Wednesday, January 23, 2008

Truth in Advertising? Starbucks' "short" $1 coffee

NPR and the Wall Street Journal report that Starbucks is testing a $1.00 cup of coffee in certain Seattle stores. The cup is being labeled as "short." The bargain does not seem quite as extreme when one considers that a cup like this would normally sell for $1.50--still over-priced for a cup of coffee, but not a price we would normally consider Starbucks league.

This move is reportedly motivated by declining sales. An interesting question, however, is what types of people this cup will attract. Will sales of this item come at the expense of the more expensive concoctions, or will this (1) motivate more people not in the habit of going out for coffee to go for the prestige and mystique of Starbucks, (2) come at the expense of other establishments, or (3) encourage current Starbucks customers to "trade down," or (4) replace current higher end items at Starbucks that would have "drifted" to lower priced establishments in the near future?

One interesting issue is the effect on capacity. In addition to the cost of the coffee at Starbucks, those who show up at peak hours also frequently end up in long lines. Will these low margin sales contribute to longer lines? It may be that one benefit of these lower priced items is that they will be quick to serve. The WSJ reports that Starbucks is also experimenting with free refills at some locations. It is not clear if the $1.00 beverages are included in this. If so, this may cause a lot of people to "hang around" at Starbucks to get the refill, taking up tables. In some areas, this could be a problem at some times. At peak hours, however, much of the business seems to be to go orders, so the "low enders" may not end up crowding out the higher end patrons.

An interesting issue is "margin arithmetic," the question of how many "short" sales are needed to make up for the loss of one "tall," "grande," or "venti" sale. The margin on a $1.00 drink is limited, unless it spurs the buying of some over-priced muffin or bagel. This leaves the question of costs--or, more precisely, marginal costs--of serving this beverage. With economies of scale and limited pressures on capacity, the margins may be decent. There is also the possibility that the new offering will make Starbucks affordable to certain teenagers and other groups who may later, with increasing affluence, "graduate" to the more expensive items.