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Starbucks Corporation has stores in 37 countries, and it has built one of the world's most powerful and recognizable brands upon high-quality coffee and the unique "Starbucks Experience." Starbucks has sought to capitalize on its growing popularity through expansion; the addition of over 3000 stores in just over a year brought its total store count to over 15,000 in 2007. In fiscal 2007, the company's 15,000 plus stores (retailer and licensed) generated US$ 9.4 billion in revenue.

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. Today, Starbucks make up 42% of the coffeehouse market. Fresh coffee continues to generate the bulk of overall sales, but Starbucks has also moved to expand its offerings: in bottled ready-to-drink coffee, for instance, Starbucks holds 90% of the market through its partnership with PepsiCo. 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.

Today Starbucks faces significant headwinds. Rising commodities prices have made goods like coffee beans and milk more expensive, while a shift in consumer spending triggered by a slowing U.S. economy may drive consumers to less costly competitors such as McDonald's, which began offering premium coffee in 2006. Ironically, the biggest 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 six new locations opened daily, the company has experienced increasing cannibalization of sales from existing locations.

Contents 1 History and Business Overview 1.1 Company Operated Retail 1.1.1 Third Place Experience 1.2 Specialty Operations 2 Trends and Forces 2.1 Expansion and Cannibalization risk 2.2 Advertising 2.3 Dependence on new products 2.4 Opportunities abroad 2.4.1 China 2.4.2 Young Markets: India, Russia 2.5 Target demographics: yuppie, teens, general 2.6 Super-specialty coffee: still growing 2.6.1 Cafes and coffee houses 2.7 Coffee, Dairy price fluctuations 2.8 Health concerns 3 Competition 4 Appendix 5 References

[edit] History and Business Overview

In 1971, the first Starbucks store was opened in Seattle, Washington to sell coffee beans and high quality coffee-making equipment for home use. When Howard Schultz first joined the company and suggested to the company that they sell coffee and espresso beverages as well as coffee beans in the early eighties, the idea was rejected. But a few years later Schultz opened his own chain of Il Giornale coffeehouses, and by 1987 Schultz was able to buy the Starbucks chain from its original owners and rebrand his own stores to match. In 1992 Starbucks Corp. went public on the NYSE with 166 stores--ten years later, it had almost 6,000.

Starbucks Corporation generates revenue both from its company-operated retail stores and from specialty operations. From 2001 to 2006, Starbucks grew its revenue by 24% CAGR, culminating in 7.7 billion in 2006.

[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 2006, Starbucks operated 5,728 retail stores in North America and 1,374 stores in 37 other countries. Its retail operated stores generated 85% of its total revenue.

In 2006, Starbucks opened 2,199 new stores and plans to open 2,400 stores in 2007.

[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. Starbucks is also promoting itself as a popular "hangout" spot, especially for the growing group of teenage coffee consumers; a Deutsche Bank survey reports that 51% of teens choose Starbucks as a hangout place, putting it just behind the cinema and the mall in popularity.

[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 15% of Starbuck's total revenue in 2006.

• 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 2006, Starbucks had 3,168 licensed stores in North America and 2,170 abroad, accounting for 45% of Specialty Ops revenue and 7% of total revenue.

• 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 27% of company's specialty revenue and 4% of total revenue.

• Branded Products: Starbucks has partnerships with Pepsi and Dreyer's to develop and distribute ready-to-drink beverages and ice creams. This accounted for 2% of company's specialty revenue and less than 1% of total revenue.

• Grocery and Warehouse Clubs: Starbucks has a partnership with Kraft to distribute coffee beans to warehouse clubs and grocery stores. This division accounted for 24% of company's specialty revenue and 4% of total revenue.

• 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.

