Starbucks Cost Structure

How Starbucks reduces the impact of coffee rates

I think there are 2 descriptions for the "irrelevance" of coffee prices.

1. Purchase contracts
2. Hedgin

Purchase contracts

Starbucks purchases the majority of its coffee from providers through fixed-price commitments. This indicates that it will not feel the result of short-term variations in coffee prices, as the price and quantity are fixed. I approximate that these dedications generally last around a year.

Hedging

Another way Starbucks can minimize its product danger is through hedging. Generally, the business will make an arrangement to offer coffee on a given future date (it purchases a future).

This suggests that it makes money when coffee costs increase, and for this reason this counteracts the input cost threat.

Conclusion

Think about the product expenses and margins by doing this: regardless of increasing commodity expenses in 2011 and 2012, Starbucks can enhancing its margins. In 2013, product expenses will probably decline, so Starbucks does not even require improved functional performance to improve success. For that reason, I think Starbucks has a great deal of capacity in the short run (especially if the imperfect hedge will benefit the bottom line), but I am likewise decently optimistic on the long-run prospects of Starbucks.

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I prepare to follow this article up with other thorough short articles about Starbucks, which will elaborate on my long thesis.

Starbucks just recently announced a revamped pricing structure. Prices for a lot of its popular (read: lower-end) items such as brewed coffees and lattes are headed downwards. A spokesperson claims that this is the very first time in Starbucks' history that rates have actually been lowered.

According to a post written by Claire Cain Miller in the New York Times, the coffee purveyor is also redesigning its menu to include lower priced brewed coffees, as well as providing promos on iced drinks. This strategy makes sense: the struggling economy determines discount rates and McDonald's brewed coffees and lattes are taking price delicate consumers.

Paradoxically, Starbucks is also increasing the prices of its higher-end more complex drinks including Frappuccinos and caramel macchiatos, of which there is less competition from rivals. In some cases, prices are rising by 30 cents (8%). There is some justification for this price increase. In Starbucks recent quarterly earnings release (third quarter ending June 28), same store sales in the U.S. were down by 6%. Broken down, 4% of this decline was due to fewer transactions (customers defecting to McDonald’s, for instance) and the remaining 2% from a decrease in average value per transaction. Thus, for the most part, customers who continued to patronize Starbucks spent the same amount on each visit.

So why raise prices right now when demand is waning? Some speculate that Starbucks is trying to make the most profit from its devoted customers who are hooked on its products. In other words, its specialty drinks are in the cash cow phase of the Boston Consulting Group’s Growth Share Matrix. For products in this cash cow phase, the general recommendation is to reduce investments and simply harvest profits from current demand.

All successful products have their heyday of strong growth and then eventually reach a point where demand remains constant or decreases. After all, remember when CB radios and radar detectors were the rage? When a product reaches the cash cow stage of its lifecycle, the general strategy is to take the money and run. What are the chances that macchiatos will experience a growth surge in the future?

With rivals (including McDonald’s and Dunkin Donuts) stealing share from Starbucks’ lower-end products and concerns about the growth of its highly differentiated premium coffee drinks, what’s the growth driver that justifies Starbucks’ current price to earnings ratio of 59? This high p/e ratio indicates that investors feel the company has higher potential growth opportunities than the average company (in contrast, GE’s p/e ratio is 10.5 and Wal-Mart’s is 15).

A company’s pricing strategy can be a good indicator of its future growth potential.

http://www.pricingforprofit.com/pricing-strategy-blog/starbucks-new-pricing-strategy-beginning.htm

A weak cost structure means Starbucks’s costs are high in comparison to their competitors