Feb 25 2009

Starbucks instant coffee: a sign of the times?

Chicago, Seattle first markets to get instant Starbucks — chicagotribune.com

I consider myself a Seattleite. I discovered the joy of drinking coffee in the home of Starbucks, Tully’s, Seattle’s Best, and countless local coffee shops that inhabit every corner of the rainy city.http://static.guim.co.uk/sys-images/Guardian/Pix/pictures/2008/02/25/0225_starbucks_460x276.jpg To me, the experience of drinking a latte, machiato, cappuccino, or simply a “coffee of the week” encapsulates the smells, soft decor and friendly greetings from the barista at my favorite coffee shop. Living overseas, I have turned to Starbucks over and over for a taste of Seattle and a feeling of home.

There is no denying that the Starbucks experience is one that does not come cheap. Here in Switzerland, a grande latte, my drink of choice, sets the consumer back nearly $7. In an economic downturn such as that the US and the rest of the world are experiencing right now, such expenses are often the first to be reduced by cash strapped consumers. In fact, I recently began bringing a thermos of homemade coffee to work every day, rather than stopping at the Starbucks at the train station as I had done for several months not long ago.

Starbucks, which recently announced the closure of hundreds of its locations around the world, is actually expanding its product line while simultaneously closing down shops. It may not be in the way you expect, though. Soon, I’ll be able to get my $7 cup of coffee for as little as $1, it will just come in a different form:

Starbucks Corp. will launch its new instant coffee product next month in Chicago and its home turf of Seattle, with a full-scale, national offensive set for the fall.

Starbucks on Tuesday formally unveiled the new product, called Via Ready Brew. It will be available in Starbucks retail outlets in the Chicago and Seattle areas on March 3, Howard Schultz, the company’s chief executive, said in an interview with the Tribune.

Instant coffee from the king of gourmet blends? Sounds suspicious. Well, it’s all about economics, you see. Starbucks coffee is a normal good, one for which demand falls as incomes fall, as evidenced by falling sales at its coffee shops around the world. In order to maintain its customer base even as incomes fall, a company like Starbucks must expand its product line to include inferior products, or those for which demand increases even as incomes fall. Clearly, instant coffee is viewed as an inferior product, due to its significantly lower price and reputation of poor quality.

Furthermore, Starbucks’ new product is in response to increased competition from lower-end fast food chains that traditionally did not compete in the coffee market, but recently have begun offering various blends and varieties of coffee to the price-sensitive coffee consumers, further harming business at Starbucks’ higher end coffee outlets.

Via marks Starbucks second announcement this month of a cheaper menu alternative, as the famous coffee chain struggles in a weak economy. Starbucks is also now selling pairings of coffee and breakfast offerings for $3.95.

Starbucks’ troubles have occurred at the same time value-oriented fast-food chains, particularly Oak Brook-based McDonald’s Corp., have thrived. McDonald’s owes part of its success to improving the quality of its basic coffee, and expanding into new drinks like iced coffee, and, more recently, flavored specialty coffees such as lattes and cappuccinos.

Still, Schultz said McDonald’s coffee offensive hasn’t really affected Starbucks: “We have a lot of respect for McDonald’s as a company. But we have not seen any significant issues with McDonald’s share of the coffee business affecting Starbucks.”

McDonald’s offers “a different product, a different value proposition,” he said. In fact, Schultz said McDonald’s should expand the overall coffee market, thus leading some customers to “trade up” to Starbucks.

Despite the CEO’s claims that Starbucks and McDonald’s coffees are “different” products, it is clear by his firm’s decision to expand into the instant coffee market that Starbucks is concerned about the loss of customers to lower-end coffee retailers.

The theory of firm behavior as studied in AP and IB Economics teaches us that firms in oligopolistic or monopolistically competitive markets, such as that for coffee shops in the US, tend to compete using non-price methods such as product differentiation and advertising. Rather than slashing the prices of all of its coffee in the face of a recession and falling consumer incomes, Starbucks has instead diversified its product line to include lower end options for consumers whose sensitivity to price and demand for gourmet coffee have been adversely affected by the weak economy.

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

25 responses so far

25 Responses to “Starbucks instant coffee: a sign of the times?”

  1. Andrew McCarthyon 25 Feb 2009 at 12:35 pm

    hey nice little article… whats the world coming to?

