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Economics and Starbucks

Introduction

Figure 1: The logo of Starbucks, it is inspired by the sea featuring a twin tailed siren from Greek
mythology (Starbucks Corporation, 2013).

Starbucks is an American global coffee company and coffeehouse chain. It has started a single
store in Pike Place Market, Seattle, Washington as a roaster and retailer of whole bean and
ground coffee, tea and spices. Starbucks mission is to inspire and nurture the human spirit-one
person, one cup and one neighbourhood at a time (Starbucks Corporation, 2013). Today, the
company has 18ooo retail stores in 60 countries and has connected with millions of customers
(Starbucks Corporation, 2013). Starbucks Coffee Company has a joint-venture with Berjaya
Starbucks Coffee Company to bring Starbucks in Malaysia (Starbucks Corporation, 2013). The
first Malaysia Starbucks store is opened at 17
th
December 1998 in Kuala Lumpur. In January
2012, Starbucks has successfully expanded around Malaysia with 140 stores (Starbucks
Corporation, 2013). Starbucks provides a range of products for customers to enjoy in the stores,
at home and on the go. The products included coffee, handcrafted beverages, merchandise, fresh
food and consumer products (coffee and tea, ready-to-drink and ice-cream). Hence, Starbucks is
in coffee industry.

Market Structure

Characteristic
Perfect
Competition
Oligopoly Monopoly Contestable
Market/
Monopolistic
Number of
Firms
Many Few Dominant
Firms
One with Pure
Monopoly.
Effective
Many
Duopoly in
Many Cases.
Type of Product Homogenous Differentiated Limited Differentiated
Barriers to Entry None High High Low Entry and
Exit Cost
Supernormal
Short Run Profit
Yes Yes Yes Any Profit
Possible
Supernormal
Long Run Profit
No Yes Yes Supernormal
Invites Hit and
Run Entry
Pricing Power Price Taker Price Maker but
Interdependent
Behaviour
Price Maker-
Constrained by
Demand Curve
and Possible
Regulation
Price Maker-but
Actual and
Potential
Competition
Limits Pricing
Power
Non Price
Competition
No Yes (Important) Yes Yes (Important)
Economy
Efficiency
High Low Allocative
but Scale
Economics and
Innovation
Low Allocative
but Economies
of Scale and
Reinvested
Profits. Risk of
X-Inefficiency
due to Lack of
Competition
High Depending
on Strength of
Contestabilty
Innovative
Behaviour
Weak Very Strong Potentially
Strong
Strong

Table 1: The Characteristic of Market Structure (Riley, 2012)

Beside Starbucks, there is always many competitive firms in coffee industry, such as Old
Town White Coffee, Ambrosia Coffee, Caribou , Dunn Bros Coffee, The Coffee Bean & Tea
Leaf, Paparich, Chinese Restaurant (Cha Can Sat) witlh the most traditional Chinese coffee
and Mamak stall with the most local taste. Fast food restaurant even promote the breakfast
coffee, such as Mc Donalds and Subway. The number of firms in coffee industry is many
and they are having intensive competition among the firms. This can be compare between
Row 2 of Table 1.

The coffee shop needs to differentiate among the others due to they are providing the
similar products, such as latte, expresso, capucino and tea. Starbucks has a simple idea on
setting their price which is customer willing to pay if they satisfy and enjoying the good
quality (Demand Media, 2013). The quality control of Starbucks is strict to ensure that the
source of coffee, customer service and the coffee products are always maintain a high
standard (Demand Media, 2013). Besides, Starbucks has an intentionally to form their
coffee lingo, such as tall for large, grande for medium and venti for small (O Connell,
2008). When the customer use the Starbucks coffee lingo to place order, the customer may
feel an escape from the urban life and experience a charge of European sophistication.
Besides, Starbucks is the only coffee firm which provides the drive-thru services to
customers. Hence, Starbucks has differentiated itself among the competitors. This can be
compare between Row 3 of Table 1.

