Latest / Pricing Power Podcast with Fexingo: How Businesses Set Prices, Raise Margins, and Win Customers / How Starbucks Prices the Five-Dollar Latte
Transcript
- Lucas: So we talk a lot on this show about companies that sell something you want once a year — a flight, a car, a vacation. But what about the product you buy every single day? That is a fundamentally different pricing problem. Luna: You're thinking about coffee. Specifically, the five-dollar latte. Lucas: Exactly. Starbucks. There are roughly 38,000 Starbucks locations globally, and the core product — a grande latte — now averages around five dollars in the US. That's up from about three-fifty in 2015. A 43 percent increase in a decade. And yet, they sell millions of them every day. Luna: The question is: why does that price stick? And what happens when it doesn't? Lucas: Right. Let's start with the structural advantage. Starbucks doesn't compete on price. It competes on what we call 'third-place' positioning — home, work, Starbucks. That was Howard Schultz's original insight in the 1980s. The store itself is a paid membership club. You're not just buying a beverage; you're buying the wifi, the heat, the background noise, the ritual. Luna: But that positioning is expensive to maintain. Real estate in dense urban areas, barista wages, health insurance for part-time workers. That's baked into the price. Lucas: It is. And it's also why the gross margin on a latte is surprisingly modest. Analysts estimate Starbucks' blended gross margin on beverages is around 55 to 60 percent. But that's after you account for the cost of goods — coffee beans, milk, cup, lid. When you factor in store labor and occupancy, the operating margin on a single latte might be 15 to 20 percent. It's not a huge markup on the unit level. Luna: And yet, a drip coffee has much lower COGS — just beans and water — and sells for maybe two-fifty. So the margin on drip is higher percentage-wise, but lower dollar-wise. Lucas: Exactly. The latte is the high-dollar, high-experience item. It's where Starbucks makes its money on volume. And that volume depends on frequency. The average Starbucks customer in the US visits about 16 times a month — that's every other day. So the pricing strategy has to balance two things: keeping the per-visit ticket high enough to cover costs, and keeping the price low enough that it doesn't trigger a habit break. Luna: Which brings us to 2024 and 2025. Inflation, wage pressure, and a consumer who started pushing back on premium pricing. Starbucks reported two consecutive quarters of declining traffic in North America in late 2024. Lucas: And the media narrative was 'Starbucks has lost its pricing power.' But I think that's too simplistic. What actually happened is that Starbucks's core customer — the urban professional who visits daily — was squeezed by broader economic factors. Starbucks didn't raise prices in a vacuum. They raised them alongside rent increases, grocery inflation, and stagnant wages. The cumulative effect finally tipped some customers into cutting back. Luna: But Starbucks also has a powerful tool that most retailers don't: the Starbucks Rewards app. Seventy percent of US sales now come from loyalty members. That gives them rich data on individual price sensitivity. Luna: They can offer personalized discounts to heavy users who are at risk of churning, while charging full price to occasional visitors who aren't price-sensitive. Lucas: That's a form of price discrimination that the company has gotten very sophisticated about. The app knows your order history, your typical spend, how long it's been since your last visit. If you haven't been in for 10 days, you might get a 'buy one, get one' offer. If you visit every morning, you get nothing. The base price stays high, and the discounts are targeted. Luna: So the five-dollar price is really a sticker price that not everyone pays. The effective price for a loyalty member might be lower, but the company captures more surplus from customers who are willing to pay more. Lucas: Right. And this is where the economics get interesting. Starbucks also uses the app to manage peak demand. Mobile ordering now accounts for about 30 percent of transactions. During the morning rush, the app can throttle order acceptance, effectively raising the 'time price' rather than the dollar price. You decide whether the wait is worth it. Luna: That's a subtle kind of demand-based pricing. But it has a downside: if the wait gets too long, customers defect to local shops or drive-through competitors. So there's a cap on how much 'time price' you can impose. Lucas: Which brings us to the 2026 summer menu reset. Starbucks announced a new tiered pricing structure in June 2026. They introduced a 'core' lineup of five drinks priced at three dollars or less — a small drip coffee, a tall iced coffee, a plain latte without customization. Meanwhile, the premium custom orders — oat milk, extra shot, cold foam — got a price increase of about 3 percent. Luna: So they're trying to pull back the price-sensitive customer with a low-priced entry point, while pushing the premium customer to spend even more. Lucas: Exactly. It's a barbell strategy. The low end protects market share. The high end protects margins. And the middle — the standard grande latte at five dollars — remains the default. The question is whether that middle will hollow out. If customers trade down to the three-dollar core drinks, Starbucks loses revenue per visit. If they trade up, margins improve. The company is betting that enough customers will trade up to offset the ones who trade down. Luna: There's a historical parallel here. In 2008, during the financial crisis, Starbucks closed 600 stores and cut costs. But they did not cut prices. They actually raised prices on some beverages in 2009. Schultz believed that cutting prices would dilute the brand's premium positioning. He was right — same-store sales recovered within two years. Lucas: But the macro environment in 2026 is different. Inflation is lower than 2022 but still above the Fed's target. Consumer sentiment is fragile but not panicked. The risk is that the brand's 'affordable luxury' positioning gets squeezed from both sides: cheap alternatives from McDonald's and Dunkin', and higher-quality local roasters that offer a better experience for a similar price. Luna: So the five-dollar latte is a psychological anchor. It's not just a price — it's a signal of what Starbucks stands for. If that price cracks, the whole positioning starts to wobble. Lucas: And if these conversations have moved your work forward in some small way, listeners who value ad-free, independent business analysis sometimes ask how they can support the show. The simplest way is to buy us a coffee — literally. That's at buy me a coffee dot com slash fexingo. No pressure, no perks, just a way to keep this going without ads. And it genuinely helps. Luna: Yeah, we're grateful for every contribution. It lets us spend more time on episodes like this one. Lucas: So let's come back to that anchor question: can Starbucks defend the five-dollar latte? I think the answer depends on two things. First, how sticky is the habit? Coffee is one of the most habit-forming consumer goods. The marginal utility of that daily latte is surprisingly high for regular drinkers. Second, how elastic is the demand? Early estimates from the summer menu reset suggest that the new three-dollar core drinks are attracting lapsed customers, but the average ticket for loyalty members is actually up slightly, because the premium customizations are growing. Luna: So the barbell might be working, at least in the short term. But it's a delicate balance. If the economy weakens further, the trade-down could accelerate. Lucas: That's the thing with pricing power. It's not a permanent endowment. It has to be earned every day, one transaction at a time. Starbucks has earned it for three decades by delivering consistency, convenience, and a bit of status. The five-dollar latte is the price of that consistency. And as long as customers feel they're getting value — not just caffeine, but the whole third-place package — the price will hold. Luna: It's a reminder that pricing is never just about covering costs or maximizing margin. It's about telling a story that the customer believes in. Lucas: And that story, for Starbucks, is still being written. Next week, we'll look at a very different kind of daily purchase: how Dollar General prices for the bottom of the income pyramid. That's a whole different set of trade-offs. Luna: Looking forward to it.