

Where Starbucks Went Wrong in Its Coffee Pricing - vwoolf
http://www.slate.com/blogs/moneybox/2012/01/04/starbucks_raising_coffee_prices.html

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byrneseyeview
This article is completely wrong. If Starbucks has hedged, they aren't
"losing" money on the price of coffee going up or down; their hedge pays out
inversely with the change in operating costs due to coffee price fluctuations.

Another way to illustrate this is to note that the cost part of the equation
is the same regardless of what happened to coffee prices in the last year:
assuming they hedged, they'd probably raise prices by the same amount had
coffee been up or flat for the year, too.

Another important flaw is that costs do not determine prices in this way. See
this legendary Quora thread for details: [http://www.quora.com/Why-is-iced-
coffee-more-expensive-than-...](http://www.quora.com/Why-is-iced-coffee-more-
expensive-than-hot-coffee?q=iced+coffee)

Yet another problem is that even if costs did determine their pricing,
Starbucks' big costs are real estate and labor. The markup on beans and hot
water alone is staggeringly high.

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Lazare
Agreed. There's so _many_ issues with the article, it's kind of weird.

As you point out, they were hedging (and so did not see their bean prices go
up), and even if they had, bean prices aren't even a major cost driver. But
imagine, for a moment, that coffee beans _were_ a major cost driver for
Starbucks: The article suggests Starbucks' management should _not_ be expected
to manage these costs. That's ridiculous to the point of outright laughter.

In other news, Southwest execs say "damn, but there's just nothing we can be
expected to do about fluctuating fuel prices" and analysts admit that Facebook
"can't be expected to understand how to run large data centres; after all
that's unrelated to their core business". </sarcasm>

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gte910h
Commodity Trading agreements are _for_ businesses who use items as the input
for their production.

Starbucks is one of the few types of companies that SHOULD be buying
commodities contracts to control unpredictability

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mikeryan
_But it doesn't really make sense for the Starbucks management team to be
speculating on coffee prices. To run Starbucks successfully you need a lot of
management skills related to operating and marketing a large chain of coffee
houses._

I dunno I'd assume that an organization the size of Starbucks can probably
afford to have a few folks dedicated to their supply chain economics separate
from the coffee house operations and marketing folks.

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yummyfajitas
I'm sure they can afford it. But do you really expect Starbuck's coffee
speculators to beat the speculators at Renaissance and GS?

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fennecfoxen
Speculation at places like Goldman Sachs isn't just about having better
future-predicting power, though. It's also about sitting on buckets of money
such that you have a lot of risk tolerance. Then people pay you to take their
risk, and you win on the average (in terms of profit) and they also win on the
average (in terms of reduced risk).

Starbucks, being as big as they are, may simply have felt that they were big
and well-informed enough that the risk of self-insurance made more sense for
them... a decision which is easy enough to snipe at ex post facto, but may
still have made more sense.

~~~
byrneseyeview
In value-at-risk terms, Starbucks' hedging requires a _negative_ amount of
capital: they need more cash on hand if they refuse to hedge. With a given
capital structure and no coffee hedging, there's a possible coffee price X
that would wipe them out. With hedging, they can place an offestting bet that
coffee will rise; then they're indifferent to that price fluctuation. That's
one less way for them to unexpectedly lose money, so their results in the
aggregate would be less aggregate.

Plus, the buckets of money thing is a canard; Goldman has to earn a percentage
on their capital, just like anyone else. If they have 10X as much equity as
Starbucks, they need to earn 10X as much net profit to get the same return.
And ceteris paribus, that means taking 10X as much risk.

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dpark
> _A reasonable alternative strategy would be to just run the business as if
> the price of coffee was destined to be flat, and then place counterveiling
> speculative bets. The point of those bets, however, isn't to speculate it's
> precisely to try to eliminate the need to speculate._

The point of speculating is to eliminate the need to speculate? What the hell?
This doesn't make a bit of sense.

What Starbucks did was place a bet that coffee prices would go up.
Unfortunately for them, they bet wrong. That's the risk no matter how they
bet, though. If they'd bet on flat prices (no lock-in) or declining prices
(the other side of the bet they actually made), the price could have gone up
and they could have lost money. That's why it's called speculation. Someone
speculates that the price will go one direction, and they make a bet to that
effect with someone else.

