December 2012

Reputation Elasticity of Demand

How Starbuck's Tax U-Turn Illustrates The Impact of Reputation on Demand

Of all the companies facing public criticism for avoiding tax in the UK, why has Starbucks been the first to blink and enter negotiations with HMRC?

We believe the case of Starbucks, Amazon and Google provides a perfect illustration of the Reputation Elasticity of Demand.

Any A-level economics student will have learnt about ‘price elasticity’ – how demand for a product changes when the price goes up and down. 

For some products – e.g. cream cakes – rising prices are likely to see a significant fall in demand, as they are a luxury product that we can all do without.  Such products are said to have high price elasticity.

Necessary products – such as petrol – are likely to be relatively inelastic, as despite the price of petrol at the pumps most of us still need to use our cars.  People may change their habits in the long-term – i.e. switch to using the bus – but there is likely to be less of an immediate change.

The same principle can be seen at play in the case of Starbucks, Amazon and Google, but with reputation rather than price being the variable.

Starbucks has been first to perform a public U-turn, as it is the easiest of the three brands to quickly replace with an alternative.  Walking 100 yards down the road to a Costa of Café Nero is an easy protest to make.

The power of Amazon – particularly with online Christmas shopping in full swing – means it’s probably more inelastic (are people willing to give up their Kindles or ditch online shopping for a trip out to the nearest town centre?).

Finally, the ubiquitous Google will probably be the last to feel and shift in demand, with people so reliant on the service that a mass migration to Bing is probably highly unlikely.

Margaret Hodge MP illustrated these varying degrees of reputation elasticity when she was interviewed on the Today programme. 

As an active campaigner against corporate tax avoidance, she happily admitted having boycotted Starbucks, with regret admitted that she had temporarily shelved her Kindle, but had to confess that she was still searching through Google.

So what are the implications of reputation elasticity for businesses?

  1. Low reputation = lower prices: if reputation affects demand it puts downward pressure on the prices you can charge.
  2. Measuring reputation is key: understanding a shift in reputation is crucial to understanding how it affects demand.
  3. Effective reputation management is profitable: better reputation means potentially higher profits.
  4. Inelastic companies must avoid complacency: demand will only tolerate so much ‘low reputation’ before it declines.  Also, a poor reputation opens the door for a competitor to enter your market and lure away dissatisfied customers.