Starbucks: Business Pricing Strategies

In every organization, pricing strategies influence the coverall performance of the company and its market position. Price is attracted more attention than any other marketing tool. In the modern economy, non-price factors determine increasing marketing importance and products are differentiated on other bases than price. Starbucks, a leading coffee retailer, operatives on a global scale. Starbucks is a market leader focused on coffee, beverages, and whole milk products. Its brand image and unique pricing strategies appeal to diverse customer groups. Yet successful performance requires bridging the gap between expectations and demands of customers (Starbucks Home Page 2009). It could even be said that successful marketing is the bridging of this gap.

At Starbucks, no single pricing program is suitable for all firms, since the complexity of pricing situations varies by product, cost, demand, and industry structure, and prices must relate to objectives, information, knowledge of alternative policies, and strategies and adjustments. At Starbucks, the top managers are faced with the problem of establishing the best price under assumed cost-and-demand conditions. the dynamics of the coffee market, and the problems of measuring both costs and coffee demand make it a difficult task. Yet, price estimates are made of what Starbucks’ management expects demand, cost, and competition to be under various conditions.

Then management team develops pricing programs that affect survival, profits, growth, volume, market share, R & D, and image. A distinction is made between coffee price determination and price administration. The activities and focus of each are different. Coffee price determination refers to the processes and activities employed to arrive at a price for a product (Marn et al 2004).

At Starbucks, the management team tends to rely more on an average cost approach to pricing than on a marginal approach. Average costs, which are rarely relevant to an optimal decision, satisfy the desire to “cover our costs and make a profit.” (Baker 2006). In real business satiations, this reliance on average coffee costs can lead to a decision that can reduce sales, increase costs, and reduce profits. Though, some executives advocate that sunk costs (costs that cannot be revoked and that are not part of the current pricing decision) should be ignored. At Starbucks, pricing strategies are not affected by current decisions — nothing can be done about them.

Yet Starbucks is recognized that over the long run, prices must be changed. A consideration of the impact of coffee sales volume on costs provides a useful train of thought. For example, price theory suggests a U shape for average costs, they decline to a point with increasing volume, reach their minimum, and then increase as volume increases (Marn et al 2004). This seems to make sense, because the concept introduces the notion of economies of scale and the impact of ability on costs, indicating that product volume beyond a certain point may increase costs.

In formulating a marketing strategy for coffee beans, Starbucks has dealt with only the broader relationships of pricing to selected elements in the marketing. Coffee price decisions in specific situations require both experience and practical knowledge. Price theory alone will not suffice. Where pricing is of critical concern, pricing specialists become necessary (Baker, 2006).

Current strategies of Starbucks suggest that among the present and future external issues that influence coffee pricing policy are the number and concentration of competitors, the degree of competition, profitability, ease of entry, product heterogeneity, size, legal aspects, channels of distribution, elasticity of demand, total industry demand, kind and size of buyers, and spatial forces. Usually, these are handled through consideration of the anticipated cost-revenue approach.

For, in the long run, coffee prices are constrained at their upper bound by market reaction and competition (since Starbucks cannot charge substantially more than immediate competitors) and at their lower bound by costs full or incremental. The latter is most important in the immediate term, whereas total costs reflect a long-run situation in a coffee market. At Starbucks, coffee prices are the result of competitive conditions such as total collusion or “cutthroat” competition. Either is dubious for any protracted period, thus the former for legal reasons and the latter for economic considerations (Hollensen, 2007).

Traditionally, Starbucks follows a premium pricing strategy which helps the company to position itself as a premium coffee retailer. The concept of price or demand elasticity refers to the sensitivity of buyers to coffee price changes. When small variations in price bring about relatively large variations in buyer reaction, the price elasticity is high (Marn et al 2004). The situation is upturned for low elasticity. Since various buyers react differently to coffee price changes, knowledge of demand elasticities helps to set prices t Starbucks.

The major problem is that detailed data are not available. Yet, several tools are used to approximate elasticities, including market tests, statistical techniques of historical or cross-sectional analysis, and surveys. Starbucks management need not determine precise elasticities; rather it needs reliable estimates and guides as to the break-even levels and likely profitability of price changes (Philips 2005).

At Starbucks, coffee pricing strategies are perceived in terms of the whole product line rather than in terms of each product. For example, some coffee products (including beverages) are priced to engender prestige for the rest of the line rather than to gain their sales. Other prices (for coffee beans) are set to permit “trading up,” to establish images, or to meet coffee price lines and price points. At Starbucks, price differentials are subject to administration scrutiny and regulation.

They are set based on quantity, distribution level, geographic area, and cash payment. Starbucks proposes distribution discounts instituted on a net or list basis according to distribution levels. Quantity discounts are cumulative or noncumulative and apply to part of a line or a whole line. Basing points, f.o.b. factory, and uniform delivered pricing are issues of geographic differentials (Marn et al 2004).

For Starbucks, legal issues, price discrimination can be defended based on meeting competition in good faith, cost savings in dealing with dissimilar customers, and promoting and not injuring competition. It is the effect of price discrimination, and not the act itself, that determines legality. Though these legal constraints are significant in establishing price differentials, the realistic guidelines are confusing and the economic consequences are mixed since price favoritism can benefit society (Pittengrew et al 2006).

In the USA, both the Federal Trade Commission and the Justice Department are interested in pricing practices, particularly in the administration of prices. In the administration of price differentials, marketing managers must be concerned with legal problems of collusion and price discrimination as well as the impact on sales, profits, and competition. Certainly, more government involvement in coffee pricing practice is the wave of the future.

