Starbucks Coffee Company

PRICING STRATEGY AT STARBUCKS

Starbucks claims the price increase is due to rising labor and non-coffee commodity costs,
but with the significantly lower coffee costs already improving their profit margins, it seems
unlikely this justification is the true reason for the hike in prices. In addition, the price hike
was applied to less than a third of their beverages and only targets certain regions.
Implementing such a specific and minor price increase when the bottom line is already in
great shape might seem like a greedy tactic, but the Starbucks approach to pricing is one we
can all use to improve our margins. As we’ve said before, it only takes a 1% increase in
prices to raise profits by an average of 11%.

Starbucks is the leader of the coffee market. As an individual company, it controls several
times more market share than any of its competitors. More than just a high-priced coffee
shop, Starbucks offers a combination of quality, authority and relative value.

Quality

Starbucks sets its prices on a simple idea: high value at moderate cost. When people feel like
they are getting a good deal for their money, they are more likely to pay a higher cost.
Quality is key. Starbucks has to maintain strict quality controls in its coffee sourcing as well
as in its customer service and peripheral products to justify its costs.
Differentiation

Starbucks also spends a lot of time and energy differentiating itself from the competition.
You can see this in the design of its coffee shops, the music played there and the types of
products it sells, such as coffee-brewing equipment and jazz CDs. Starbucks makes sure to
keep current on the latest technology, often times being the first to introduce the newest
advancements to its customers. For example, Starbucks was one of the first companies to
adopt location-based promotions and mobile payments.

The Value of Authority

Starbucks' pricing strategy has a lot to do with how it positions itself as an authority on
coffee, allowing the company to charge premium prices. Thus, when Starbucks introduces
new products at higher prices, consumers are willing to pay extra without even having tried
the products because they associate the Starbucks name with high quality.

Relative Value

Starbucks also uses relative pricing. It offers premium items, like its espresso drinks or its
Starbucks brand whole-bean coffees sold in grocery stores, along side lower-cost items, like
its drip coffees or its Seattle’s Best line. While the risk exists that more customers will choose
the lower-priced items, by offering higher-priced items along side lower-cost alternatives,
Starbucks is justifying the higher price through comparison.

Value Based Pricing Can Boost Margins

For the most part, Starbucks is a master of employing value based pricing to maximize
profits, and they use research and customer analysis to formulate targeted price increases that
capture the greatest amount consumers are willing to pay without driving them off. Profit
maximization is the process by which a company determines the price and product output
level that generates the most profit. While that may seem obvious to anyone involved in
running a business, it’s rare to see companies using a value based pricing approach to
effectively uncover the maximum amount a customer base is willing to spend on their
products. As such, let’s take a look at how Starbucks introduces price hikes and see how you
can use their approach to generate higher profits.
 An Overview of the Starbucks Pricing Strategy

The Right Customers and the Right Market

While cutting prices is widely accepted as the best way to keep customers during tough times,
the practice is rarely based on a deeper analysis or testing of an actual customer base. In
Starbucks’ case, price increases throughout the company’s history have already deterred the
most price sensitive customers, leaving a loyal, higher-income consumer base that perceives
these coffee beverages as an affordable luxury. In order to compensate for the customers lost
to cheaper alternatives like Dunkin Donuts, Starbucks raises prices to maximize profits from
these price insensitive customers who now depend on their strong gourmet coffee.

Rather than trying to compete with cheaper chains like Dunkin, Starbucks uses price hikes to
separate itself from the pack and reinforce the premium image of their brand and products.
Since their loyal following isn’t especially price sensitive, Starbucks coffee maintains a fairly
inelastic demand curve, and a small price increase can have a huge positive impact on their
margins without decreasing demand for beverages. In addition, only certain regions are
targeted for each price increase, and prices vary across the U.S. depending on the current
markets in those areas (the most recent hike affects the Northeast and Sunbelt regions, but
Florida and California prices remain the same).

Product Versioning & Price Communication

They also apply price increases to specific drinks and sizes rather than the whole lot. By
raising the price of the tall size brewed coffee exclusively, Starbucks is able to capture
consumer surplus from the customers who find more value in upgrading to grande after
witnessing the price of a small drip with tax climb over the $2 mark. By versioning the
product in this way, the company can enjoy a slightly higher margin from these customers
who were persuaded by the price hike to purchase larger sizes.

Starbucks also expertly communicates their price increases to manipulate consumer

perception. The price hike might be based on an analysis of the customer’s willingness to
pay, but they associate the increase with what appears to be a fair reason. Using increased
commodity costs to justify the price as well as statements that aim to make the hike look
insignificant (less than a third of beverages will be affected, for example) help foster an
attitude of acceptance.

What pricing strategies you can learn from Starbucks?

The profit maximizing tactics Starbucks implements in their pricing strategy are vital
components of a process anyone can use. Here are some of the takeaways you can apply to
your own business:

1. Study your customer personas.

Starbucks understands that the majority of their customer base is fairly insensitive to price,
and uses small price increases that everyday consumers barely notice to boost margins.
Quantify your buyer personas and the demand for your product or service will help you
choose a price that captures the maximum amount your customers are willing to pay.

2. Justify the exchange rate for your product.

Communicating price increases effectively is crucial to a successful price hike, and managing
customer perception is a key part of the Starbucks strategy. Support your price increases
using changes in the market such as higher commodity costs and ease the pain on the
consumer by finding an attractive way to publicize the new prices. Starbucks said their
beverage prices were increasing by an average of 1%, but that low average probably stemmed
from including all of their beverages in the equation, including ones that remained at the
same prices.

3. Use product differentiation to put your company in the lead.

You can justify maximizing your profits using the fairest of reasons, but if the customers
don’t value your service the way they value a delicious cup of coffee, then a decrease in
demand is inevitable. Build a service or product that consumers can’t live without, and you’ll
be able to implement price hikes without turning off your customers.
4. Don’t increase the prices of the products with the highest margins.

Raise the prices of the products surrounding them. As mentioned earlier, Starbucks raised the
price of the tall size brew exclusively in order to persuade customers to purchase larger sizes
(with slightly higher margins). Price hikes for your lower margin products can entice
customers to upgrade to more expensive options, especially with respect to products and
services that are tiered based on time usage and features. The goal is to use the price increases
to guide the customer towards your most profitable product.

Conclusion:

Overall Starbucks has maintained a competitive advantage since creating its original blue
ocean of bringing quality, bistro-style coffee choices to the masses. In order to stay current, it
will need to focus on its core competencies and avoid spreading themselves to thin. To avoid
competition from other coffee chains, they will need to create new value innovation by
enhancing the customer experience by investing in online content and interactivity. Rather
than creating more new products, I think their strength lies in their brand and by enhancing
the connection to their loyal customers, they will separate themselves from other coffee
chains.