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Why Starbucks Corporation Raised Prices Again

By Bob Ciura - Jul 20, 2015 at 2:22PM

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Coffee costs are down from last year's peak levels, but Starbucks is a premium brand and people will pay up.

Starbucks in Washington, D.C. Source: Company website.

Starbucks (SBUX -1.21%) recently announced it will raise prices yet again. This time, the increases range from $0.05-$0.20 for most affected drinks. This is now the third price increase Starbucks has passed through in as many years. The move will increase the cost of the average customer order by about 1%, according to the company. The types of drinks affected will vary by market, but for the most part, prices will increase for tall and venti brewed coffee drinks, as well as its grande latte. Bagged coffee won't be affected.

Each time Starbucks bumps up its prices, the company receives a certain amount of criticism early on. But eventually, the anger fades, and after all is said and done, customers keep filing through the door for their daily caffeine fix.

This time, Starbucks' price increase strikes a different tone, but it's essentially all part of the same strategy.

Precedent for price increases
Starbucks has a history of raising prices. In June 2013, Starbucks upped its prices by about 1%. Then, just last year, Starbucks raised prices on some of its in-store beverages by a similar $0.05-$0.20, as well as the retail price of packaged Starbucks coffee bags sold in grocery stores by about $1. The move to raise prices last year was more understandable, because coffee prices had soared leading up to the decision. As of June 2014, the price of arabica beans had risen more than 50% year to date. It's entirely reasonable for a company to pass along higher costs to customers.

This time around, Starbucks' decision to increase prices may raise eyebrows because coffee prices have actually declined to start 2015. The price of arabica beans is down approximately 42% from the peaks reached last year. From this perspective, it doesn't seem like Starbucks is making this decision out of necessity, to control its cost structure. Other coffee sellers are taking steps to reduce prices to reflect the lower coffee prices. For example, The J.M. Smucker Company recently cut the price of its Folgers and Dunkin' Donuts brands by about 6%.

Why is Starbucks raising prices, even in the face of lower coffee costs? Because it can.

The underlying strategy remains the same
Starbucks is universally known as a premium brand. High prices have never dissuaded customers before. In fact, establishing itself as a high-end name allows Starbucks to maintain high prices and fat margins.

Starbucks is obviously confident enough that its customers will still flock to its stores, even if it hikes prices. Starbucks enthusiasts apparently can afford its already lofty prices, so it stands to reason they can afford to fork over a few more dimes per cup. That's how it played out last year. Starbucks grew total sales by 10% in fiscal 2014.

Starbucks is off to an equally impressive start to the current fiscal year. Starbucks recently wrapped up a record quarter. Revenue and earnings per share both jumped 18% in the second quarter, year over year. The quarterly revenue number was a record, and EPS was a record when adjusting for splits. Comparable-store sales, which measures sales at locations open at least one year, grew 7% globally, including 7% in the Americas as customer traffic was up 3%.

Customers are going to Starbucks more often, and they're spending more. Its brand is clearly still as strong as ever, and since Starbucks' momentum isn't slowing down, there is very little reason not to increase prices whenever possible. Starbucks enjoys a premium brand and excellent pricing power, which other coffee retailers that cater to lower-income consumers don't have.

Investors have reaped the rewards of Starbucks' aggressive pricing strategy. Revenue and earnings are rising, and the stock price is up 58% in the past two years. The strategy is clearly working, so in that context, I wouldn't at all be surprised to see Starbucks pass along another price increase next year, regardless of what happens to underlying coffee prices.

Bob Ciura owns shares of Apple. The Motley Fool recommends Apple and Starbucks. The Motley Fool owns shares of Apple and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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