Elasticity Estimates

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.

Suppose Starbucks raises the price of latte from $3 dollars to $5 dollars a cup the quantity of

demand would decrease. If Starbucks were to increase its price of a latte McDonalds, Panera

Bread, Krispy Kreme, and Dunkin Donuts would decrease their prices in order to compete.

When price rises, quantity demanded decreases along with the demand curve. This will allow

price and quantity to always change in opposite directions.

Starbucks coffee has an elastic demand, some 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 “McDonalds and Dunkin’ Donuts is offering coffee at three to four dollars less than the

coffee at Starbucks”. Now with the value of U.S dollars gradually falling, the incomes of

consumers have diminished. As income fall, the demand of normal goods will decrease and will

cause a shift in the demand curve. 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.

http://welkerswikinomics.com

Income elasticity impacts change in demand curve. When income increases the quantity of

demand increases and when income decrease quantity of demand decreases. An article from

Business week states “according to Oct. 5, 2006 presentation to analysts, customers who shopped

Starbucks for the first time in the last year had an average income of $ 80,000 a year vs. the $ 92,

000 a year average for those who first visited five years ago. As incomes increase, some goods,

for some people, become “inferior.” This just means that as income increases, these people

consume more this good. Consumers will switch into a more expensive or more-prestigious good

the more money they make. So if Starbucks coffee price is high customer that make enough

money won’t mind the high luxury price and will still consume the latte’s Starbucks provide.

The concept of cross-price elasticity of demand measures the responsiveness of consumers of

one good or service to the change in price of another. If two goods are substitutes, we expect to

see consumers purchase more of the good when the price of its substitute increases. If they

complement each other we should see a price rise in on good cause demand for both goods to

fall. Basically impact of prices changes substitutes and complements when the price of related

good changes. Cross-price elasticity of demand is used to see how sensitive the demand for a

good is to a price change of another. High positive cross-price elasticity tells us that if the price

of one good goes up, the demand for the good goes up as well. A negative tells us the opposite

increase in the price of one good cause a drop in the demand for the other good. A small value

either negative or positive would tell us that there is little relation between the two. If the cost of

milk goes that would impact on the cost of latte because milk is a complement to coffee.

www.businessweek.com

A big impact on sales has to do with pricing of products and sales which increase revenue

growth. When a product becomes acceptable to consumers and is substituted by another that

would suggest McDonalds, Panera Bread, Krispy Kreme, and Dunkin Donuts coffee strategy

would hurt and severely damage Starbucks. Starbucks coffee has an elastic demand even though

some may be addicted to coffee Starbucks coffee will decrease if the price grows only because of

the availability from other companies such as McDonalds, Panera Bread, Krispy Kreme, and

Dunkin Donuts which they will offer a much cheaper price to attract the consumers. The other

firm’s prices are three to four dollars less then the coffee at Starbucks. The problem lies in

Starbucks insisting on saying that they are in a different market place then McDonalds, Panera

Bread, Krispy Kreme, and Dunkin Donuts. Starbucks claims that no one will switch or even

think about switching or sometimes go to other companies such as McDonalds or Dunkin Donuts

etc. That is just foolishness because everyone knows if you prefer Cook, occasionally you will

have a Pepsi especially when it comes to saving. If Starbucks were to increase its price of a latte

from $3 dollars to $5 dollars McDonalds, Panera Bread, Krispy Kreme, and Dunkin Donuts

would decrease their prices in order to compete.

In comparison “vastly increase competition in coffee market. McDonalds entered into the

Premium coffee selling for $1.39 for a small compare to Starbucks $1.75.” McDonalds has been

aggressively markets its coffee winning breakfast time from the consumers and includes

promotional items to allure them in. To which Consumer Reports indicate that they are head-to-

head comparisons with the coffee from Starbucks.

