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Starbucks Corporation (NYSE: SBUX) is an international coffeehouse that has built one of the world's most powerful and recognizable brands upon high-quality coffee and the unique "Starbucks Experience." [1] Starbucks has sought to capitalize on its growing popularity through expansion; the addition of over 1500 stores in just over a year brought its total store count to over 16,600 in 2008. In fiscal 2008, the company's stores (retailer and licensed) generated US$ 10.4 billion in revenue. [2]
Starbucks first revolutionized the coffeehouse industry by marketing expensive, high-quality coffee as well as a "third place" between work and home - a warm, clean, and inviting environment where customers go to escape the chaos of daily life. [3] Not all of the company's strategic decisions have stuck, however - breakfast sandwiches were axed in early 2008 after slow sales made it hard to justify the rising costs of the special items.
With the current economic conditions, Starbucks faces significant headwinds. While past concerns over commodities prices, particularly coffee beans and milk, have subsided, a shift in consumer spending triggered by a global economic recession may decrease sales in the coffeehouse market in general, as well as drive consumers to less costly competitors such as McDonald's, which began offering premium coffee in 2006. An additional challenge facing Starbucks may be its own dominance - with a Starbucks on every street corner in some parts of its core U.S. market and an average of 8.5 new locations opened weekly in the country, the company has experienced increasing cannibalization of sales from existing locations. The company seeks to address these issues by cutting costs. It responded in 2008 by scheduling the closing of 600 underperforming stores, a process that will be completed in 2009. [4]
[edit] Business Overview
[edit] Company Operated Retail
Through its company-operated retail coffee houses, Starbucks sells high-quality whole bean coffee, freshly brewed coffee, premium teas, a variety of cold blended beverages, various food/pastry items, and coffee/beverage related equipment and accessories, as well as a line of CDs.
In 2008, Starbucks operated 7,238 retail stores in North America and 1,979 stores internationally. Its retail operated stores generated 84% of its total revenue. [6]
[edit] Third Place Experience
Starbuck's success is due in large part to the trendsetting triumph of its coffeehouses as an informal and convenient "third place" outside of home and work, ideal both for informal meetings and a quiet moment away from the hubbub of daily life. Wi-fi internet access in all stores also makes it a place where customers can work. Book and music events also take place at Starbucks, in accordance with the company's goal of making each location a community center of sorts to garner the loyalty of local customers. [7]
[edit] Specialty Operations
Starbuck's specialty operations segment tries to develop the company's brand through third parties outside the traditional coffeehouse. Specialty retail operations accounted for 16% of Starbuck's total revenue in 2008. [8]
- Licensed Stores: Located in places like airports and supermarkets, licensed stores generate licensing fees and royalties as well as revenue from Starbuck's coffee, tea, and CDs resold in the licensed locations. In 2008, Starbucks had 4,329 licensed stores in North America and 3,134 abroad, accounting for 48% of Specialty Ops revenue and 8% of total revenue. [9]
- Packaged Tea and Coffee: Starbucks sells its packaged coffee and tea as a retail product at various food stores. This accounted for 21% of company's specialty revenue and 3% of total revenue. [10]
- Branded Products: Starbucks has partnerships with Pepsi and Dreyer's to develop and distribute ready-to-drink beverages and ice creams. This accounted for 4% of company's specialty revenue and 1% of total revenue. [11]
- Foodservices Operations: Starbucks sells its coffee to foodservice operators like restaurants, offices, hotels, and cafes (including the Barnes and Noble Cafes) that operate under different licensing contracts. This segment accounts for 25% of company's specialty revenue and 4% of total revenue. [12]
- Other: Starbuck also has entertainment business relationships with Hear Music, Satellite XM Radio (24-hour Starbucks Hear Music digital music channel), and provides wireless broadband Internet service in company-operated retail stores in U.S and Canada. Starbucks also has a credit card agreement with Chase. This division accounts for 2% of specialty revenue and less than 1% of total revenue. [13]
[edit] Quarterly Business Financials
Starbucks' revenue decreased 7.6 percent to $2.3 billion in Q2 (ending March 29th, 2009), a drop from $2.5 billion the previous quarter. Compared with the previous year, operating income was $40.9 million and operating margin was 1.8 percent- declines from an operating income of $178.2 million and an operating margin of 7.1 percent Q2 2008. Such losses were driven mainly by an 8% decline in comparable store sales. Net earnings for the Q2 of FY 2009 were $25.0 million, compared with $108.7 million for the previous year. and sales by comparable stores grew by 1.3%. These losses come with a restructuring effort on the part of Starbucks which include store closings and cost-saving initiatives. Since restructuring announcements announced in January 2009, Starbucks has closed 507 U.S. stores and 64 International stores. Plans call for efforts to close 800 company-owned Starbucks in the U.S.[14]
[edit] Trends and Forces
[edit] Health of Global Economy
Starbucks coffee is a premium coffee and, as such, a luxury good. The company relies on consumer discretionary spending to drive sales. Consequently, a major economic change can have a large impact on revenues. With the global economic recession of 2008-2009, for example, potential customers have less money and are more likely to forgo a $4 specialty coffee in favor of a cheaper alternative. Revenues in Q1 2009 were down 7% to $2.6 billion from Q1 2008 as consumers pinched their pockets. Until the economy recovers, Starbucks' bottom line may continue to be negatively affected.
