Like many large firms, Starbucks started small.
Gordon Bowker, Gerald Baldwin, and Zev Siegl
opened the first Starbucks in 1971.
Starbucks' current CEO, Howard Schultz, realized
that many consumers wanted a coffeehouse where
they could sit, read, and drink higher-quality
coffee
than they could get in diners or donut shops.
But it was not difficult for other coffeehouses
to copy the Starbucks approach.
By 2009, fierce competition and a weak economy
led Starbucks to close hundreds of stores
and cut prices.
Starbucks become profitable once more in 2010,
partly due to expansion in overseas markets.
Starbucks is in the coffeehouse market, which
has low barriers to entry, so the firm has
many competitors.
But the coffee at Starbucks is not identical
to the coffee at competing coffeehouses.
The coffeehouse market is therefore monopolistically
competitive rather than perfectly competitive.
Monopolistic competition is a market structure
in which barriers to entry are low, and many
firms compete by selling similar, but not
identical, products.
This becomes the keystone difference between
Monopolistic Competition
and Perfect Competition markets.
Differentiation of the product eclipses the
service provided by the vendor of the product.
Rember the farmer's market products where
vendors sell their virtually identical carrots?
How is it that Sasha Gillette can sell more
than her competors sell?
She can differente her service to clients
more than her generic product could.
In Monoplistically Competitive markets differentiation
of the product and the differentiation of
the service unites, to make the perfectly
elastic demand curve into a
downward sloping demand curve.
[Music]
The whole purpose of places like
Starbucks is for people with no
decision-making ability whatsoever to
make six decisions just to buy one cup
of coffee short tall light dark CAF
decaf and low-fat nonfat mochachino.
So people who don't know what the hell
they're doing or who on earth they are
can for only 2.95 get not just a cup of
coffee but absolutely defining sense of self.
Caramel macchiato tall decaf
cappuccino called the cops cappuccino
[Music]
When a firm creates or recognizes a market
for a good and that good is something so fundamental
as grapes made into wine, or beans brewed
into coffee, the product differentiation may
be embodied through social preferences for
the provider; preferences both for and against
the name on the wall.
If a Starbucks increases the price of caffe'
lattes, it will lose some, but not all, of
its customers.
In this case, raising the price from $3.00
to $3.25 reduces the quantity of caffe' lattes
sold from 3,000 to 2,400.
Therefore, unlike a perfect competitor, a
Starbucks coffeehouse faces a
downward-sloping demand curve.
We explore the effects of price and quantity
for any firm on this now familiar schedule
to reveal Total Revenue, Average Revenue and
Marginal Revenue.
Different from the Perfect Competition example,
Marginal revenue initially is positive as
price decreases from $6.00 to $3.00, but marginal
revenue's drop becomes negative below $3.00 per cup.
If a local Starbucks reduces the price of
a caffe' latte from $3.50 to $3.00, the number
of caffe' lattes it sells per week will increase
from 5 to 6.
Its marginal revenue from selling the sixth
caffe' latte will be $0.50, which is equal
to the $3.00 additional revenue from selling
1 more caffe' latte (the area of the green
box) minus the $2.50 loss in revenue from
selling the first 5 caffe' lattes for $0.50
less each (the area of the red box).
The output effect expresses how when more
output is sold, the quantity is higher.
The price effect measures how price reductions
sell more products.
But remember, reduction in price applies to
all cups sold.
Like a competitive firm, the monopolist produces
the quantity at which marginal revenue equals
marginal cost.
While this graph makes this example seem obvious,
I want you to understand that when price is
reduced from $3.50 to $3.00, that change in
price was for all coffee sold by the coffee house.
The Price effect will increase quantity with
a downward sloping demand curve.
As an economist, give attention to the loss
experienced when price is decreased versus
the quantity increased for the new sales level.
Compare the green box to the right to the
pink box on the left.
In this example, reducing price on the first
5 cups by $0.50 reduced revenue by $2.50 while
the increase in revenue resulted in an increase
of $3.00.
