The Economics of Cupcakes

April 7, 2012

A few weeks ago a friend of mine asked me about cupcakes. Or, more specifically, what I thought of them. Here’s the gist of my answer:

  • Melbourne has recently been inundated with boutique cupcake shops, mostly in the CBD.
  • They appeal to a market of (predominantly) women who cycle through various sweet goods. Think of the Suga craze from years back, then exclusive chocolates a la Max Brenner and Koko Black, and now cupcakes & macarons (next up will be gourmet doughnuts, mark my words, I hear they’re all the rage in London right now).
  • All shops appear to have roughly the same prices.
  • All cupcakes are overpriced, over-crazed and insanely popular.
  • I have a bit of a soft spot for them, especially red velvet.

Reflecting on my answer, I realised there’s something funny going on regarding the pricing of cupcakes. Every single cupcake shop in Melbourne has close to identical pricing: $2 for a mini and roughly $4 for a regular. Are customers so sensitive with regards to cupcake prices (in other words, is the elasticity of demand so high) that no shop dare charge more for fear of losing customers, nor charge less for fear of becoming unprofitable?

See how thrilling my life is?

There could be a range of factors at play here, including that of price-fixing or tacit collusion. Perhaps cupcake shops are purposefully and collectively pricing this way. It may be beneficial for them collectively to offer similar prices. In a weaker sense, it could merely be a mutual understanding that a race to the bottom wouldn’t help anyone. Alternatively, production costs and customer base could be identical for all shops, so everyone is stuck making zero profits. Whichever factor it is, my hypothesis is that the classic conception of price-based competition doesn’t exist for cupcakes, at least not at the moment.

It seems like cupcake shops can’t (or won’t) compete based on price. On what basis then, do cupcake shops differentiate themselves? Arguably, differentiation via company branding is quite difficult to achieve, because the entire appeal of cupcake shops it that they’re small and they sell sweet and pretty things, and there are only so many ways you can visualise this idea in a logo. I mean, really, how many cutesy shapes and pastel colour combinations are there?

And then there’s the indisputable fact that all cupcakes, essentially, look the same. In economics this is called product homogeneity, and it usually equates to increased competition in a market. Increased competition causes firms to price more aggressively (i.e. undercut each other) until their profits are so low they can just afford to stay in business. Also, because running a cupcake business is such a simple process – not just because of product homogeneity, but also due to simple distribution channels and a short production line – it’s fairly easy to replicate, which means lower barriers to entry and even more competition. What this all says is that we should see strings of cupcake shops popping up quickly, which we do!

Given that the product line is so homogenous, I am rather impressed (perhaps amused is a better word) at how cupcake shops try to to make their product as physically distinguishable for others as possible. As you can see, it’s all in the icing…

Selling inventive flavours and, in particular, Asian flavours such as matcha and pandan, is another avenue along which shops can distinguish themselves from their peers. A few creative flavours that have caught my eye include:

  • Fig and mascarpone or rhubarb from Joy
  • Coconut and pandan from Cupcake central
  • Teddy Bear from Little Cupcakes
  • Custard tumble from the Cupcake Bakery
  • Durian or matcha from the Cupcake Family

But it seems that they’re all quite good at selling a mix of classic and more unusual flavours; there isn’t one cupcake shop that stands out in this respect. Joy Cupcakes push the fact that they only use natural flavours and colourings (a laudable practice), but I’ve been disappointed by Joy several times.

Carrot Cake from Cupcake Central. One of these little babies made my day last Monday.

So really…it’s all in the icing. And taste, I suppose. I know this is up to personal opinion, but here’s how I’d describe each place:

  • Cupcake Bakery – on the whole a little dry and not enough oomph
  • Little Cupcakes – excellent, but there’s too much icing on the large ones so stick with the minis
  • Joy Cupcakes – unpleasant chemical taste in the icing although the cake is fluffy
  • Cupcake Family – moist cakes although the icing tends to be too thick and yoghurty
  • Cupcake Central – really good, perfect sweetness in the icing

Icing and taste. They’re the two (rather negligible) factors on which shops can distinguish themselves. Because effectively all cupcakes are the same thing. Sugared cakes. Practically interchangeable, wouldn’t you agree? Arguably, a cupcake from the Cupcake Bakery is a perfect substitute for a cupcake from Cupcake Central. This begs the question: How loyal is the customer base for each cupcake shop? Do people stick with the one place for reasons beyond convenience? Or are we all cupcake whores?

Speaking for myself, I prefer a monogamist lifestyle of nothing but Little Cupcakes. In fact, I’m so boring I’ll usually get the same flavour each time (or maybe a Belgian Chocolate if I’m feeling bold). Little Cupcakes was the first place I ever went to. It’s also my favourite. For me at least, this has nothing to do with price or a particularly outstanding product, but pure familiarity.

But if I weren’t as picky about cupcakes, I suppose any decision about which cupcake shop to buy from would be purely based on convenience. Joy Cupcakes, for example, is popular with the corporate crowd, since it’s up the Paris end of Little Collins. Cupcake Central drags in students and tourists at Melbourne Central. Little Cupcakes and the Cupcake Bakery have the right idea by franchising and spreading the sugary love across shops in the CBD and other shopping centres. But apart from convenience (and outstanding taste for the fussy among you), there doesn’t seem to be much to draw a particular customer to a particular shop time and time again.

With all this in mind, I must sadly conclude that not only is there very little loyalty to a particular cupcake shop, but there is very little loyalty to cupcakes in general. As I outlined earlier, cupcakes are just one in a series of popular dessert items that circulate wildly for several years before falling to the wayside (dare I use the most awful of words, a “fad”?)

My view is that the customer base for cupcakes is largely transient and fickle, and as soon as something else sufficiently in vogue comes along, they won’t hesitate to abandon these poor little cupcakes, forlorn and forgotten in the dust. I see little evidence of the current cupcake frenzy being sustained in the long term, but for now a cupcake shop on every corner suits me and my sugar cravings just fine, thank you very much!

Filed under: Cupcakes, Dessert