Competing as Starbucks

Starbucks meets some of the conditions which are necessary to be considered part of a perfectly competitive market. Those conditions are as follows (Morris & Sayre):

1. Many small buyers and sellers all of whom are price takers
2. No preferences shown
3. Easy entry and exit by both buyers and sellers
4. The same market information available to all

Starbucks cannot be considered to be in the type of market that is considered perfect competition by economists because they don't meet all 4 conditions. One of the conditions that is not met is number two, that no preferences are shown. Starbucks charges more than most coffee shops and one of the main reasons they continue to sell their coffee is because certain customers prefer Starbucks as opposed to other shops.

The competition is strong in the coffee industry and in order for Starbucks to continue to succeed, they must come up with new and innovative ideas to meet demand and carve their place in the market. Unfortunately some of the new ideas did not mesh with one of Starbucks main goals, which is to show that they provide more than a cup of coffee; they provide an experience. The video below shows a few customers who feel they got more than coffee from Starbucks (http://www.starbucks.ca/about-us).

In 2007 Starbucks chairman Howard Shultz wrote a memo regarding Starbucks changes. They were losing their individuality and becoming like every other coffee chain (Shultz, Howard). He felt that it was necessary for Starbucks to realign their business practices to bring back the Starbucks experience.

Starbucks struggled to find the balance between trying to give customers an experience when they enter the store and keeping up with the demand. In addition, the economy became very turbulent which eventually led to Starbucks announcement in 2008 that it would be closing 600 stores (Allison). Because of Starbucks rapid growth, change in consumer demand and the state of the economy, they experienced diseconomies of scale.

The store closures had a large impact on costs and profits for the coffee chain. In an article by Melissa Allison, she wrote “Starbucks said the store closures will lead to pretax charges of about $328 million to $348 million, including $8 million in severance costs and $120 million to $140 million in lease-termination costs and future lease obligations (Allison).” The short-run costs are extremely high but they made the best decision when considering the long-run costs. By choosing to close the underperforming stores, they increase profits in the long-run.

Over the years, Starbucks has been criticized for the prices they charge. The question is, if Starbucks is too expensive, why do customers keep returning? How can Starbucks manage to charge such prices without losing customers to other, less expensive coffee chains? The answer is that among other things, they have been successful in creating a Starbucks experience and customers continue returning for the experience. Rachel Hennessey wrote an article about why Starbucks exceeds despite market shortcomings and she agrees that part of the success lies in the fact that customers like the ambience. She wrote “When you enter a Starbucks store, you will notice a rich warm color scheme, alternative music, organic-looking art, and baristas in green aprons (Hennessey).”

If Starbucks were to lower their prices, the quantity demanded would increase. This would drive the quantity supplied to increase as well. Eventually the market would adjust and a new equilibrium would be reached.

Allison, Melissa, Starbucks closing 5 percent of U.S. stores, http://seattletimes.com/html/businesstechnology/2008028854_starbucks02.html

site accessed on October 27, 2012

Hennessey, Rachel, 3 Reasons Why Starbucks Still Shines, Despite Market Shortcomings,
http://www.forbes.com/sites/rachelhennessey/2012/08/06/3-reasons-why-starbucks-still-shines-despite-market-shortcomings/

site accessed on October 28, 2012

Morris, Alan; Sayre, John, Principles of Economics, p. 261

Schultz, Howard, Starbucks chairman warns of "the commoditization of the Starbucks experience",
http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html

site accessed on October 27, 2012

The Health Nut

If I had the resources to set up a business, I would open The Health Nut, a business that provides healthy food options for people on the go. There are currently quite a few fast food chains but they mainly serve calorie laden meals. There are a few healthy options such as Jugo Juice and Booster Juice but these chains do not provide a drive through service for busy customers. As a society we seem to be more aware of our choices and our health. We are also a very busy and appear to have trouble balancing our professional and personal lives. I feel many consumers would like a fast, affordable and healthy option for meals to grab on the go whether it’s a soccer mom on her way to practise with the kids, an office employee on their way to a meeting or a busy student rushing between classes.

My business would start out small with the hope to expand. If the first location were successful l, I would plan on opening more locations and keep expanding from there. The ultimate goal would be to create a franchise.

The market for a business like this is enormous. I checked McDonald’s website and saw that there are more than 1,400 McDonald's restaurants in Canada employing more than 80,000 Canadians (http://www.mcdonalds.ca/ca/en/contact_us/faq.html). These restaurants are placed all throughout Canada. McDonald’s also has many, many more restaurants located worldwide but I would want to keep my business within Canada. In the beginning, the market within my reach would be fairly small and mainly restrained to the area I chose for my business. People of all types and ages would patronise my restaurant but the majority of the business would likely come from health conscious consumers between the ages of 20 – 45 who lead a busy lifestyle. With success and new restaurant locations, the size of the market I could reach would increase.

Some of the fixed or short-run costs to consider would be salaries, rent, utilities, capital investments and business taxes. When starting up, the short-run costs need to be kept as low as possible until the business starts to earn a profit. Once a profit is being earned, new locations may be opened. With regards to future planning, all the short-run costs would become long-run costs.

As the business expands, the economies of scale for the business will change. With each new location opened, the output levels will need to be evaluated. Businesses must strive for the highest level of output for the lowest average cost per unit in order to succeed.

