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Ever since Starbucks (SBUX) raised its prices by about $0.09 a cup, there has been a lot of speculation that the move will push customers to McDonalds or Dunkin Donuts, or that the move will hurt Starbucks' business in general. While it's true that consumers in general have less disposable income than they used to and that the number of competitors in the "Gourmet Coffee" space has increased, I don't think this move will hurt Starbucks’ business at all.

First off, unlike your typical fast food business that focuses on speed, price, and taste, Starbucks’ business is based around the customer experience, the product, and selling a sense of "affluence" to its customers. Starbucks' competitive edge has never been around pricing, a dollar menu, etc.

It has always been about selling the experience where you get a cup of coffee, read the newspaper, read your e-mail on your blackberry, get some work done on your laptop, or spend time with friends. That's an experience you simply can't get from another "Fast Food" provider and it's definitely not something that people are going to look to McDonalds or Dunkin Donuts to provide.

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In fact, if you compare the Starbucks to the business that many analysts peg as its competitors in the coffee space, you have to come to the conclusion that Starbucks isn't competing with those companies in the first place. True, Dunkin Donuts, Starbucks, and McDonalds all sell coffee, but generally speaking, they sell it to different groups of customers who have different motivations for buying. So while there is some overlap, Starbucks isn't in direct competition with McDonalds or Dunkin Donuts.

Second, McDonalds’ coffee [even though some people prefer it] and Starbucks’ coffee aren't the same animal. The former sells a more commoditized product whilst the latter sells multiple varieties of coffee to customers who nearly always request their own personalized version. The customer who wants their preferred blend with 1/2 soy milk, 1/2 organic skim milk, whipped cream, and a whisper of cinnamon can't exactly get what they want from Dunkin Donuts or McDonalds.

Now, it is worth noting that with some consumers preferring McDonalds, this is a wake-up call for Starbucks to re-examine its product formulas. However, at the end of the day, you simply can't get the same exact product from McDonalds.

Third, it's an increase of nine cents, not an increase of nine percent. If you're already in the habit of paying $5.30 for your favorite blend of coffee, an extra $0.09 isn't going to make a difference. Nine cents amounts to an increase of 1.7%, less than the "stated" rate of inflation and is probably too small for most customers to even notice. Plus, seeing as how Starbucks is a ubiquitous "yuppie hangout", I doubt its affluent customers are going to be crying over nine cents and running to McDonalds.

I also suspect that for many people, Starbucks is a common, every day luxury. If pinched household budgets force people to give up the weekend car, the new Plasma TV, vacations, luxury clothing, etc. $5 coffee may be the one of the few luxuries they're able to keep. The nine cents probably only meant something to the worried analysts and people who never liked Starbucks and thought the coffee was overpriced in the first place.

Whilst Starbucks’ earnings growth has been declining as of late [the recent strong quarter not withstanding] it hasn't been due to pricing. Instead, I think a lot of their growth was driven by expansion/building new stores, and at present, they've saturated the US market and have created a situation where they've become ubiquitous. In order to generate long-term growth, Starbucks has to continue to find new ways of monetizing its current customer experience, strengthening its brand as a provider of high-end coffee, and providing a unique customer experience in addition to continuing to expand into foreign markets.

Higher prices aren’t going to necessarily hurt a company that was never in the habit of competing on price. Instead, such a company needs to be able to continue to build its brand and sell a customer experience that people will pay a premium for. If anything, the nine cents price increase was a good move in light of the higher cost of milk, chocolate, etc. At the end of the day, Starbucks’ future will always be based on its ability to continue to build its brand, further monetize the customer experience, and expand into new markets.

Disclosure: The author doesn’t own a position in Starbucks; however, he is the only non coffee drinker in Seattle.

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Source: Starbucks Price Increase: Much Ado About Nine Cents