There is no significant barrier of entry for coffee industry due to low entry and exit cost.
Everyone who is interested in coffee industry may just start selling any kinds of coffee at
anytime and anywhere. They can even start selling coffee at their own house. As the entry
cost is low, even though the one want to exit the industry, there has no significant sunk cost.
The entry and exit cost for the coffee industry is low as compare to others industry, such as
agriculture, manufacturing, petroleum and gas and real estate. This can be compare
between the Row 4 of Table 1.

Firms may make any possible profit for short run due to they are not at mature state due to the
changes of variable input. As firms in the industry are making a supernormal profit (Graph 1), it
will attract new firms to come in the industry because there is still have place for others to
venture as well. However, if the firms of the industry are making a subnormal profit (Graph 2), it
means, the firms is suffering a loss, some of the firms may leave the industry and venture other
industry which is more attractive and profitable. This can be compare between the Row 5 of
Table 1.


Graph 1: The Supernormal Profit of Monopolistic Firm. Graph 2: The Subnormal Profit of Monopolistic
Firm.

As the market has regulate itself by the entering and leaving of the firm, the firm in the market
will only earn normal profit (Graph 3) in the long run. This is tabulate at Row 6 of Table 1.

Graph 3: The Normal Profit of Monopolistic Firm

Starbucks has strong non-price strategy to do branding. The white and green Starbucks coffee
cups are specially designed as a walking advertisement for itself. It has more penetration than
advertisement on boards or TVs because the others can SEE the people are enjoying the
Starbucks coffee. It is a solid evidence and prove that it is a worth customer buy coffee. It has
evidenced by more than two trillion customers each year (O Connell, 2008). Besides, Starbucks
also approaches customer by celebrating festival together. Starbucks will decorate their stores to
lift up the festive spirit. The workers will also greet the customers with the element of the festival
(Starbucks Corporation, 2013). Starbucks will offer customers beverages that attract the local
example during the major festive seasons such as National Day (Merdeka) (Freebies Land
Malaysia, 2013). Hence, Starbucks has strong non-price competition strategy. This can be
compare with others at Row 8 of Table 1.


Figure 2: Starbucks is celebrating National Day with Malaysian by offer free upsize while buying a Grande
Frappucino. (Freebies Land Malaysia, 2013)



As Starbucks as a firm in the coffee industry has many firms to compete, products are
differentiates, low entry and exit cost, very important at non-price competition. Hence, it is a
monopolistic market structure. This can be proved by Column 5 of Table 1.

Demand

Change in quantity demand is a movement along the demand curve to a new point when there is
a change in price. Law of Demand is the quantity of a good per period of time will fall as price
rises and will rise as price falls, other things being equal (centeris peribus).


Referring to Graph 4, the original price of lattes is at P1 and the original quantity demanded of
lattes is at Q1. A New York Starbucks increased the price of lattes by ten cents at 25th of June,
2013 (Bloomberg Businessweek, 2013). The price of lattes has increased to P2 and the quantity
demanded of lattes has decreased to Q2.

Graph 4: The Movement along the Demand Curve (2012)



Change is demand is a shift of demand curve when a determinant of demand other than price changes.

According to Luis Genaro Munoz, chief executive of Columbia(the second largest producer of mild
Arabica coffee), coffee drinkers from Brazil to Asia are increasing consumption and willing to pay
more for high-quality coffee (Bloomberg, 2011). As Starbucks is providing the good quality coffee,
demand has increases for high-quality coffee. Since there is an increase for demand, the demand
curve should shift outward from D0 to D1 at Graph 5.



Supply

Supply curve shows the relationship between the price of a good and the quantity of the good
supplied over a given period of time.

Change in quantity supplied is a movement along the supply curve to a new point due to a
change in price.

Change in supply is a shift of the supply curve when a determinant other than price changes.