Starbucks faces three major obstacles first competition especially with U.S being the fast pace

economy that it is. Starbucks would have to adapt to change of the constantly growing and

recession with in the industries in order to draw consumers. With competition the price of

Starbucks coffees and products sales will be the central point for buying power of the consumers.

Starbucks would have to make sure that the products they sell and the price are beneficial to

them and the consumers. In the middle of last year I read that Starbucks is in trouble. They

announced that they will close 600 stores. With the price of gas climbing Americans are making

wiser choices in finance. Consumers are skipping the $4 dollars latte and going to competitors

and spending less and making easier choices.

Pricing Strategy

Starbucks positions itself as a specialty premium coffee retailer and has a strong and well known

brand image. As Starbucks is a premium coffee brand, its target market has always been middle

and upper class with the disposable income needed to frequent the coffeehouse. One of the main

reasons Starbucks has been so successful is because they focus on quality and experience rather

than price. The Starbucks’ image and experience has been one of the key elements to their

success. Starbucks has succeeded in giving coffee a new cachet and established themselves as a

price setter through product differentiation. Consumers have been willing to pay for what they

consider an elite lifestyle and many believe that the higher the price, the better the quality.

Although premium brand coffee makers have some market power to set prices above the generic

value brands, Starbucks operates under monopolistic completion where there are many small

firms that sell similar products, therefore they do not exert complete market power in the

industry.

Starbucks has, up until now, been able to take advantage of premium pricing but according to an

article in Business week, “Starbucks is looking to rebound from dismal US sales as more

consumers cut back on spending. In its first-quarter report last week, same-store sales - a key

indicator of a retailer's performance - dropped 10 percent. That's worse than the 8 percent decline

in the fiscal fourth quarter.”

Because there are a lot of options for the more cost conscious consumer looking to save money

on coffee purchases, Starbucks felt the need to make a price change. After all McDonald’s Corp

is offering new, lower-priced specialty coffee drinks and Dunkin' Donuts is advertising value-

minded deals. So when Starbucks founder ,Howard Schultz, decided to offer a $1 cup of coffee

in certain stores to compete with McDonald’s and to increase existing store sales, some critics

thought it may have done more harm than good. Their thoughts were that the decrease in price

may have implied that there is nothing more to Starbucks than coffee. By offering a cheap cup of

coffee, Schultz may be reducing the company to commodity status, and the natural result being a

price war. No longer is buying a cup of Starbucks coffee an experience. But because coffee is an

elastic product in which price controls demand, Starbucks may want to consider a small decrease

in their price to increase demand which will increase revenue and allow them to be more

competitive.

Pricing decisions also serve as a marketing tool and is one of the most compelling attributes of

product positioning. It makes a very clear statement about how a consumer should perceive a

product. Starbucks cannot become the low price leader; it takes away from the brand image and

ambience that they are known for.

When Starbucks became a major competitor, it was because the company’s environment was like

none other and focuses on the benefit of the customer. People considered Starbucks as a “third

place” after home and work. Howard Schultz’s vision was not to build a coffee shop, but instead

build a company that treats people with dignity and respect. He wanted to establish a place

where you can go relax and have a delicious coffee and smother yourself in a comfortable seat

that makes you feel like you’re sitting on your living room couch. Ear pleasuring music will be

consuming your background and make a customer feel as if they are at their home away from

home. Or a place where you can bring your laptop and get some work done if there were any

distractions at home or work. Starbucks is also the type of place where you can meet a friend,

stay and talk for hours, and feel like you’re the only two people in the place.

Customers and employees as well receive an experience for Starbucks, in which Starbucks

constantly strives to pleasure everyone around them. The environment is so inviting, relaxed,

and probably trendier than most people’s living room, and at the same time, quick paced if you

need a coffee to-go. Starbucks has set an environment where the relationship between customers

and employees sets the company apart from other coffee shops. Starbucks sets a different type

of trend than any other coffee house that seems to be contagious to customers and even other

companies.

