Debt Free

Yesterday I talked about the Ferrari effect, where the top end of the consumer market is unaffected by economic conditions that conspire to slow down consumers with less wealth. There is another effect that can be noticed when the economy is not as robust as it has been for prior years. I call it the “Starbucks effect”. When consumer confidence is lower and consumers are looking at the economy with some trepidation.  One of the first things to get cut from their budget are the inexpensive luxuries, to wit, the $4.50 latte.

Starbucks experienced a 1% decline in same store traffic, year over year for Q4, 2007 (ending 9/30/2007). They actually had a 5% increase in average transaction value, but that was driven by a price increase on menu items and expanding their lunch program by more than 1,000 locations.

Starbucks has noted a problem, and in their quarter-ending conference call indicated “we recognize that the flat-to-negative trends needs to be addressed” and  ”The pressure we are seeing on the traffic isn’t entirely unexpected considering the challenging operating environment and similar trends reported across both the retail and restaurant industry. It is apparent that our customers are feeling the impact of the economic slowdown.”

One should take note that this was for the period ending in September of 2007, before the bulk of the problems experienced by the credit industry. For Q1, 2008 Starbucks had a 3% decline in the number of same store transactions in U.S. stores. They also raised prices, which helped them raise the average transaction value by 2%. Investors have responded to the consumer’s propensity to avoid inexpensive luxury goods and Starbuck’s flagging sales by shedding their stock, and sending the share price from $26 at the end of November 2007, to its recent close of $18.26.

If you are looking for investment opportunities, this can be a great tool. Take note that when economic conditions dictate that an economic downturn may be in our future, one of the first classes of consumer goods to suffer are inexpensive luxury goods typically consumed by people who shouldn’t so much money on inexpensive luxury goods. As consumer uncertainty regarding their future increases, the trend is for a pullback from spending in certain areas. Spending on luxuries will drop more quickly and farther than spending on necessities. $4.50 coffee drinks while considered a necessity for some consumers have been reevaluated by an increasing number of others, resulting in the sales figures reported by the green giant of coffee shops.