Rafi Mohammed

Is a "60 - 80 cent" Discount Going to Stifle Starbucks' Growth?

Posted on January 8th, 2008 (2 Comments)

Janet Adamy wrote a fascinating article in yesterday’s Wall Street Journal (“McDonald’s Takes on a Weakened Starbucks”) on McDonald’s entry into the specialty coffee market. Jumping into the coffee drink fray, McDonald’s is installing coffee bars in its close to 14,000 U.S. stores. Specially trained coffee barista employees will whip up coffee products (lattes, cappuccinos, and Frappuccino-like drinks) that directly compete with Starbucks’ coffee concoctions. McDonald’s expects this initiative to add a billion dollars in revenue to its current U.S. operations (current revenue is $21.6 billion).

So how does McDonald’s plan to take on Starbucks? By price…of course. The fast food giant isn’t claiming to offer a better product or more comfortable environment. Instead, its advertisements in test markets emphasize price: McDonald’s coffee products are 60 to 80 cents lower than competitors’ products. From a value perspective, McDonald’s is in essence telling its customers “our product isn’t necessarily better, but it is cheaper.” That said, McDonald’s does have advantages over Starbucks. Consumer Reports recently rated its drip coffee to be better than Starbucks. And McDonald’s are often more conveniently located.

So what do you think? Is the Starbucks’ experience and high quality coffees worth a 60 to 80 cent premium over McDonald’s? Admittedly, Starbucks offers a superior environment to enjoy a coffee drink. But that may not be a major advantage - Janet’s article mentions that about 80% of orders purchased at U.S. Starbucks are consumed outside the store. A 60 to 80 cent savings is significant for a coffee drink that is going to be consumed in the car or at the office. Would it be déclassé to stroll into the office with a McDonald’s coffee cup in hand? At first brush, perhaps yes. But in Boston, many coffee drinkers proudly purchase their coffee from a donut vendor…Dunkin’ Donuts.

McDonald’s is also seeking to serve new customers by expanding the coffee drink market. Advertisements in its Kansas City test market emphasize that customers won’t face a “condescending look” for mispronouncing the size of the drink. Instead of using the Starbucks vernacular of “tall,” “venti,” and “grande,” McDonald’s labels its drink sizes as simply small, medium, and large. Additionally, from passing out complimentary lattes and mochas, McDonald’s realized that many of its customers “don’t know what a latte is.” A new segment of customers may become hooked on coffee drinks.

My bet is that a “60 to 80 cent” discount is going to stifle Starbuck’s growth…it’s all about price my friends.

By the way, I recently read and highly recommend “How Starbucks Saved My Life” by Michael Gill Gates. Michael's book provides an interesting look at the inner workings of a Starbucks' store. The Wall Street Journal rated it one of the top 10 books of 2007 and it is indeed a great read.

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Readers' Comments on This Blog Entry

From Donna on January 8th, 2008
Gosh...coffee is such a different experience for some many people. Starbucks didn't just create a easy place to get a latte, they created a whole culture. So, it's tough to pull folks away from brand loyalty with a discount immediately. Has Starbucks saturated their market? Will their only growth come from McD's customers? I agree that there is a whole new market for McDs that Starbucks isn't serving and there are definitely some folks that will move to a new vendor based on price..I heard a great comment when I first started my career..."There's no loyalty and penny off can't buy". It was specifically for commodity semiconductors. But Starbucks took a commodity and made it a specialty...so does this really apply to their type of coffee anymore? McDs can grab some growth away from Starbucks, but it will take awhile to chip away at their customer base and their brand. McD can create a new brand for their coffee products, might be smart for those folks that want to be part of the "cool club" and not the cheap club. It's a fascinating story...
From Steve on January 8th, 2008
Starbucks has a serious problem in the long run. This is a brilliant move by McDonalds. That price difference is going to have a significant effect on a lot of folks. I'm not talking about the professional in a downtown office sopping at the corner. I'm talking about just about everybody else that is familiar with McDonalds and with the trade off you make when you eat there. Product will be solid and the price is right. Very significant for Starbucks.