Coffee price is the ingredient of the marketing program that has enjoyed the most extensive economic analysis. In deciding marketing strategies, though, it cannot be separated from the other components (Paley, 2006). The significance of price as a marketing factor varies with the kinds of coffee products and market situations. In some cases, non-price issues become more significant than price ingredients (Marn et al 2004).

Pricing programs of Starbucks, even within the same coffee industry, vary greatly. Coffee pricing strategies consider both cost and demand conditions, and the dynamics of markets, thereby accounting for both internal and external variables. Though the determination of an optimal coffee price is usually impossible, a satisfactory one can be developed by market research. The major pricing decisions at Starbucks include determining prices for each product or service, discount structures, price relationships among coffee lines, and price maintenance levels.

Problems encountered in establishing prices recount to the inability to determine costs exactly, the difficulties of dealing with expectations, and the variations in the impact of coffee policies on different products in a company’s product line. Marketing aptitude is a critical component of effective price determination (Nagle and Hogan 2005).

At Starbucks, pricing strategies are adopted that tend to depress or invite competitors, that relate to the payout in research and development, or that generate images of qualities or bargains. Companies can decide to have high, low, or competitive prices (Marn et al 2004). Starbucks’ followers or leaders use several bases for price variations: geographical coffee price discrimination (single and multiple points, f.o.b. factory, freight payment, and equalization, and zone pricing), discounts and allowances (quantity, seasonal, cash, trade, and advertising discounts), channel and service discounts, guarantees against price, and Starbucks prices over time. Regardless, Starbucks’s pricing strategies are reviewed and overhauled, for they tend to become “baked in” and to mirror traditional approaches, especially in retailing (Monroe, 2001).

For Starbucks, gaining an accurate understanding of competitors’ prices often is difficult in coffee beans markets because of problems in determining comparability. For Starbucks, premium pricing presents different problems from those of pricing mature products. New products place the manufacturer more or less in a monopoly position, but one that will erode. They also create situations in which price reactions are largely guesswork.

Two general pricing strategies are used during the initial stages of product implementation — skimming or penetration pricing. The former refers to “skimming the cream” from some coffee segments in succession using a relatively high price, therefore recouping investments quickly. It encourages new competitors to enter the coffee market because of attractive margins. The viewpoint is one of segmenting markets by time, getting a premium price from those segments that will pay it, and then gradually reducing prices. Thus, the core coffee markets are cultivated first, and then attention is directed to the fringes (Marn et al 2004).

To help determine the “best” price, Starbucks uses economic analysis that management applies the marginal principle, namely, set the coffee price at the point where the marginal revenue of a sale is equated with the marginal cost. Thus, Starbucks management estimates the quantity likely to be sold and the costs at various price points. An extension of this is the premium price approach, which recognizes the uncertainty in estimating both quantities sold at various coffee prices and costs, and introduces probabilistic reasoning (Baker, 2006).

Starbucks should follow the current pricing strategy as it best needs its needs and expectations of repeat customers. At Starbucks, coffee products are relatively homogeneous; thus several large competitors (Nestle, McDonald’s) constitute a significant part of the market; and buyers are well informed, then estimates of consumer reaction become a significant aspect of the pricing picture. So do competitive reactions that are ferreted out by the use of marketing.

Starbucks analyses what competitors have done in the past, coupled with careful analyses of the current competitive situation. This approach furnishes guides on what they are likely to do. This process, utilizing subjective likelihood estimates, can provide Starbucks with good guides for contemplated coffee price changes (Marn et al 2004). Both purchasing situations and the decentralization of authority at Starbucks affect coffee pricing policies.

Coffee prices may vary by the number of roasted beans purchased, and the purchaser’s geographic area, trade position, and the functions Starbucks perform, as well as by the method and timing of purchases. Starbucks featuring profit-center, coffee pricing, and transfer pricing, (prices charged by one company unit to another) influence product prices and raise significant problems for competitors (Baker, 2006).

In sum, coffee pricing is viewed by Starbucks management from the perspective of a company’s total product line, since coffee products have complementary and competitive demands and by-products. In some cases, coffee demand influences the demand for beverages and other non-coffee products sold by Starbucks. This relationship reflects cross elasticity of demand, with a negative cross elasticity referring to complimentary coffee products, a positive cross elasticity to substitutable products. For Starbucks buyers, price reductions and increases have symbolic meanings.

Bibliography

Baker, R. J. 2006, Pricing on Purpose: Creating and Capturing Value. Wiley.

Hollensen, S. 2007. Global Marketing: A Decision-Oriented Approach. Financial Times/ Prentice Hall; 4 edition.

Marn, M et al 2004, The Price Advantage. Wiley; 1 edition.

Monroe, K. B. 2001, Pricing: Making Profitable Decisions. New York: McGraw-Hill.

Nagle, Th. T. Hogan, J. 2005, Strategy and Tactics of Pricing: A Guide to Growing More Profitably. Prentice-Hall; 4 edition.

Paley, N. 2006, The Manager’s Guide to Competitive Marketing Strategies. Thorogood.

Pittengrew, A. M., Thomas, H. Whittington, R. 2006, Handbook of Strategy and Management. Sage Publications.

Philips, R. 2005, Pricing and Revenue Optimization. Stanford Business Books; 1 edition.

Starbucks Home Page. 2009. Web.