One area of business that Starbucks spends the least amount of their money on is its

advertisements compared to competitors. Schultz believes that experience beats ads. In an

article from Businessweek.com “Starbucks: Keeping the Brew Hot”, explains that given that

philosophy of experience beats ads, conventional advertising has been no real significance to the

growth of the Starbucks brand. Rather, it has been the store experience that has defined the

brand. This begins with the quality and intense flavor of the coffee. But equally influential are

the store design and ambiance as well as the recruitment and training of the “baristas,” the

counter staff whom Schultz regards as his brand ambassadors.

Instead of putting millions into image-building campaigns, Starbucks has chosen to spend its

money on employee benefits. Starbucks was one of the first companies to offer part-time

employees equity and health benefits, unlike its competitors in which it’s hard for them to

imitate.

Starbucks has also created projects that have given back to the community, created recyclable

products, and has branched off into different brands, which has brought the company to another

level. Starbucks constantly strives to be different and better than everyone else and if they stick

to their core competencies, the company will continue to be successful.

Since Dunkin Donuts is a privately held company, no financial information is available to

determine its share of the market. But based on the amount of stores that Dunkin Donuts has, it

would be safe to assume that they have captured much of the market. And because McDonalds

serves many more products than the other key competitors, it may be extremely difficult to report

accurate market share information.

Based on the information that is available, McDonald is the market leader. Starbucks market

share has been increasing steadily over the last couple years, but Panera Bread has the largest

increase in market share over the past year. Meanwhile, McDonalds, Krispy Kreme, and

Caribou Coffee have been decreasing.

There are four ways that companies can do to improve market share. Make a better product than

that of the competitors, change the price or offer special incentives for buyers, such as discounts

or sales, find new distribution channels to reach more consumers, advertise and promote the

products. Although the price appears to be higher than most of their competitors, the fact that the

coffee contains more caffeine per cup, that one cup may be enough for the entire day. This could

actually save both time and money opposed to having to buy more than one cup.

Starbucks relies on its relationships with coffee producers, outside trading companies, and

exporters for its supply of green coffee. The company is dedicated to selling only the finest

whole bean coffees and coffee beverages therefore it purchases green coffee beans from coffee-

producing regions around the world. Because the supply and price of coffee are subject to

significant unpredictability, the company tends to trade on a negotiated basis at a significant

premium above commodity coffee prices. The amount negotiated depends on the supply and

demand at the time of purchase. Supply and price can also be affected by other factors in the

producing countries, including weather, political and economic conditions. Agreements

establishing export quotas or by restricting coffee supplies have also affected price. Due to

unpredictability in the prices, the company has largely used fixed-price purchase commitments to

be sure they have enough of a supply of quality green coffee and control the price. This contract

states the quality, quantity, and delivery of the coffee.

Forecast

Determents of Demand

Determinants of demand consist of 1) price, 2) the incomes of consumers, 3) the prices of related

goods and services, 4) the tastes of preferences patterns of consumers, 5) the expected price of

the product in future periods, and 6) the number of consumers in the market. These variables

change the quantity demanded at each price and determine where the demand curve is located.

Price—with all other things remaining constant, as the price rises, the demand will fall and

inversely, as the price falls, the demand will rise.

As the price of Starbucks coffee increases, the demand for that particular brand of coffee will

decrease. In this event, many people may choose not to drink Starbucks coffee and decide to

switch to a less costly alternative such as frequenting a lower cost coffeehouse, purchasing

coffee at a gas station, or perhaps even brewing their coffee at home. Other alternatives to coffee,

such as teas, energy drinks, or any caffeinated beverage may also take the place of coffee. As the

price of Starbucks coffee falls, consumers will demand more of the coffee because it will be

more affordable.

For example, if the price of a cup of coffee went up by $0.25, consumers could replace their

morning caffeine with a cup of tea. However, if the price of caffeine were to go up as a whole,

we would probably see little change in the consumption of coffee or tea because there are few

substitutes for caffeine. Most people are not willing to give up their morning cup of caffeine no

matter what the price.

