case 3.1 Coffee: "Buy Low and Sell High"scan0027.pdf
In 2000, overproduction in the international coffee market caused the price of coffee to drop below production costs. In December 2001, coffee prices reached a low of 41.5 cents per pound, the lowest price in more than 30 years. Farmers in countries such as Angola, Honduras, Sri Lanka, and Zimbabwe even stopped tending their coffee trees in an effort to save on spending for fertilizer and maintenance. Part of the problem was the usual cyclical swings in price caused by the movements of supply and demand. Recall our discussion of the short- and long-run movements in price. In response to a high price, supply increases. There is often a tendency for supply to overshift to the right, causing prices to plummet. The "long-run adjustment" of supply with demand is rarely, if ever, as smooth as depicted in textbook diagrams. With coffee prices so low, it is believed that consumers would benefit with a lower price for a cup of coffee. However, as readers well know, not all cups of coffee are created equal. While coffee prices kept falling, specialty coffee retailers such as Starbucks were charging its customers $3.50 for a "tall skinny latte." Despite the fact that Starbucks is usually located in high-rent areas, we can imagine that the markup on these specialty drinks, given the wholesale price of coffee, definitely helps pay the rent and more. This shows that, although the wholesale market for coffee may be subject to the vagaries of shifting supply and demand, the retail market provides a better opportunity for sellers to exert market power by catering to the tastes and preferences of those who prefer a higher-quality product and are willing to pay for it. Starbucks is a company that until now has played with the forces of supply, demand, and market power like a virtuoso: It buys low in the depressed wholesale market and sells high in the differentiated specialty retail market.
In mid-2004, wholesale prices started to move upward, increasing by about 30 percent between May and June. The effects of the farmers who had stopped or reduced production due to low prices had started to make an impact on the market.
(Imagine a leftward "long-run" shift in the supply curve.) There was also a drought and unusually low temperatures in Brazil, the world's largest coffee producer.1° (Imagine a leftward "short-run" shift in the supply curve.) Big coffee sellers, unlike Starbucks and other specialty retailers, had not been able to raise prices during the past 4 or 5 years because of the overall depressed market for coffee beans. Now the cost pressures from the higher price of wholesale beans have finally enabled them to justify the raising of their prices to restaurants and other away-from-home customers. What will consumers do in the face of rising prices for nonspecialty coffee. As is explained in great detail in chapter 4, the demand for coffee is considered to be relative inelastic. Therefore, industry analysts expect coffee drinkers to consume about the same amount as they always have. As a 10- cup-per-day consumer interviewed by a newspaper reporter stated, "I hate that the price might go up, but I got to have my coffee."11 Interestingly enough, Starbucks actually welcomes the higher wholesale price of coffee. As explained by its CEO, Rin Smith, "We are paying higher prices for coffee, which we think is a good thing. One of the consequences of the low prices is that a lot of farmers have gone out of business and that threatens our long-run [emphasis added] supply." This statement shows that sometimes continuity of supply can be as important as the purchase price. If higher coffee prices help keep coffee farmers in business, then buyers like Starbucks are willing to pay the higher price. Moreover, as stated earlier, differentiated sellers such as Starbucks are in even better positions to raise the price than the processors who sell coffee to restaurants. In fact, in September 2004, Starbucks announced that it was raising the average price of its beverages by 11 cents, citing "increases in the cost of coffee and sugar
Case 3.2 Air Travel: "Buy High and Sell Low"
Ever since the U.S. airline industry was deregulated in the late 1970s, the major air carriers have been struggling to overcome the resulting competition that beset them. In the booming 1990s, the major airlines had finally started to earn respectable profits. But the technology bust, short recession, and post-9/11 downturn in air travel dissolved any hopes of their establishing a long-term record of profitability. When this edition was being prepared, their losses continued to mount. United Airlines and USAirways were in protected bankruptcy under Chapter 11. Delta Airlines seemed to be headed for the same fate. American Airlines was threatened with bankruptcy in 2003. Its purchase of TWA several years earlier apparently made it no more secure than the other "legacy" carriers. Yet, the "low-cost carriers" have survived and even thrived in the deregulated environment. Southwest Airlines was one of the pioneers in introducing low-cost, no-frills airline service, offering flights of relatively short distances (usually less than 500 miles) ,13 In doing so, it believed its competition to be more the automobile than the major airlines. Its financial success in using a different type of business model soon led to the start of JetBlue and AirTran (formerly ValueJet). The success of the low-cost airlines can be seen in their very nomenclature. In markets where fierce competition leads to price reductions, only those with a low-cost structure can survive. An alternative would be to take the "Starbucks approach" and offer premium services at a higher price. To a large extent, this is what the major airlines have tried to do by catering to business travelers who have typically been more sensitive to the scheduling of flights rather than the price. However, when the entire market demand slumps, it becomes much more difficult to rely on those segments of the market that are willing to pay more for premium service. Furthermore, to reduce cost many companies have been restricting the travel of their employees or requiring 'them to substitute this travel with more Web-based or video conferences. If travel is required, employees are being required to find the lowest fares. In an effort to compete with the low-cost carriers, the legacy airlines have been continuing to pare down their workforce and negotiating with the unions to reduce wages. Prior to September 11, 2001, United Airlines had more than 100,000 employees. In 2004, this number had fallen to less than 55,000. On September 8, 2004, Delta Airlines announced a layoff of 7,000 workers. In January 2005, Delta announced a sweeping reduction in its air fare structure. The company is hoping that its lower structure will enable it to survive these price cuts. What has made the situation even worse for the legacy airlines is the rising price of oil. In the fall of 2004, the price of oil was almost $50 per barrel. This caused American Airlines to project its fuel bill in 2004 to be about $1 billion more than planned. If the legacy airlines were unable to sustain their higher prices in the face of mounting competition from the low-cost airlines, they have certainly not been able to pass on higher fuel costs by increasing airfares. However, some of the major airlines made a feeble attempt to do so by charging a ticketing fee. In September 2004, Northwest Airlines announced that it would begin charging passengers $5 per ticket for trips booked through its reservations agents and $10 for those purchased at airports. American Airlines quickly followed suit. American Airlines reported that this fee was expected to bring in additional revenue of about $25 million per year. 14 In conclusion, market forces have caught the management of the major airlines in a cost trap with hardly a means of getting out. Supply and demand conditions for oil have drastically raised fuel prices, and at the same time supply and demand conditions for air travel have made it difficult, if not impossible, to increase air fares. Contrast this to the situation facing the managers of the sellers of coffee. Specialty coffee retailers such as Starbucks enjoyed huge profits by being able to mark up the price of their coffee while paying relatively little for the beans. As supply and demand.
((I need write a summary and explain by a graph for both case study and compare between them.))