Posted: May 25th, 2022

Middle of extreme cost reduction strategies

Starbucks Management Analysis

Company Overview

Starbucks (NASDAQ: SBUX) is today the global leader in coffee retailing, supply chain and quick service restaurant (QSR) development for beverages and light foods. As of November 29th the company has a market capitalization rate of $31B, generating $11.7B Revenue and $1.2B Net Profit, including a complete reversal of their liquidity ratios from 2009 to today. A transformation of this level is extremely difficult to attain during periods of economic growth. To attain this level of accomplishment in the midst of uncertain, often challenging times, the management teams at Starbucks had to concentrate on excelling at their core strategies and making in-store operations as efficient and profitable as possible. To see an analysis of the transformation of Starbucks during the last five years, please see Appendix A: Ratio Analysis of Starbucks Financial Performance, 2006 — 2011. The most challenging years for Starbucks over this time period were 2008 and 2009, where the company struggled to find its core messaging and unique value proposition in the middle of extreme cost reduction strategies. The company lost its way during these years and had several quarters of losses, which led to a drastic re-aligning of their supply chain, retailing, pricing and service-based assumptions regarding their business. While painful for the company to make these modifications to strategy, the latest fiscal year results indicate how successful those decisions were in reinvigorating their pretax profit margin to 15.47% and a net profit margin of 10.6% across a global base of just over 17,000 locations in 70 nations (Starbucks Investor Relations, 2011) . The changes that Starbucks made to their supply chains, the concentration on operations and business process re-engineering, and the intelligent use of customer data all combined to solidify the platform of the company (Harrison, Chang, Gauthier, et.al., 2005).

Mission and Vision Statement

Starbucks has their mission and vision statements on their website and often publish it for the investment community to underscore how unique they are from a customer service, marketing, supply chain and operations standpoint. The Starbucks mission is defined as follows: “Our mission: to inspire and nurture the human spirit — one person, one cup and one neighborhood at a time” (Starbucks Investor Relations, 2011).

Starbucks supports this mission with a vision of being the most ethical and profitable coffee supply chain and retaining business globally, investing heavily in Corporate Social Responsibility (CSR) initiatives to further underscore the commitment they have to their mission and vision statements. Starbucks also has an industry-leading vision of how to construct and operate an ethical supply chain that concentrates on Fair Trade practices, ensuring each member of the supply chain gets compensated at market rates for their beans and coffees.

Starbucks has a strong social conscience within its corporate culture and concentrates on creating a company that respects the rights and needs of the individual. Howard Schultz’ mother worked two or three jobs when he was a child to pay just for healthcare insurance. This impacted him powerfully and today Starbucks is one of the only U.S. companies to provide healthcare for part-time workers, spending more on this benefit than on coffee (Starbucks Investor Relations, 2011).

Strategic Analysis

Starbucks’ re-emergence as a major force in global coffee retailing can be traced back to the decision to stop price cutting and discounting strategies, shifting to strategies aimed at driving up same-store visits and purchases by the most loyal customers (Starbucks Investor Relations, 2011). This strategy of concentrating on the customer experience and selectively using technologies and process improvement to further underscore and accentuate customer experiences transformed the company’s financials within just a fiscal year, with the liquidity and Return on Assets (ROA) registering significant gains in the latest fiscal results shown in Appendix A.

In conjunction with this approach to defining the clarifying the customer experience in their stores, Starbucks also began investing heavily in China and the surrounding nations. The net result was a much more focused multichannel management strategy and series of initiatives that gave Starbucks a strong foundation to build on in China. As of the close of their latest fiscal year their investments in China continued to pay off with profitable operations reporting the fastest growth of any subsidiary and the highest ROI of all Starbucks global operations (Starbucks Investor Relations, 2011). Starbucks is today saying their goal with Chinese expansion is to have it attain a growth rate comparable to a “second U.S.” both in terms of profitability and sales.

Based on an analysis of their current financial statements and the many filings the company has made with the Securities and Exchange Commission (SEC), the distribution of their sales by product area has been ascertained in addition to the behavior of their most loyal and profitable customers. Based on this analysis of their latest financial statements and SEC documents, Starbucks is generating 75% of all sales from their beverages, 19% from food and 4% from their packaged coffee products. This distribution of products by category has significant implications on their global supply chain and the commitment the company has to operating a Fair Trade-based coffee supply chain that complies to CAFE standards (Starbucks Investor Relations, 2011). This analysis also indicates that a high proportion of Starbucks total operating expenses are in variable-cost-based categories of materials and products supporting the beverage business. Based on the analysis of their financial statements and SEC filings, Figure 1, Starbucks Product Mix was created. This figure illustrates the distribution of product sales by beverages, food, whole bean and soluble coffees and coffee-making equipment.