[edit] Expansion and Cannibalization risk
Starbucks currently has over 11,500 stores in the United States alone. Over the past two years, Starbucks has expanded aggressively, adding 3,500 stores, often within eyesight of existing stores. Until recently, the company has been blessed with extraordinary growth in transactions per store (traffic) and same store sales, which has consistently been in the high single to low double-digits. The trend reversed itself, however, in Q1 FY2009. A conference call with Starbucks CFO Troy Alstead revealed an expected drop of 9% in the statistic. [16] Much of this may be attributable to the US economic slowdown, but nvestors fear that these weak growth figures could indicate saturation in the U.S. market. Regardless, Starbucks aims to double its US locations to 20,000 and eventually open 40,000 locations worldwide. [17]
Starbucks closed 600 underperforming locations in 2008. This seems to be an admission that cannibalization seems to be a major problem. [18]
[edit] Advertising
For most of its history, Starbucks has shunned traditional television advertising, relying primarily on word-of-mouth to build its brand. To put things in perspective, in 2006, Starbucks spent a total of $38M on advertising while rivals McDonald's and Dunkin Brands spent $782M and $116M respectively. In recent quarters, Dunkin Brands and McDonald's have stepped up advertising efforts for their coffee offerings which may be partly to blame for Starbucks' recent 1% decline in store traffic. In response to intensifying competition and slowing traffic growth, Starbucks recently announced that it would launch its first national advertising campaign.
[edit] Opportunities abroad
Much of Starbucks' growth is driven by the international market, which like the domestic market has a targeted unit volume of 20,000 units. The international segment has grown rapidly in recent years to over 5,000 stores in nearly 40 foreign countries. [19] In 2008, international sales increased by 23% to US$ 1.8 billion. Canada and the U.K. are Starbucks' current strongest markets abroad (69% of foreign revenues), while India, Russia, and China represent key areas of focused future expansion.
[edit] Target demographics: yuppie, teens, general
Starbucks targets a higher-income crowd of the young and college-educated, a group that tends toward higher luxury-consumption levels. Although this focus allows the company to maintain high profit margins, it also puts Starbucks at greater risk from a shift in consumer spending habits. If Starbucks chooses to expand further into coffee for home consumption, it could find a new consumer base in baby boomers (the largest demographic, 26% of the population), who are more likely to drink their coffee at home but who are more price sensitive than "yuppies" (young urban professionals). Teen coffeedrinkers are also important to Starbucks--many believe that this segment will be the main driver of domestic specialty coffee consumption in the next few years.
[edit] Super-specialty coffee: still growing
Starbucks' higher-quality Arabica coffee beans are richer in flavor than commercially mass-produced coffee, and demand for specialty coffees is increasing. In 2007, coffee sales surpassed soft drink sales and became the largest beverage market in the US at $44 billion. That number is expected to grow to $59 billion by 2012. Specialty coffee represented 30% of the market in 2007. [20]
[edit] Coffee, Dairy price fluctuations
Starbucks is heavily reliant on raw materials, and a spike in prices could dramatically narrow the company's profit margin.
