Competing As Starbucks

In the book “Principles of Microeconomics 6Ed”, (261) by Sayre Morris States that for a firm to be considered in perfect competition, the following four features of perfect competition must be met:

·         Many small buyers and sellers all of whom are price takers.

·         No preferences shown.

·         Easy entry and exit by both buyers and sellers.

·         Same market information available to all.

Starbucks does not seem to be in a perfectly competitive market because the four features of perfect competition, as stated above, are not met in entirety. Clearly the feature “no preference shown” is not met. Some customers prefer Starbucks coffee either due to the experience they provide or the taste.

Starbucks needs to get back to the core business values as they have shifted away from it.  Chairman Howard Schultz stated in the memo that “due to the commoditization of the Starbucks experience” decisions, “have lead to watering down of the Starbucks experience, and, what might call the commoditization of our brand”. La Marzocca coffee machines were installed to provide faster service and cut costs. The installation of these machines blocked customers from watching the drink being made and removed the intimate experience with the barista. The memo also confirms that the sum is much greater but much more damaging than individual pieces. Due to deep recession, especially in the US, customer income dropped and customers started to look for alternative products and the demand for Starbucks dropped.

The drop in demand for Starbucks coffee and the decline in revenue forced the company to close stores. As company noted that “many of the unprofitable stores were being cannibalized by nearby Starbucks locations”.  The company decided to shut those stores which were not profitable where the total losses are greater than total fixed cost. Starbucks claimed that store closures will lead to pre-tax charges of about $328 million to $348 million, including severance pay and lease termination costs (mostly short term costs). Instead of dipping more into the red, the firm decided to close those stores and increase the sales of nearby stores.

Starbucks coffee is very expensive compared to its competitors. The company was able to charge the higher prices by providing good service and an experience above and beyond its competitors. The brand name is also valued highly by the customers.  According to businessinsider.com “11 Things Starbucks Does Better Than Almost Any Competitor”. (http://www.businessinsider.com/starbucks-does-better-2011-7?op=1)

If Starbucks reduces the price of their coffee, their profits will increase. The upper half of the demand curve is elastic and the lower half is inelastic. We can see from the graph that revenue starts rising when the price drops from $5 to $2.5. At $4.5 the quantity sold is 1 million so the revenue is $4.5 million. Revenue keeps rising until the price drops to $2.5. When the price drops below $2.5 then revenue starts falling.