  2. Bjorn Borgerson 26 Feb 2009 at 1:44 am

    I see and to some extent agree what you say in the article. Starbucks however wasn't doing great even before the economic downturn, and they were already having to close down stores. I think the main reason for this was that there were too many Starbucks stores… it doesn't seem to make sense to place two stores so close to each other that they are actually competitors. Starbucks kept growing until they reached a diseconomy of scale, and the only way to solve this is to reduce output. In the long run that means closing stores. Now that they have recently gained a comparable substitute (McCafe), they will have to work more on differentiating themselves. In that aspect I agree with what is being said about Starbucks having to enter the Instant coffee market, or fear loosing customers…

  3. Bjorn Borgerson 26 Feb 2009 at 4:23 am

    I see and to some extent agree what you say in the article. Starbucks however wasn't doing great even before the economic downturn, and they were already having to close down stores. I think the main reason for this was that there were too many Starbucks stores… it doesn't seem to make sense to place two stores so close to each other that they are actually competitors. Starbucks kept growing until they reached a diseconomy of scale, and the only way to solve this is to reduce output. In the long run that means closing stores. Now that they have recently gained a comparable substitute (McCafe), they will have to work more on differentiating themselves. In that aspect I agree with what is being said about Starbucks having to enter the Instant coffee market, or fear loosing customers…

    P.S. – Sorry, forgot to tell you great post!

  4. Virginia Hasenmeyeron 27 Feb 2009 at 10:29 pm

    I thought this article was very good and made me think more about price competition and brand loyalty. I think Starbucks is a coffee shop which has expanded a great deal due to the brand. The coffee does not taste much different from other coffees. The reason why it is too expensive is because we buy the brand and not the coffee itself. Bjorn pointed out that there are many coffee shops in one corner, which is kind of a waste of money for the company. This is because every shop costs capital which is the fixed costs, and therefore having two coffee shops next to each other doesn't make much sense. The products which they sell have to be the same, because that is what Starbucks is famous for. Everywhere you go they might have Starbucks, but they sell the same thing. Also, they don't even price differentiate because it is led by only one company which has all the power.

    Since Starbucks is one of the leading coffee shops and their profit was increasing, McDonald's thought that they could start a similar business. Now in McDonald's they are selling Frappes, which is the same thing like Frapoccino in Starbucks. The only way which these two companies are competing is over their name and the price. McDonald is a very famous fast food brand and is famous for being cheap. Therefore, they are putting their prices way below the prices of Starbucks. But for some reason, people are still buying more at Starbucks. I think this is because of the name. All over magazines such as In Touch, you see Paris Hilton and co. with Starbucks coffees. Just the label, will want other people to buy it too. Therefore, Starbucks will continue running their business, however due to the financial crisis they might have to shut down some of their shops.

  5. Bjorn Kvaaleon 01 Mar 2009 at 5:01 am

    I agree with Bjorn in the fact that Starbucks has reached the point of diseconomies of scale and must therefore reduce output and return to constant returns to scale if they want to maximize profits and be efficient. Yet Starbucks is not trying to reduce output, but instead create a new instant coffee brand which will be cheaper and inferior to the good old Starbucks coffee. Yet in these times of recession, that is what people demand. Starbucks is part of the coffee market, which is an oligopoly, and the only thing they are trying to do is to advertise a new product to increase there market share in the coffee industry and become more powerful. With successful advertising and other non-price competition, Starbucks might be able to increase its market share over the long run. Yet I do not understand why it would be beneficial for starbucks to have two coffee shops right next door to each other. Starbucks must cut down on costs and they are by closing down stores all over the world. This also relates to the game theory slightly because like in the example between starbucks and sf coffee, starbucks can either not advertise or they can advertise. Seeing that it would be beneficial to advertise and increase output and make a new "brand", Starbucks will try to make its instant coffee and increase its market power.

