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February 06, 2005

Big 'Bucks

Yesterday I went to Starbucks and bought a mocha for me and a hot chocolate for my son. Look at the receipt on the left. It cost $5.90, before tax, for that.

$2.25 for the hot chocolate is particular amazing. The raw ingredients for that are 8 oz. of milk and a squirt of Hershey's chocolate syrup, plus a cup and a lid. That can't possibly cost Starbucks more than 10% of what they are charging me for it.

They have rent and employees to pay, but I have read that a typical restaurant has to charge 3 times what the ingredients cost to cover all the overhead. Here Starbucks is charging more like 10 times what it cost.

Microsoft also charges a lot more for software than the actual cost of manufacturing. It's not clear what it actually costs, but it can't be much; I'm pretty sure that duplicating a software CD costs the same as duplicating a music CD that sells for $10. Microsoft employees can buy discounted Microsoft software at the company store; the cost was always described as "COGS" (cost of good sold). Office Professional costs a little more than Office Standard, which made some sense back when Office Professional came on more floppies than Office Standard. Today, they both come on one CD, but Professional is still more (the current company store prices are $50 for Office Standard sells and $60 for Office Professional).

The difference is that Microsoft has huge up-front development costs for Office; I don't think there is much development costs in figuring out how to mix chocolate syrup and warm milk to make hot chocolate.

Posted by AdamBa at February 6, 2005 09:38 PM

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You think Starbucks is bad? Its profit margin is just 7.6%. Microsoft's profit margin is 26%! This abnormally high profit margin is a typical sign of monopolistic pricing; if Microsoft weren't a monopoly then a dozen competitors would have jumped in to carve themselves a part of these profits, thus reducing the profit margin to saner levels.

Posted by: Oren at February 7, 2005 08:53 AM

The average family restaurant sells items that are, what, ~$12 each? For those products the 3x profit multiplier gives you a decent amount of cash, but when you are down at the $3 level a 3x multiplier simply just doesn't throw off enough raw cash to cover the fixed overheads. The same 10x multiplier most likely applies to a $3.65 grande decaf no whip soy mocha as well.

Maybe *$ should be selling kids hot chocolate as a distinct loss leader (parents are often way more price conscious about stuff for their kids than they about stuff for themselves) and be forcing it's other products to carry more than their fair share of overhead but, rightly or wrongly, that's not what they have chosen to do.

Plus, it's not like you don't have a choice! If you don't want to pay $2.25 for a hot chocolate then go down the street to the independent espresso hut, or better yet, make your own. If *$ is over-charging then the competitive coffee market will make it change it's ways.

Posted by: Andrew at February 7, 2005 09:34 AM

When consuming at Starbucks it isn't the research and development that you have to cover, but the huge corporate infrastructure that is required to decide which local establishment to put out of business next in order to build another new store. They have to pay a real estate analysis firm to find the right location and ensure that there are a minimum number of established coffee houses already in the neighborhood to ensure there will be enough traffic to keep the enormous profits rolling in.

Next you have to hire a team of attorney's and real estate agents to negotiate your 100 year lease, meet with local business groups, get your store built, hire a store manager, staff, add a new regional manager into the mix since this region already has 24 stores. Now for the advertising and promotions. All that on top of the salaries for top brass and it is surprising you can get a cup for less than 10 bucks.

Posted by: Jeff Nemcher at February 7, 2005 11:37 AM

I would point out that ... you bought it. Complain about profit margins all you want, but you bought it anyway.

But here's the problem. You're complaining about profit margin, and that's ... quite frankly, none of your damned business. What is your business is the PRICE. Period. If you don't like the price, don't pay it. The company has a right to make a profit, and as much profit as the market will bear. If they can't sell at a certain price, they'll have to lower it, but only you (and millions of others, of course) can force their hand.

That's the common misconception about economics, that how much profit a company makes is relevant to anyone but the company and it's shareholders. The company doesn't set the price. The market does. A company with an over-priced product doesn't stay in business long if they don't reduce their prices to match market expectations. Regardless of what you might think about how much profit they're making, the market has set the price exactly where it is.

Just as Starbucks can make 1000% profit on a drink (but it's no where close to that, not even remotely), there are other companies that can't make more than 0.5% because the market won't pay more than that. We're the ones in complete control.

But if you want to know what you're getting over the cost of the ingredients that you're paying for, I can some it up in one word ... caché. Starbucks has it in spades right now, and there's a reason why you choose to walk around with a Starbucks cup in your hands. It's the exact same reason people choose to buy Tommy Hilfiger or Nike over other brands of clothing ... because they want to be seen wearing them. That's why with Starbucks being priced above even similar quality drinks, their brand has been deemed to have value.

Posted by: Rob Stevens at February 7, 2005 02:20 PM

I agree I am 100% guilty of buying the hot chocolate for the inflated price (it's not like I need the $3.65 mocha either!). Actually I was complaining to my wife about the hot chocolate and she said if you order a "kids" size hot chocolate, it is only $1 and not much smaller. Hoho!! So in a sense they are selling the kids size hot chocolate at a "loss" (meaning, they are not making as much on it as on other sizes, of course they are still making money).

It's true that Starbucks spends a ton of money building the brand, and that's why they a) can charge so much and b) have to charge so much (if they are only making 7.6% with their current prices).

- adam

Posted by: Adam Barr at February 7, 2005 03:34 PM

The Co. Store has changed there policy (I think within the last year) on many of the software sales and its no longer just cogs but is calculated by a percentage of the msrp. Also its a different equation for hardware. There was an initial mix up with the streets and trips that came with a gps unit for the first day where it was offered as the software equation versus the hardware equation. It was fixed the next day...which doubled the price....after an uproar, they then split the difference.

Posted by: J.P. at February 8, 2005 10:02 PM

The price of an item is determined not by cost, but by demand. If someone will pay $100 for an item costing $1, that is their choice. Of course, someone else may soon make that item for $99.

The point is that if an item costs more than a person will pay, it won't be made. If you don't like Starbuck's prices, don't pay them. Ditto for Microsoft software.

Though, yes, I'd like lower Company Store prices, but if I buy it, I obviously found it a value.

Posted by: hf at February 12, 2005 01:40 PM

Here's what I think is going on. Starbuck's convinced folks that it was OK to spend $3 on coffee (OK, espresso or latte). Maybe most of us can't afford to buy a BMW, or a plasma TV, but we can afford to spend money on expensive coffee. So, they think, let's sell hot chocolate. But what should we sell it for? At anything under $1, it would seem too cheap compared to all their other products, so let's sell it for $2.25! It's expensive, but you're already spending $3 for coffee, so you're not going to notice $2.25 for hot chocolate. (OK, so you *did* notice, but only after you bought it).

Nice coffee stain....or was it hot chocolate?

Posted by: Charles Lin at April 6, 2005 04:18 PM