Question

HOW STARBUCKS USES PRICING
STRATEGY FOR PROFIT
MAXIMIZATION




In January 2020, Starbucks raised their beverage prices by an average of 1% across the U.S, a move that represented the company’s first significant price increase in 18 months. I failed to notice because the price change didn’t affect grande or venti (medium and large) brewed coffees and I don’t mess with smaller sizes, but anyone who purchases tall size (small) brews saw as much as a 10 cent increase. The company’s third quarter revenue rose 25% to $417.8 million from $333.1 million a year earlier, and green coffee prices have plummeted, so what gives?


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 revenues by an average of 11%.




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.
on Wednesday April 8, Starbucks announced that it expects its fiscal second-quarter earnings to be cut nearly in half as the coronavirus pandemic causes sales to plunge in its two largest markets.















After reading, answer the following questions:

1- What would happen to Starbucks’ profit if the prices of all three go down, holding other things fixed?

2- On Wednesday April 8, Starbucks announced that it expects its fiscal second-quarter earnings to be cut nearly in half as the coronavirus pandemic causes sales to plunge in its two largest markets. What would be the right pricing strategy to maximize revenues for Starbucks in the current circumstances?

3- If you have your own business, what do you learn From Starbucks case study?

Answer 1

Solution

1.Starbucks has the customers who are relatively price insensitive.So,If the prices of all the 3 segments go down,their revenue will also reduce because reducing prices will not increase their customers. In addition,they might loose their loyal customer base who choose them for exclusiveness,premium,quality perceprtion reasons.At the same they might be able to attract enough additional customers from other segments to nulnify the lost revenue from their existing premium loyal customers.

2.Since their sales have plunged during these hard times,it should not reduce it's prices but instead it should maintain it's exclusiveness and premiumness by keeping the prices constant.

Incase if it fears customer loss due to this recessionary trend,then it can think how to create more value for it's customers at the present prices instead of reducing it's prices since it is viewed as premium brand and has customers who treat coffee at this price as affordable luxury.

3.I would try Starbuck's technique of creating and maintaining a brand using which I can isolate the risks caused due to competition in pricing.I also admire the way they maintain their brand perception and targeting and maintaining the loyality of a particular section(*target section) of their customers