Ahh, coffee, the morning ritual of getting a hot cup of joe, is a scene that plays out across North America day after day. The coffee market is worth billions of dollars annually in the US and Canada and is known for its highly variable margins. As a proud Canadian who frequently travels to the US, something that has always stood out to me is the high cost of a cup of coffee south of the border. Ultimately this has everything to do with market share and pricing, let’s explore:
Take, for example, a medium coffee at Starbucks and McDonald’s:
Starbucks: $2.45 in the US, $2.65 in Canada or a 1.08 exchange
McDonald’s: $1.59 in the US, $1.76 in Canada or a 1.11 exchange
As some of you may know, the USD to CAD exchange rate ranges in the area of 1.35 to 1.40. The average cost for the vendor of your standard morning black coffee is about $0.20, add $0.20 for the cup and lid for a total of about $0.40, which means that your morning cup of joe is about 25% cheaper in Canada than it is in the US.
As Canadians, we’re fairly used to paying more for everyday items thank our neighbours to the south. A smaller market, lower quantities, and increased shipping costs; there are many reasons why goods generally cost more in Canada than the US. As a benchmark see a variety of examples below:
Notice that the index values, in most cases, tend to surpass the exchange rate of about 1.35 to 1.40. So why is coffee so cheap in Canada as compared to the US? To answer this, it is essential to keep in mind one of the key pillars in the Balanced Revenue Management Framework, marketing.
The Financials between Canada and the US are relatively constant; coffee is a high margin business. The value delivered to customers also remains comparatively consistent between the two markets; all of the value-added specialty drinks are available. What is drastically different is the competitive landscape and market dynamics.
Market Share and Pricing
In the US, Starbucks is the market share leader with close to an estimated 40% volume share, followed by Dunkin Donuts (which is priced in line with Starbucks for a medium coffee at $2.45). Two words separate the Canadian market, “Tim Hortons.”
In 2014 Tim Hortons had an estimated market share in Canada close to 75%, absolutely dominating the market. Now things are beginning to shift, McDonald’s and Starbucks have made headway in recent years, but Tim Hortons is still the top dog, owning the lions share of the market.
The price of a medium coffee at Tim Hortons, $1.76 (conveniently matched by McDonald’s), is about a 72% index to Dunkin Donuts in the US. Tim Hortons has an aggressively priced offering compared to Starbucks, and also a cult-like following. For Canadians, Tim Horton’s tastes like home.
This touches on an essential aspect of putting a pricing and revenue management strategy into practice; value and financials are significant, but having the right market context and position can make the difference between winning and losing. If Starbucks and McDonalds were to price using the 1.35 exchange index, they would be $3.31 and $2.15 for a medium coffee. Starbucks would be almost 2X as expensive compared to today’s 50% index.
When trying to steal market share and build a brand, it would be hard to do so with such a high price premium. McDonald’s would be about 20% more expensive, however crossing the $2.00 price threshold would make the offering look costly compared to the alternative of Tim Hortons.
Both US retailers are employing a price strategy to garner as much market share away from Tim Hortons in the Canadian market. You can see that when McDonald’s adds aggressive promotions of $1.00 coffee for weeks at a time, and one free coffee after seven purchases.
Initially implemented to combat the famous Roll Up the Rim contest, McDonald’s aggressive tactics have seen Tim Horton’s reply with their own offer of free coffee after seven purchases, creating a price war to retain customers and hold market share. With high margins, market share is valuable to all major coffee chains.
The US market is comparatively not as competitive. The market is highly fragmented; there is more stability in the pricing and promotional vehicles; thus, the coffee is more expensive.
The key takeaway is that price and market position is relative to who your competition is. It is ok to have different strategies in different markets to accomplish business goals and optimize profitability. However, it is imperative to understand the market dynamics and competition in order to capitalize.
So to answer the question, are Americans paying too much for coffee?
As a retailer, NO.
As a consumer (a Canadian consumer), YES!
ABOUT THE AUTHOR Michael Stanisz is a Partner at Revenue Management Labs. Revenue Management Labs help companies develop and execute practical solutions to maximize long-term revenue and profitability. Connect with Michael at [email protected]