SUPPLY, DEMAND, AND PRICE: THE MANAGERIAL CHALLENGE

Case 1: Coffee: Buy Low and Sell High

In 2000, over production in the international coffee market caused the price of coffee to drop below production costs. In December 2001, coffee prices reached a low of 41.5 cents per pound, the lowest price in more than 30 years. Farmers in countries like Angola, Honduras, Sri Lanka, and Zimbabwe even stopped tending their coffee trees in an effort to save on spending for fertilizers and maintenance. Part of the problem was the usual cyclical swings in price caused by the movements of supply and demand. With coffee prices so low, it is believed that consumers would benefit with a lower price for a cup of coffee, However while coffee prices kept falling, specialty coffee retailers such as Starbucks a leading coffee shop chain a model on which our Indian counter part caf Day and Barista has been designed were charging its customer Rs35.00 for a tall skinny latte.Despite the fact that Starbucks is usually located in high-rent areas, we can imagine that the markup on these specialty drinks, given the wholesale price of coffee, definitely helps pay rent and more. Starbucks is a company that until now has played with the forces of supply, demand, and market power like a virtuoso: It buys low in the depressed wholesale market and sells high in the differentiated specialty retail market. In mid-2004, wholesale prices started to move upward, increasing by about 30 percent between May and June. The effects of the farmers who had stopped or reduced production due to low prices had started to make an impact on the market. There was also a drought and unusually low temperature in Brazil, the worlds largest coffee producer. Big coffee sellers, unlike Starbucks and other specialty retailers, had not been able to raise prices during the past 4 or 5 years because of the overall depressed market for coffee beans. Now the cost pressures from the higher prices of wholesale beans have finally enabled them to justify the raising of their prices to restaurants and other away-from-home customers. What will consumer do in the face of rising prices for nonspecialty coffee? Industry analysts expect coffee drinkers to consume about the same amount as they always have. As a 10- cup- per- day consumer interviewed by a newspaper reporter stated, I hate that the price might go up, but I got to have my coffee. Interestingly enough, Starbucks actually welcomes the higher wholesale price of .As explained by its CEO, Rin Smith, We are paying higher prices for coffee, which we think is a good thing. One of the consequences of the low prices is that a lot of farmers have gone out of business .. In September 2004, Starbucks announced that it was raising the average price of its beverages by 11 cents, citing increases in the cost of coffee and sugar

Case 2 : Air Travel : Low cost Airlines Case Study

On June 2002 in an effort to encourage more passengers to travel by air in the lean season, Indian Airline(IA) reduced fares by between 15 percent and 20 percent on seven sectors from Mumbai including Bangalore, Goa, Mangalore and Jamnagar. This is not the first time that the domestic airlines have reduced fared on select sectors to attract more business. Some years ago, all the airlines had reduced fares on the Mumbai,-Delhi and return sector in order to boost the sale of air tickets. However , the first salvo for the word for the war of low-cost airlines was aired in July 2002 when IA introduced the Apex fare that allowed passengers to travel in economy class discounted up to 64 percent rates. To avail this discount, the passenger had to book tickets 21 days in advance. Even then within two weeks after the launch 16,000 tickets were sold. Soon, Jet Airways followed suit. They observed that revenue implications of the Apex fare tickets sold were favourable. IA pointed to the fact that the revenue generated under the scheme was incremental. Those who had booked under the scheme are of a specific segment of travelers and are not the regular travelers who would generally fly. The scheme seemed to be a success. A year later in August 23 2003, the first Indian low-cost airline, Air Deccan, was launched. It was the first airline in India to fly to second tier cities like Hubballi, Mangalore, Madurai and Visakhapatnam. Pioneered by Captain G.R Gopinath , known as the father of low cost airlines in India, Air Deccan became known as the common mans airlines. Gopinath dreamt of enabling every Indian to fly at least once in his/her lifetime.This was a great place to start in burgeoning economy. Next year price wars continued as Air Sahara offered irresistible discounts. But by October the price wars in the skies heated up with Air Deccan announcing a 20 percent drop on the fares on the trunk routes. An airline spokesperson said that the lower fares were already available to the passengers. The move came just a day after the three other airlines- IA, Jet Airways and Air Saharaannounced a 10 percent hike in their fares mainly on account of the northward movement in the global prices of oil. However, a passenger flying with the low-cost airline between Delhi and Chennai would pay Rs 4,700 instead of Rs 6,800 which was charged earlier. A passenger travelling on the same sector with other airlines and purchasing the tickets at the last moment would be charged more than Rs11,000.The low-cost airlines argument for this counter intuitive price announcement was passenger load factors were encouraging for the next two months and the cash flow situation was good. The twist in the tale of the low-cost airlines came with the rising oil prices. By the beginning of 2005, Air India posted a loss of Rs75.23 crores. A review showed that the SARS virus and pilots strike combined with the rising aviation turbine fuel (ATF) prices were the cause for the heavy loss. But in May that year the no- frill low cost private airline, Kingfisher Airline, started its operation with a fleet of flour leased Airbus A-320 aircrafts. The war in the skies began; while fuel prices soared, the new Kingfisher bravely went ahead purchasing 40 different types of aircraft for more than $8 billion. Throughout 2005 as crude price rose so did that of ATF,the vital fuel for the airline industry. In that year two more low cost airlines were launched. The

Paramount Airways and the Indian Express , a subsidiary of Air India, started operations, Indigo Airlines, Spice Jet and Go Air begun operations in the following years. We see that the low cost airlines have survived and thrived in the new open sky policy. The success of the low-cost airlines can be seen in its nomenclature. In markets where fierce competition led to price reduction, only those with low- cost structure can survive. In an effort to compete with the low cost airlines, the full fare airlines have been continuing to pare down their wage bill by announcing 5 percent to 25 percent salary cut for pilots as Jet Airways did. It received tough resistance from them who argued that expat pilots should also get the same wage cut or be phased out. What has made the situation even worse is the rising price of fuel. By June 2004 the ATF price rose to an all-time high of Rs 26,000 per kilolitre. IA estimated a fuel bill of Rs 1,445 crores for 2004-2005 up from revised estimate of Rs1,297 crores in 2003-2004, whereas the fuel bill had been Rs 866 crores in 1999-2000.If legacy airlines were unable to sustain their high prices in the face of mounting competition from low-cost airlines, they were not able to pass on the higher fuel prices by increasing airfares either. However, some airlines did try to introduce a fuel surcharge , but that was not well taken by the travelling public. At the times of going to press, news reports of Rs 3,195 crores loss accumulated by the airlines industry for the fiscal 2007-2008 hit the stands.

Questions: The graphs that you will be constructing need not be to scale. Caselet 1: 1. How would you depict the movement in price from 2000 to 2001? 2. Referring to the CEO,s statement, it appears that he is happy with the high prices of coffee.. but high price is the result of supply restriction What is the CEOs expectation? 3. Depict the phenomenon of price increase in 2004.

Caselet 2: 1. How were the reduction in fares brought about in 2002. Explain in terms of the SS-DD model. 2. Depict graphically what happened in 2005 in the air travelmarket: The impact of rising oil prices; tha action taken by Kingfisher Airline, the arrival of Indigo , Spicejet, etc.

Finally, contrast the market outcomes and the supply and demand responses in the coffee market with those in the air travel market.