COFFEE, LIPSTICKS, AND THE ECONOMY
Starbucks' decision to close six hundred coffee outlets appears to be driven at least in part by a "triple whammy:" Increasing competition, a weak economy, and the drain on consumers' wallets resulting from the current all time high gasoline prices.
The first factor—increased competition—is actually a fairly common one for "evolving" product categories. When Starbucks' spurred on the mass market for high quality brewed coffee in the U.S. some fifteen years ago, the chain faced only modest competition. Fast food chains and donut shops featured "regular" coffee at lower prices and a few small chains and local establishments served the higher end clientele. In such an early phase of the Product Life Cycle (PLC), the growth in demand is often greater than the increase in supply that results from the entry of new firms into the market. Thus, price pressure—and the risk that your customers will defect to lower cost alternatives—tend to be lower than they are in more "mature" product markets. Now, however, a number of other outlets offer premium coffee—it not always quite in Starbucks' league—at significantly lower prices. The entry of McDonald's and other national chains into the premium coffee market category is no real surprise. In most industries, there is a limit to how long one firm can continue to dominate the market.
With a weaker economy, many individuals are worried about losing their jobs. Others do not get the over-time and bonuses they have come to expect during better economic days. That three dollar plus cup of coffee is, realistically speaking, one of the easier things to eliminate from one's budget. A three dollars-a-day habit, after all, translates into some $1,000 over the course of a year. It is much more difficult to cut from the family grocery budget.
Problems are now compounded by all time high gasoline prices. In the short run, there is very little that most consumers can do about their gasoline consumption. They can cut back on driving vacations and other unnecessary driving, but there are often not attractive public transportation options for getting to work or picking up children from school. Many consumers are now stuck with big, low-gas mileage cars they picked up when oil prices were lower. Ironically, because many still owe a great deal on these cars whose resale value has now declined, switching to more gas-efficient cars can be difficult. This compounds the budget problems that many families are experiencing. There is clear evidence that high gas costs have cut in significantly to consumer retail purchases, especially at the end of the month.
Does this mean that vendors of high cost luxury products like Starbucks will go out of business? Hopefully not. We are not talking about gourmet coffee aficionados cutting out Starbucks entirely. Many will continue to go, albeit not as regularly. However, businesses that have high fixed expenses (the cost of real estate and labor) and much lower variable costs (the cost of the actual coffee and cups) are highly sensitive to volume. Thus, a ten percent decline in sales, for example, results in much more than a ten percent decline in profits. If customers opt for lower priced items when they actually do go, this problem is compounded.
Ironically, another "luxury" product actually seems to thrive during recessions (see http://findarticles.com/p/articles/mi_m3374/is_5_25/ai_99984765). The so-called "Lipstick Index," based on time series analysis of the economy and sales of lipsticks, actually suggests that lipstick sales go up during bad economic times. The hypothesis is that a lipstick—even a rather heftily priced one—is an affordable indulgence.