Income -- as income increases the demand for a product will increase as well. As income

declines, the demand for the goods will go down as well.

In today’s economy, many people have been losing their jobs or have had their income reduced.

As a result, consumers have had to cut back on non-essential items such as higher end coffees

like Starbucks. Many people will no longer be able to afford the $4-5.00 specialty beverage.

When income increases, people have more disposable income therefore are able to treat them to

a specialty beverage.

Complements --If the price of the complement rises, the demand for the product falls. If prices of

the complements go down there will be a higher demand for the product. Complements of

Starbucks coffee can be milk, cream, sugar, sugar substitutes, and flavored syrups. For example,

if the price of sugar should increase, many consumers may be unwilling or unable to purchase it

and opt for another alternative, which would decrease the demand for coffee. On the other hand,

if the price of sugar goes down, consumers will be able use it for many more things including

sweeten their coffee.

Substitutes-- As the price of the substitute rises, the demand for the product rises. As the price of

the substitutions goes down, the demand for them will increase.

Substitutes for Starbucks coffee could include cheaper coffees, teas, hot cocoa, water, energy

drinks, soda, and caffeine pills. If the price of any of these substitutes should rise, the demand for

coffee will rise because consumers will be unable or unwilling to pay the additional price and

switch back to coffee.

Tastes— As preferences for a particular good or service changes, so will the demand for the

item. If people enjoy drinking and develop a preference for the stronger tasting Starbucks

coffee, they will want more of it. If consumer do not like the stronger tasting Starbucks coffee,

the will want less of it. Income changes and lower priced substitutions could affect their tastes

and a cheaper priced alternative could become a new preference.

Expected prices— If a consumer expects that a price of a certain commodity will rise than they

may opt to stock up on the product as the lower price before it goes up. Inversely, consumers

may believe that a price of a good will be reduced, they will hold off on purchasing the product

until the price goes down to the lower rate. Many consumers may stock up on Starbucks coffee

beans if they know that the price is going to be increasing in the near future. On the other hand,

consumers may wait to make their Starbucks purchase if they know the prices are going to drop

in the near future.

Number of consumers-- If there are more buyers than there must be more of a market demand.

The more consumers, the more demand. The higher the demand for a good the higher the prices

will rise.

State technology—Producers will search for advanced, economical technology so the cost of

producing Starbucks coffee will decrease. The lower the cost in production of the coffee results

in a higher supply due to the cost effectiveness of the production. According to Starbucks 10k

report, Starbucks relies heavily on information technology systems across its operations,

including for management of its supply chain, point-of-sale processing in its stores, and various

other processes and transactions. The Company’s ability to effectively manage its business and

coordinate the production, distribution and sale of its products depends significantly on the

reliability and capacity of these systems. The failure of these systems to operate effectively,

problems with transitioning to upgraded or replacement systems, or a breach in security of these

systems could cause delays in product sales and reduced efficiency of the Company’s operations,

which results in higher production costs.

Expected price of the good—Producers may withhold production of Starbucks coffee in the

current period if they expect the price of coffee to rise. They will be more willing to sell the

coffee at a higher price rather then selling and producing at the lower price.

Number of firms— The higher the number of coffee suppliers in the industry the higher the

supply of coffee in the industry. There will be more coffee to go around for the consumers. If

there are more buyers than there must be more of a market demand. The more consumers, the

more the demand. The higher the demand for a good the higher the prices will rise.

Forecasting

Sales forecasting is the process of estimating what the business’s sales are going to be in the

future. Sales forecasting is an important part of business management. Starbucks cannot

manage inventory, cash flow, or plan for growth without an idea of what future sales are going to

be. A business’s sales revenue from the same month in a previous year, combined with

knowledge of general economic and industry trends, work well for predicting a business’s sales

in a particular future month.

