Will the Hard-Core Starbucks Customer Pay More? The Chain Plans to Find Out
Starbucks, facing competition from McDonald's, seems have decided to raise prices.
Wait a minute... don't firms usually offer lower prices when facing competition? What's going on here?
What's going on here is that Starbucks and McDonald's coffee are vertically differentiated. That is, there's a quality difference between the products --- most customers would prefer Starbucks if the prices were the same. The only way that McDonald's can get customers, therefore, is by offering prices that are so low that customers are willing to accept the lower quality.
So which Starbucks customers quit the brand to instead shop at McDonald's, and which stay loyal? The price-sensitive ones and quality-insensitive ones leave... and the price-insensitive and quality-sensitive ones stay.
This means the following: Prior to McD entry, Starbucks is serving both price-sensitive consumers and price-insensitive consumers. It would like to raise prices for the price-insensitive consumers, but doing so would cause the price-sensitive consumers to stop drinking their coffee.
When McDonald's enters, the price-sensitive consumers immediately stop going to Starbucks --- they now have a lower-priced alternative, and they're happy to give up on quality to save on price.
So who's left shopping at Starbucks? Only the price-insensitive consumers! And this means that Starbucks' customer group has, as a whole, become much less sensitive to prices. And when you have price insensitive consumers it makes sense (and cents) to raise prices.
To stuff this back into economics-y jargon... Competition, in this case, has caused Starbucks demand to become less elastic. And less elastic demand translates to higher prices.
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3 comments:
Consumer Reports likes coffee from McDonalds coffee more than coffee from Starbucks:
http://archive.newsmax.com/archives/ic/2007/1/29/102949.shtml
http://www.consumerreports.org/cro/food/beverages/coffee-tea/coffee-taste-test-3-07/overview/0307_coffee_ov_1.htm
Meg
Meg is a dog (literally --- a border collie specifically), so what does she know?
Anyway, it's largely irrelevant whether Sbux coffee is actually better or whether uninformed consumers just think it's better. The firm is still able to command price premium.
Oh poor Starbucks’ customers!
They have been innocently wrung between the competition strategies of Mc Donald’s and Starbucks. The result is that they have to pay higher prices to get their preferred coffee taste.
Obviously, this is not a case of “loyal customers” as loyal customers are not supposed to be appreciated that way. Starbucks’ customers are paying higher prices as a result of being addicted to the taste of Starbucks coffee.
The article unintentionally gives drug dealers a good lesson for optimally pricing their illegal merchandise.
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