-647700-81730600The Alternative Approach to Starbucks Premium Pricing Strategy
Bandaranayake TMIK 51500020
Jayathilake NR 51500032
Starbucks isn’t the place to go for cheap coffee. It is selling an experience, not a commodity.
Market of coffee
Everyday nearly 2.5 billion cups of coffee are consumed. Coffee is one of the most widely traded commodities in the world. The global market for coffee is considered by unstable prices and production levels which effects directly on the incomes and survival of producers.
Consumers have been willing to pay for what they consider an elite lifestyle and many consumers believe that the higher the price, the better the quality. Above the standard value brands premium brand coffee makers have some market power to set prices
We Selected Starbucks to analyze how they are growing day by day using premium pricing strategies and what are the secret behind the premium pricing strategies.
Starbucks is the largest and most successful coffeehouse chain in the world. There are more than 22500 of its stores currently running in worldwide. The brand is known for professionalism, excellent customer service and its wide variety of beverages. Its products are priced higher than its competitors but what really counts for the real coffee lovers is the quality.
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.
Starbucks positions itself as a specialty premium coffee retailer and has a strong and well-known brand image. As Starbucks is a premium coffee brand, its target market has always been middle and upper class with the disposable income needed to frequent the coffeehouse.
In this analysis we want to find out how Starbucks internal sources and capabilities create competitive advantage which lead to premium pricing strategy through the usage Resource based model to find out
Starbucks has raised prices for at least the past three years, according to spokesperson Lisa Passe, typically by 1-2% each year. The firm’s premium brands are discretionary and labor market conditions continue to weaken. Labor force participation is near a thirty-year low and income growth remains flat. At the same time, competition has increased. Fast food companies such as McDonald’s (NYSE:MCD) and Burger King (BKW), and even fast-casual joints have added coffee to their menus.
Latest 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. it only takes a 1% increase in prices to Starbucks raise profits by an average of 11%.When people feel like they are getting a good deal for their money, they are more likely to pay a higher cost. Starbucks appreciates that the mainstream of their customer base is impervious to price, and uses small price rises that everyday customers may not notice to increase margins. The goal is to use the price increases to guide the customer towards your most profitable product.
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 maintains strict quality controls in its coffee sourcing as well as in its customer service and peripheral products to justify its costs.
The Starbucks experience is entirely exclusive in itself and complements its pricing strategy. The idea is to provide the best quality products at moderately higher cost. However, Starbucks does not just sell coffee but an entire experience that is knit around the idea of luxury. Moreover, Starbucks customers are apparently impervious to the price difference between its products and the competing ones. These factors have helped it sustain both a premium pricing strategy and a premium image. Its premium pricing strategy complements its ethical, global and premium brand image.
Previous IO Model implements an external view to explain that forces outside of the Starbucks represent the dominate influences on a firm’s strategic actions such as consumer income, monopolistic competition resulted Starbucks to use premium pricing strategy.
For example, it found out Coffee consumption increases with household income, and whereas many of its peers market to lower-income customers, Starbucks targets urban professionals in higher income brackets who are less sensitive to price.
In this study we are using internal prospective to explain that the reason behind Starbucks premium pricing strategy is its competitive advantage created by some internal tangible and intangible resources which are subjected to resource based model.
This is the most important area where most of Starbucks’ focus has remained since always. Great products do not require a lot of marketing. This is the belief that Starbucks has held traditionally. However, the world knows that Starbucks serves the best coffee sourced from all around the globe. These cocoa beans are acquired from farmers in diverse areas and then processed with great care before being served. Starbucks roasts its beans longer than others to bring out the exclusive flavor.
Starbucks comes under Short run monopolistic competition with imperfect information.it is compulsory for Starbucks in maintain short run in the business cycle in order to gain economic profits through premium pricing strategy.
If Starbucks raises its prices above those of similar restaurants with which it competes. Will it can keep and grow its customer base? yes. Because the people value restaurant is different from other restaurants,
Because products in a monopolistically competitive industry are differentiated, firms face downward-sloping demand curves. In the short run, the model of monopolistic competition looks exactly like the model of monopoly.
Because Starbucks faces a downward-sloping demand curve, its marginal revenue curve is a downward-sloping line that lies below the demand curve, as in the monopoly model. We can thus use the model of monopoly that we have already developed to analyze the choices of Starbucks in the short run.
