[2014] Starbucks: Investors or Consumers?

Top 15 Year in Review: Starbucks

Starbucks Has Lost Sight of Why It Started

This year, Starbucks lost sight of why it started.

It served customers good coffee and, more important, took care to offer a warm, human experience of drinking it. Starbucks CEO Howard Schultz used to call this the "third place," a space between work and home. It is a big part of why Starbucks became one of the world's leading coffee brands.

Why do people go to Starbucks? To drink coffee. That was the whole point.

But the news out of Starbucks' Seattle headquarters this year has had little to do with coffee. Early in the year, Starbucks teamed up with the food chain La Boulange to serve alcohol and food in 32 stores, which makes it look like a fast-food place to grab dinner. It encourages customers to order on the app before they arrive and pick up at the nearest store, which makes it look eager to hurry you out rather than have you stay. Not long ago it also announced that it would start delivering food and drinks in the second half of next year. "This will be our version of e-commerce," Schultz said.

None of this looks like a third place. Have you noticed that Starbucks hardly mentions coffee anymore?

At the end of the year, Schultz released the company's five-year plan. He promised investors that revenue would reach US$30 billion in 2019, more than double the US$14 billion of 2014. That means revenue growth of about 18% a year. The company also wants its food business to double to US$4 billion. Starbucks chief operating officer Troy Alstead told The Wall Street Journal earlier: "We know much more clearly than before what to do to expand in food."

It is all about scale and efficiency. Investors like that. But customer satisfaction has fallen 4 percentage points from last year. When Starbucks needs a good report card, it sacrifices consumers and chooses investors.

In the US, Everything Starbucks Does Is About Per-Store Revenue

One of Wall Street's most basic yardsticks is same-store sales growth. If growth comes only from new stores rather than from higher sales at existing ones, the company is seen as having lost its growth potential: once it runs out of room for new stores, it stops growing.

So whatever Starbucks does in the US now, you needn't ask why. It is all about raising per-store revenue. It has to show investors that its future still has room for imagination.

Starbucks already has more than 11,000 stores in the US, so there is little room left to open new ones, and per-store revenue has become what it wants most from this market. When coffee alone can no longer drive revenue growth, selling things other than coffee becomes the obvious next step. Food, alcohol and all the merchandise in its stores follow the same logic.

Besides its usual seasonal drinks, Starbucks has expanded its menu to 255 items. More choices mean more chances to spend.

Most of the time, without asking whether customers want their drinks to go, Starbucks serves coffee in paper cups. The logic: only coffee in a paper cup can leave the store, and only customers who keep moving bring in bigger returns.

It launched cold-drip coffee in the Boston area, and in 32 stores in Chicago, Seattle, Portland and Los Angeles it started an evening service that sells wine and beer from 4 p.m. each day. Each is an attempt to add a specific product line that keeps customers spending for longer.

Beyond its core drinks, Starbucks has also widened its range of merchandise. It asked the creative agency Carte Blanche, for example, to design a new set of 100 cups and mugs. These and other products, released before the Christmas holidays, sold well.

The Pressure Comes From Wall Street and From Rivals

According to Starbucks' 2014 annual report, its revenue grew about 10% year over year in each of the four quarters. Growth this steady has lasted nearly three years, and at its fastest Starbucks grew even faster than McDonald's. Investors expect a lot from it.

Starbucks also feels pressure from its peers. According to IRI Beverage Industry Magazine, the top-selling brewed coffee in the US in 2014 was Keurig Green Mountain, with 19.9% of the coffee market. Starbucks was second at 12.5%, and Folgers Gourmet Selections third at 11.4%. Brands like Costa cannot yet threaten Starbucks, but every new rival means a smaller slice of the profits.

Starbucks faces some pressure on the supply side too. According to the shipping data service PIERS, in the first nine months of this year Starbucks imported nearly 14,000 bags of Arabica beans from China, more than five times what it imported the year before. Starbucks only started building a farmer support center in Yunnan, China, in the past two years; Nestlé has been active there for decades.

So Starbucks, which looks to be doing well and to lead its industry comfortably, is in fact under pressure from every side. That is also why a company that has never advertised released two ads this year: one presents its stores as public spaces, the other shows how a cup of coffee is made.

China Is the Exception

In China, Starbucks has only one word: expand!

Because the Chinese market is still young, entering more cities and opening more stores brings in more new customers.

According to the International Coffee Organization, per-capita coffee consumption in China has grown 30% a year since 1998, and the number of coffee shops in large and mid-sized cities has grown steadily by 25% a year.

Besides Starbucks, Chinese consumers also know Costa and Pacific Coffee. And recently, riding a new wave of enthusiasm for all things Korean, Korean coffee brands such as Zoo Coffee, Caffé Bene and Maan Coffee have begun moving into China in force.

Starbucks is expanding fast in China.

In January 1999, Starbucks opened its first store in Beijing, at the China World Trade Center. For the next 10 years, it opened 30 to 50 stores a year. But in 2012 it added 204 stores, and in 2013 it added 317.

By September this year it had added 350 stores, for a total of 1,367, and by the end of the year Starbucks had more than 1,500 stores in China. That is roughly one new store a day. It is pushing into more second- and third-tier cities, as with its first flagship store in southwest China, which opened recently at Taikoo Li in Chengdu.