Jugo Juice is a great example of a similar business. Jugo Juice was founded in 1998 in Calgary, AB (http://www.jugojuice.com/about-jugo/history). They have grown from one small business in Calgary to having locations in 7 of Canada’s provinces (http://www.jugojuice.com/about-jugo/locations). Clearly this business has been very successful. They saw that society was starting to take notice of their health and were pioneers in providing healthy alternatives in the fast food industry. One of their major strengths is that they took initiative when they saw change happening and were able to start a business to supply products for the new demand. That being said, I feel my restaurant has potential to compete with Jugo Juice because I believe one of Jugo Juice’s biggest weaknesses is the fact that they don’t have locations that offer a drive through service.

In the food and service industry, it is crucial to keep customers happy and today’s consumers are busier than ever. A healthy fast food drive through option may be just what consumers are looking for!

Law of Diminishing Returns

I recently read the article ‘The Diminishing Returns to Tobacco Legislation’. This article discusses the different strategies the government has taken regarding cigarettes and the effect they cause to diminishing returns.

 

One thing that struck me as odd is that when the government implemented cigarette taxation from 1985 to 1995, there was a 52% change to the real price of cigarettes yet when a similar change was made in later years, the effect was not strong. Another section of this article points out that while advertisements on cigarette packages warning of the health problems were initially successful they no longer seem to be working. This could be because consumer awareness for health concerns has reached maximum potential awareness. It could also be that consumers also choose to ignore or discredit the warning as the shock value is no longer there.

 

The point of diminishing returns for the government appears to be at a standstill. When taxes are raised and new advertisements are displayed, they don’t seem to have much of an effect on the amount of cigarettes being consumed. Most of the smokers that are left appear to be strongly addicted and will choose to continue feeding their addiction regardless of the efforts the government makes to reduce usage.

 

I believe that some of the money the government has put into raising awareness to the health problems caused by cigarettes has been equalized by reduced health costs. One possible avenue that the government could take is to encourage producers to make a nicotine and chemical free cigarette option. Some smokers may switch to the healthier option if they are addicted more so to the habit then the nicotine. Sales might increase due to non-smokers taking up the habit if the health risks were not as severe. This would in turn increase revenue and reduce health costs which would help offset the money that would be spent on the campaign to produce a new and healthier cigarette option.

 

If a new cigarette option were introduced, demand would likely increase which would in turn drive the supply up. The price of cigarettes may also be driven up if more consumers are now willing to buy the product.

 

Of course the government could always choose to make cigarettes illegal but this would be a very poor decision. Because cigarettes do involve an addiction, this product is considered to be inelastic. Consumers are willing to buy cigarettes regardless of the price and whether or not it is legal. As we know from Chapter 4 of the textbook, the government knows that this product has an inelastic demand and chose to impose a sin tax in order to make a profit. Making cigarettes illegal would be highly ineffective so imposing sin taxes instead was a smart choice for the government. Instead of spending millions or billions of taxpayer dollars on trying to control yet another illegal substance, the government chose to make a profit which they can in turn use to create a healthy economy.

 

Lemieux, Pierre, The Diminishing Returns to Tobacco Legislation,

http://www.pierrelemieux.org/artdiminish.html
site accessed on October 15, 2012

Tourism Industry in Canada

The tourism industry in Canada is strong with Canadian arrivals increasing by 8% and domestic travel increasing by 12%. The amount of international travellers from India, China and Brazil is expanding and Canadian citizens also appear to have positive travel expectations.  On the other hand, the number of U.S. travellers has declined over the last 10 years.

Travel is affected by many factors, one of them being exchange rates. The Canadian dollar has been gaining strength and this seems to fall in line with the decline of U.S. travellers. It appears that the Canadian dollar has an elastic demand as U.S. travel is fairly responsive to a change in price.

The exchange rates seem to have less of an effect on other international travel.

As for Canadians own travel expectations, long term travel within Canada is slightly down but is up for various other locations.
 

It is interesting to note that while long term travel expectations within Canada is down, short term actually shows an increase in travel in domestic travel.

One potential reason that short term domestic travel for Canadians may be up is because of the economy’s current instability. People are unwilling or unable to spend large amounts on international travel and instead choose budget friendly vacations within Canada.

The overall current state of the tourism industry in Canada is healthy and appears to be improving. 

This industry has an elastic demand as there are many other available substitutes. There are thousands upon thousands of travel destinations to suite every preference and budget. Consumers have the ability to choose from a wide variety of options when making their travel choices.

Deloitte, Ipsos & TIAC, Navigate,
http://tiac.travel/_Library/documents/navigate_winter2011-12.pdf
site accessed on October 6, 2012

Elasticity and Total Revenue

Earlier this year, Garth Brooks came to the Calgary Stampede to perform and we saw a huge demand for tickets. Tickets went on sale for $62 each and sold out in just 58 seconds leaving many fans, including myself, disappointed and ticketless. There were still tickets available for purchase but many consumers felt the price was too high and decided to forgo the concert. After the initial sell-out, the demand for the remaining limited tickets reached an inelastic point. A few consumers were still willing to buy, but most did not want to pay the prices being asked.
 

When the demand for tickets was at it it’s highest, the demand was inelastic meaning if the price were to change, the response would be minimal. The drop from 100,000 to 90,000 would only make up 10% of the total quantity demanded. As long as the tickets were reasonably priced, most people were still willing to buy. We know this is the case since the demand for tickets when they first went on sale at $62 was huge.

When the demand for tickets reached its lowest point, the demand was elastic meaning if the price were to change, the response would be significant. The drop from 10,000 to 0 wiped out all demand for the product so there is a 100% change. At the highest price, there were little to no consumers who were willing to buy tickets.

The graphs below depict the change elastic demand to inelastic as well as the unitary price.

 

Schneider, Katie, Garth Brooks: Gone in 58 Seconds,
http://www.calgarysun.com/2012/04/14/garth-brooks-gone-in-58-seconds
site accessed on October 3, 2012