20 Oct 2021

Under the Spotlight: Starbucks Corporation (SBUX)

Nothing beats a traditional American breakfast: scrambled eggs, bacon, pancakes and plenty of very, very watery coffee. Present in thousands of diners across the United States, you won't find anything remotely similar to this in the largest chain of coffee shops in the country and the world: Starbucks.

Instead of eggs and bacon, muffins, bagels and scones, traditional from British and New York bakeries are present. American coffee is an option, but it can be replaced by espressos, lattes and frappuccinos, fully customisable to the customer’s taste. With 50 years of history, Starbucks is now part of the daily lives of millions of people around the world, but it wasn’t always like this.

B2C: Bean to Customer

Founded in Seattle in 1971, Starbucks emerged to sell premium coffee beans to baristas and coffee aficionados in Washington’s capital. As you can imagine, the market for this type of product in the 70s was still very small, causing the business to slip for a few years.

What skyrocketed the company to success was the sale of the company in the 1980s to businessman Howard Schultz, who decided to change not only the business model, with the opening of franchises, but also the main product, which would become hot and cold coffee beverages. This change caused the business to expand to the point that eventually the Mermaid’s coffee brand would be recognised virtually all over the world.

If you can’t beat them…

The cafeteria market, as well as the entire food sector, has extremely attractive profit margins: Starbucks’ gross margin, for instance, is 28.15%. However, as the value of each product sold is very low, it is necessary to sell large quantities to achieve large numbers of revenue. And to make matters even worse, the barrier to entry in the industry is extremely low, after all, anyone can set up a coffee shop.

For this reason, mergers and acquisitions were fundamental for the company’s growth. One of the most successful items on the cafeteria’s menu, the frappuccino, came precisely from the acquisition of Coffee Connection, in 1994. The drink is a mixture of a frappé (smoothed milk, but in French and, therefore, more expensive) with a cappuccino, resulting in something that looks like a milkshake, that can be made with or without coffee, in addition to having a little less orthodox base options, such as strawberry flavour, for example, one of the company’s best sellers.

Today, with more than 32,000 stores and around 350,000 employees across the planet, the strategy of acquiring key competitors was unquestionably a success for the company, which expects to earn US$29 billion in 2021. However, the company will face huge challenges to continue to expand globally.

Crossing borders

If the mergers and acquisitions strategy was very successful in the American market, it might be difficult to replicate in other countries. This is especially true in emerging countries, which have a very dispersed market, without major players dominating the sector running large chains in several cities. Growth in other countries is essential for the company’s expansion plans to succeed.

The United States is currently the main country for the company, with the largest number of stores, followed by China, Canada and the United Kingdom. However, if the US is today the largest coffee shop market, it doesn’t seem to offer much opportunity for growth: in 2020, the balance of new stores opened in the country was zero, while other countries inaugurated more than 1,150 new establishments, even in a tough year, with stores closed due to the Covid-19 pandemic.

Even though it’s growing, the international market is still not very representative for the company, accounting for just US$6.6 billion of last year’s revenue, which was US$23.5 billion. A positive thing is that in the international market, Starbucks has a higher percentage of franchised stores, which dilutes operational risk and ensures greater predictability of revenues. The number of franchised stores is still very small, however, accounting for only 16% of the company’s revenue, while in the case of other giants in the food sector, such as McDonald’s, this number reaches 93%.

On a tight belt

In 2008 Starbucks began offering a “skinny” product line, with low-calorie, sugar-free drinks. But in addition to trying keeping its customers slim, the company is committed to not letting something else get fatter: it’s costs. Since 2016, the company’s operating cost is around US$3.8 billion per year, reaching US$3.9 billion only in 2021, a growth of just over 2%. In real terms, that is, if we consider the period’s inflation, the growth value is negative.

Keeping costs in line with revenues growing about 10% annually is an explosive combination, causing the Starbucks share price to more than double in the past five years. Low spending growth also enabled the company to survive the Covid-19 pandemic, even though it closed many of its stores due to lockdowns around the world.

By 2021, the company’s revenue and cash flows are expected to reach record levels again, following the reopening of global economies as people leave home looking for exactly what made Starbucks famous: cozy environments and high-quality coffee drinks to follow a good conversation.