Is Starbucks Pushing Prices Too High?

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Longtime competitor Dunkin' Donuts has also made moves to grab the market of affluent women and professionals, two strong bases for Starbucks. That's included a partnership to distribute coffee on JetBlue Airways (JBLU) and hiring chef and talk show personality Rachael Ray, who is featured in ads grabbing a cup of Dunkin' Donuts iced coffee while racing around between her high-profile jobs. "Rachael [Ray] has a tremendous following with women 18 to 49," says Will Kussell, chief operating officer of Dunkin' Brands. "There's a great opportunity to grow that part of the business.… We've believe we've taken market share from all our competitors."

Declining Customer Affluence

Second, new Starbucks customers—who provide a significant amount of sales growth—are increasingly less affluent and less educated than its current customer base. That makes them more sensitive to price increases in the future. According to a Oct. 5, 2006, presentation to analysts, customers who shopped Starbucks for the first time in the last year had an average income of $80,000 a year, vs. the $92,000 a year average for those who first visited five years ago. Some 30% of the new customers had finished college, vs. 45% in the past.

"The Starbucks customer five years ago shrugged everything off, because [the company] had such an affluent base," says Joe Buckley, Restaurant Analyst for Bear Stearns (BSC). "Starbucks has been very successful broadening their customer base, but one result of doing that is that their customers aren't quite as indifferent to what's going on around them.… Marginal customers might be peeling out based out higher costs and budgetary issues."

All this is exacerbated by the amount of scrutiny Starbucks is under. Because it is famous for high coffee prices, consumers immediately notice any shifts. Customers visit the stores every day, and "every time they raise prices, it's been front-page news," says Glass. "It's never front-page news on any other company."

What's the Limit?

So what price increase will finally drive customers away? Analysts demurred. "I have no idea," says Glass. "Demand elasticity or inelasticity is the kind of thing where you'll never know until you step over it."

Not everyone agrees. Hugo Sueiro, a 40-year-old lawyer in line at the Midtown Starbucks, says he's indifferent to the current price increase because he rounds up the total to the nearest dollar to give a little tip to the baristas. If it ever increased beyond that dollar ceiling, though, that's another story. "That's it—I'm going to Dunkin' Donuts," he says.

Helm is marketing editor for BusinessWeek in New York. Goudreau is a reporter for BusinessWeek in New York.