Sooner or Later, China Will Be About Per-Store Revenue Too

After 15 years, China has become Starbucks' most important market. In May this year, Starbucks had 1,219 stores in China, passing Japan to rank third in the world; the two markets ahead of it are both in North America. Shanghai, behind only Seoul and New York, now has the third-most Starbucks stores of any city in the world. This also means, to some extent, that opening stores alone can no longer deliver the growth it did a few years ago.

Same-store sales in China and the Asia-Pacific region grew about 7% in 2014, above the global average. But in a market with as much potential as China, Starbucks naturally expects more from each store.

In October, Starbucks China announced it would bring in its premium line, Starbucks Reserve, choosing four of the 28 coffees it sells worldwide for the Chinese market. To build up the Reserve brand, Starbucks also opened eight Reserve stores in Beijing, Shanghai, Guangzhou, Shenzhen and Chengdu. These stores rank well above ordinary ones in interior design, staff, product range and, of course, price. This is probably an important step in Starbucks' push for higher per-store revenue in China.

Will Starbucks Become Another McDonald's?

When Starbucks first went public, Howard Schultz said it would never sell food, because Starbucks was a coffee company, not a restaurant chain. Yet today the customer experience at his US stores is criticized as little different from McDonald's.

In 2011, Starbucks dropped the word "Coffee" from its logo. In 2012 it bought the US bakery chain La Boulange and rolled La Boulange's pastries and sandwiches out to Starbucks stores across the country. Starbucks no longer serves just coffee and light snacks. It is trying to cover all three meals, and even late-night drinks.

Yes, Starbucks and McDonald's may be growing more alike: both feed customers at fast-food speed.

In this year's ranking of the world's most valuable brands from the consultancy Interbrand, McDonald's came ninth, while Starbucks came only 76th. McDonald's takes in about US$7 billion in revenue a quarter, Starbucks only about US$4 billion. But Starbucks is growing faster.

Over the past 10 years, Starbucks grew 8.83%, against 7.09% for McDonald's. This year in particular, Starbucks' numbers look far better than its rival's. From the start, Starbucks avoided burgers and fries, the kind of junk food now under heavy attack. So at a time when healthy eating is in fashion, it looks more popular than McDonald's and has won over the customers who have given up on McDonald's.

But McDonald's is also working hard to move into coffee. It launched its McCafe coffee line in Australia as early as 1993, though it reached the US only in 2009. With so many McDonald's restaurants to work from, McCafe often gets into a market before Starbucks arrives.

Seen this way, isn't McDonald's Starbucks' real competitor?

Fortunately, Starbucks Is Still Inventive

Starbucks may be the coffee brand that has done the most with the internet, especially mobile.

At its 2013 annual shareholders' meeting, Starbucks chief digital officer Adam Brotman said Starbucks had 10 million active users on iOS and another 10 million on Android, with nearly 100,000 downloads a week.

In 2014, payments through the Starbucks app in the US are expected to reach US$1.5 billion. In the second quarter alone, they already made up 15% of in-store purchases, about 6 million transactions a week.

This is its strength. And to its credit, it keeps building around what customers now want.

At Apple's September event, for example, it appeared as a partner for Apple Pay, Apple's mobile payment platform. It also added wireless charging to 200 stores in the San Francisco Bay Area. In December, Starbucks began letting customers in the Portland area order coffee ahead. Users pay in the mobile app, then pick up at a nearby Starbucks. Once you order, the app generates a QR code that holds your order and your linked Starbucks card. At the store, you show the QR code and take your coffee. The service is expected to cover the whole US in 2015.

Starbucks' Year in Review

April: decided to move its European headquarters from the Netherlands to the UK.

June: launched wireless charging in 200 stores in the San Francisco Bay Area, installing 100,000 Powermat Spots chargers in total. Users need only fit their phones with a compatible charging ring. The service was first tested in 17 stores in Boston and Cambridge in 2012.

September 23: bought out the remaining stake in Starbucks Japan for US$914 million, ending its partnership with Sazaby League.

Late September: launched its first global brand ad, "Meet me at Starbucks," filmed in 59 stores in 28 countries. It mainly depicts the idea of Starbucks as a "third place."

October 18: brought the Starbucks Reserve line to China, opening seven Reserve stores in Beijing, Shanghai, Guangzhou and Shenzhen.

Early December: opened its largest flagship store in the world, the Starbucks Reserve Roastery and Tasting Room, in its hometown of Seattle.

December 4: released the company's five-year plan. CEO Howard Schultz told investors revenue would reach US$30 billion in 2019, more than double the US$14 billion of 2014.

December 5: launched a "mobile order and pay" pilot in Portland; the company expects to roll it out across the US in 2015.

Mid-December: released its second ad, "Perfection," which mainly shows how a cup of coffee is made from start to finish.

December 16: opened Starbucks China's first flagship store in its southwest and central China regions, also its eighth Reserve store, in Chengdu.

In 2007, Joe Nocera wrote in The New York Times that there were two Howard Schultzes: one with coffee in his veins, and one a fiercely competitive businessman.

Investors or consumers? He made his choice long ago.

The Top 15 are: Apple, Google, Baidu, Alibaba, Tencent, Amazon, Disney, McDonald's, Starbucks, Nike, Xiaomi, IKEA, Uniqlo, Wanda and Vanke. This list will change as companies, markets and trends change. We will follow these companies, and their competitors and partners too.

For why we started the Top 15 reporting project, read this article, which we think turned out rather well.