Economic indicators and their relevance to Starbucks strategy

Starbucks

Economic indicators inform companies about the broader trends in the economy. Most companies are well aware of their own internal performance, but economic indicators can provide additional information. For example, if the economy is slumping, then a slight downturn in a company's revenues might be expected. If the economy is booming, however, then that same downturn would be a red flag. So economic indicators can sometimes serve as a benchmark against which firm performance can be evaluated, or at the very least can be a frame for understanding firm performance. This makes sense -- managers often consider the influence of the external environment when making strategy and the economy is definitely an important part of that environment. A second use of economic indicators is to help give the firm a sense of economic trends. These can help the organization set future strategy, by extrapolating the past trends over the coming months.

There are a wide range of economic indicators. Some are more relevant to the business than others. Starbucks has a stock market beta of 1.08 (MSN Moneycentral, 2014), which means that in general its performance is closely correlated with that of the broad market, which in turn is closely related to overall economic performance. This paper will take a look at some key economic indicators. The indicator will be explained, its recent history outlined, and then an explanation provided as to how that particular indicator might be useful to strategic managers at Starbucks. Two-thirds of the company's stores and revenues, approximately, are in the United States, so there is a fairly high degree of relevance for major U.S. economic indicators.

Consumer Price Index (CPI)

The Bureau of Labor Statistics publishes the consumer price index (CPI), which is a headline measure of inflation. The CPI tracks the average price of a basket of goods. The main CPI number includes both relatively static goods as well as more volatile goods like food and energy. This metric is somewhat relevant for Starbucks, as an indicator of purchasing power. In general, small changes in the CPI are not going to affect the purchasing power of Starbucks' consumers, because small changes tend mainly to affect those who already cannot afford Starbucks' premium offerings. However, at this point, any sign of the CPI increasing too rapidly will bring about an increase in interest rates in the U.S., which in turn would slow the economy. The Federal Reserve tends to have a target CPI range, and the annual CPI needs to be within that range. If it is below that range, that will indicate a trend towards expansionary monetary policy while a CPI above the target range will indicate a likelihood of contractionary monetary policy.

The latest CPI figure was 0.3% in December, for a total of 1.5% in the previous twelve months. The main driver of this increase was energy, which increased 2.1%, seasonally adjusted. The Fed's target is reported to be 2% (Jacobsen, 2013), which means that the current rate of inflation is below the Fed's target. Thus, the forecast for monetary policy is for expansionary monetary policy. Given that interest rates are current at rock bottom, the forecast is for a continuation of current rates. For Starbucks, this means a continuation of the status quo for the foreseeable future, until there are signs that the Federal Reserve is going to be compelled to raise interest rates.

Unemployment Rate

The unemployment rate measures the number of people who are actively in the workforce who are not employed. It does not include those who are not in the workforce including many long-term unemployed who have given up on finding work and it does not include those who are underemployed. This measure provides some indication of the health of the company but is a lagging indicator with relatively little predictive power. The unemployment rate dropped to 6.7% in December, the lowest level in many years. This affects Starbucks because the higher the unemployment rate, the less competition there is for workers. This usually results in a lower cost of labor. Labor costs are expected to move higher when unemployment rates are lower, so the decline in the unemployment rate is a sign that labor costs for Starbucks may be set to increase. The only saving grace here is that the unemployment rate today is still quite a bit higher than the rates under which Starbucks grew rapidly in the 1990s and early 2000s. If the company could grow rapidly then, it can grow rapidly now.

Producer Price Index

This index reflects the prices that manufacturers receive for their goods. This is not the most useful for Starbucks, which is a retailer with some vertical integration -- it buys its main input wholesale on the commodities market and performs its own processing. The PPI increased 0.4% in December, and has seen similar increases to the CPI in recent months. PPI is another measure for inflation, but one that removes retail markups. As a retailer, however, Starbucks is probably more directly affected by the CPI than the PPI. However, the PPI supports the CPI's findings that inflation is still fairly low but may be increasing.

Interest Rates

Of interest to Starbucks is the interest rate. The company recently increased its debt to pay for a legal settlement and now has over $1 billion in long-term debt on its books. Rising interest rates benefit Starbucks as a debtor, because it has borrowed at low rates. Interest rates reflect both the cost of borrowing in the economy and the direction of the Fed's monetary policy. At present, interest rates are at very low levels. The current rate is 0.07%, which is within the Fed's target of 0-0.25% (NY Fed, 2014). This is a very low rate, indicating expansionary monetary policy, and is barely above zero. This is very low cost money. Starbucks' cost of capital is therefore very low, and that makes more projects attractive to the company than would be attractive if the interest rates were higher.

Gross Domestic Product (GDP)

The GDP is a measure of the nation's economic productivity. This measure is useful for gauging the general trend in the nation's overall economy. It can also be a useful predictor of monetary and fiscal policy, because both the government and the central bank use GDP as a benchmark economic number. When the GDP is falling, expect expansionary monetary and possibly fiscal policy; when the GDP is rising, expect contractionary policy, but usually only if it is rising too fast or has been rising for a long time. The current GDP change is that it is increasing at an annual rate of 4.1%, which is a decent amount, and higher than it has been increasing in recent years. This is not an amount that is high enough to indicate any sort of economic overheating. The 4.1% figure is for Q3 2013, and is up from 2.5% in Q2 (BEA, 2013). For Starbucks, the GDP is starting to improve quickly, which should mean a slight increase in the number of people who are feeling confident in the economy, and therefore in discretionary spending, of which Starbucks surely qualifies. With a rising GDP, it is also time to monitor the CPI more closely because if both of them are indicating the pending need for contractionary monetary policy, that is something Starbucks needs to know ahead of time.