Therefore, the price effect shows an attractive
result.
that's going to lead us into probably
the most important concept to
understanding what the grass look like
in this unit it's the idea that demand
doesn't equal the marginal revenue yeah
in the last year remember there was a
horizontal demand curve which equal to
marginal revenue it was MR.
DARP but
that's not going to happen in the
situation and last June's get confused
why pay attention it'll make sense let's
use the ultimate review packet as an
example right I am a price maker there's
no perfect competition when it comes to
producing economics package there's not
millions of firms all producing the same
exact stuff mine is unique it's slightly
different than any other review packet
that's out there and my videos unique as
well the point is I'm a price maker so
here's the price the client manage the
total revenue and the marginal revenue
for my company for each given day if I
decide to sell the packets for 14 bucks
let's assume no one's going to buy it
the price is just way too high no one
buys for 14 so my quantity is 0 and i
get no total revenue if I lower my price
then more people will buy so if I lower
the price down to 12 let's say one
person buys so I sell for twelve dollars
1 times 12 is my toll revenue so notice
my total revenue goes from 0 to 12 so my
additional or marginal revenue is 12 now
you might be thinking of course you sold
another unit for twelve dollars and so
you made twelve dollars additional
revenue yeah make sense well what's this
I want to sell another unit what I got
to do I think I can't just sell another
units because no one else is going to
buy it at $12 I gotta lower the price so
to sell another unit I got a lower price
let's say down to ten dollars at ten
dollars to people buy it per day 2 times
10 is 20 that's my total revenue notice
my additional revenue i went from 12 to
20 right my total revenue what from 12
20 so my additional revenue is 8 now
think about that's kind of weird I sold
another unit for 10 bucks but my
additional revenue is less than when i
sold it for it's only eight I lost two
dollar somewhere well where'd i lose the
two dollars I lost the two dollars on
the revenue I could have earned by
selling it for twelve dollars right when
I lower it down to 10 that's great i get
another customer but I lose the revenue
on the person I could have sold it to
for a higher price and let's do it again
let's say hello the price down to eight
at 83 people buy so the total revenues
24 so my additional revenue is for
notice I sold another unif rate but I
only made an additional four dollars my
marginal revenue does not equal the
price it doesn't equal to the man now if
I keep lowering my price notice what
happens if I low my price down to
dollars per packet then four people will
buy six times four is 24 look my total
revenue doesn't change at all in fact I
get no additional revenue my margin
revenue 0 from so in the next unit my
Marjorie of is actually negative I'm
actually making less additional money by
lowering the price now again this seems
counterintuitive it seems like if I just
sell more units I can just make more
money but it doesn't work that way
because I'm losing money on previous
units I could have sold for a higher
price it actually creates a graph it's
right here the demand curve is downward
sloping just like a normal market curve
showing the law to man with the prices
high so people want to buy price of
low more if you want to buy now but
marginal revenue doesn't equal that
demand curve in fact the marginal
revenue if we plotted those numbers I
just showed you it would look like this
right it's dollar sloping and it's less
than the demand and that's why teachers
talk about the monopoly gang sign boom
looks like this you got to man you got
marginal revenue so when you draw the
graph you're figuring out on a test foo
I am a module everyone it's important
understand what it looks like but it's
also important understand why it looks
that way so the demands downward sloping
because the law demand and the marginal
revenue is less than the demand curve
for all price makers because to sell
another unit they got a lower the price
of all units including the ones that
could have sold for a higher price I
repeated that three times you know it
must be important!
Any firm that has the ability to affect the
price of the product it sells will have a
marginal revenue curve that is below its demand
curve.
We plot the data from Table 13.1 to create
the demand and marginal revenue curves.
After the sixth caffe' latte, marginal revenue
becomes negative because the additional revenue
received from selling 1 more caffe' latte is
smaller than the revenue lost from receiving
a lower price on the caffe' lattes that could
have been sold at the original price.
This all condenses down to the product of
the change in price and quantity.
The slope of the Marginal Revenue curve will
always be steeper than the Demand curve and
at some point it will intersect the horizontal
axis moving into the negative marginal revenue
domain.
Know what the Monopoly Game Sign means for
your company.