~~~
eru
> If they'd bet on flat prices (no lock-in) [...]

You can buy contracts to bet specifically on flat prices. And of course you
can also bet on moving prices, without committing on up or down. No bet isn't
an implicit bet on flat prices.

~~~
dpark
Sure. You can bet many ways. No matter what you do, though, it's a bet and you
take the risk of losing money vs any other bet you could have made.

And no bet is an implicit bet. You're betting that you can get as good (flat)
or better (declining) a price in the future as you can get right now by
locking in.

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droithomme
I used to go to Starbucks every morning. But they got too expensive. Their
product always has had a ridiculously high profit margin, with the cost of
preparing a cup being under 10 cents and selling for $1.49, then $1.59, then
$1.79, now it is $2.19. Starbucks price should not have been raised in this
economy just because raw inputs went from 10 cents to 13 cents. Finally the
customers, well myself at least, said this is absurd I am being ripped off
here, and I bought a good espresso machine for home. Come to think of it
though, this is all pretty irrelevant since it seems they are still packed
with enthusiastic customers most of whom are renting wifi for the price of
coffee. Hey, if the market can bear it, jacking up your prices continually is
not the worst plan.

~~~
ImprovedSilence
Little known fact about Starbucks cup sizing: the menu goes 'tall', 'grande',
'venti', but you can still order a 'small', it's not on the menu, and costs
like $1.12 or something.

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chc
I think you mean "short." If you ask for a "small," they will probably offer
you a tall (for the same reason that somebody requesting a Big Mac at Burger
King will be offered a Whopper instead).

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RobertKohr
Um, isn't this the definition of sunk cost? They already lost money on their
bet. Trying to raise prices in the future to pay for the past is a blunder.

If they can get away with raising prices and not losing customers, it is
irrelevant that they overpaid for coffee they already bought. They just earn
more per cup. If they can't get away with it, then this is a foolish thing to
do, as they can't make their previous payments vanish.

Didn't their executives go to business school?

~~~
zacharyvoase
It is a prime example of sunk cost (and the sunk cost fallacy), but it doesn't
explain why they're only raising prices now, rather than back in October when
they locked in the agreement. The linked-to WSJ article explains that
Starbucks will be paying 'more than their competitors' for coffee, but they're
still not paying 'more for coffee' than they expected to. That's the nature of
a forward purchase agreement.

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scott_s
Planet Money did a story that talks about fuel speculation in the airline
industry: [http://www.npr.org/blogs/money/2011/09/30/140954343/the-
frid...](http://www.npr.org/blogs/money/2011/09/30/140954343/the-friday-
podcast-how-money-got-weird) (The fuel speculation part is 8 minutes in.)

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DanBC
> _Unfortunately for them, the coffee market fell soon after that leaving
> Starbucks locked in to paying higher prices than what you can get on the
> spot market._

Just spin it as FairTrade supreme version?

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eru
Depends on the nature of the counter part. Could be Goldman Sax, could be some
coffee producer, could be a fund that's run for the benefit of little old
widows but with no other connection to coffee.

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zacharyvoase
I find it really surprising that the article doesn't once use the words
'hedging' or 'liquidity', since an understanding of those very basic concepts
would have made the second paragraph either useful or redundant.

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smallegan
Unfortunately I think the author is just speculating.

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j45
They should have less bitter coffee while they're at it so people aren't so
bitter.

~~~
j45
It's a well known fact that Starbucks buy cheaper coffee than say a Tim
Hortons.

