of buyers and sellers.

The ever-increasing demand for coffee, coupled with supply constraints around the world, is driving up prices. (Dobson, 2011)

This issue is explained by the theory of market equilibrium, an increase in demand and decrease in supply of coffee will cause Starbucks coffee to increase its price to establish an equilibrium market. The change in equilibrium quantity is uncertain because the increase in demand increases the equilibrium quantity and the decrease in supply decreases it. Recent storms that have hit Columbia, the world’s second largest producer of mild Arabica coffee, have hampered Columbia’s supply to companies such as Starbucks Corp. (Dobson, 2011) Such natural disaster decreases the supply of coffee and shifts the supply curve leftward which caused an increase in price to establish the market equilibrium. London-based International Coffee Organization (IOC) says that global coffee consumption rose 2.4 percent to a record 17.7 billion pounds (134 million 60-kg bags) in 2010 and forecasts the upward trend to perpetuate irrespective of the high prices. Coffee prices reached historic highs in 2010, and will likely continue their upward climb through 2011. (Dobson, 2011)  On the demand side, there is an increasing preference for premium coffee from a rising demographic of affluent young professionals in emerging markets like Brazil, China and India. (Team, 2011) As the demand of coffee continues to increase caused by the taste and preference shift towards Starbucks premium coffee, the demand curve shift towards right and price increases to establish market equilibrium.   

Market Structure

Market structure is defined by economists as the characteristics of the market. It can be organizational characteristics or competitive characteristics or any other features that can best describe a goods and services market. The major characteristics that economist have focused on in describing the market structures are the nature of competition and the mode of pricing in that market.

Starbucks is a huge, worldwide corporation. But its competition is all local. For each Starbucks, there are several nearby places that also sell coffee. Starbucks will never be a monopoly, but the idea and panache of Starbucks make the chain unique. Starbucks fans will feel that it is the only place to get their favorite latte. Starbucks is in monopolistic competition. Monopolistic competition is a market in which many firms produce similar goods or services but each maintains some independent control of its own price. Monopolistic competitors cannot influence market price by virtue of their size. No one coffee house is big enough to affect the market price of a cup of coffee even though they can take control of their own selling price. Competitors of Starbucks like Costa Coffee, Coffee Bean, Caribou are all selling latte, espresso, cappuccino, tea and bakes goods like cake and muffins etc. Therefore, in a monopolistic competition, all coffee houses achieve whatever degree of market power they command through product differentiation. Product differentiation is a strategy firm uses to achieve market power. Accomplished by producing products that have distinct positive identities in consumers’ mind. Starbucks gain control over price in a monopolistic competition by differentiating itself through branding. Consumers become loyal to the brand Starbucks and only buy coffee from Starbucks. Brand loyalty is able to convince the consumer that Starbucks version of coffee is unique and more desirable than that of the competition. As long as the consumers remain brand-loyal, Starbucks could increase the price without losing the quantity demanded by their consumers. Brand-loyal consumers have high repurchase rate, they buy the same brand again and again. The company’s strategy to focus on their core competencies to differentiate themselves has made Starbucks into a coffee powerhouse.

Operating in a monopolistic competitive society, Starbucks has been able to maintain customers in the short run that were more interested in their details rather than price.  When a business is making a profit in the short run, they will eventually reach equilibrium in the long run because their demand will eventually decrease, as we have seen in the recent times.  Due to this, in the long run, this monopolistically competitive firm will result in a zero economic profit.  Because Starbucks has profited on their brand loyalty, they know that some loyal customers will never depart despite the towering prices.

With the news of Starbucks closing six hundred store,(Herman, 2008) it is evident that they have been running in a marginally inefficient business model.  Most monopolistically competitive firms are marginally inefficient because production average total cost is not at the lowest point.  With a downward-sloping demand curve, long-run equilibrium will not occur at minimum ATC. In this event, in the long run, the marginal cost is simply less than the price of the good.  This translates to the price of the Starbucks beverage to be marked up over the cost of production.  The cost of producing for Starbucks may not be the most cost-effective, but it is less than the price charged for their gourmet brews.  

Reference List :

Dobson, C.

Coffee Prices Soaring as Supply Can’t Keep Up With Demand | Global Markets | Business | Epoch Times

In-text: (Dobson, 2011)

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GLOVER, K.

More Bad News for Starbucks as McCafe Moves in For the Kill

In-text: (GLOVER, 2013)

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Herman, C.

Venti Trouble? Starbucks To Slash Stores

In-text: (Herman, 2008)

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Starbucks Coffee Company.

Our Heritage

In-text: (Starbucks Coffee Company, 2013)

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Starbucks Coffee Company.

Starbucks Coffee Company

In-text: (Starbucks Coffee Company, 2013)

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Team, T.

Starbucks Shielded From Rising Commodity Costs

In-text: (Team, 2011)

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Walsh, H.

Starbucks Drinkers Won’t Get Break as Colombia Supply Drops

In-text: (Walsh, 2013)

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