The Coming of the $1 Cupcake

So last night, my date introduced me to the wonderful world of cupcakes.  Red Velvet Cupcakery to be exact (Penn Quarter near Chinatown).  And before last night, I was not a believer.

So what is behind the rise in the popularity behind the remarkable world of cupcakes?  Was there a new invention?  Did they create an elusive recipe? Though my Red Velvet was super sweet and delightfully delicious, it wasn't something to write home about or nutritious enough to substitute for lunch or dinner.

So clearly, the cupcakes are considered a luxury item.  And with prices that surpass $3 per cake, sampling a few can easily set you back $15-20.  (For this price, I could buy a burrito and a six pack of domestics)

The production of cupcakes is relatively inexpensive.  There are only a few flavors, the raw material is cheap and so is the labor to produce and sell. In addition, product inventory is low and since all their stores are tiny matchboxes, with lines that stretch outside a block long, the amount of rent they pay is minimized (they should pay the city for renting out the sidewalk).

Since there were only a handful of favors (Red Velvet and Chocolate), Process Costing  (used in companies that make many units of similar products) equals Total Manufacturing cost/Total Unit Produced.

Cupcakes seem to sell well without much marketing. All you need to do is head for the long lines.  Thus, they are able to bring in a lot of customers without having to spend much on overhead (marketing).  The women are crazy over it, and the men are lining up because their girlfriends asked them to do it.

With a low manufacturing overhead cost, their Predetermined Overhead Rate is also relatively low.

So with high revenues, do things look all rosy for the cupcake industry?  For the time being, yes, but in the long run -- a different picture.

First, I'm willing to stick my neck out and say that the cupcake industry is benefitting from its recent wave of popularity (Thanks to Hollywood and Sex in the City) as well as the downturn in the economy (Most people consider cupcakes as an affordable luxury -- a way to feel good about rewarding yourself with a trendy cupcake without breaking the bank).

Since it's relatively easy to make cupcakes (I'm sure even I could learn how to if I had the patience), and the start-up investment costs is much smaller than opening a cafe or restaurant, there currently is new competition sprouting up all over town.  I bet it won't be long before they open up cupcake kiosks in Giant and Safeway.

The majority of the costs are fixed that means that the price of rent and machinery stays the same despite output.  Variable costs would be raw materials (flour, sugar, cream) and labor would be step variable, since they would fluctuate depending on sales but in increments.

Since the demand for cupcakes is inelastic, when the price of cupcakes come down due to oversupply, the demand will not necessarily go up.  People who are willing to wait long lines for cupcakes will likely (over time) still wait in line when the prices come down to a buck, and vice versa.

Huge returns naturally attracts competition.  Extra competition attracts capacity.  Now with more supply, the cupcake stores' incentive is to lower prices so that they can retain some of that business. 

Long lines at Georgetown Cupcakes.

Meanwhile demand remains constant and may decline over time, as people lose their adoration for them and the men get tired of waiting those long lines or realize this is wrecking havoc on their diets.

So, despite my great experience with Red Velvet (thanks to my friend), I'm not yet hooked (like I am for stand-up paddling) and fortunately for us, with new competition and lower prices, things don't look all rosy for the cupcake industry.

Yes, my friend, there will be a $1 cupcake in the not too distant future.  And no, you will not see me wait in that line.