Wake Up and Smell the Coffee: Starbucks Still Doesn't Get It

You own a business that is suffering declining store traffic for consecutive quarters. Your business is being challenged by competitors that offer a quality product at a fraction of the price you charge for yours. What do you do?

If you are Starbucks (SBUX), you raise prices and make the affordability gap between you and your competitors even greater -? Please tell me how this make sense.

Starbucks recently announced that meeting estimates for the upcoming quarter "would be a challenge" due to higher milk and coffee prices. Now, if they were serving more people each day, this decrease in margins would be offset by the additional transactions. What this warning tells me is they are still facing stagnant or declining store traffic in addition to decreasing margins. Can anyone explain how making your product less affordable will solve this store traffic issue?

I mean, Mcdonalds (MCD) and Dunkin Donuts both serve milk and coffee, so we must assume they are facing the same cost pressures, right? It would be foolish to assume only Starbucks is facing these issues. Yesterday, McDonald released results and revenue came in 12% higher at more than $6 billion, while sales at restaurants open for more than a year were up 7.4%.

They also met expectations of 71 cents a share profit from operations, 26% higher than last year and Starbucks admits they are struggling . How did McDonald's do it? They sell a quality product at affordable prices, novel. Said CEO Jim Skinner, "In the U.S., we are aggressively going after the $60 billion beverage industry with the focus on coffee. We added credibility in this arena now with lots of premium coffee last March. Yesterday, premium coffee sales were up 20%. This credibility gave us brand elasticity to expand further into specialty beverages. Currently, we are testing a wider range of offerings, including hot and cold drip coffee beverages an espresso-based coffee and ice beverages. We are encouraged by the preliminary results. Including these specialty offerings, total coffee sales are up more than 30%."

I have been pounding this point since January: Starbucks is at the peak of what they can charge for a cup of coffee. Increasing those prices will lead to further decreases in store traffic and with Starbucks now relying on more ancillary sales to customers for revenues and profits, decreased visits now have a compounding negative effect on the bottom line.

I also fully understand the hard core Starbucks "aficionados" will continue to visit Starbucks, no matter what type of home equity loan becomes required to purchase a latte; it is the casual customer who is walking away in hoards and the numbers continue to back up this assertion. Goldman Sachs (GS) analyst Steven Kron said yesterday that higher prices could reduce store traffic given the state of the consumer, media coverage and increasing competition in the coffee space. Not could, Steve, will.

The only way for Starbucks to reverse this decline is to get more people into their stores. Once there they will buy more muffins, sandwiches, CD, toaster ovens, and SUV's or whatever else they sell there now. Raising prices will not accomplish this. If the consumer is becoming more cost conscious and recent retail sales report would support this, than one must assume discretionary items like a cup of coffee will be one of the first items they will pinch pennies on.

I also recognize that it is only 9 cents on some drinks (ones in cups?), but we live in an appearance-is-reality world out there and the last thing people want to hear nowadays are the words "price increase." It is a turn-off, and the extra revenue they may get per cup is more than offset by the negative sentiment they are creating.

I have asked this question repeatedly and have yet received a decent answer. Why should I pay $5 for a cup of coffee when I can get the same thing for $2 other places and not have the DMV like "wait in line" experience?

Answer? I shouldn't, and apparently increasingly other folks are not either.

Comments

[William Trent1:]

It is unbelievable how much attention has been paid to a relatively small increase in the price of one product, given how much increase there has been in so many others. The fact that it is receiving this attention is simply testimony to the hold Starbucks has on the collective imagination.

2007 Jul 26 09:54 AM

[Todd Sullivan:]

it is the perception of cost that people will take into account..

2007 Aug 07 04:44 PM

[aerius:]

While your article is interesting it contradicts itself. Why should you pay $5 for a coup of coffee when you can get it for cheaper? Why are McDonald premium coffee sales up 20% when they can pay less for the non-premium version? Does the 20% support your comment that "increasingly other folks" are not willing to pay more for coffee?

Since the inception of starbucks their strategy has been to provide a premium product with the associated perception (lifestyle/culture). Business 101, you create a competitive advantage through cost or differentiation; they chose the latter. While I agree that raising prices may reduce store traffic, I think it’s a bit more premature to declare that it is the losing strategy. In my opinion their problems is that competitors are branching out into their niche and they are doing a poor job of defending it. Why are people going to McD instead of Starbucks? Maybe the taste isn’t different enough, the brand isn’t powerful enough, the “random crap” that they sell is diluting the image, whatever. If Mercedes or BMW cut their prices today would that increase the number of people buying them? Probably, but it doesn’t mean that they are making more money or that investors are better off.

2007 Jul 26 10:24 AM

[Todd Sullivan:]

Mcdonald's sells coffee for 1.99 far less than the $5 starbucks does and that is the point.. why pay $5 when it can pay $2? they do not have a "premium" vs whatever else..

2007 Aug 07 04:43 PM

[omooc:]

I heard, yesterday, from a reporter over CNBC, that a financier has been accumulating SBUX. Still, I find your comments compelling. In any case, I like MCD much better -- the dollar menu is my favorite (being a retiree, every penny counts). Besides, MCD serves "senior-citizen coffee" at 50 cents, or even 25 cents -- some stores serve premium coffee for this amount. And there is no wait. SBUX apparently did not do well yesterday and today (-033 and -053, respectively). Of course, MCD cannot make money on dollar menu, but that is another story. Well done. omooc

2007 Jul 26 08:37 PM

[Sherwyn:]

aerius and Mr. Trent just don't get it. SBUX is no longer perceived as having a product that is so much better than their competitors. Yes, SBUX will keep the die-hards, but lose a large number of casual customers. Most people today, don't feel the need to pay that much for a satisfying cup of joe. Econ 101....price-demand curve; they're over the top and heading down!

2007 Jul 27 10:51 AM

[Todd Sullivan:]

sdrucker....

nice reply... thank you

2007 Aug 07 04:45 PM

[cs1001:]

I just threw in the towel with Starbucks. My medium size vanilla latte went up to $4.04 I have been going there for years. There was something about that $4. mark, enough is enough. I just did a post about it on my blog, beyondbitch.wordpress.com

Oct 27 12:21 PM