Starbucks: A Venti Triple Mocha Latte Experience

Starbucks - it's becomes a household name. Not only for it's super-caffeinated coffee and long, confusing names but for it's high prices. Everybody knows that if you want to grab a cup of anything from the gourmet coffee chain, you need some money in your pocket.

One would think that this would turn customers away. Why would someone want to buy a $2 cup of java when they can go to a place like McDonald's or Dunkin Donuts and get the same size for almost a dollar less? Clearly Starbucks must be doing something right, because they're customers would never think of doing such a thing, even after a market-wide 3% price increase (reviewjournal.com).

October 16, 2004 was a sad day for Starbuck's loyalists everywhere. It marked the day that the company raised it's prices by $0.11 across the board. Customers everywhere threatened to do the unthinkable, and go to rival chains. Long-time customer Chris Bradshaw said this about his daily "venti decaf mocha latte" habit:

"The price increase may cause me to think about the price in a way I haven't thought about it before." (reviewjournal.com)

Even though fellow patrons agreed with Mr. Bradshaw, it clearly wasn't enough to make an impact. Revenue still jumped to almost $5,300 million (hoovers.com) - an increase of approximately 20% from the previous year (investor.starbucks.com), and totaled nearly $3,100 million in profit. On top of that, sales continued to climb $6,400 million in 2005 and $7,800 million in 2006, with growth profit margins of 59.1% and 59.2%, respectively. Futhermore, in just that one tragic week, stocks rose from $45.50 to $49.47!

There are many reasons that customers and economics enthusiasts both believe could have contributed to this price raise, the most important one being the steep rise in coffee bean and sugars (reviewjournal.com). Starbucks faced the problem of either shortening supply, which would most likely result in angry customers, or increasing prices, which would also angry customers - but many not quite as much. Thankfully, Starbucks coffee seems to be fairly price inelastic, meaning that the price of the coffee does not effect the quantity of coffee sold. See for example, Figure 1.

The supply and demand "curve" is vertical to the price axis. This shows that even though the price has jumped, the quantity supplied has remained mostly the same. A small coffee shop, a local Dunkin' Donuts or McDonald's may have a completely different graph - the curve most likely would have been horizontal, sloping downward, telling us that as the price rose, quantity sold fell. This would mean the it would be an elastic product, meaning that changes in price greatly impact changes in quantity.

So what makes Starbuck's inelastic, instead of elastic like most other coffee companies? It could be the fact that it has triple the amount of caffeine as a No-Dos in one 16oz cup, it could be simply the fact that it's become a household name, or maybe it's just that they're names sounds so sophisticated (and confusing!). Either way, one can be sure that according to the laws of supply and demand, we'll be seeing Starbuck's for quite a long time!