[Music]
When we studied Perfectly Competitive markets
we pivoted on the point of production where
Marginal Cost equals Marginal Revenue to discover
where profit maximization happens.
This optimal point of productions is the same
for Monopolistically Competitive markets,
and every other market we explore.
I like evaluating graphs, but all graphs need
to be created from tables like this one.
By now, we know the headings, the acronyms,
and how changes in price are the controlling
power of companies to make revenue.
As the price of caffe' latte drops $0.50 a
cup total revenue initially climbs,
marginal revenue drops, and profits climb out of its
negative zone to embrace profitable operations.
When price reaches $3.50 a cup, look straight
at marginal revenue and marginal cost - they
are equal.
This is the point we were looking for!
Scanning this row you can see profit is $5.00.
Some folks think about this situation and
believe that more is better!
So production is increased as marginal cost
breaches $2.00, $3.00 and $4.00 and marginal
revenue plunges below zero and money is lost
for each 'next cup' produced.
To maximize profit, a Starbucks coffeehouse
wants to sell caffe' lattes up to the point
where the marginal revenue from selling the
last caffe' latte is just equal to the marginal cost.
As the table shows, selling the fifth caffe'
latte "point A in panel (a)" adds $1.50 to
the firm's costs and $1.50 to its revenues.
The firm then uses the demand curve to find
the price that will lead consumers to buy
this quantity of caffe' lattes (point B).
In panel (b), the green box represents the
firm's profits.
The box has a height equal to $1.00, which
is the $3.50 price minus the average total
cost of $2.50, and it has a base equal to
the quantity of 5 caffe' lattes.
So, for this Starbucks profit equals $1 * 5
= $5.00.
This process is a very important series of
steps, taken sequentially to insure you have
identified each step correctly.
First find marginal revenue equal to marginal
cost, point A.
This identifies the quantity to produce: quantity,
not price.
Next draw a line vertically to intersect the
demand curve, point B.
Etch the horizontal line to the vertical axis
and find the price to charge.
Where the vertical line intersects the Average
Total Cost curve you have identified your
average cost of production at this level of
output.
The green profit box for this example shows
the height of $1.00 and a width of the quantity
produced 5 cups.
Follow these steps in this order and you will
always find the sweet zone of profitability
for your Monopolistically Competitive firm,
at least for the short term.
[Music]
[video]
Ok, did everyone notice how patrons fled Farbucks
to the coffee Haus right across the street,
another Farbucks Coffee?
Why would Farbucks want to create their own
competition?
Hmmm.
We need to look closer at this odd situation.
Panel (a) shows that in the short run, the
local Starbucks faces the demand and marginal
revenue curves labeled Short run.
With this demand curve, Starbucks can charge
a price above average total cost (point A)
and make a profit, shown by the green rectangle.
But this profit attracts new firms to enter
the market, which shifts the demand and marginal
revenue curves to the curves labeled Long
run in panel (b).
Because price is now equal to average total
cost (point B), Starbucks breaks even and
no longer earns an economic profit.
We call this the short run because the monopolistically
competitive firm has no direct competition
and owns the market for their product.
Even a firm that is not the lowest cost provider
of products can generate a profit, and those
that are production competitive can make a
tidy profit, at least in the short run.
If the firm is not productively efficient
and their average total costs exceed the demand
curve, a loss will be experienced no matter
what the level of production.
Just because the monopolistically competitive
firm is a price setter, it does not mean the
consumers are forced to be price takers at
any price.
People can still decide to stay out of the
market.
As the monopolistically competitive firm makes
a profit, others will become aware of the
profit potential and enter the market to slice
it into more competitive slices.
Slices new entrants to the marketplace want
to consume.
Now cost competitiveness becomes paramount
in the marketplace as price and cost interact
to identify profitable winners and loss bound
losers.
Ultimately, average total cost will become
tangent to the demand curve and no profits
will be found across the sector.
Zero long run profits are the impetus of innovation
in monopolistically competitive markets.
You have a coffee bean, a grape variety, or
a smart phone brand you want consumers to
believe is unique and something they want
to have.
Differentiation is the name of the game.
You want followers, trend setters, and loyal
consumers proud to wear you hats in public.
