Starbucks Pricing on Cost or Value??

Starbucks boosts prices on some beverages - USATODAY.com

There are no direct “lean” fingerprints on the news stories about Starbucks adjusting their prices, but let’s talk about it anyway.

One of Toyota’s contributions to the management world is the idea (actually born from basic economics) that the price charged to the customer should be set by the market.

Traditional management thinking starts with your production cost, including materials, labor, and overhead. This approach takes your cost and tacks on some desired profit margin, which is a sort of entitlement thinking. Let’s say the company feels entitled to a 50% margin. If your production cost for a good or service is $1, then you would set a price of $1.50.

If the market is willing to pay $1.50, then great. If most of the market only values the product at $1.25, they might go elsewhere and the company loses business. If this is a proprietary or monopoly product, the customer might be stuck in the short-term, but they’ll work to find alternatives, which isn’t good for the company in the long-term.

If a lot of the market is willing to actually pay $2, then the producing company is leaving money on the table, if they’re not charging as much as the market would bear.

The Toyota approach would be to take the market price, say $1.50, and then work backwards to get costs low enough to meet a profit target. This is also called “target costing.” If the market only wants to pay $1.25 and you want a 50% margin, then you had better work to get your production costs down to about 83 cents.

In the news article I linked to, Starbucks announced it is raising the prices of some “complex” drinks — a Frappucino seems pretty labor-intensive when you watch them being made. Starbucks is also lower the costs of basic drinks, like black coffee (my usual beverage).

Does it sound like Starbucks is basing its prices on the complexity (and therefore, labor cost) of its drinks? This doesn’t sound Lean to me.

I wonder if they are adjusting their prices to what they think the market will bear, but they’re really using the excuse (that most customers, ironically, accept as sounding reasonable) that they have “no choice” - as other companies sometimes say - because of the labor costs?

I recently had another example of the “rising costs” excuse. My home alarm monitoring company sent a letter that said “it is now necessary” to increase my fee by $2 because of “ongoing increases in operating costs.” Hmm. That’s not my problem that they can’t manage costs. One of those costs is the advertising budget for the TV ads proclaiming their new name and corporate identity.

A more honest letter, one that you’d never receive would say, “We are going to charge $2 more because we think the market will bear it. We expect that you will just absorb the price increase rather than cancel (endangering your family and home). We’re also guessing it’s not worth $24 a year for you to go through the effort to change service companies. And if we lose you, so be it, we are adding new customers thanks to our advertising.”

Maybe Starbucks *is* taking a market view, but they just can’t say so. Are black coffee drinkers inherently price sensitive (as part of their reason for not drinking lattes), so it makes sense to lower prices in a recession? And $4.50 Frappucino drinkers have self-identified as not being very price sensitive (or they’re not hurting personally), so increase their prices?

Maybe it’s perfectly economically rational, even if it’s being explained away as a “cost” issue?