Starbucks: Perfect Competition?

The assumptions of a perfect competition market are:

1. A large number of buyers and sellers with no control over prices
2. Products are identical
3. Few entry and exit barriers
4. Perfect information

Do these assumptions fit Starbucks, making it part of a perfect competition market?  Yes and no. It depend on what portion of the Starbucks business you are examining.  If you consider their participation in the coffee bean market as buyers, then yes Starbucks appears to meet the 4 assumptions of perfect competition.  Despite Starbucks' apparent size, they are a relatively small consumer of coffee beans world wide overall, so they are price takers with very little influence on the price of coffee beans.  Coffee beans are essentially identical within the two major varieties (Arabica 80% and Robusta 20%).  Starbucks has access to the same information as any other coffee bean purchaser.  Essentially anyone can purchase coffee beans so there are few is any entry and exit barriers to the coffee bean market.

However, as a seller of coffee beverages (restaurant industry), Starbucks does not fit the assumptions of a perfect competitor.  Starbucks does have control over the prices they are able to charge for their product, coffee, which is higher than most other coffee sellers such as Tim Horton's and McDonald's.  Are these prices too high?  If they were, then nobody would buy it and Starbucks would go out of business.  The reason that Starbucks is able to charge higher prices for coffee is that they have differentiated their product from all others.  They offer not only premium coffee, but a complete coffee experience.  If Starbucks lowered prices, they would reduce their profitability even further.  Costs would remain the same, but revenue would decrease. 
As indicated in the articles from 2007 below, the massive, rapid expansion that Starbucks undertook resulted in too many locations and a change in equipment removed the coffee making experience that differentiated Starbucks from their competitors.  The memo from Starbucks Gossip clearly recognizes this shift away from the coffee experience to just coffee as a product as a major challenge for Starbucks future.  Starbucks realizes what distinguishes them from their competitors, but is trying to maximize profits by increasing the quantity of product they can produce and sell (number of locations), while reducing the costs of production (more efficient equipment).  However, this strategy has produced the opposite result.  By having too many stores too close to each other, the amount of revenue hasn't increased to the same degree as their costs.  In economic terms, Starbucks has experienced a decrease in marginal revenue per store.  Therefore, the only practical decision was to close a large number of stores in order to reduce their total costs, with minimal reduction in total revenue, thereby increasing overall profitability.  In the short-run, the costs to close the stores may have exceeded the savings in fixed and variable costs due to lease cancellation obligations and employee severance pay.  But in the long-run, these unprofitable stores will no longer continue to siphon off profits from the more profitable stores, thereby allowing Starbucks to return to profitability.


Citations

Starbucks Gossip(http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html)
CBC News(http://www.cbc.ca/money/story/2008/07/01/starbucks-closures.html)
 The Seattle Times(http://seattletimes.nwsource.com/html/businesstechnology/2008028854_starbucks02.html)