Who Pays for Your Coffee? The long commute on public transportation is a commonplace experience of life in major cities around the world, whether you live in New York, Tokyo, Antwerp, or Prague. Commuting dispiritingly combines the universal and the particular. The particular, because each commuter is a rat in his own unique maze: timing the run from the shower to the station turnstiles; learning the timetables and the correct end of the platform to speed up the transfer between different trains; trading off the disadvantages of standing room only on the first train home against a seat on the last one. Yet commutes also produce common patterns— bottlenecks and rush hours—that are exploited by entrepreneurs the world over. My commute in Washington DC is not the same as yours in London, New York, or Hong Kong, but it will look surprisingly familiar. Farragut West is the Metro station ideally positioned to serve the World Bank, International Monetary Fund, and even the White House. Every morning, sleep-deprived, irritable travelers surface from Farragut West into the International Square plaza, and they are not easily turned aside from their paths. They want to get out of the noise and bustle, around the shuffling tourists, and to their desks just slightly before their bosses. They do not welcome detours. But there is a place of peace and bounty that can tempt them to tarry for a couple of minutes. In this oasis, rare delights are served with smiles by attractive and exotic men and women—today, a charming barista whose name badge reads “Maria.” I am thinking, of course, of Starbucks. The café is placed, inescapably, at the exit to International Square. This is no quirk of Farragut West: the first storefront you will pass on your way out of the nearby Farragut North Metro is—another Starbucks. You find such conveniently located coffee shops all over the planet and catering to the same desperate commuters. The coffee shop within ten yards of the exit from Washington’s Dupont Circle Metro station is called Cosi. New York’s Penn Station boasts Seattle Coffee Roasters just by the exit to Eighth Avenue. Commuters through Shinjuku Station, Tokyo, can enjoy a Starbucks without leaving the station concourse. In London’s Waterloo station, it is the AMT kiosk that guards the exit onto the south bank of the Thames. At $2.55 a tall cappuccino from Starbucks is hardly cheap. But of course, I can afford it. Like many of the people stopping at that café, I earn the price of that coffee every few minutes. None of us care to waste our time trying to save a few pennies by searching out a cheaper coffee at 8:30 in the morning. There is a huge demand for the most convenient coffee possible—in Waterloo Station, for example, seventy-four million people pass through each year. That makes the location of the coffee bar crucial. The position of the Starbucks café at Farragut West is advantageous, not just because it’s located on an efficient route from the platforms to the station exit, but because there are no other coffee bars on that route. It’s hardly a surprise that they do a roaring trade. If you buy as much coffee as I do you may have come to the conclusion that somebody is getting filthy rich out of all this. If the occasional gripes in the newspapers are correct, the coffee in that cappuccino costs pennies. Of course, the newspapers don’t tell us the whole story: there’s milk, electricity, cost of the paper cups—and the cost of paying Maria to smile at grouchy customers all day long. But after you add all that up you still get something a lot less than the price of a cup of coffee. According to economics professor Brian McManus, markups on coffee are around 150 percent—it costs forty cents to make a one-dollar cup of drip coffee and costs less than a dollar for a small latte, which sells for $2.55. So somebody is making a lot of money. Who? You might think that the obvious candidate is Howard Schultz, the owner of Starbucks. But the answer isn’t as simple as that. The main reason that Starbucks can ask $2.55 for a cappuccino is that there isn’t a shop next door charging $2.00. So why is nobody next door undercutting Starbucks? Without wishing to dismiss the achievements of Mr. Schultz, cappuccinos are not in fact complicated products. There is no shortage of drinkable cappuccinos (sadly, there is no shortage of undrinkable cappuccinos either). It doesn’t take much to buy some coffee machines and a counter, build up a brand with a bit of advertising and some free samples, and hire decent staff. Even Maria is replaceable. The truth is that Starbucks’ most significant advantage is its location on the desire line of thousands of commuters. There are a few sweet spots for coffee bars—by station exits or busy street corners. Starbucks and its rivals have snapped them up. If Starbucks really did have the hypnotic hold over its customers that critics complain about, it would hardly need to spend so much effort getting people to trip over its cafés. The nice margin that Starbucks makes on their cappuccinos is due neither to the quality of the coffee nor to the staff: it’s location, location, location. From meadows back to coffee kiosks A nice story, but those of us who like Westerns may prefer the gritty cinematography of Unforgiven or the psychological isolation of High Noon. So, David Ricardo and I get no prizes for our screenwriting, but we might be excused, as long as our little fable actually tells us something useful about the modern world. We can start with coffee kiosks. Why is coffee expensive in London, New York, Washington, or Tokyo? The commonsense view is that coffee is expensive because the coffee kiosks have to pay high rent. David Ricardo’s model can show us that this is the wrong way to think about the issue, because “high rent” is not an arbitrary fact of life. It has a cause. Ricardo’s story illustrates that two things determine the rent on prime locations like meadowland: the difference in agricultural productivity between meadows and marginal land, and the importance of agricultural productivity itself. At a dollar a bushel, five bushels of grain is a five-dollar rent. At two hundred thousand dollars a bushel, five bushels of grain is a million-dollar rent. Meadows command high dollar rents only if the grain they help produce is also valuable. Now apply Ricardo’s theory to coffee bars. Just as meadowland will command high rents if the grain they produce is valuable, prime coffee-bar locations will command high rents only if customers will pay high prices for coffee. Rush-hour customers are so desperate for caffeine and in such a hurry that they are practically price-blind. The willingness to pay top dollar for convenient coffee sets the high rent, and not the other way around. Spaces suitable for coffee kiosks are like meadows—they are the best quality property for the purpose, and they fill up quickly. The ground-floor corner units of Manhattan’s Midtown are the preserve of Starbucks, Cosi, and their competitors. Near Washington DC’s Dupont Circle, Cosi has the prime spot at the southern exit, and Starbucks has the northern one, not to mention staking out territory opposite the adjacent stations up and down the Metro line. In London, AMT has Waterloo, King’s Cross, Marylebone, and Charing Cross stations, and indeed every London station hosts one of the big-name coffee chains. These spots could be used to sell secondhand cars or Chinese food, but they never are. This isn’t because a train station is a bad place to sell a Chinese meal or a secondhand car, but because there is no shortage of other places with lower rents from which noodles or cars can be sold—customers are in less of a hurry, more willing to walk, or order a delivery. For coffee bars and similar establishments selling snacks or newspapers, cheaper rent is no compensation for the loss of a flood of price-blind customers.
Purchase answer to see full attachment