Figure 1: Starbucks Product Mix

Source: (Starbucks Investor Relations, 2011)

Including food items on the menu of their stores has given Starbucks the opportunity to branch out of just being a coffee shop to being a location customers want to met friends, relax, and talk about their lives. This “third place” approach to defining their value proposition has helped the company compete effectively with smaller regional competitors who also are pursuing this market position. Competitors including McDonald’s, Peet’s, Caribou Coffee and Panera Bread are among the smaller Starbucks competitors aggressively pursuing place as a part of their core value proposition (Harrison, Chang, Gauthier, Joerchel, 2005).

One of the most critical factors in the overall turnaround of Starbucks continues to be the tighter integration of marketing strategies and financial results. Emerging from the 2008 and 2009 downturn, Starbucks began to look at and simulate thoroughly what each decision would mean in terms of aggregated gross margin cross the global business. This focus on gross margin and profitability over market share led to the company re-defining its marketing strategies and concentrating more on high value-add drinks and products, not just relying on a series of cost reductions as it had done in the past (Harrison, Chang, Gauthier, et.al., 2005). This shift to selling value and the newness of their drinks instead of just competing on price was highly effective in winning back customers who had left due to the pricing strategies cheapening the brand and often, the in-store experience. Starbucks found that their products, from the beverages to the food items, were highly inelastic in terms of demand; drops in price really had not effect on volume (Starbucks Investor Relations, 2011). This was particularly true in the areas of their low-priced products which did not have the intended consequence of increasing overall demand. Starbucks did discover that their brand was highly inelastic however. Customers have very high expectations of what the brand stands for, and a low price (which for many translates into lower-value coffee) is not one of them.

Starbucks also completely re-assessed their retail expansion strategy, concentrating on high-profit regions and locations. This is a complete reversal of what had been the strategy of completely saturating a given metro or urban area with small and large stores. At one point Starbucks had over 30% coverage and cannibalization of stores in a given region (Starbucks Investor Relations, 2011). This high degree of overlap was done with a Darwinist approach to retailing planning and development. This had been very effective as a strategy in emerging markets, yet as the economic slowed down and began to contract, the need for being more selectively about retail locations became very apparent. Today the focus at Starbucks is about having more profitable stores per square foot first, not focusing necessarily on the overall coverage of a given region. This focus on profitability per square foot has also driven up the metrics of the most loyal customers to 16 visits per month, up from just seven in previous fiscal years (Starbucks Investor Relations, 2011). This ability to transform this aspect of their operations has been critical for keeping their most loyal customers coming back to the store while also attaining the status of being a “third place” for customers to visit and meet with friends (Harrison, Chang, Gauthier, Joerchel, 2005).

Third, Starbucks continued to expand its supply chain from a global standpoint, increasing the number of suppliers in China and throughout Asia to further support retail expansion in those regions. This strategy was combined with the company’s focus on CAFE-based compliance and support for Fair Trade-based trading practices with coffee suppliers. This renewed focus on managing their supply chains to tighter levels of profitability and performance metrics including increasing quality standards has led to a significant reduction in operating expenses and control of variable costs (Starbucks Investor Relations, 2011). Starbucks was also able to manage costs of closing locations effectively, and when this strategy was combined with supply chain cost savings, greater focus on in-store profitability and faster new product introductions, Starbucks was able to reverse a negative trend on gross margins and profitability. Beginning in FY 2010 and continuing through the current fiscal period, Starbucks continues to see their gross margins and operating profits including Net Margin, Gross Margin and EBITDA Margin. Figure 1, 5-Year Trend Margin Analysis Shows Impact of Strategic Marketing shows the aggregate impact of these decisions on overall company profitability. Starbucks has a business model that is highly reactive to changes made in product and service mix yet ironically, as history shows, is less receptive to price changes. With the increase in prices on new beverages rushed through research & development (R&D) Starbucks has created a reason for their most loyal customers to come back and visit them at least 16 times a month (Starbucks Investor Relations, 2011). This 16-visits-per-month figure is the breaking point in customer loyalty for the company; their marketing strategies revolve around this figure and set it as a goal for continually gaining new visitors to their stores. It is the watermark or objective of long-term marketing efforts to earn the right to serve customers 16 times a month (Starbucks Investor Relations, 2011).

