Stealing Starbucks' buzz

NEW YORK (CNNMoney.com) -- As dairy prices rise, forcing Starbucks customers to shell out more for a grande decaf no-whip mocha, some small coffee stores are finding a way to outbrew the cappuccino king.

Starting Tuesday, Starbucks (Charts, Fortune 500) will raise U.S. prices on cappuccinos, lattes and other coffee drinks by about nine cents a cup to help offset soaring costs for milk and other commodities, according to the company.

Cuppy's President Doug Hibbing hopes to skim off some of Starbucks' customers.

Wholesale milk prices have soared over the past year, amid strong global demand, which has resulted in higher retail prices for dairy products and higher production costs for coffee shops like Starbucks, according to Rick Kment, a dairy analyst at Omaha, Neb.-based agriculture consulting firm DTN.

In fact, Starbucks' chief financial officer warned it would be "very challenging" for the coffee shop chain to meet the high end of its 2007 earnings forecast, in part because of rising dairy prices.

But for Doug Hibbing, president of Fort Walton Beach, Fla.-based Cuppy's Coffee & More, a small specialty coffee franchise, there's an upside to the dairy squeeze.

Although some diehard java fans don't balk at spending more than $3 for a latte, Starbucks customers may go elsewhere if prices get too high, Hibbing believes. And Cuppy's 38 stores are more than happy to sell them their caffè lattes instead, which cost $2.50 to $2.75 for a 12 oz. cup.

"If (Starbucks) raises their prices, it gives us more latitude to take a share of the business," Hibbing said.

Whether they stop in to Starbucks or get their joe elsewhere, 51 percent of adults in the U.S. said they drink coffee daily, according to the National Coffee Association, which means there's a big market for the espresso-obsessed.

Even as dairy costs rise, "the margins in specialty coffee are still very comfortable," Hibbing admits. "It does cut into the profit margin some, but it's not a deal breaker by any stretch of the imagination."

And therefore, Cuppy's can keep prices well below the cost of Starbucks, at least for the time being. In addition, "because our stores are locally owned and operated we don't have the layers and layers of overhead some of our competitors have."

And that's what Hibbing hopes will stimulate the company's expansion. Cuppy's expects to open 100 franchised locations by the end of the year.

Small World Coffee, on the other hand, is happy being a local joint with only two locations in Princeton N.J. - in fact, that's what gives the coffee shop its edge.

Despite a Starbucks location around the corner, sales have grown steadily over the past 13 years, thanks in part to a loyal customer base and a "community-oriented style of service," according to co-owner Jessica Durrie.

"We've seen a lot of other chains come and go," Durrie said. "Because we are independently owned and operated it gives us a strong foundation in a competitive marketplace."

But Durrie also admits that the rising cost of milk is having a big impact on the business. "Besides coffee, milk is our other largest expenditure," Durrie explained. In fact, Small World Coffee is planning to raise their prices by about 5 percent by the end of August.

Although it has been a few years since the small business last upped the cost for its brewed beverages, "every single time we've raised our prices, we've always been really nervous."

Like Starbucks, "we sell an affordable luxury," Durrie said. "If incomes don't rise accordingly, people will scale back."