These days the news is full of stories about falling oil prices, the weakening Euro, and interest rates that can’t decide which way to go. However, there is another commodity that has dropped just as fast as oil. It is something that the majority of Americans use every single day but has largely gone unnoticed. As you can see in the graph, over the last six months the price of coffee has dropped nearly 40%!
When oil drops, we can all see it at our local gas station, but why has this massive drop in coffee prices not shown up at our local Starbucks? The simple explanation is that you get what you pay for and when you go to Starbucks, coffee beans actually make up a very small part of what you are buying. To better understand the cost components of your morning cup, let’s break it down.
Raw coffee beans at current prices are about $1.40/lb. There are roughly 3,500 beans in each pound of coffee. A single shot of espresso is about 80 beans. Therefore, the cost of a shot of espresso is roughly $0.03. Assuming your Grande Latte has a double shot, only about $0.06 of the total price that you pay - $3.45 - comes from the raw coffee beans themselves. Even as prices have come down significantly, the truth is that the beans actually don’t play much of a factor as part of the overall cost, and consequently, the price of a latte.
Why doesn't Starbucks go ahead and drop the price just a little for us? The answer is that what is only a few cents to you and me is actually a couple hundred million dollars in profits for Starbucks. They use around 500 million pounds of coffee each year. The real question is: what can we learn from this? The true lesson here is that retailers are very hesitant to lower prices because when commodities fall, it dramatically increases their profits. However, we shouldn't be surprised if Starbucks raises their prices when the cost of coffee beans returns to previous levels and then subsequently blames the commodity markets for the increase.