There are various forecasting models that can be used for forecasting sales for coffee. Two

methods are qualitative and quantitative. The qualitative method uses subjective judgment based

on non-quantifiable information, such as management expertise, industry cycles, research,

development, and labor relations. The qualitative method does not require a demand history for

the product or service. The quantitative method is a research method that relies on interviews,

observations, and a small number of questionnaires, focus groups, subjective reports and case

studies. Much of the focus is on collection and analysis of numerical data and statistics.

Starbucks is subject to a number of significant risks through qualitative and quantitative methods

that might cause the company’s actual results to vary materially from its forecasts, targets, or

projections. The significant risks involved are lower customer traffic or average value

transactions. These negatively impact comparable store sales, net revenues, operating income

and earnings per share. These risks are due to the impact of initiatives by competitors and

increased competition with lack of customer acceptance of price increase to cover costs of new

products. Delay in store openings for reasons beyond the company’s control, or lack of desirable

real estate locations available for lease at reasonable rates, both of which could keep the

company from meeting annual store opening targets and in turn negatively impact net revenues,

operating income and earnings per share. Other risks are material interruptions in the company

supply chain beyond its control, such as material interruption of roasted coffee supply due to the

casualty loss of any of the Starbuck’s roasting plants or the failures of third-party suppliers, or

any interruptions in service by common carriers that ship goods within the company’s

distribution channels.

The qualitative method is best used for forecasting the next three years since it emphasizes on

real time expert’s research and analysis. The numbers are variable and subject to change based

on opinions from consumers and by far the economical changes that have the greatest impact on

sales!

Summary/Conclusion

Starbucks has had much market power in the gourmet coffee industry. They have attracted

customers by an experience of an upscale French coffee shop with a neighborhood feel. All are

welcome to join the bandwagon as long as they are willing to pay the price for premium. In the

current economic state, their prices have caught up to them causing their demand to decrease.

Peopledo not want to spend their limited income on premium coffees that they can get from any

of their competitors, like Dunkin’ Donuts, McDonalds and Panera Bread.

Starbucks has been forced with the changing times and the economy to drive down their prices to

compete in the industry. The closing of stores and the reduction of staff proves that their pricing

model only projected a short term profit, as in the case of any firm operating in a monopolistic

competition. Whatever forecasting models Starbucks has projected does not hold true as the

income effect and added popularity of their competitors began monopolizing the premium coffee

market. This proves that the price of coffee is elastic and if prices are high than the demand for

the good will decrease.

Many outside factors also contribute to Starbucks losing its brand appeal. People have begun to

realize that they have alternatives to purchasing Starbucks coffee and still sample the luxurious

blend by brewing it at home themselves. Customers no longer follow the hype supported by the

Starbucks name and are becoming more price/value oriented. To remain a major player in the

coffee shop market, Starbucks must reinvent themselves with the changing lifestyles, tastes and

react to the alternatives within the market.

Works Cited

2 Feb. 2008 <http://www.mhhe.com/business/management/thompson/11e/case/starbucks-

2.html>.

"2007 National Coffee Drinking Trends Report." http://theshot.coffeeratings.com. 19 July 2007.

"Business & Commerce.” UniXL. 01 Feb. 2008 <http://www.unixl.com>.

"C.A.F.E Practices." www.starbucks.com. 10 Feb. 2008.

Coffee Talk Supplier Guidelines at Starbucks. 2 Feb. 2008

<http://www.greenbiz.com/news/reviews_third.cfm?NewsID=26691>.

"Corporate Update.” UBS. 30 Jan. 2008 <www.ubs.com/indepedentresearch>.

Darby, Seyward. "Polish Rivals Shrug Off Starbucks Arrival." Business Week. 13 Feb. 2008. 7

Mar. 2008 <http://businessweek.com>.