[edit] Trends and Forces

[edit] Expansion and Cannibalization risk

Starbucks currently has over 10,500 stores in the United States alone. Over the past two years, Starbucks has expanded aggressively, adding 3,000 stores, often within eyesight of existing stores. Despite this, 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. Weaker growth in traffic and same store sales reported in the first half of 2007, raised investor concerns that Starbucks' recent expansion has been too aggressive and was beginning to result in cannibalization. Starbucks recent Q4 earnings report showed continued deterioration, with the company reporting a 1% decrease in store traffic, its first decrease since the company began reporting the figure three years ago. Investors 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. Starbucks cut its previous forecast for 2008 new stores from 1,600 to 1,175 (US), plus mentioned closing 100 or so underperforming locations. This seems to be an admission that cannibalization seems to be a major problem.

Starbucks has moved aggressively to combat sagging growth. In November 2007, the company launched its first national advertising campaign— a major shift in marketing tactics for a company that has relied primarily on “buzz” and local gossip for most of its 36-year history. More recently, the company announced that Chairman Howard Schultz would take over as chief executive. Schultz, who is originally responsible for Starbucks' astronomical growth, announced plans to slow the number of new stores built in the U.S., close struggling locations, improve the customer experience inside stores, streamline management and accelerate the chain's expansion overseas. In July 2008, Starbucks announced that it would close 500 more locations in the U.S. and cut 7% of its work force, an open acknowledgement of the challenges posed by domestic cannibalization^[2].

[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] Dependence on new products

The introduction of new beverages creates excitement and drives foot traffic to stores, possibly attracting new customers and often leading to repeated visits. Starbucks has a reputation for creating trend-setting new beverages like its espressos and its popular Frappucinos. In 2005-2006, Starbucks introduced 22 new beverages, including some permanent additions to the menu board.

Innovations in the food offerings are also essential to Starbucks' further growth. During 2002-2006, per store food sales grew 11% annually (compare to a 6.5% growth in total volume). Starbucks is extending its food offerings to capture market shares in the growing breakfast and lunch segment. Starbucks is introducing a lunch and breakfast program with a warming platform. This adds 3% in annual sales per store.

[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 is still in relatively early development, however, and Starbucks can expect rapid growth from its 3000-plus stores in 37 foreign countries. In 2006, international sales increased by 27% to US$ 1.3 billion (17% of Starbucks' operated retail; 18% of specialty operations). Canada and the U.K. are Starbucks' current strongest markets abroad, while India, Russia, and China represent key areas of focused future expansion.

[edit] China

Starbucks already has sizable presence in China, but the company is planning an even bigger expansion. A massive potential market with 8.3 billion in estimated retail value and 20% of the global population, China marks Starbuck's most significant international opportunity.

According to Euromonitor, 2005 retail coffee sales in China doubled in 2005, a volume increase of 11%--compare this to an increase of only 7.5% in retail sales for tea and other drinks. Still, a China focus is not without its risks for Starbucks. The risk of an anti-American/anti-globalization attitude may make it harder for some Chinese to accept and embrace coffee consumption, long viewed as an inherently Western or American practice. Also, China's middle class is growing, but rural incomes are still only 30% of urban incomes, and Chinese consumers continue to spend less than American consumers--a problem for Starbucks, which depends on high margins from an "affordable luxury" theme.

[edit] Young Markets: India, Russia

Starbucks has little to no presence in India and Russia, but plans to enter in a big way.

India is another tea-drinking nation, but it too finds a boom in popularity of specialty coffee shops: from 2000 to 2005, coffee shops grew from 5.2% of the retail foodservices market to 13% in 2005. National income has also been rising, with steady increases since 2000--a blessing for the relatively expensive Starbucks. But a venture into India also has hurdles: Starbucks can only enter by joint venture or franchise, foreign ownership of real estate is restricted, real estate prices in urban areas are extremely high, and established local competitors often already have a big advantage (for instance, Barista Coffee Company's 5000 acres of coffee plantations in South India yield cheaper coffee than imported Starbucks' beans).

The Russian coffee market is also young, with only 140 coffee shops in the country at the close of 2005. However, tea sales have dropped more than 7% by volume in the past decade; meanwhile coffee has grown to capture 15% market share. But Starbucks will face challenges in Russia, too; imported green coffee faces a 5% tax, and imported ready-to-use coffee a 10% tax.

