Starbucks Coffee

1. Starbucks Coffee

2. Starbucks – General Case InformationIndustry Definition • The specialty coffee industry is comprised of companies that roast and/or prepare coffee from anywhere in the world, for sale in the United States. Companies whose primary business is coffee sales through grocery stores in the form of whole bean, ground, k-cup and/or pods are excluded.

3. Starbucks – General Case Information • Specialty Coffee Industry Growth Rate: 11% • Total revenues of $8.96 billion in 20031 • Total revenues of $13.5 billion in 20072 • Starbucks 5-year historical growth rate: 23% • Total revenues of $4.1 billion in 20033 • Total revenues of $9.4 billion in 20073 • 1SCAA Report: Specialty Coffee Retail in the USA 2005. Retrieved from: http://www.javadavescoffee.com/PDF_Documents/specialtycoffeeretail.pdf • 2Seattles Best Coffee Franchise. (n.d.) Retrieved from: http://www.americasbestfranchises.com/seattles-best-coffee-franchise • 3Starbuck’s Corporation 2007 Annual Report

4. Starbucks – Major Assumptions • Starbucks will redefine the Specialty Coffee industry, by targeting the expanding healthy drink segment, driving its growth rate beyond 2007 • Based on evidence in early 2008, the recession will be assumed to be short-lived and not very deep • Recent loss of investor confidence (evidenced by stock price) is due to recent drop in comparable store sales • Store expansion at current rates will not saturate the market by 2012

5. Starbucks – Major Objectives • Revenue Growth • Return to historical annual growth rate of 23% by 2012 • CAGR of 18% between 2007 and 2012 • Return on Sales • Increase return on sales from 6.5% (2007) to 7.4% (2012)

6. Starbucks –Major Objectives • Return on Equity • Defined as net income after taxes divided by total stockholder’s equity • Increase from 27% (2007) to 35% (2012) • Return on Assets • Increase from 11.5% (2007) to 15.5% (2012)

7. Starbucks – Corporate Vision • Starbucks vision is to become the leading retailer of specialty foods and beverages. We will achieve this goal by focusing on healthy product choices and maintaining customer loyalty. Starbuck’s history of pursuing green business practices and a superior customer experience will be carried forward in this vision.

8. Key Aspects of Starbucks Case Strategy

9. Starbucks – Strategy Overview • Offensive Strategy Against a Weaker Rival • Target: Panera Bread • Weaknesses to be attacked: • Coffee quality • Advertising • Strengths to be attacked: • Healthy perception • Unique loyalty program

10. Starbucks – Key Aspects of Strategy • Continue store expansion – 86.8% • Invest at a slower rate to allow for strategic initiatives • Advertising – 1.1% • Promote great coffee products, healthier options, loyalty program, sustainable practices • Question freshness and quality of competitor’s coffee • Product mix – 2.0% • Add healthier choices to menu • Loyalty program – 1.3% • Update and personalize • Re-optimize customer experience –8.8% • Optimize store flow • Develop superior, dedicated staff

11. Starbucks – Key Aspects of Strategy • Advertising – Year 1 • Double media spend compared to 2007 • Internet and store-front advertising • Promote product quality, question competitor’s quality • Promote sustainable history of Starbuck’s • Promote revised loyalty program starting H2* • 100% expense • *H2 is an abbreviation for the second half of the fiscal year

12. Starbucks – Key Aspects of Strategy • Advertising – Year 2 • Maintain accelerated media spend • Internet advertising, store-front advertising, select TV advertising • Promote NEW healthier menu • Promote product quality, question competitor’s quality • Promote sustainable history of Starbuck’s • Promote revised loyalty program • 100% expense

13. Starbucks – Key Aspects of Strategy • Product mix –Year 1 • Establish “healthy” criteria • Calories, fat, antioxidants, other • Revise menu to offer more healthy choices • New product offerings • Healthier options for current popular products • Sizes • Strive to maintain taste in all options • Target rollouts starting beginning of year 2 • 100% expense

14. Starbucks – Key Aspects of Strategy • Product mix – Year 2 • Start rollout of new menu • Update equipment as required • 20% expense • 80% capital (equipment updates)

15. Starbucks – Key Aspects of Strategy • Loyalty program – Year 1, H1 • Redefine characteristics of the loyalty program • Must be more than “buy 10, get 1 free” • Personalize based on purchase history • Free refills on certain items, free extras • Increase benefits based on purchase volume of referred loyalty club members • 100% expense

16. Starbucks – Key Aspects of Strategy • Loyalty program – year 1, H2 • Rollout NEW loyalty program • Training • Infrastructure updates • 50% expense • 50% capital