Starbucks competes with several other similar firms in a market in which entry and exit are relatively easy. It`s demand curve D1 is downward-sloping; even if Starbucks raises its prices above those of its competitors, it will still have their customer base as you can see below. This can idenfied as premium pricing strategy.
Companies must use effective pricing strategies to sell their products in a competitive market place so they can make a profit. Business managers need to consider a range of factors, such as prices offered by competitors, costs for production and distribution, product image positioning in the minds of consumers, and determining the demographics of potential buyers.
To make premium pricing palatable to consumers, companies try to create an image in which consumers perceive that the products have value and are worth the higher prices. Besides creating the perception of a higher quality product, the company needs to synchronize its marketing efforts, its product packaging and even the decor of the store must support the image that the product is worth its premium price. Starbucks can charge a premium price because their entire brand image is based around luxury.
Weapon behind Premium pricing strategy
Businesses use a premium pricing strategy when they have a distinct competitive advantages over similar products. How Starbucks created its competitive advantage? So far all the studies have been focused on creating competitive advantage through external environment components, but next we are analyzing how competitive advantage create through internal environment.
Resource based view model (RBV) – What makes your business unique
RBV holds that sustained competitive advantage can be achieved more easily by exploiting internal rather than external factors as compared to industrial organization (I/O) view.
RBV is a managerial framework used to determine the strategic resources with the potential to deliver comparative advantage to a firm, the resource-based view offers strategists a means of evaluating potential factors that can be deployed to confer a competitive edge.
Finding out the internal resources which gives sustained competitive edge to Starbucks through filtering RBV
It is very hard to find a resource which will pass all the above mentioned criteria, for example, even though good management team can be a good resource but it can be imitable, and provide social flat form to sell is substitutable, also strategic formal planning can substitute but informal strategic planning can be a VRIO resource,
So here are our four characteristics/ resources/ strategies that will give sustained competitive advantage to Starbucks
Less money on advertisement , Burn money on employees and society
One area of business that Starbucks spends the least amount of their money on is its advertisements compared to competitors. Schultz believes that experience beats ads. In an article from “businessweek.com “Starbucks: keeping the Brew Hot” explains that given that philosophy of experience beats ads, conventional advertising has been no real significance to the growth of the Starbucks brand
Instead of putting millions into image building campaigns, Starbucks has chosen to spend its money on employee benefits. Starbucks was one of the first companies to offer part-time employees equity and health benefits, unlike its competitors in which it’s hard for them to imitate. Starbucks has also created protects that have given back to the community, created recyclable products, and has branched off into different brands, which has brought the company to another level. Starbucks constantly strikes to be different and better than everyone else and if they stick to their core competencies, the company will continue to be successful.
2. 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.
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.
3. 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.
4.Product Versioning & Price Communication
They also apply price increases to specific drinks and sizes rather than the whole lot. 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.
Here are some of the takeaways from Starbucks
1. Study your customer personality.
Starbucks apprehend that the mainstream of their customer base is honestly insensitive to price, and uses minor price rises that ordinary consumers hardly notice to lift margins. Measure customer personality and the demand for your product or service will assist you pick a value that seizures the maximum amount your customers are willing to pay.
2. Rationalize the exchange rate for your product.
Communicating price increases successfully is crucial to a fruitful price hike, and handling customer insight is a key part of the Starbucks strategy. Backing your price increases using changes in the market such as higher commodity costs and ease the pain on the consumer by finding a smart way to publicize the new prices.
3. Use product differentiation to put your company in the lead.
You can maximize your returns 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 cut in demand is unavoidable. Create 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. Increase the prices of the products with the least margins.
Starbucks raised the price of the tall size brew solely in order to encourage customers to buying larger sizes (with slightly higher margins). Price hikes for your lower margin products can induce customers to promote to more luxurious choices, mainly with respect to products and services that are built based on time usage and features. The aim is to use the price rises to monitor the customer to your most money-making product.
This analysis shows that Starbucks has not become a brand synonymous with coffee without a reason. From sourcing to roasting and packaging, the brand is exemplary in all areas. It has crafted an exclusive and extraordinary experience for its loved customers. Its premium pricing strategy is the secret behind its ever increasing growth. We found out main characteristics of Starbucks which gives competitive advantage through RVS model. And thus Starbucks use this competitive advance to use premium pricing strategy to booster profits. Finally we mentioned lesson learned from Starbucks that can apply to your day to day business.