Figure 1: 5-Year Trend Margin Analysis Shows Impact of Strategic Marketing

Source: (Starbucks Investor Relations, 2011)

In aggregate, the focus on strategic marketing and the streamlining of supply chains to fuel global growth in China has led to significant gains in gross margins to 58.4%, increasing operating margins to an all-time high of 13.3%, attaining a net contribution margin of 13.4%.

What these financial metrics indicate is that even in the middle of a global recession, Starbucks continues to excel at managing the research and development (R&D) strategies, quickly translating innovation into revenue. In conjunction with this core competency of making R&D spending translate into revenue, the company also has the ability to launch new products globally extremely well, synchronizing efforts and ensuring a high degree of profitability in the process (Harrison, Chang, Gauthier, Joerchel, 2005). Third, the integrated nature of their supply chains to fuel growth in China, which is what the senior management team has openly called their “next U.S.” also contributes to reducing variable operating costs while increasing gross margins. Combining all of these factors together account for 60% of gross margin contributions in their latest fiscal year (Starbucks Investor Relations, 2011). The blistering, rapid pace of Starbucks global growth can be attributed to these core strengths in R&D, new product development and introduction, and excellent management of their supply chains globally (Kanter, 2010). In retrospect, investing even more in R&D and increasing the pace of new product introductions would have had an even more profitable effect on their corporate financials vs. completing a price reduction temporarily in 2009 which tended to alienate loyal customers who took it as a message that the brand was cheapening itself.

Despite these strategies however, Starbucks still faced significant inventory levels throughout the FY 2009 and 2010 timeframes and is just now fully recovering from these conditions today. At their worst, Starbucks was challenged with a series of liquidity shortages primarily in their North American markets (Starbucks Investor Relations, 2011). The cash cycle metrics for this time period are shown in Figure 2, 5-Year Trend Operations Cycle Shows Impact of Strategic Marketing. Cash cycles continue to improve in addition to Inventory Turnover, which steadily is decreasing from the highest in the company’s history during FY2009.

Figure 2: 5-Year Trend Operations Cycle Shows Impact of Strategic Marketing

Source: (Starbucks Investor Relations, 2011)

Company’s Competitive Strength and Cost Structure

The strategy of investing heavily in R&D to quickly develop and launch new products is a proven strength of Starbucks and was instrumental in turning the company around in FY2009. The focus today from a competitive standpoint is to transform this rapid pace of innovation and new product introductions into earing 16 or more visits per store. As early as 2002 Starbucks realized that this connection of R&D to increased foot traffic existed, yet found the connection elusive to promote and continually gain traction with globally (Plog, 2005). What transformed the company was a study completed showing which customers had the highest lifetime customer value (LCV) and their preferences for how they learned of new products and what experiences they expected in the stores (Starbucks Investor Relations, 2011). What the study showed from a competitive standpoint that the entire experience, not just the drinks, or the light food items, had a much more immediate impact on CLV than any aspect of pricing or promotion (Starbucks Profile, 2005). Starbucks realized they were most trusted for the quality of the experience and drinks, not having a competitive price or even known for having special deals during the holidays.

Globally Starbucks was focusing more on China than many areas in Europe and throughout the rest of the world, with the potential to significantly increase profit per square foot in that nation’s stores. Starbucks quickly realized that the Chinese stores also delivered the highest levels of profits and Return on Investment (ROI) of any of their locations glob ally. Figure 3, Financial Analysis of Regional Marketing Strategies shows a comparison of store portfolios and new store economics, based on their filings with the Securities and Exchange Commission (SEC) and annual reports (Starbucks Investor Relations, 2001).

Figure 3: Financial Analysis of Regional Marketing Strategies

Source: (Starbucks Investor Relations, 2011)

Starbucks prioritizes their investment initiatives on R&D, enriching their in-store experiences to drive up CLV, and managing their supply chains to ethics and quality. This has given the company a very strong, defensible market position globally and further strengthened their competitive position in the U.S., which continues to be their largest market. The competitors that Starbucks most often contends with for market share include Dunkin’ Donuts primarily through the Eastern and Central U.S., Caribou Coffee, and a series of smaller chains. No other chain has the global breadth and depth of retailing, R&D operations and the ability to translate innovation into revenue with the speed of Starbucks. While they are challenged with smaller competitors in regional markets and at times with backlash against globalization in other nations, Starbucks still commands well over 70% of global market share for coffee retailing in the markets it competes in (Starbucks Investor Relations, 2011).