Starbucks is warning of a threat to world coffee supply because of changing climate. According
to Jim Hanna, Starbucks sustainability director, said its farmers were already seeing the effects of
climate change, with severe hurricanes and more resistant bugs reducing crop yield (The
Guardian, 2011). If the condition continues as they are then is a potentially significant risk to the
supply chain, especially the Arabia coffee bean. If Starbuck is lack of coffee bean (raw
materials), then it has to decrease its supply. Hence the supply curve will shift inward from S1 to
S3 at Graph 6.


Graph 6: The Shift of Supply Curve (2012)


Government Intervention

The main reasons for government to intervene the market is to correct for market failure, to
achieve a more equitable income and wealth distribution and to improve the performance of
the economy.

Malaysia government is promoting the Goods and Services Tax (GST) will to replace the
service tax and sales tax (SST) and will implement it between 18 and 24 months. The
reasons of the government want to replace it the GST can overcome the weakness of the
current tax system which is the cascading tax, double tax and pyramiding tax, tax erosion
and leakages through transfer pricing and other ways (Royal Malaysian Customs
Department, 2013). GST is a more transparent and business friendly tax system to increase
tax compliance and easier to record and audit. Besides, implementation of GST may
enhance the effectiveness and transparency of tax administration and management. The
implementation of GST will not affect the people who income below RM 3,000 per month
and is expected no price of essential foodstuff will increase (Royal Malaysian Customs
Department, 2013).


The price of goods and services which currently includes the SST will be reduced due to the
proposed GST rate is 4% which is lower than the current tax rate (Royal Malaysian
Customs Department, 2013). Starbucks is categories as restaurants and hotels can enjoy
the reduction in price with 1.20% (Table 2). This will encourage the goods and services
sector to produce more to boost the economy due to the lower cost.

Categories Reduction in price (%)
Clothing and footwear 2.71
Communication 1.86
Furnishing, Household Equipment and
Maintenance
1.57
Restaurants and Hotels 1.20
Transportation 0.94
Alcoholic beverages and tobacco 0.73
Housing, water, electricity, gas and fuels 0.12
Miscellaneous goods and services 0.08

Table 2: Consumer Price Index (CPI) shows the result of goods and services will result in price reduction (Royal
Malaysian Customs Department, 2013)

Besides, the GST has lessened the burden of the tax payer so that they can have more disposable
money (Table 3).

Income
Group
Average monthly
expenditure(RM)
SST GST
Tax
burden
(%)
Tax paid
(RM)
Tax
burden
(%)
Tax Paid
(RM)
Poor 570 2.38 13.57 2.17 12.37
Lower 1,856 2.75 51.04 2.43 45.10
Middle 3,767 2.94 110.75 2.57 96.81
High 7,211 3.13 225.70 2.74 197.58
Average 2,041 2.88 58.78 2.53 51.64

Table 3: Comparison of tax burden under GST and SST (Royal Malaysian Customs Department, 2013)


Externality
The main reasons for government to intervene the market is to correct for market failure, to
achieve a more equitable income and wealth distribution and to improve the performance of
the economy.

Malaysia government is promoting the Goods and Services Tax (GST) will to replace the
service tax and sales tax (SST) and will implement it between 18 and 24 months. The
reasons of the government want to replace it the GST can overcome the weakness of the
current tax system which is the cascading tax, double tax and pyramiding tax, tax erosion
and leakages through transfer pricing and other ways (Royal Malaysian Customs
Department, 2013). GST is a more transparent and business friendly tax system to increase
tax compliance and easier to record and audit. Besides, implementation of GST may
enhance the effectiveness and transparency of tax administration and management. The
implementation of GST will not affect the people who income below RM 3,000 per month
and is expected no price of essential foodstuff will increase (Royal Malaysian Customs
Department, 2013).


The price of goods and services which currently includes the SST will be reduced due to the
proposed GST rate is 4% which is lower than the current tax rate (Royal Malaysian
Customs Department, 2013). Starbucks is categories as restaurants and hotels can enjoy
the reduction in price with 1.20% (Table 2). This will encourage the goods and services
sector to produce more to boost the economy due to the lower cost.


Graph 7: The Positive Externality (2010)