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Monday, October 09, 2006

Latte Price Discrimination at Starbucks?

Randal C. Picker from the Law School at the University of Chicago wonders if Starbucks is practicing price discrimination:

Latte serves up a lesson in bootleg economics, by Randal C. Picker, Commentary, Chicago Tribune: ...[T]he Tribune detailed Thursday in an interesting article about Starbucks and the bootleg latte.

As the Tribune describes it, Starbucks' pricing creates a doppio-latte arbitrage opportunity. ... [H]ere is the strategy as I get it. A doppio is described as a double shot of espresso that would usually be served in an 8-ounce cup. That would set you back $1.75. A latte, which goes for $3.20, is a double shot of espresso plus milk and foam in a 16-ounce cup. Our arbitraging customers order the doppio but ask for it in a 16-ounce cup and then add free milk available in canisters at Starbucks. Pop the cup in a microwave, and you have the latte and have saved $1.45. (This, of course, is just saving money; real arbitrage would mean that enterprising customers would start selling the fake lattes in competition with Starbucks, but the Trib article didn't say anything about that.) ...

Starbucks provides free milk so that customers who want to add milk to their coffee can do so. ... But Starbucks has no simple way to control how "free" milk is used at its stores. Starbucks obviously could post signs or refuse to sell drinks in wrong-sized cups. The cup size limit is the most natural technical constraint; signs would be more directly contractual but would detract from Starbucks' ambience.

Of course, imposing a cup size limit might irritate some customers. Is Starbucks better off without these customers? Perhaps, but there's a more interesting alternative. Starbucks may be engaging in what an economist would call latte price discrimination. That means selling the same thing--the latte--to different customers for different prices. If we assume that the fake latte is profitable for Starbucks even when sold for $1.75, Starbucks may be perfectly willing to allow some of its customers to home-brew using Starbucks ingredients. ...

Although Starbucks probably wouldn't announce a policy of allowing customers to create fake lattes--too many genuine latte purchasers might switch over--it might want to engage in latte price discrimination... So the next time you go to Starbucks, take a good look around. If you order a doppio in a 16-ounce cup, does the barista wink at you? Maybe the barista is being friendly, but maybe, just maybe, you are being told that your fake latte is just fine.

As noted above, it isn't arbitrage. Is it price discrimination? I don't think they're essentially the same product - one's fake. To me, the fake would be a lower quality, lower cost alternative which might still be profitable for Starbucks even with the added milk, but it's not price discrimination. In any case, if Starbucks wanted to price discriminate, there are better ways to do it.

    Posted by on Monday, October 9, 2006 at 12:03 AM in Economics | Permalink  TrackBack (0)  Comments (10)


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