India Wakes Up to Smell of Starbucks Coffee - Case Study Example

Wakes Up to Smell of Starbucks Coffee Introduction The story of Starbucks started on March 30, 1971 when its three founding partners came together to sell coffee beans and equipment at 2000 Western Avenue, Seattle, Washington. In 1975 they relocated to 1912 Pike Avenue and operate out of this location even today. Starbucks Corporation is presently the world’s number one speciality coffee retailer. It has over 17000 outlets in 50 countries. However, the bulk of its outlets are in the USA (11000), Canada (1000), and the United Kingdom (700). In 1992 Starbucks became a public limited company (www.mhhe.com) through an IPO. The coffee is supplied mainly through its own and franchised coffee-shop chains as well as through supermarkets. Starbucks’ main competitors in the speciality coffee-shop business are Costa Coffee, Barista and Coffee Bean. Though its mainstay remains its coffee brewing business, Starbucks also offers other hot and cold drinks, hot and cold sandwiches, ice cream, pastries and snacks. Many people have bought its mugs and tumblers to express their appreciation for the Starbucks brand. A more recently created Starbucks Entertainment Division and its Hear Music label also offers books, music and films. Clearly Starbucks has expanded from just a coffee label to a much larger enterprise (www.starbucks.com). Comments on Starbucks’ Pricing Strategy In the given assignment, we are asked to comment on the pricing strategy of Starbucks chain. We are told that at a local Starbucks, customers are offered a variety of alternatives with the following price list: Freshly brewed coffee £1.55 Café Latte £1.99 Capuccino £1.99 Vanilla Latte £2.29 Caramel Machiato £2.65 Café Americano £1.70 Expresso £1.35 Café Mocha £2.25 White Café Mocha £2.65 The above prices are for the ‘tall’ size of the above beverages. From the pricing list, we can see that the price of similar types of coffee is close to each other, meaning that Starbucks is following a product pricing strategy where similar types of products are priced in the same range. Of course, its Expresso and basic Freshly Brewed Coffee are in the first tier and are priced lowest of all at £1.35 a cup and £1.55 a cup respectively. Its Cafe Latte, Cappuccino and Cafe Americano come in the price range £1.70 to £1.99, and the last or uppermost tier is for its fancier offerings such as Vanilla Latte, Cafe Mocha and White Cafe Mocha, costing between £2.25 and £2.65 respectively. It is also possible that the people ordering these beverages form different classes of customers for Starbucks. Quite possibly the cost of making these beverages and the additional labour and ingredients that are put in have also affected the final price charged by Starbucks. So we can see that there are three tiers of prices possibly indicating low, medium and high class customer preferences. Anyway as far as a cup of coffee goes, there is not much overall variation between the lowest price of £1.35 and the highest price of £2.65 a cup at Starbucks- indeed it is very reasonable and such a price difference will readily be accepted by a consumer (Kotler, 1990). Product pricing theory advises us that when setting the price of a product, we should take into account the price elasticity of demand for a product (McConnell & Brue, 2005). However one must regard a cup of coffee as a basic necessity especially in the winter season, so its price elasticity is relatively low. Its only real substitute is tea, but even that loses favour in the winter season. For avowed coffee fanatics, no other beverage will do. Starbucks’ pricing strategy will most likely also be impacted by the price charged by its competitors, whether it is entering into a new marketplace and is willing to offer price discounts in the beginning period, or whether it wants to place itself at the higher end of the market and charge higher prices, focusing only on a select group of high end customers having purchasing power. Obviously it is aided in this by its international reputation, its perception as a quality brand and its reputation for promoting socially responsible activities in the community it operates in. Its entry strategy will depend on whether it is the first entrant or any of its competitors are already located in the new marketplace it is seeking business in (www.starbucks.com). The nature of the market and the types of customers and their coffee drinking habits should form part of Starbucks’ marketing research before it enters into a new country or a new marketplace. How Should Starbucks Finance a Planned Expansion into India The newspaper report by Andrew Buscombe in the UK’s The Independent of January 14, 2011 brings the news that Starbucks is considering a launch of its stores in India. It has been trying to strike up a partnership with a local firm since 2007, and the Tata Group has lately offered collaboration. India, with its population in excess of a billion souls, cannot afford to be overlooked. Already all of Starbucks’ competitors seem to have a presence there, from Barista to Coffee Bean to Costa Coffee. So it appears that to Starbucks dismay, it may be the last well known entrant in this well known market. There may be tough competition in the beginning, when it is seeking to earn market share and customer’s preference over the other offerings by competitors as well. In India, it would make sense to start outlets in the North, where there are more coffee drinkers, and move gradually to the South. The South Indians prefer tea to coffee. Another thing that needs to be considered is the pricing factor. Tea is generally available for just five rupees at any roadside tea stall, whereas pricing a coffee cup at even fifty rupees, or ten times the cost of tea, would convert to just 70 cents. So it is not a profitable proposition, and Starbucks may just have to dig in and wait for the long haul when it manages to eke out a profit after three to five years of the initial investment. The point is to convert tea drinkers to coffee drinkers in the South, and convert coffee drinkers to regular and diehard Starbucks customers in the North (www.independent.co.uk). Clearly there is market potential and even income affordability by a rising middle class segment in India. That is why all of Starbucks competitors have already opened up shop here. Regarding the question of financing, Starbucks has traditionally been in favour of franchising its outlets across America and Canada. The owner and operator get to use the Starbucks name and logo and profit from the business. So in the North American continent, franchising seems to be the mode of choice. However in India one is torn between equity financing and debt financing. It is also worthwhile to note that India has a vibrant primary as well as secondary market for IPO’s and