This blog post examines why the specialty coffee shop market operates as monopolistic competition rather than perfect competition, using the Starbucks case study, and unpacks the logic of the market structure created by price, differentiation, and narrative.
The Reality of the Coffee Market That Perfect Competition Cannot Explain
Starbucks is the undisputed leader in Korea’s coffee shop market. Last year, its sales reached 3.1001 trillion won, six times that of the second-place company, Twosome Place. However, Starbucks’ coffee is not the most expensive in Korea. Franchises exist that charge more for coffee than Starbucks. Even among small, privately-owned coffee shops located in residential neighborhoods, it’s common to find places selling coffee at higher prices than Starbucks. With the number of coffee shops exceeding 100,000, is setting prices higher than the market leader truly a case of ‘gutsy business’? This is possible because the coffee shop market is what’s known as a ‘monopolistic competition market’.
Suppose there are infinitely many coffee shops in Korea, and all coffee tastes and quality are completely identical. In this case, a price would form where demand and supply are in equilibrium. Under these conditions, no coffee shop could set prices higher than this equilibrium price. The moment they raise prices, customers would immediately move to another shop. Conversely, there would be no compelling reason to lower prices either. Customers might temporarily flock to a store, but with daily production capacity limited, lowering prices would only reduce sales.
This type of market is called a ‘perfectly competitive market’. A perfectly competitive market refers to a structure where numerous sellers offer nearly identical products, and there are no significant barriers to market entry. In a perfectly competitive market, individual producers cannot set their own selling prices. They must simply accept the price formed by the market. However, there is something somewhat peculiar about this. In the real world, completely identical goods are almost nonexistent. Economics textbooks cite rice or milk markets as prime examples of perfect competition, but in reality, rice from Icheon differs from rice from Gangjin, and milk also varies by grade.
Economists recognized this as a problem over a century ago. Until the early 20th century, classical economics developed its theories based on the premise of perfect competition. However, by the 1930s, British economist Joan Robinson and American economist Edward Chamberlin pointed out that perfect competition is nearly impossible in reality. They systematically developed theories on monopolistic markets, oligopolistic markets, and monopolistically competitive markets. This theoretical shift is called the ‘revolution of imperfect competition’.
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Among these, monopolistic competition is the most common market form encountered in our daily lives. Coffee shops, clothing stores, beef soup restaurants, Chinese restaurants, hair salons, and the private education market all fall under monopolistic competition.
Monopolistic competition resembles perfect competition in that it involves many sellers. However, the goods and services sold in this market possess slightly differentiated elements depending on the producer. These differentiating factors are highly diverse. Exceptional taste, clean hygiene, a friendly owner, or attractive part-time workers can all be factors of differentiation. Through such differentiation, producers in monopolistic competition form a certain degree of their own distinct market. Consider the existence of regular customers. Even if coffee from one shop seems no different from another, if someone insists on patronizing a specific coffee shop, that shop gains a position similar to a monopolist for that customer.
Consequently, producers in monopolistically competitive markets possess a certain level of control over prices, unlike in perfectly competitive markets. For example, if customers come to buy coffee just to see a good-looking part-time worker, that shop might be able to set its coffee prices somewhat higher without suffering a major blow to sales. If a neighborhood coffee shop exists that is more expensive than Starbucks, it clearly has other competitive advantages.
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Monopolistic competition is distinctly different from monopoly. Unlike a monopoly market, a monopolistically competitive market has low barriers to entry and numerous goods that can serve as substitutes, even if not identical. Consequently, the monopoly power an individual producer can wield in a monopolistically competitive market is highly limited. Even if a business has secured many regular customers, if a similar shop opens across the street, they must inevitably share the market. For this reason, economics textbooks explain that the long-run profit in a monopolistically competitive market is zero. Here, profit refers to economic profit, which includes opportunity cost. Even if economic profit is zero, it is possible to earn accounting profit, which excludes opportunity cost.
The way for producers in a monopolistically competitive market to maintain high profits in the long run is to continuously enhance the competitiveness of their goods and services to steadily increase their regular customer base, or to reduce costs through management innovation. If the economy improves and overall market demand increases, the problem can be relatively easily solved, but this is beyond the control of individual producers.
This is why many companies are obsessed with developing new products, repeatedly making efforts to ‘squeeze a dry towel’. This is also why self-employed individuals post photos and videos on Instagram day and night. Even the owner of a neighborhood coffee shop selling coffee more expensive than Starbucks’ cannot escape this logic of competition.