  6. Helen Poxonon 01 Mar 2009 at 11:16 pm

    I have read this article and i think that it was really interesting, i have also read all the response to the article and i think that some really good comments have been made. I think that it is interesting how Starbucks had come up and is launching there new section of coffee, which is cheaper and inferior. When i read this i thought that it could be a really good idea but i was also thinking that, would it stock up to be as good as their coffee that they sell at the moment. It sounds to me that Starbucks the well known brand loyal shop that many of us go to today is suffering from lower price competitors such as McCafe which is run by MacDonald s another well known fast food company. Even though Starbucks chief executive says that they are no being affected by them, most likely they are behind closed doors! Personally i would rather pay a few extra CHF to get a nicer quality of coffee and a nicer atmosphere to sit in. This is only because i can afford to though, many people are cutting out their luxury items to pay for their bill now that they have a lower income coming in or may not an income at all. Starbucks is closing down loads of their stores all over the world and i agree that having more than one Starbucks on the same street or corner is a waste of money. Rather than closing down any store in which ever country, they should look for places where they have 2 or more stores in the same sort of area. This way they will have more people going to one store in the area instead of less people going to the store and produce being wasted such as their baked goods! I think that their non-price competitive idea of an inferior good is better than lowering all their prices of all of their products, as i think that they would still be making losses rather getting any profit. As Bjorn thinks that they are at the stage of diseconomies of scale then introducing a product like this should bring them up to a constant economies of scale (starting to increase output and price again). Like Virginia said many people will choose Starbucks over most of the other offers on the market is because of the free advertising that they get from celebrities who are spotted and put into magazines such as "OK" and "Hello" or "Heat". Consumers chose their product usually by brand loyalty, these days its about living life to the best (like celebrities therefore people chose Starbucks.

  7. Amit Zaidenbergon 02 Mar 2009 at 7:46 pm

    I recently talked about this very subject with my brother when he brought up Starbucks losing money due to the recession. However we did not agree on whether or not this was a good decision, broadening their product market. He said that theyre losing money now and they will lose an even larger amount by entering a new market, them entering the instant coffee market will have a just as much luck as "Joe the plumber" entering the instant coffee market. However, i rebutted that the brand name of Starbucks matters because although in the market it has no market share or loyalty in customers. This is true before the recession, however now all the customers lost due to Starbucks being a normal good and entering the inferior good market will still have theyre brand loyalty to Starbucks still exists and rather than take their chances with a new instant coffee they will try the Starbucks brand which they know and are loyal to. As a result, I believe that entering the instant coffee market is a good move for Starbucks and will cut their losses by entering a new market.

  8. Josh Appletonon 03 Mar 2009 at 3:31 am

    I agree with Amit. Starbucks is having to compete now with cheaper and inferior forms of coffee due to current recession. Only today a number of large banks reported record losses which will surely be worrying people. In order to 'stay in the game' and compete with the inferior and increasingly popular coffee chains Starbucks has been forced to develop new products which will also attract the poorer consumers. While offering the inferior coffee Starbucks will continue to sell they're higher priced beverages to keep those few consumers who are still willing to pay that $7 for their coffee. I think strategically Starbucks has made a smart move by broadening their target consumers and I think that this is a very interesting article.

  9. Laila Brenninkmeijeron 03 Mar 2009 at 5:35 pm

    I agree both with Virginia and Bjorn. With Virginia because as you said "We buy the brand and not the coffee itself" As you also mentioned it is basically due to brand loyalty: people tend to buy Starbucks only because it is "Starbucks". People are easily influenced by brands and because it is a normal good people prefer to buy coffee form the Starbucks brand rather than a coffee from the grocery store which can be easily as good and dependable. I also think that the tendency for people to prefer coffee and other beverages from Starbucks or certain brand is psychological. This is developing brand loyalty. They start thinking that, for example, Starbucks is actually the "best" brand and that they have the "best" beverages when in fact it cannot really be differentiated from any other coffee. The consumption of a certain brand, like Virginia also said, is also easily influenced by celebratities who are recognized as being trend setters consuming the product. I agree with Bjorn , setting up Starbucks stores too close to each other causes the same brand to compete with each other and this causes internal competition which is not helpful when they already have external competition. Also the one store which earned enough revenue to sustain the store is split in half when another store is set up close because the costumers that used to go to the old store are now going to the new store; costumers are being split in half and therefore the old store wont have the revenue it was had before.

  10. Dominic McNameeon 03 Mar 2009 at 5:43 pm

    Starbucks does seem to be reacting how they should be. By offering inferior goods in a hard economic time would keep customers coming back. Also, this has the potential to make Starbucks even larger once the rescission is over as people may start coming for the budget coffee then move up once their incomes rise again.

  11. Bastion 03 Mar 2009 at 7:48 pm

    Starbucks has reached dis economies of scale is multiplying to fast an they cannot cover there costs. I agree with Bjorn that the rapid expansion has left them with two Starbucks on every corner. There aren't enough people to go to Starbucks anymore because there are so many. As Amit said entering the instant coffee market is a smart idea for Starbucks, one because there name is so popular that other people will be attracted to the brand and will buy Starbucks instant coffee.

    I also agree with Dom, Starbucks is reacting correctly by selling inferior goods which are attractive during this economic crisis.