- Coffee: Coffee beans are a major expense for Starbuck because the company purchases premium green coffee beans that are traded above commodity coffee prices. This higher-quality coffee often carries a substantial price premium, depending on market supply and buyer demand at the time of purchase. In 2004, Starbucks established the Starbuck's Coffee Agronomy Company, a wholly owned subsidiary located in Costa Rica, to ensure company's continued role of the Central American coffee industry. By maintaining a voice in the coffee production industry and by negotiating flat premiums, Starbucks can manage its coffee spending to a degree--but it can never fully insulate itself from the reality of fluctuations in coffee prices. Coffee prices in 2008, for example, were 20% higher on average than 2007. [21]
- Dairy: Starbucks is a major consumer of dairy, which accounts for another large fraction of production costs. In 2007, dairy prices increased 10%. [22]
[edit] Competition
Starbucks' close competitors include other specialty coffee shops, doughnut shops, and restaurants.
Starbucks holds a dominant position in the specialty coffeehouse market and has no single clear rival in the sector. (Its closest specialty coffeehouse competitor is Caribou Coffee, with 415 stores in the US--less than 5% of Starbucks' 11,000-plus). Its most intense specialty coffeehouse competition is dispersed among the thousands of independent or small-chain coffee shops around the nation and the world.
More intense competition comes from perennial heavy hitter McDonald's (MCD), which became a Starbucks rival when it upgraded its coffee in 2006. McDonald's has 14,000 stores in the U.S. and caters to a wider demographic than Starbucks; it also enjoys increased traffic from its variety of well-established breakfast options. McDonald's coffee sales increased 15% in 2006. In January 2008, McDonald's made yet another aggressive foray in the battle for high-end coffee drinkers, announcing that it would install coffee bars in all 14,000 of its U.S. locations. Aggressive marketing campaigns have also emphasized the large cost differential. That being said, there may be enough room for McDonald's and Starbucks to coexist. It should also be noted that McDonald's brew Seattle's Best brand coffee, a brand owned by Starbucks.
The National Coffee Association estimates that the US coffee market will reach $29 billion in 2011 [23], and the markets the two competitors target are different. The former aims at the cheaper coffee to go, whereas the latter aims at providing a premium experience for a luxury price. McDonald's larger retail footprint may overlap more with Starbucks' core markets, but their stark differences as stores are reflective of the general differences between their core customers.
Privately owned Dunkin Donuts is another major competitor, with nearly 5,000 stores in the U.S. Although Dunkin' Donuts' retail footprint also overlaps largely with that of Starbucks, their customer experience is much more similar to the coffee-to-go model rather than the "third place to work and relax" model. Consequently, they are likely to compete more directly with McDonald's than with Starbucks.
[edit] Appendix
[edit] References
- ↑ Starbucks 10-K 2008. Section 1 - Business. pg 2
- ↑ Starbucks 10-K 2008. Section 6 - Selected Financial Data. pg 20
- ↑ Starbucks 10-K 2008. Section 1 - Business. pg 2
- ↑ Starbucks 10-K 2008. Section 6 - Selected Financial Data. pg 20
- ↑ Starbucks 10-K 2008. Section 6 - Selected Financial Data. pg 20
- ↑ Starbucks 10-K 2008. Section 6 - Selected Financial Data. pg 20
- ↑ Starbucks 10-K 2008. Section 1 - Business. pg 2
- ↑ Starbucks 10-K 2008. Section 6 - Selected Financial Data. pg 20
- ↑ Starbucks 10-K 2008. Section 2 - Business. pg 2
- ↑ Starbucks 10-K 2008. Section 2 - Business. pg 2
- ↑ Starbucks 10-K 2008. Section 2 - Business. pg 2
- ↑ Starbucks 10-K 2008. Section 2 - Business. pg 2
- ↑ Starbucks 10-K 2008. Section 2 - Business. pg 2
- ↑ Starbucks Reports Second Quarter Fiscal 2009 Results
- ↑ Starbucks Investor Relations
- ↑ AP. “Starbucks CFO: Company may miss Q1 profit.” 4 Dec 2008.
- ↑ Fox News. “Starbucks Hikes Expansion Plans to 40,000 Stores.” 5 Oct 2006.
- ↑ Starbucks 10-K 2008. Section 1 - Business. pg 2
- ↑ Starbucks 10-K 2008. Section 6 - Selected Financial Data. pg 20
- ↑ VendingMarketWatch News. "Specialty Coffee to Continue Growth Through 2012." 17 July 2007.
- ↑ Starbucks 10-K 2008. Section 1 - Business. pg 6
- ↑ Starbucks 10-K 2008. Section 2 – Results of Operations. pg 30
- ↑ [Morningstar Analysis of Starbucks]
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