[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 2005, specialty coffee sales increased by 15% to 11 billion, with a CAGR (compound annual growth rate) increase of 7.4% (high, due to increase in number of cafes). Coffee consumption has been at an all-time high since the 90s, with no signs of a significant slowdown. There is still room to expand for the specialty coffee market, too--a recent survey estimates that only 15% of Americans drink specialty coffee daily, and only 60% drink occasionally.

[edit] Cafes and coffee houses

The growing specialty coffee segment is fueled by an increased in development of cafes/coffee houses--from 2001-2005, the total number of US cafes increased an average of 9% a year, with the majority of the growth due to Starbucks' phenomenal success. Cafes account for 69% of total sales of specialty coffee's 11 billion dollar market.

[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 accounts for about 10%-20% of productions costs, since Starbucks 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.
• Dairy: Starbucks is a major consumer of dairy, which accounts for 5%-10% of its production costs. According to the USDA, however, dairy has been declining in price since 2006, and forecasts predict more of the same.

[edit] Health concerns

Consumer awareness of the rise of obesity has caused some would-be Starbucks customers to turn to healthier options: many of Starbucks' beverages contain dairy, sugar, and a good amount of caffeine. Beverages account for 77% of total revenue, and significant shifts in demand patterns could have a huge negative impact on Starbucks sales. As part of an effort to make Starbucks more appealing to health-conscious consumers, the coffee chain has started using 2% and soy milk in many of its products.

A number of studies have been published recently debating the effects of caffeine on consumer health. When taken as a whole, the studies tend to be inconclusive on whether or not coffee is "good for consumers," but if or when such a conclusive study is released, Starbucks will doubtless be heavily influenced.

[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 416 stores in the US--less than 10% of Starbucks' 15,000-plus). Its most intense specialty coffehouse competition is dispersed among the thousands of independent or small-chain coffeeshops around the nation and the world.

More intense competition comes from perennial heavy hitter McDonald's (MCD), which became a major 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. McDonald's plans represent a significant threat to Starbucks as its larger retail footprint will allow it to offer similar products at a lower price in many of Starbucks' core markets.

Privately owned Dunkin Donuts is another major competitor, with nearly 5,000 stores in the U.S. Although Starbucks unit growth surpasses Dunkin Donuts (there were 2000-plus new Starbucks locations to 400 new Dunkin Donuts stores in 2006), the much less upscale Dunkin Donuts presents a significant threat by forcing Starbucks shops to share zip codes. 16% of the two stores' U.S. shops overlap (coexist in the same zip code), with the regions of heaviest overlap in the Northeast (73% overlap), the Mid-Atlantic (36%), and the Southeast/Midwest (22%). Dunkin Donuts does not have a significant presence on the West Coast, however, where Starbucks easily overpowers it with about 4000 stores to Donuts' 40.

Unlike its two largest chain competitors, Starbucks portrays its coffee as a luxury, and it prices accordingly; if Starbucks customers begin to favor to less expensive coffee, the company will suffer. Starbucks' coffee also contains more caffeine than rival offerings--if customers begin to prefer lower-caffeine coffee, competitors could gain a significant advantage before Starbucks manages to change its offerings accordingly.

The Starbucks-Pepsi partnership is the undisputed owner of the the domestic ready-to-drink coffee market, with 90% market share. The global market is a different story, however--Coca-Cola Company (KO)'s Georgia product line has 31.3% of the international market, easily dwarfing Starbuck's 3.8%.

Operational Metrics	Revenue	Same Store Sales	Net Income	Total # of Shops
Starbucks	9.4B	5%	672M	15,756
McDonald's	21B	5.7%	3,544	31,667
Dunkin Donuts	517M	N/A	N/A	7,000

[edit] Appendix

BetterInvesting Files

[edit] References

• Company Website

1. ↑ Starbucks Investor Relations
2. ↑ Starbucks to Shut 500 More Stores, Cut Jobs
3. ↑ mergent
4. ↑ ^{4.0 4.1} DRI, 2007 10-K, Item1, pg 2
5. ↑