  12. Gabrielon 04 Mar 2009 at 12:39 am

    I agree with the method that Starbucks is using, it is obvious that they have to take measures since there was obviously an over allocation of resources since there where too many Starbucks stores. Closing down stores will lead to a decrease in cost but not necessarily a very big loss in demand since most stores were very close together and Starbucks consumers would not mind walking the extra distance. They have decided to make a very simple product with a very low price so that consumers will still buy they products during the financial crisis.

  13. Aleya Thakur-Weigoldon 04 Mar 2009 at 1:58 am

    I thought this article was very interesting and I agree with many of the comments that have been made. I think that Starbucks has managed to brand itself in such a successful way that many people will stay loyal to their brand of coffee. I think it is very smart of them to provide a less expensive option to customers, with the instant coffee. This way the customer has the freedom to decide whether to buy the cheaper or more expensive coffee, while staying loyal to their brand. On the other hand I also agree with Bjorn, Starbucks has expanded way to fast and as Basti said, there are not enought people to go to Starbucks anymore.

  14. Younes Huberon 04 Mar 2009 at 3:56 am

    As mentioned above by many, Starbucks has reached a diseconomy of scale and therefore has had to close down stores. Yet brand loyalty remains and I believe that the strategic decision to enter the instant coffee market was theoretically intelligent, since they need to eliminate as much competition as possible from companies such as McDonald’s, yet by doing this they may ruin their image as a whole. Nowadays people see Starbucks as a great place to grab a coffee because it is good tasting coffee and is a normal good, unlike instant coffee which is an inferior good. Producing both inferior as well as normal goods of the same product may lead to confusion in many customers; they may as well dismiss Starbucks's good quality coffee for "just another dishwater-tasting coffee". A risky move.

  15. Helene Gleitzon 04 Mar 2009 at 5:12 am

    As mentioned by almost everyone already, I think that Starbucks has made a good move by entering the instant coffee market. As we know, Starbucks sells the same coffee as everyone else, but has 'the name'. We are therefore willing to pay a few extra bucks to get the nice packaging and show off the brand on the cup. As a Frappucino lover myself, I will still continue to go to Starbucks and order my favorite drink, and won't be influenced by the fact that Starbucks is now selling instant coffee. However, it is evident that the number of Starbucks in the world have become ridiculous. Look at the Bahnhofstrasse for example: there are at least 3 Starbucks shops to which you could go to and order Lattes. It seems a little irrational to me and I think the firm would benefit if some of them closed.

    During the economic crisis, it seems obvious to have a plan to stay afloat and prepare for the future. It was therefore a good move for Starbucks to enter a new market and broaden their product range.

  16. Stefan B.on 05 Mar 2009 at 12:19 am

    Personally, i agree with Bjorn. There are too many shops, focusing more on quandity than quality. With quality i see the main problem lies with the employees at Starbucks. Starbucks has the problem of deciding who they want to take or not. I am often times angry at the way the Baristas approach their clients. They are sometimes unfriendly, or dont know what they are doing. This seems very unprofessional to the clients, and obviously gives Starbucks a bad reputation. Like Basti said, Starbucks has too rapidly expanded, due to this they focused more on expansion, not caring about quality. Even though i like a drink at Starbucks once in a while, i prefer mixing my own drinks with milk, sirups, sugars etc, since im spending less money and i can do whatever i like most. And just like Mr. Welker, i take it in a thermo, since Starbucks is only set for more and more profit, not respecting the needs of the customers such as a good customer service and fair prices.

  17. Daniel D'Amcoon 05 Mar 2009 at 4:45 am

    Starbucks has created too many stores making it extremely hard for them to cover the costs. By opening up multiple shops in one area it forced the smaller coffee companies to go out of business. However, because Starbucks can not cover the costs they are finding themselves having to shut down many stores and this is resulting in smaller coffee shops opening back up again. Now Starbucks is selling inferior goods to differentiate themselves from the other coffee shops. This method of sales is extremely effective especially right now while we are experiencing a recession. Instead of making more expensive products and trying to compete with other coffee shops that way they are lowering their standards and costs by creating simple products and making them more attractive to consumers.

  18. Dimitri Da Ponteon 05 Mar 2009 at 6:03 am

    I must say Amit has a very good argument. Starbucks is a brand many have a loyalty to. I find it interesting that firms such as Starbucks have to start producing inferior goods in the face of recession. A smart move on their part, for as incomes are falling the demand for a ‘normal good’ coffee will decrease, while their demand for ‘inferior good’ instant coffee will increase. This also gives the chance for the people who have a brand loyalty to Starbucks to return as loyal customers if they had been unable to afford their coffee anymore.

