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Starbucks: Shorting coffee

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starbucksAccording to a piece in the Wall Street Journal, Starbucks (NASDAQ: SBUX) is thinking outside-of-the-cup. The company is experimenting with new pricing strategies in Seattle, such as selling short drip coffee for $1.00 a cup (8 ounces). What's more, there are even free refills.

With increasing competition – such as from Dunkin' Donuts and McDonald's (NYSE: MCD) – and the slowing economy (as well as higher supplier costs), it seems that Starbucks has no choice.

To get some perspective on things, I interviewed Rafi Mohammed, a pricing expert and author of The Art of Pricing. He recently wrote a piece on how McDonald's represents a real threat to the Starbucks' franchise. Simply put, there are many consumers who prefer steep discounts on coffee – even if the quality is not pristine.

However, by playing ball, Starbucks can get some benefits by using a discounted pricing strategy. According to Rafi:

"Pricing plans targeted towards new customer segments can create growth. For example, low-priced dollar menu items account for 23% of McDonald's revenues, and items from Wendy's Super Value Meals account for 25% of its revenues. Starbucks' $1 coffee is its start to using price to generate growth and remain competitive with new entrants (mainly McDonald's).

"Also, with 80% of U.S. orders consumed outside of the store, I believe that Starbucks' next pricing move should be to offer discounts on its takeout prices. This will help make it more competitive with rivals and offer prices that are more in line with the value it provides."

Tom Taulli is the author of various books, including The Complete M&A Handbook and The Edgar Online Guide to Decoding Financial Statements. He also operates DealProfiles.com.

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Last updated: November 25, 2009: 11:37 AM

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