WAKE UP AND SMELL THE COFFEE

I recently heard that industrial distributor Grainger was offering its Internet customers a free coffee with their order. It got me thinking–not about the Internet, but about coffee.

Here is a product, an industry really, which has had an amazing run over the past few years. It has gone from the “and a coffee” afterthought, a staple of everyday life seldom thought of outside its existence as a habit, to a culture unto itself. Coffee is no longer simply coffee, it’s a latte, or a mocha latte, a Kenya AA, and any number of other coffee subsets. It can be a downright pain trying to decide whether a half-caf, double latte with a twist is going to hit the spot.

While you may laugh at the urbanites who crave such beverages at four bucks a hit, perhaps you might laugh a little less at the profit picture. When was the last time you saw the price of coffee drop substantially, either in the store or at Starbucks? I can’t remember any recent drop. Would it surprise you to learn that that the price of coffee beans has dropped nearly 60% in the last three years? It sure surprised me.

There are a number of reasons why this deserves to be so–with more than 150 levels of distribution, not to mention the tony surroundings and marketing expenses of building that coffee culture–the price of the product is only distantly related to the cost of the bean.

Market leaders like Starbucks offer these up as evidence that they deserve the price they charge for your morning java. In fact, Starbucks president and CEO Orin Smith has argued that the price they charge is a good thing, because it enables them to justify spending more for the beans. Nevertheless, the coffee farmers are on the verge of starvation. “Meanwhile,” said one industry pundit, “Surprise, surprise, supermarket and restaurant chains have been making a killing.”

It is true that the industry does sense a crisis and is trying to keep farmers on-line lest they choose to grow some higher profit product and choke off supply, but that’s a whole other topic.

What the coffee industry has managed to do is successfully dislocate the cost of the product from the price it charges.

The most significant fact it has learned about their market, is that it doesn’t matter what they charge or, more accurately, it doesn’t matter if they charge less. You’re only going to drink so much coffee, so it doesn’t matter whether it’s a buck a cup or three bucks a cup. It is a case, in economic terms, where demand is inelastic. Drop prices and all you do is hurt your profits.

I think there is a parallel with the aftermarket worth considering. With the exception of accessories, demand for service only occurs when there is a need for service. People are not going to have service done when there is no (real or perceived) need. Demand is inelastic. When there is the need for service, is there really an imperative to find the best price? For sure, there is a point in pricing beyond which you can’t go, but if you asked the consumer I think you’d find that they don’t focus on price nearly as much as we think they do.

Why do we spend so much time trying to out-discount the other guy, when other industries have realized that you can make out just fine by charging what the market will bear? When was the last time you saw a coffee house boasting its discount latte?

I know that this is really a macro-economic example that may be at odds with the micro-economics of your own experience, but I do think it’s something worth pondering. Maybe you might want to think about it the next time you’re enjoying your morning coffee. — Andrew Ross, Editor

P.S. Starbucks posted a 40% profit bump in the first quarter. How’d you do?

NEXT MONTH

Next month, the Jobber of the Year will be revealed. We’ll also focus on the Filter Market and bring news of the AIA Convention. In the interim, stay tuned to Autoserviceworld.com.