17. Starbucks – Key Aspects of Strategy • Re-optimize customer experience – Year 1 • Analyze store flow • Study process and traffic patterns in stores • Redefine layout and process, optimizing throughput and emphasizing customer experience • Develop superior, dedicated staff • Improve candidate screening and training • Define career paths, promote from within • Flexible schedules • 100% expense

18. Starbucks – Key Aspects of Strategy • Re-optimize customer experience – Years 2-5 • Implement store flow updates • 90% capital • Continue development of superior, dedicated staff • 10% expense

21. Starbucks – Notes to Pro-Forma Financials • 2007 data taken from Starbucks 2007 Annual Report • Cost of goods sold includes “Store operating expenses” • “Other operating expenses” has been split between Marketing and R&D in a 1:2 ratio. • Based on 2003-2007 data, non-strategic spends scale with revenue as follows: • Administrative: 0.963:1 • Marketing, R&D: 0.974:1 • “Net interest and other income” is assumed to be zero in 2007 (actually a net gain) • “Income from equity investees” is ignored

22. Starbucks – Notes to Pro-Forma Financials • Assuming media spend of ~$25M in 2007 based on $17M spend in 20054 • Average useful life of new assets is assumed to be 10 years. • Depreciation after 2007 is estimated as follows: • Previous year depreciation • less 2007 depreciation / 10 • plus current year new asset value / 10 • 4Starbuck’s Market Share and Media Spend. (January 15, 2005). Retrieved from: http://www.brandautopsy.com/2007/01/starbucks_marke.html

23. Starbucks – New Strategic Assets Required Assume revenue ÷ total assets grows at rate of 3.52% per year based on 2001 – 2007 data (scale, efficiency…) 2012 revenue / assets = 1.76 *1.03525 = 2.09 2012 revenue = $21.99B 2012 assets = $21.99B / 2.09 = $10.50B New strategic assets needed = $10.50B – $5.34B = $5.16B

25. - Pro-forma cash from operations averages 10.9% of revenue (net income + depreciation) - Planned strategic capital spending averages 6.7% of revenue - Issuing some debt slows the growth of Stockholder’s Equity, increases ROE and reduces ROS. Starbucks maintained nearly constant Stockholder’s equity from 2003-2007, primarily through stock repurchases.

28. Starbucks Industry Analysis Section

29. Starbucks – Industry Definition(Repeated from Beginning) • The specialty coffee industry is comprised of companies that roast and/or prepare coffee from anywhere in the world, for sale in the United States. Companies whose primary business is coffee sales through grocery stores in the form of whole bean, ground, k-cup and/or pods are excluded.

30. Starbucks – Industry Characteristics • Market Size • The retail value of the U.S. Specialty Coffee market in 2007 is estimated at $13.5B1 • Market Growth Rate • The U.S. Specialty Coffee market grew at a rate of 11% per year between 2003 and 20072 • Stage in Industry Life Cycle: Growth Phase • Number of Companies in Industry • There were about 24,000 coffee shop businesses in the U.S. with local mom-and-pop coffee shops, competing with established national brands like Starbucks, Seattle’s Best (owned by Starbucks), Caribou and Peet’s coffee. • 70% of sales are generated from the top 50 coffee shop operators

31. Starbucks - Industry Characteristics • Customers5 • There are 52 million coffee drinkers in the U.S. • Committed coffee drinkers are between 25 – 45 years old, affluent and educated • 65% of committed coffee drinkers have an annual income of 100K+ • Coffee shop patrons are 28% more likely to be single than the average American adult and 70% more likely to have a post graduate degree • Occasional latte devotees are in the higher average income of $76,000 and similarly, cappuccino and espresso drinkers reflect an average income of $60,000 • According to the latest National Coffee Drinking Study from the National Coffee Association, Coffee shops are frequented by both the young and old: 40% between 18-24 years old and 54% between 25-39. Each group represents individuals drinking coffee each day 5Small Business Market Research Reports: Coffee Shop 2012. Retrieved from: http://www.sbdcnet.org/small-business-research-reports/coffee-shop-2012

32. Starbucks - Industry Characteristics • Ease of Industry Entry: Difficult • Ease of Industry Exit: Easy • Product Characteristics: Somewhat Differentiated • There are four tasting terms to help differentiate specialty coffee within the industry6 • Aroma: the way the coffee smells, examples include earthy, spicy, floral and nutty • Acidity: the pH level of the coffee. Coffees with high acidity are described as bright, tangy and crisp with a clean finish. Coffees with low acidity feel smooth in your mouth and tend to remain longer • Body: the weight of the coffee • Flavor: how the coffee tastes 6Coffee Taste Characteristics. Retrieved from: http://www.starbucks.com.au/Coffee-Taste-Characteristics.php

