The Starbucks Recession Indicator

by Elena Foshay

Starbucks Coffee, one of the success stories of the booming economy and now global symbols of prosperity, is suffering. John Borden of Eyes Not Sold reports that over the last twelve months Starbucks stock has gone down 41% while the S&P 500 is down 3%. Howard Schulz, now beginning his second term as Starbucks’ CEO, reported to Time’s blog,

“for the first time in our history as a company, we have negative traffic this year vs. last.” [link]

Is this a bad sign?

An individual’s daily grande vanilla nonfat latte is a luxury good whose consumption depends on disposable income. Though some would place their latte above other essential items in terms of priority, the marginal propensity to consume lattes becomes lower with permanent decreases in income. Schulz blames the macroeconomy for the Starbucks’ declining performance: Schulz told Time,

“The current economic environment is the weakest in our company’s history, marked by lower home values, and rising costs for energy, food and other products that are directly impacting our customers.” [link]

If disposable income decreases, the daily Starbucks is one of the first things to go.

In his interview with Time, Schulz explained that there is little room for adjustment of Starbucks coffee prices. This is partly due to fairness towards their employees, who enjoy relatively high wages and good benefits. But Schulz also said that Starbucks tested different methods of decreasing prices (like offering $1 coffee or free refills), and “wasn’t happy with the results.” Sticky price logic tells us that, since prices can’t adjust, a decrease in Starbucks consumption will have a multiplier effect. The first response will be a decrease in production, leading to a decrease in employment as fewer baristas are needed, which eventually leads to a decrease in national income. And a decrease in national income, or GDP, that remains consistent over the course of a few months indicates a recession.

Leamon Crooms, posting on the Inside Arizona Business blog, argues that the decrease in consumption of Starbucks is something we should pay attention to. He describes the “Starbucks Recession Indicator,” which shows that:

A recession is approaching if your neighbors are buying fewer and smaller non fat lattes. A recession is here if you are buying fewer and smaller lattes. [link]

If this is true, the drop in Starbucks’ stock prices is something to worry about, particularly if the drop is matched among other luxury brands. Perhaps here we would see a substitution effect towards relatively more inexpensive goods (Dunkin Donuts drip coffee, for example). This increased consumption of drip coffee could mitigate some of the ripple effects, but a recession still seems inevitable.

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3 comments for “The Starbucks Recession Indicator

  1. Li Chang
    July 5, 2008 at 10:53 pm

    I believe Crooms is right in assessing that the drop in Starbucks stock is a good indicator that the economy is headed towards a recession. For the past decade, Starbucks has boomed and so has it’s stock prices. Starting up as just a modest coffee shop, it was expanded into a huge international corporation that has expanded its menu into so many different other markets, such as food and drink. Perhaps, this is and will lead to their downfall as more and more people realize that coffee is an expendable part of their budget. Just last week, Starbucks announced it will close over 600 stores, which is part of a massive project to scale back on its growth. I believe as the current economy continues on its downward trend, we will continue to see the fall of Starbucks stock along with other commodities.

  2. Calvin Tay
    July 6, 2008 at 9:30 pm

    I disagree. If Starbucks is truly a luxury item, it should be able to maintain its sales because consumers are buying more than just coffee when they choose to go to starbucks. Its a status symbol.

    Yes when times are going well for the economy, people think less when they buy their Starbucks coffee. It is easy therefore for Starbucks to simply expand and people will tend to buy into the experience. However, many wrong steps have been taken by Starbucks and the $1 coffee with free refills is a major one. Although it was a controlled testing of the market in Seattle, it has affected the perception of the brand. And the investors know that.

    Some argue that it was a strategic move by the CEO to create publicity and renew Starbucks in the minds of the consumers. However, whether its negative impact is overcome by this increase in publicity is highly debatable.

    Therefore, I propose that the fall of Starbucks or any other so-called “luxury brand” (note: Just because you pay a high price for it doesnt mean it is really a luxury brand.) is not truly an indicator of the market but one that could have happened anytime if a strong and competent competitor had entered the market. Rather, it is the failure of these “luxury” brands to effectively maintain its brand image and communicate the true benefits of their target market, choosing instead to feel complacent when the economy is booming. All the recession is really doing is to uncover the weaknesses of their business model.

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