Latte Battle taken up by McDonalds

There is a great feature on the battle between McDonald’s and Starbucks in the Telegraph on the day that it has been announced that Starbucks is replacing CEO Jim McDonald with founder Howard Schultz. The competition for market share in the retail coffee market is a classic example of a contestable market

Diseconomies of scale?

Starbucks has enjoyed super-charged growth in recent years (it opened over 2,500 stores in 2007 alone) but there are grounds for thinking that it may have become too big and is suffering from diseconomies of scale. In a conference call to city analysts, Howard Schultz conceded that ‘“The most serious challenges we face are of our own doing. We invested in infrastructure ahead of the growth curve; and, although necessary, it led to bureaucracy.” In short, the company has become too bureaucratic leading to a sharp rise in overhead costs, it will need to do some serious pruning of senior and middle management.

There is a growing challenge from Dunkin Donuts and also from McDonalds which is investing heavily in up-market coffee machines which will dispense ground coffee and sold by McDonad’s baristas across their 14,000 North American outlets.

Price points

A key part of their strategy will be to sell brewed coffee up to sixty cents cheaper than Starbucks for an equivalent size of cup and these lower prices will come from a lower cost base. As the Wall Street journal reports;

‘McDonald’s process is more automated. It uses a single machine to make all the components of each drink. Espresso is brewed using beans with a darker roast that are more finely ground than those for drip coffee, resulting in a concentrated form that’s usually mixed with hot milk to make lattes and cappuccinos. McDonald’s has three flavors it adds to its espresso drinks, a significantly narrower lineup than Starbucks, which boasts thousands of drink combinations.’

Changing consumer preferences

Starbucks has seen its share price fall steeply over the last two years. Their prospects are not being helped by the severe economic slowdown in the US economy as well as the extra competitive pressures on the high street. Many of the stores that Starbucks has opened have not made a profit. Running stores is costly and consumer preferences are changing in a way that Starbucks must adjust to. Today, about 80% of the orders purchased at US-based Starbucks outlets are consumed outside the store.