Delsalvo, D., J. Kennon, and E. Koch. The Complete Idiots Guide to Investing 3rd Edition. New

York, NY: Alpha Books, 2005.

Flight, Georgia. "Grinding Out Success Next to Starbucks." www.cnn.money.com. 15 Mar.

2007.

Gillespie, Elizabeth M. "Starbucks Axes Sandwiches as Part of Fix." Yahoo. 31 Jan. 2008. 7

Mar. 2008 <http://biz.yahoo.com>.

Goldman, David, ed. "Starbucks Puts the Brakes on New Stores." CNNMoney.Com. 12 Feb.

2008 <http://money.com/2008/01/30/news/companies/strabucks_earnings/index.html>.

Groppeelli, A., and E. Nikbakht. Finance 5th Edition. Hauppauqe, NY: Barron's, 2006.

Holmes, Stanley. "Starbucks: Keeping the Brew Hot." Business Week. 6 Aug. 2001. 7 Mar. 2008

<http://www.businessweek.com>.

http://www.quickmba.com/marketing/market-share/.

"Key Statistics." Yahoo Finance.Com. 7 Mar. 2008 <http://finance.yahoo.com/q/ks?s=SBUX>.

"Liabilities." Wikipedia. 23 Feb. 2008 <www.wikipedia.com>.

Lynch, Peter. One Up on Wall Street. New York: Simon & Schuster Paperbacks, 1989.

Mizrahi, Charles. "Starbucks Vs. McDonals." Gurufocus.Com. 12 Feb. 2008

<http://www.gurufocus.com/news.php?id=21677>.

"National Coffee Drinking Trends." The National Coffee Association of USA, Inc. 10 Feb. 2008

<http://www.ncausa.org>.

"New Starbucks Open in Rest Room of Existing Starbucks." The Onion. 13 Feb. 2008

<www.theonion.com>.

Parnell, John. Strategic Management. 2nd ed. Cincinnati: Atomic Dog, 2006.

Press, Associated, and Bw Staff. "Starbucks' CEO Refill." Business Week. 7 Mar. 2008

<http://www.businessweek.com>.

Pressman, Aaron. "Starbucks: Trouble in Latte Land." Business Week. 16 Nov. 2007. 13 Feb.

2008 <http://businessweek.com>.

Press Release. "Starbucks Launches the "Hear Music Media Bar"" Starbucks. 14 Oct. 2004. 25

Feb. 2008 <http://starbucks.com>.

"SBUX Annual Report." MarketWatch. 31 Jan. 2008 <http://marketwatch.com>.

Sellers, Patricia. "A Double Shot of Productivity." CNNMoney.Com. 12 Feb. 2008

<http://money.cnn.com/magazines/fortune/fortune_archive/2006/10/16/8390317/

index.htm>.

Starbucks.Com. 2008. 9 Feb. 2008 <http://www.starbucks.com/aboutus/environment.asp>.

"Starbucks Company Profile." Investorguide. 31 Jan. 2008 <http://www.investorguide.com>.

Starbucks Corporation Fiscal 2007 Annual Report on Form 10-K. Washington, DC: United

States Securities and Exchange Commission, 2007. 9 Feb. 2008 <http://media.corporate-

ir.net/media_files/irol/99/99518/200710K.pdf>.

"Starbucks Investor Relations." www.starbucks.com. 05 Feb. 2008.

"Supplier Code of Conduct." www.starbucks.com. 20 Feb. 2008 <www.starbucks.com>.

"Supplier Diversity." www.starbucks.com. 06 Feb. 2008.

"The Value Chain." 02 Feb. 2008 <www.netmba.com/strategy/valuechain>.

"What America Drinks." Beverage Marketing Association. 16 Feb. 2008

<http://www.ameribev.org>.

Zelman, Kathleen M. "What's the Buzz About Energy Drinks?" WebMD. 10 Feb. 2008

<http://www.webmd.com/diet/guide/whats-the-buzz-about-energy-drinks>.