Thursday, April 30, 2009

Starbucks Overdose

If you have ever been to the loop area of Chicago you have probably noticed that there are a fair number of Starbucks locations. OK, that was a slight understatement. I can’t think of a single location in the Loop that is not within sighting distance of a Starbucks. Given the scarcity of retail space in Downtown Chicago, having three or four Starbucks locations on a single block hardly seems like an optimal allocation.
I am struggling to see the economic logic of extreme chain concentration. Surely the marginal revenue of an independent establishment would be greater than that of the 50th Starbucks within a relatively small area.
Since every location within the Loop is within two blocks of a Starbucks, I can’t imagine that a new location would attract many new customers. However, if one of the Starbucks were converted to an independent shop it would likely attract a large share of customers who preferred not going to Starbucks. Thus you would think that an independent shop would be willing to pay more to lease a location than Starbucks.
I can think of two possible explanations:
1. The major chains that dominate the area are engaged in an implicit price fixing. Basically, Starbucks and the other chains (I am looking at you Dunkin and Caribou) fear that any independent shops would significantly diminish there business. Thus when they open a new location they are really acting to freeze out any independent competitors.
2. Even though the expected return on investment is higher for an independent coffee shop the high price of commercial real estate may scare off many entrepreneurs. For a company like Starbucks committing to an expensive lease is not a great risk, but a local entrepreneur may be unwilling to take the same risk, preferring to locate to a cheaper neighborhood.

I don’t think that these two explanations tell the whole story, so I would be very curious to hear what other people think.

1 comment:

Michelle said...

Now here it is 3 years later. Are any of the Starbucks still there or did they all close down?