Owners do not have to accept breaking even.
The key to earning economic profits is to
sell a differentiated product or to find a
way to produce an existing product at a lower
cost.
Firms continually struggle to find new ways
to stay one step ahead of other firms that
attempt to copy their success.
Monopolistically competitive firms sell mostly
identical products and about anyone can enter
the marketplace.
So how does Starbucks own such a sizable portion
of the market for coffee?
It is because Starbucks sells an experience.
No two shops in a market area are identical,
music they play is trended to local tastes
and preferences, they were the first coffee
shop to give Wi-Fi for free to customers,
power outlets at each table for laptops and
smartphones, they innovated with specialized
drinks ordered by customers with loyalty cards
that indicate favorite drink selections when
they order.
All these enhancements for differentiation
come with no barriers to entry.
So what options remain for Starbucks differentiation?
[Music]
In a monopolistically competitive market,
neither productive efficiency nor allocative
efficiency are achieved.
Economists have debated whether this results
in a significant loss of well-being to society
in these markets compared with perfectly competitive
markets.
There are two important differences between
long-run equilibrium in monopolistic competition
and perfect competition.
Monopolistically competitive firms charge
a price greater than marginal cost and they
do not produce at minimum average total cost.
Because a monopolistically competitive firm
maximizes profit at an output level that is
not at the minimum point of its average total
cost curve, it has excess capacity.
If the firm increased its output, it could
produce at a lower average cost.
The demand curve for a monopolistically competitive
firm slopes downward because the good or service
the firm is selling is differentiated from
the goods or services sold by competing firms.
Firms differentiate their products to appeal
to consumers.
When firms are successful in differentiating
their products, this indicates that some consumers
find these products preferable to the alternatives.
Consumers, therefore, are better off than
they would have been had these companies not
differentiated their products.
Consumers face a trade-off when buying the
product of a monopolistically competitive
firm: Consumers pay a price greater than the
marginal cost, and the product is not produced
at minimum average cost, but consumers benefit
from being able to purchase a product that
is more closely suited to their tastes - this
is allocative efficiency.
[Music]
The competition is mounting here by the
day yes interesting announcement that
you're putting Seattle's that's another
brand of yours in Burger King's across
the country kidding I would assume very
different customers and it's coming to
the source yes well here's a statistic
that people are surprised by despite the
long term success that we've enjoyed we
have less than ten percent share of
coffee consumption in north America and
less than one percent share
international now having said that
there's a lot of places that people are
drinking lots of coffee that are not
compatible with the brand equity
observer fast food environments are are
part of that but we have this wonderful
brand that has been under the shadow of
Starbucks for 20 years 12 Seattle's best
coffee it's more approachable accessible
it's a lighter roast and we're now going
to unleash the alex hopper to have
ubiquitous distribution throughout the
country and q XR is one of those places
burning peeing i think it's a fantastic
place for Seattle's best coffee to live
and it also gives Burger King an
opportunity to compete with their
competitors by offering great talk line
and we like to let's just say the name
magana well premium coffee they have
been a formidable Challenger haven't
they well these are something about
McDonalds you know who is a great company
and have done extraordinary things that
when they got behind coffee our business
started to grow again so they raised
awareness there's been a lot of money on
advertising and make me help you they
did help yes yeah in a perverse way they
did and so what I'm saying is that
the level of awareness that was created
by McDonald's tens of millions of
dollars of advertising created more
trial in the marketplace and
differentiation well and doesn't it help
that you have legislation pushing for
people to move away from soda well you
have that as well ever thought about
that but thank you yeah but the point is
if you look around this
and the environment that we create is
it's not only the quality of the coffee
which we believe is has no peer it's the
experience it's a relationship our
people have with a customer and I think
we've created an environment that is so
significantly different than anyone who
is in the fasting business is trying to
sell great coffee but I want to push you
on McDonald's and dunkin donuts oh good
they're always two block radius of my
office yeah people i work with go to all
of them yeah what do you look at a
dunkin donuts and mcdonald and admire
and say you need to bring that here and
what you look at and say yeah not for us
well let's go back to what we said