  19. Yael Burlaon 05 Mar 2009 at 6:04 am

    When I go to america, I can usually find a Starbucks within a 5 minute walking distance.. Then again, I can probably find 3 Starbucks stores within this radius. Starbucks has opened up so many stores that it is now having trouble balancing their costs. As a result, when AVC and ATC are higher than price, some stores find themselves in a position where they HAVE to shut down since they are only harming themselves by staying in the market. Because most of the products sold at Starbucks are considered normal goods, people with lower incomes do not generally buy coffee from there. However, because many Starbucks are shutting down, they are selling inferior goods as a way to manage their costs and still increase demand for those with low incomes.

  20. Jonnyon 05 Mar 2009 at 6:24 pm

    Like many have said money is tight so people are more aware where they are spending their money and how much. For few Starbucks coffee is irreplaceble, but others think it as an expensive normal good. So they dont mind taking a step down to cheaper alternatives like McDonalds ect. Starbucks is smart as they know some people are willing to pay the same amount no matter what and they are taking advantage of those. But many arnt willing as it costs so much so they are giving them an alternative. Some can be brand loyal but cant afford the current prices, so are forced to move. But as they have new alternatives at a cheaper rate these loyal people can stay

  21. Matt Coucheron 05 Mar 2009 at 7:06 pm

    Starbucks has become part of the economies of scale. With the economic downturn, and Starbucks' overpopulation of every street corner across the globe, they are having to shutdown some of the cafes because they have expanded too quickly and cannot cover the costs of such rapid expansion. Instant Coffee would be a brilliant strategy for Starbucks to take as it gives people a cheaper alternative during this recession while still maintaining brand loyalty.

  22. Laura Nanette Gon 10 Mar 2009 at 4:49 am

    This topic has been well discussed by students above, though there are some facts I would like to add on to. As discussed before it is true that starbucks is actually only "coffee", although they do make sure it is fair trade, the beans might not be very different from the beans in other coffee shops. Starbucks has been able to globalize its product so well through perfect advertising. Famous actors and singers with starbucks drinks are photopgraphed and put in all pictures. Starbucks themselves have made their product seem as though they are the only good product; similar to what apple has done with the ipod (another topic to be discussed). This perfect advertisment has cut out most competition on the market; and has let starbucks rise to the top. However, as mentioned above already, Starbucks is setting up more and more stores. It is found on every continent and even kicked out cultural competition. The prices however of drinks and food from Starbucks are high. Starbucks' expansion started off balanced out in the countries; with several stores in a large city. Nowdays there are thousands of starbucks all over the world, in D.C. alone there are over 71 Starbucks. With such a large number, one can be found every few streets away. This cuts out other competition, but the over expansion has risen large amounts of costs that the consumer is not willing or able to pay in such a short amount of time. Starbucks has closed several hundred shops already and is planning to shut down several more )(including ones that are opposite a Starbucks itself), and this way will be cutting costs down.

    If Starbucks can be compared to a Monopoly would not be right idea, however they are acting similar. Starbucks is selling drinks at a high price with lower quantity. But because customers are not willing to pay such amounts, costs have gone up with the quanity increase of shops (not coffee necessarly). If this is a market failure, could be discussed.

  23. Markus von der Marwion 12 Mar 2009 at 2:24 am

    Starbucks has made a huge name for itself and has millions of loyal customers. Starbucks was forced to shut down many of its stores, it just had way too many. Seperate starbucks shops were competing with each other. Introducing starbucks instant coffee seems to be a good move, with there being so many loyal customers. Especially during this economic downturn, with starbucks being relatively expensive. Instant coffee is an inferior good, which should do well in a recession.

  24. Lloyd Kluegelon 12 Mar 2009 at 6:57 pm

    in the past years starbucks has been overexpanding and over-charging customers. another mistake they made was not monopolizing the market for their coffee, meaning that other companies, such as McDonald's in switzerland has the same coffee machines as starbucks, thereby selling similar coffee at way lower prices. in addition, in the economic crisis, people start saving more on unnecessary expenses such as coffee.

    starbucks strategy was to serve good quality coffee. by selling their own brand of instant coffee, thereby comprising the companies image.

    instead of selling instant coffee, starbucks should finally drop the prices of their normal coffee.

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