With Howard Schultz's second act at Starbucks in full swing, some analysts say the company has found a way forward after ambitious expansions left it in financial straits.
Schultz "smelled the coffee"
The most ubiquitous name in coffee may happily keep its title, thanks to recent efforts to more affordably mimic the "pleasant café atmosphere" that made the company a success in its early days, The Economist reports.
The company recently set up 15th Avenue Coffee and Tea in its base of Seattle, Wash., reportedly at a lower cost than it takes to open a Starbucks store. The Starbucks brand is referenced in “small print on the door: ‘inspired by Starbucks,’” The Economist notes. Locals protested the opening of the store in a city dominated by Starbucks, though arguably the company viewed even this negative attention positively.
Founder Howard Schultz left the company in 2000, handing over control to Jim Donald, though Schultz remained as chairman. On Valentine's Day in 2007, Schultz sent a memo to the company that leaked to the public and was published by The Wall Street Journal and others. A kind of love letter to the company, the memo claimed that several "decisions … in retrospect, have lead to the watering down of the Starbucks experience, and, what some might call the commoditization of our brand."
"For example," Schultz wrote, "when we went to automatic espresso machines, we solved a major problem in terms of speed of service and efficiency. At the same time, we overlooked the fact that we would remove much of the romance and theatre that was in play with the use of the La Marzocca machines."
Other "decisions" included what The Economist calls "a suicidally rapid worldwide expansion." But in January 2008, Schultz returned as CEO, and since then, the company's share price has risen from a low of $8 in November 2008 to more than $20, which is "a bit higher than they were when Mr Schultz took charge for the second time," The Economist adds. "So far this year, they are up by nearly 120%, while the S&P 500 index is not quite one-quarter higher."
When McDonald's began introducing Italian-style coffee beverages alongside regular coffee in 2007, some saw it as a direct threat to Starbucks, which charges significantly more for its drinks. But as McDonald's made its move, Starbucks began "fighting back with an 'if you can't beat 'em, join 'em' strategy, by offering heated breakfast sandwiches and adding drive-thru windows to some of their locations," Time Magazine's Bill Tancer wrote in early 2008.
But Tancer examined some data from the market research firm Hitwise that showed that the Starbucks customer base was more expansive than McDonald's, despite the price gap. "The Big Mac customer base has remained relatively stable, while Starbucks' coffee-drinkers have diversified. It used to be that Starbucks attracted customers from a small, elite segment of the country; now, its visitors pervade many more segments across America." The reverse, he suggests, does not appear to be happening.
Further, in June 2009, Starbucks made very public improvements to its food line, announcing on its Web site that in efforts to "improve the taste of its food and focus on real, wholesome ingredients," the company had "simplified many of its recipes and baked in authentic, high-quality ingredients like whole grains, Oregon blueberries and Michigan cherries."
The company utilized customer service forums such as the Web site MyStarbucksIdea. In addition to answering customer questions, Starbucks has even responded to customer ideas, such as the green spill-proof swizzle stick, whose evolution was chronicled by brand agency Razorfish's Garrick Schmitt at the 2009 MediaBistro Circus, a conference for media professionals. Schmitt said the product, which is officially known as the "splash stick" and acts as a stopper for the sip hole in your to-go cup, "changed the customer experience" at Starbucks.
Most recently, Starbucks released an instant coffee product called Via. Although some analysts called the idea a "no big deal" in February, CNN Money suggested in September, following the release of Via, that the recession is posing a threat to Starbucks, and could be enticing customers to try affordable competitors including McDonald's and Dunkin Donuts. Via is one answer to this challenge, but "the company could face resistance from coffee purists who generally see instant coffee as inferior to brewed."
Related Topic: Mom 'n' pop coffee stores vs. Starbucks
Starbucks might have recently started adopting non-Starbucks stores such as Seattle's 15th Avenue Coffee and Tea, but last year Slate's Taylor Clark showed that mom 'n' pop coffee stores around the country are faring quite well despite Starbucks competition—and without Starbucks' help.
SBUX management met with numerous investors in recent months in both the U.S. and Europe and the feedback is pointing to continued improvement in [same-store sales] and significant progress on the cost cutting front.Trading at 9X 2010 EBITDA, we [sic] think a lot of good news is reflected in the shares.
That's advice from Jefferies & Company restaurant analyst Jeff Farmer, who has a "hold" rating on the volatile stock. His enthusiasm for the cost-trimming steps the giant coffee chain has taken in recent months has him pegging next year's earnings at $0.98, far above consensus.
Cost savings from closing stores and a strong marketing plan justifies his faith in future earnings. "Based on our view that [same-store sales] will trend positive in FY10 and that the company's cost savings guidance is conservative, we are comfortable with our Street-high $0.98 estimate," he writes, adding he estimates same-store sales will climb 1 percent, to minus 2 percent for the year.
Farmer, however, tempers his positive outlook with a few critical questions, the answers to which could provide a clearer view into the future. Here's a sampling:
- Full details on Via launch? Via margins vs. brewed coffee. Distribution details and will Starbucks bring on a third party, as with Kraft and packaged coffee?
- Starbucks has been testing a new “lean store” format with the primary objective of improving ergonomics and in turn operations quality and profitability. The bottom line is that Starbucks believes there is plenty of opportunity to cut labor and waste (“cost of quality” in Starbucks speak) and to improve operating efficiencies. How many U.S.stores are currently operating in the lean store format and does the company intend to aggressively pursue this new format by reformatting existing units?
- At the end of F3Q09, Starbucks had closed 676 of the 800 planned U.S. unit closures. What has the SSS experience for the surrounding units been? What is the estimate for the SSS tailwind from these store closures?