Pricing Strategy Patterns

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Pricing Strategy Patterns

The desire to smooth prices has been posited by coffee manufacturers as one

explanation for not fully adjusting prices to changes in costs. In an investiga-

tion by the United Kingdom Competition Commission, Nestle commented:

Starbucks spokeswoman Helen Chung stated, “We do not change our prices

based on short-term fluctuations in the coffee market” (Seattle Times,

December 7, 1999). P&G commented in conjunction with its 2004 price

increase that P&G “increases product prices when it is apparent that

commodity price increases will be sustained” (Associated Press, Dec. 10,

2004). Coffee manufacturers often cite movements in futures prices as moti-

vation for price adjustments, further corroborating their stated desire to

smooth prices.

Not evident from market-level averages is the fact that individual manufac-

turer prices often remain fixed for long periods of time. Figure 2 presents a

typical manufacturer-price series for Folgers coffee.

Historically, adjustments in prices have occurred primarily when coffee

commodity prices are relatively volatile. Table 5 presents the standard devi-

ation of weekly coffee commodity prices by year, as well as the average

frequency of manufacturer price adjustments during the year. These statis-

14

Cost Pass-Through in the U.S. Coffee Industry / ERR-38

Economic Research Service/USDA

Figure 2

Atypical wholesale price series

0

5

10

15

20

25

10/29/97 10/29/98 10/29/99 10/29/00 10/29/01 10/29/02 10/29/03 10/29/04

Wholesale price

Coffee commodity price

Price per ounce (cents)

Source: Author’s analysis of Promodata wholesale-price data and New York

Board of Trade commodity data.

“In making price changes, NestlÐ"© was influenced first by the need

to avoid price volatility that could confuse the customer and be

difficult for the trade to manage. Secondly, NestlÐ"© aimed to

smooth price increases to avoid sharp changes that could damage

the confidence of the consumer. The company said that the history

of recent price changes, given below, led to results which were

overall more satisfactory to consumers than prices which changed

more frequently in response to changes in green-coffee-bean

prices, which fluctuated daily” (United Kingdom Competition

Commission, 1991).Page 2

tics calculate the number of price adjustments, not including the price

adjustments associated with trade promotions.

There is a strong relationship (correlation coefficient of 0.84) between the

frequency of price adjustments at the manufacturer level and the volatility of

coffee bean prices over a given period. For example, the lowest standard

deviation of weekly commodity costs and the lowest average frequency of

manufacturer price adjustments both occur in 2003, while the highest stan-

dard deviation of weekly commodity costs and the highest average

frequency of manufacturer price adjustments occur in 1997.

The data show, that in some years, price adjustments were very infrequent.

In 2003, the average frequency of manufacturer price adjustments in the

year over the different UPCs was 0.2 times and the standard deviation of

weekly coffee bean prices was about 0.1 cent. Taking into consideration that

green-coffee-bean costs constituted about 40 percent of marginal costs in

2003, this implies that the standard deviation of marginal costs was about 2

percent during that year.

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Another way of analyzing the data is to compare the frequency of price

adjustments across brands (table 6). The frequency of price adjustments is

relatively similar across the three major coffee brands: Folgers, Maxwell

House, and Hills Bros. Starbucks is an outlier in having extraordinarily few

price adjustments. One potential explanation for Starbucks’ behavior may be

that it is a premium product, with a considerably higher price range and

perceived quality.

Table 7 uses Nielsen Homescan statistics to summarize the household

income characteristics of customers of different brands of coffee and shows

clearly that while customers of Folgers, Maxwell House, and Hills Bros.

have similar demographic characteristics, far more