33. Starbucks - Industry Characteristics • Stability of Demand: Non-cyclical • Customizing according to interests in local markets is a way for coffee shop owners to create loyalty and increase sales • Espresso and other specialty coffees are becoming popular in the quick service restaurant • Consumption of gourmet coffee has remained steady, and has been the strongest growth segment of the market • Purchases of espresso beverages has risen from 4% to 7%, and continue to rise in popularity

34. Starbucks - Industry Characteristics • Special Industry Challenges • Market Dominance: large companies such as Starbucks, Dunkin Donuts and McDonalds dominate the market • Financial Strength: a large amount of financial backing is needed to open a shop (approx. $60,000 to $350,000) • Brand Loyalty: coffee shops have to overcome the loyalty of the customer to local coffee shops • Substitute Competitors: increasing threat posed by sophisticated home brewing machines

35. StarbucksFive Competitive Forces Summary • Rivalry: Very Strong • Potential Entry: Strong • Substitutes (teas, juices, energy drinks, smoothies): Strong • Buyers: Weak • Suppliers: Strong

36. StarbucksFive Competitive Forces • Rivalry: Very Strong • Number of competitors is increasing in the industry • Greater competition between larger companies within the industry • Product demand is growing • Volume is important to continue to drive customers to shop • High potential payoff for strategic moves, for example targeting the health drink segment which is a growing market

37. StarbucksFive Competitive Forces • Potential Entry: Strong • Capital requirements are moderate, ranging from $60,000 to $350,000 • High level of tariffs and trade restrictions exist within the industry • Restrictive regulatory policies exist • Distribution channels are exclusive and are generally dominated by the larger companies • Brand preferences and customer loyalty are high

38. StarbucksFive Competitive Forces • Substitutes: Strong • Wide variety of substitutes available: substitutes for coffee drink include teas, juices, soft drinks, energy drinks and smoothies. • Substitutes rank high on quality and performance • Buyers may choose to spend discretionary income on substitute products • Little to no switching costs involved on the part of the buyer

39. StarbucksFive Competitive Forces • Buyers: Weak • Product quality and level of service in the coffee industry is very important to the buyer • Product ranges from valued-priced to premium, this differentiates competitors within the industry and where buyers shop • Buyers in this market tend to be individuals who do not purchase in bulk • Cost of product is not significant enough to cause a buyer to price shop • Buyer does not have full information: supplier cost, market price

40. StarbucksFive Competitive Forces • Suppliers: Strong • Suppliers are dominated by larger, more financial stronger companies • For a quality product, very few substitutes exist • Suppliers’ product is important to businesses • Supplier products are differentiated, generally ranked by quality grading system • Product differentiation gives suppliers higher level of control • Price of product is determined by economic/political conditions

41. StarbucksDriving Forces • Product innovation: Favorable • Innovative coffee products offer selection broader than the traditional cup of coffee will increase industry profitability. • Product innovation can be divided in two parts: • Seasonal offering such as chilled, frozen and iced coffee to help boost sales. • Non traditional coffee drink lead to customer excitement to buy more of coffee drink

42. StarbucksDriving Forces • Increasing differentiation: Favorable • This is the source of competitive advantage for all specialty coffee shops in the industry. Coffee product differentiation will create new market segment and increase industry profitability because of new customers.

43. StarbucksDriving Forces • Changing societal concerns, attitudes, and lifestyles: Unfavorable • Customer’s Health perception can have negative affect on specialty coffee industry revenue and profits. This is particularly important, given health concern about non organic product.

44. Starbucks Industry Segment Analysis Section

45. Industry CompetitorsRanked by 2007 Annual Revenue • McDonalds • Starbucks • Dunkin Donuts • Tim Horton's • Panera Bread • Peet’s • Coffee Bean and Tea Leaf • Caribou • Independent Shops (24,000 in US)

46. Starbucks – Strategic Group MapSpecialty Coffee Industry (Current)

47. Premium Quality Peets Premium, Unhealthy Premium, Healthy Indp Starbucks Tim Hortons Panera Above Average Quality McDonalds CBT&L Brand Perception Low Quality, Healthy Dunkin Caribou Low Quality, Unhealthy Average Quality Low Medium High Healthy Perception

48. Starbucks – Strategic Group MapSpecialty Coffee Industry (In 5 years)

49. Starbucks Premium Quality Peets Premium, Unhealthy Indp Tim Hortons Premium, Healthy Panera Above Average Quality McDonalds CBT&L Brand Perception Low Quality, Healthy Dunkin Caribou Low Quality, Unhealthy Average Quality Low Medium High Healthy Perception

50. Starbucks – Healthy Drink SegmentMinimum Segment Success Factors • Strong financial position • Reputation: ability to achieve brand recognition as a healthy alternative for health conscience individuals • Geographic: Need to have a national presence as well as high physical presence • Distribution Channel: Need to have a solid distribution channel in place to achieve a greater profit margin on products