equity financing. Mumbai’s SENSEX is a well known market index across the world and especially among the South Asian countries. The name and fame of Starbucks as an international brand, the leadership and the management of local outlets will all have a impact on its initial public offering in India. A company should only consider a debt offering as in bonds or debentures as a last resort in case the IPO was unsuccessful. In this case a loan can be taken from a local bank in India or bonds or debentures issued in the debt market. Another means of financing would be direct investment by its overseas head office in the USA. This is called foreign direct investment and shows the faith and resolve of the head office in its overseas operations. This could be a possibility but there have been reports that Starbucks has closed down as many as 900 outlets in the USA and Canada since 2008 due to the recent recessionary tends felt all over the world. Yet the management of Starbucks might consider investing money in the Indian operations because of the potential here. Profitability and market share are bound to follow. Another thing that needs to be considered while looking at whether to follow the debt route or the equity route is that debt carries a fixed rate of interest which must be paid to the creditors of the company, while an equity offering via issue of shares gives no such obligation- it is entirely up to the earnings and profitability of the company and the decision of its Board members as to the declaration and payment of dividend. A creditor or equity holder of the company can easily convert his debentures or shares into cash by selling them in the bond or equity market (Rao, 1989). Factors to Be Considered by Starbucks regarding its Pricing Strategy in the Indian Market In January 2011 Starbucks announced the intention to start its outlets in India. Of course this is big news for India and for Starbucks as well. The challenges are evident too. For one thing it is reported that some or most of its competitors are already in India. So it may have to follow a reactionary strategy rather than a market dominating strategy. It may have to work to cultivate the taste and preferences of the Indian public and switch preferences from tea to coffee as indicated in the UK newspaper report. Lastly and most importantly, it will have to consider the price at which the coffee can be sold to the Indian public. The man on the street is known to drink ‘sweet chai’ or tea for just five rupees a cup. Overcoming the pricing challenges will be a key factor for Starbucks as it seeks to create a name for itself in India. Starbucks’ Tall Latte Index: Is It Really Useful? The Economist Magazine has used the price of Starbucks coffee around the world to develop a tall-latte Index. Like the Big Mac Index, it is based on the theory of purchasing power parity which says that exchange rates should equalize the price of a basket of goods in each country. In this case, the comparison is based on just one item, a tall-latte. Previously the Economist used to publish a Big Mac Index based on the cost of a quarter pounder from McDonalds. In support of this measure, the Economist has published the history of the relationship between hamburgers and America (‘As Hamburgers Go, So Goes America’, 1997). Rather than to be taken seriously, it was meant to be a light hearted comparison of the purchasing power parity. It would make some sense because a McDonald’s quarter pounder burger would be available in each of the compared countries and thereby a comparison could be made. However, any economics professor would tell you that basing the comparison on just one item of consumption i.e. a burger is foolhardy; it is rather wiser to base your comparison on a wider basket of goods that signify daily consumption items. So while interesting, the Tall Latte or the Big Mac Index does not really make good economic sense (Samuelson & Nordhaus, 2006). The Possible Implications of the Data for Firms in Thailand and the Euro Area The comparison of exchange rates based on the purchasing power parity theory but using just the Latte Index or the Burger Index as a base is likely to give a confusing picture. The article ‘Burgers or Beans?’ (www.economist.com) states that the Euro is 30 percent overvalued to the dollar, and the Sterling 17 percent overvalued. The comparison chart in the article stated shows that Thailand’s currency would be 46 percent undervalued using the Big Mac Index and 31 percent undervalued using the Tall Latte Index. However the situation in the Euro area would be just the reverse- that currency is 24 percent overvalued using the Big Mac Index and 33 percent overvalued using the Tall Latte Index. Reasons to be Cautious in Interpreting the Tall-Latte Index It has already been indicated above that interpreting the Tall Latte Index as a measure of comparison of purchasing power parity or value of local currency in different countries is misleading. The cost and pricing of a Tall Latte could depend on a number of factors. The choice and cost of the coffee beans, their quality and variety, cost to ship to the country in question, cost to transport to the stores and the degree and type of competition in a particular country, plus the coffee drinking habits of the local community all have an impact on the price of a tall latte. Sometimes competition for market share brings out discounted price promotions, at other times a rise in the cost of cocoa beans could result in an unavoidable rise in the price of a cup of mocha- so it is wise to stick to the traditional larger basket of goods for comparison purposes rather than base it on one or two items like the Big Mac Index or the Tall Latte Index. References Buscombe, A. (2011, Jan 14). India Wakes Up to Smell of Starbucks Coffee. http://www.independent.co.uk/news/world/asia/india-wakes-up-to-smell-of-starbucks-coffee-2184987.html#. Accessed 25 Mar 2011. Kotler, P. (1990). Marketing Management, 6th ed. Prentice Hall. McConnell, C.R & Brue, S.L. (2005). Economics, 16th International Edition. Mc Graw Hill. Rao, Ramesh K. (1989). Fundamentals of Financial Management. Prentice Hall. Samuelson, P. & Nordhaus, W.(2006). Economics, 18th International edition. Tata McGraw Hill. Starbucks Official Website at www.Starbucks.com. Accessed 25 Mar 2011. The Economist Magazine (2004, Jan 15). Burgers or Beans? http://www.economist.com/node/2361072. Accessed 25 Mar 2011. The Economist Magazine (1997, Aug 21). As hamburgers go, so goes America. http://www.economist.com/node/154515. Accessed 25 Mar 2011. The Economist Magazine (2004, Jan 15).The Big Mac Index. http://www.economist.com/node/2352137. Accessed 25 Mar 2011. Thompson, A.A. and Gamble, J.E (19xx). Starbucks Corporation Case study. http://www.mhhe.com/business/management/thompson/11e/case/starbucks-2.html Read More