Overall Strategy Effectiveness

Starbucks realized in 2009 that their organizational structure was actually inhibiting growth, not contributing to it. As a result, the company re-organized its sales and same-store visits, improve Chinese supply chains and Asian operations, and improve the retailing products sales. The re-organization also brought about a stronger focus on accountability fo sales and marketing by market segment and business unit, further leading to increased profitability and growth. As a result of this alignment, the company is today setting a goal of launching 30,000 retail locations by next year (Starbucks Investor Relations, 2011).

In terms of corporate culture and strategy Starbucks continues to emphasize creating a foundation for individual and group achievement, personal and professional growth, and a focus on giving employees a chance to see the impact of their efforts on the success of the company (Webb, 2011). The senior management at Starbucks continued on corporate-wide programs that define a culture of achievement and recognition both on an individual and group level (Starbucks Investor Relations, 2011). The company has also shifted its culture by concentrating on analytics to measure in-store performance and the results of continual testing on new procedures for creating the over 68,000 versions of drinks that can be ordered in a fully-functioning Starbucks (Starbucks Investor Relations, 2011). As a result of these initiatives Starbucks has a strong learning-based culture (Starbucks Investor Relations, 2011).

In terms of ethical nature of the company and its strategies, Starbucks is considered a leader in the areas of Corporate Social Responsibility (CSR) Programs and Fair Trade. This program was initiated in 2000 and continues today with the focus on the Coffee and Farmer’s Equity Practices (CAFE) organization that Starbucks is a charter member in. This initiative continues to be a thought leader and highly effective in ensuring the viability of growers globally is protected from severe price competition and price gouging. By enforcing these standards, Starbucks has helped to stabilize the global supply chain for coffee and related products, saving it from consolidation. If that had occurred, pricing for coffee would have eventually skyrocketed and hundreds of growers would have been forced out of business. Starbucks has successfully stabilized this vital connection in supply chains by working with CAFE best practices in all of their business units.

The key business units in Starbucks include the Americas, China and Asia Pacific, and EMEA, covering Europe, the UK, the Middle East, Russia and Africa. Each of these divisions is further supported by retail operations and their own e-commerce sites. Of these three divisions, China has consistently shown the greatest year-over-year growth and continued growth of CLV in key cities including Beijing and Shanghai. In addition, the U.S. market continues to stabilize and grow with more selective store selection and a concentration on in-store experiences. These strategies are aimed at driving up the CLV levels of the most loyal customers. The continual focus on new food products will continue to increase the number of loyal customers who visit 16 times or more in a given month.

Appendix A: Ratio Analysis of Starbucks Financial Performance, 2006-2011

Source: (Starbucks Investor Relations, 2011)

References

Melanie Godsell (2007).”Starbucks to push food line. ” Marketing QSR. June, pp. 34 — 35.

Jeffrey S. Harrison, Eun-Young Chang, Carina Gauthier, Todd Joerchel, and et al. (2005) “Exporting a North American Concept to Asia: Starbucks in China. ” Cornell Hotel and Restaurant Administration Quarterly 46.2: 275-283.

Kanter, R.. (2010) “How to Do Well and Do Good. ” MIT Sloan Management Review 52.1. 12.

Mintel Research, 2006, A Classy Cup of Coffee, Convenience Store News March 15, 2006. Retrieved November 29, 2011 from http://www.csnews.com/csn/foodservice/article_display.jsp?vnu_content_id=1002158065

Starbucks Investor Relations (2011). Investor Relations. Retrieved November 29, 2011, from Starbucks Investor Relations and Filings with the SEC:

http://investor.starbucks.com/phoenix.zhtml?c=99518&p=irol-irhome

Stanley C. Plog. (2005) “Starbucks: More than a Cup of Coffee. ” Cornell Hotel and Restaurant Administration Quarterly 46.2: 284-287.

Starbucks Profile, 2005 — Starbucks Corporation. Company Profile. June, 2005. DataMonitor Corporation. New York, NY.

Yu, H., and W. Fang. (2009) “Relative impacts from product quality, service quality, and experience quality on customer perceived value and intention to shop for the coffee shop market. ” Total Quality Management & Business Excellence 20.11: 1273.

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