Starbucks (NASDAQ: Sbux) Has Enjoyed

Starbucks (NASDAQ: SBUX) has enjoyed unprecedented expansion over the course of its existence, earning it rapid growth, strong profits and the envy of businesspeople the world over. The brand has become iconic and the company transformed the way the world drinks coffee. Yet in 2008, the company entered an era of challenge. In the core U.S. market, Starbucks closed approximately 600 underperforming stores (Linn, 2008). This announcement came mid-year, following on an earlier announcement of 100 store closures, product line reductions and a decrease in new openings (Harris, 2008). The main cause of these difficulties was cited as the weakening economy, but there were other issues. One is that Starbucks, in its eagerness to saturate the market, had allowed their standards to slide with regards to the choice of locations (Lomax, 2008). These standards had for years been a hallmark of Starbucks' success. Another issue cited by some is the quality of Starbucks' coffee, in particular their espresso, which is now made by automatic push-button machines. This decline in the quality of the product offering has placed Starbucks in the position of charging a premium price for a standard product, which has in turn opened them up to competition, most notably from McDonald's. All is not bleak, however, for Starbucks, as the firm has successfully brought its coffeeshop concept to Asian markets such as China and Japan. Further expansion into the Asian, Middle Eastern and Central European markets promises to further offset weakness in the core U.S. market. Even in these markets, however, competition is emerging (Shuey, 2007).

Fiscal 2008 saw Starbucks' profit growth stall, the firm recording a $315.5 million net income, down from $672.6 million the year previous in the face of higher costs and charges relating to the store closures. The company's cost structure was in part affected by increases in commodity and transportation prices through the first half of the year. However, same stores sales also declined sharply in the year, a drop of 9%, as CFO Troy Alstead noted in an analyst conference call. This decline is attributable to the value proposition offered by Starbucks, increased competition and the general economic slowdown (Shepherd, 2008).

In this same conference call, however, CEO Howard Schultz provided some guidance for the future of Starbucks when he stated that "Starbucks shouldn't drastically change its identity or brand. This is not the time...after building one of the most recognizable brands in the world, to throw the baby out with the bathwater." (Ibid.) the course of the coffee industry in the next five years will therefore see Starbucks attempting to weather the present economic storm without major fundamental changes to the company, its branding or its operations. The company has sufficient financial strength to weather the storm. Starbucks has a strong balance sheet. Despite the recent acquisition of $500 million in long-term debt, the company has strong liquidity. It is expected that with regards to the economy, Starbucks will attempt to preserve profitability through cost reduction. In 2008, this meant cutting underperforming stores and staff. This trend may continue over the next couple of years.

Another area of vulnerability for Starbucks has been its product offerings. Starbucks built its success, and high margins, based on premium positioning. This came from product offerings and what the company terms "The Starbucks Experience." The latter is the entire coffeehouse package, including atmosphere, service and music, as well as the product offerings. It does not appear that the economic potency of the Starbucks Experience has waned in recent months, but there is evidence that the product offerings have become a source of competitive weakness. In terms of product, Starbucks built its reputation on providing premium coffee at a premium price. This value proposition is under attack from two sides. On one side is the emerging "third wave" coffee culture, where specialist shops with high-end espresso machines produce a vastly superior product at an equivalent price. On the other side, competitors such as Dunkin Donuts and McDonalds have moved aggressively against McDonald's with product offerings of a similar quality but at a much lower price point. This is the strongest competitive threat to Starbucks at present (Tancer, 2008). McDonald's has moved into Starbuck's turf and can be credited with stealing some market share away from the coffee giant.

This trend can be expected to intensify over the next five years. McDonald's and Dunkin Donuts are among the most significant competitors, but there are more, many of them regional. One of Starbucks' most significant sources of growth in recent years has been in overseas markets, where the company partners with local firms to operate their franchises. Much of the success in overseas markets has been attributed to the Starbucks Experience and in Asian markets to the ability of the company to provide a third space away from work and home. This, however, is easy to replicate and since many consumers in these markets are not savvy coffee drinkers, competition has few barriers to entry and can easily replicate the coffeehouse experience. Thus, in markets such as Japan and the UAE, competition has intensified and the intensity of competition can be expected to increase.

Starbucks will need to respond to this increase in competitive intensity both domestically and abroad. In North America, Starbucks is expected to attempt to re-diversify its product offerings and build upon the Starbucks Experience concept. The company has purchased the Coffee Equipment Company, maker of the high-end Clover drip coffee machine (Starbucks, 2008). This purchase was intended to give Starbucks a technological competitive advantage over their fast-food rivals. The next five years should see the mass rollout of Clover systems to help deliver this advantage and re-establish the premium nature of the Starbucks product.

The company is also expected to focus on the Starbucks Experience. The proliferation of organic and free trade beans has popularized such premium coffee options, but Starbucks' size makes purchasing such beans on a scale useful to the coffee giant difficult. Aside from the Clover, there is little the company can do to avoid the commoditization of its core product and ward off higher-end competitors. Thus, the company is expected to focus its competition more on the experience. This is in large part because competitors such as McDonald's and Dunkin Donuts cannot offer the same atmosphere and customer experience that Starbucks can. Over the next five years, Starbucks will leverage their competitive advantage in terms of atmosphere in order to ward off these competitors. Overseas, they will take a similar approach, leveraging their status as world leader, painting competitors as the imitators they are.

Financially, Starbucks will suffer a slowing of growth as they implement the changes required to meet these challenges. The premium coffee market will continue to shrink, putting downward pressure on same-store sales. The company will invest more in rolling out the Clover and in marketing, which combined with declining sales could result in losses for the first time in many years. However, these losses will be short-term in nature. If Starbucks can successfully retain their premium positioning in the face of the competition from fast food chains, they will be well-positioned to ride the economic rebound when it occurs.