Starbucks' New Gimmick: Reasonable Prices

Starbucks is determined to get you in the door, even if it takes reasonably priced coffee drinks to do it.

The Seattle-based chain has announced that it will now offer any iced grande -- that is, medium-sized -- beverage for $2 after 2 p.m. (The catch: Offer only good for customers who bought coffee from Starbucks that morning, and have managed to hang on to their receipts.)

Yes, $2 sounds like the normal amount one would expect to pay for a medium iced coffee, but at Starbucks it represents about a 50 percent discount to the list price.

Anyone listening to July 30's earnings call won't be surprised to see Starbucks dipping its toe into the realm of discounting. J.P. Morgan analyst John Ivankoe asked Starbucks C.E.O. Howard Schultz about what he had in store for value promotions in the fourth quarter.

Schultz said:

"We have no intention of doing things that would dilute the integrity of the premium position that Starbucks occupies, and what I mean by that specifically is we are not going to go down the fast food lane and do things that are what I believe not in the interest of, long-term interest of the value of the brand and the experience."

Starbucks knows it has a revenue problem, but it doesn't want to trade that for a brand-image problem; that's why, as discounting initiatives go, this one's relatively dignified.

Requiring proof of a morning purchase ensures that the promotion is rewarding Starbucks loyalists, rather than those opportunistically dropping in just for the discount. Starbucks is clearly looking to increase current customers' visits per week rather than convert new ones.

It also drives traffic during a slow part of the day, and getting customers in the door gives Starbucks an opportunity to sell an additional items, like an afternoon snack.

And since Starbucks does, after all, deal in legal addictive stimulants, encouraging people to add an afternoon caffeine habit to their morning one will benefit the coffee chain in the long run.

But any way you slice it, discounting still smacks of desperation. That's why brands like Louis Vuitton and Apple don't do it, and why Starbucks should be especially cautious about how little it takes to erode a premium image.

The key question is whether the $2 iced coffee promotion will really "move the needle" enough to make up for the brand capital expended by the promotion. Luckily, margins on coffee are high enough to let retailers to cut the price in half and probably still make money. But will the offer generate enough new traffic to compensate?

This is sure to be only one of many ways that Starbucks experiments with driving up revenue. On last Wednesday's call, Schultz also alluded to more uses for the Starbucks card, saying, "There's a big opportunity there and that is a hidden asset that I don't think we have exploited in the past."

Weigh In: If you were Howard Schultz, what would you do to drive traffic?

by Liz Gunnison