before there's no finish line here so no
one at Starbucks despite the fact that
we had record earnings last quarter is
celebrated there's no victory lap we
have a lot of work to do and we've got
competitors all over the world who want
to take the fluid off starbucks table we
get that now the consumer has lots of
choices we believe very strongly quality
of our coffee the value proposition the
environment the trust and reputation of
the company almost in every scenario
will convince our customers at starbucks
into place the continued to go now our
competitors are aggressive they're using
price and promotion but they are not a
coffee company McDonald's is they is a
company that sells fast dude in Hamburg
sorry you're selling more food now yeah
where you anymore yeah but food is
complementary in an adjacent and Jason
to disturb oh oh yeah and let's just
let's define that starbucks is sourcing
only three percent of the finest coffee
in the world the other ninety seven
percent is not good enough for us the
irony of the fact that we've grown all
these years it's a quality of the access
a quality of coffee blending and
everything we do around coffee has
gotten significantly better and so we're
going to be bringing coffees to the
marketplace that we haven't had before
and continue to reaffirm and invest in
the authority that we have around coffee
in the coffee experience and and I think
what's happened over the last two years
is that not only have we taken over 500
million dollars of costs out of the
business but there's a new muscle I mean
disciplined and most of that savings is
permanent and we'll have much more
leeway in the middle of our PL to invest
in our people our coffee the customer
experience on a go-forward basis
Firms can differentiate their products through
marketing, which refers to all the activities
necessary for a firm to sell a product to
a consumer.
Marketing includes activities such as determining
which product to produce, designing the product,
advertising and distributing the product,
and monitoring how consumer tastes affect
the market for the product.
Firms use two marketing tools to differentiate
their products: brand management and advertising.
Brand management refers to the actions of
a firm intended to maintain the differentiation
of a product over time.
Firms use brand management to postpone the
time when they will no longer be able to earn
economic profits.
In the interview we just watched, you learned
that Starbucks created their image while also
creating their own competition in the same
market places: Seattle's Best Coffee.
Their own competition also created a brand
image different from Starbucks.
Starbucks can control price for a substantial
part of the market where their footprint is
marked by two boots.
A successful advertising campaign will allow
a firm to sell more of its product at every
price, and it will be able to increase the
price it charges without losing many customers.
But advertising also increases costs.
If the increase in revenue that results from
the advertising is greater than the increase
in costs, the firm's profits will rise.
Once a firm has established a brand name,
it has an incentive to defend it.
A firm can apply for a trademark, which grants
legal protection against other firms using
a product's name.'
A company will spend substantial amounts of
money to ensure that its brand names are entitled
to legal protection.
If a firm's trademarked name becomes widely
used for a type of product, the firm may no
longer be entitled to legal protection from
unauthorized use of that trademarked name.
Consider this: Starbucks image was placed
into the You've Got Mail clip where people
with no decision making ability whatsoever
come to feel important, and into Shrek's Farbucks
scare running to the coffee house next door
- another Farbucks.
I guarantee these insertions into widely distributed
films without obvious advertising messages
was a welcome advertising campaign for Starbucks.
It worked.
[Music]
The factors under a firm's control the ability
to differentiate its product and the ability
to produce it at lower cost combine with the
factors beyond its control to determine the
firm's profitability.
A firm's owners and managers can control some
of the factors that allow it to make economic
profits.
Examples include the firm's ability to differentiate
its product and produce a product at a lower
average cost than competing firms.
Some factors that affect a firm's profitability
are not directly under the firm's control;
for example, increases in input prices.
Sheer chance also plays a role in the success
of your business.
The firm appearing as the first in the marketplace
has one obvious advantage and that is the
short-run profits made as price setters and
limited competition.
Kleenex is a trademarked product that has
been used to refer to a generic product
(facial tissue).
Bic is a first in the market ink pen.
Frappuccino is a registered trademark of Starbucks.
Each brand name is used interchangeably by
consumers for the family of products they founded.
Ultimately, consumers seek the product at
the price seen as competitive.
Those price competitive providers hold longevity
in the differentiated marketplace in the long-run.
[Music]
