Starbucks Risk Analysis: Types, Severity, and Mitigation

Overview of the Business

Starbucks is a purveyor of coffee and related products, including food, other beverages, whole beans, and coffee equipment. The company is headquartered in Seattle but operates globally. It runs a mix of corporate-owned stores and ones operated by franchisees. Starbucks generated $19.1 billion in revenue in its most recent fiscal year, with net income of $2.7 billion (MSN Moneycentral, 2016). There are specific risks associated with running a food business, and additional risks inherent in both franchising and international operations. Several other categories of risk also apply to Starbucks as a consequence of the nature of its business.

Market Risk

There are several categories of market risk that apply to Starbucks, ranging from commodity price fluctuations to intense competition. Starbucks faces significant risk from price volatility in coffee, its primary input. The price of coffee is determined in part by the cost of production — approximately $1.00–$1.10 per pound — but ultimately set by the global market, which is in turn affected by environmental conditions and the competitive dynamics among major buyers. Because Starbucks cannot immediately pass price increases onto consumers in a competitive marketplace, the company bears some exposure to fluctuating coffee prices. This risk is likely to materialize — coffee prices fluctuate regularly — but the damage to the company is relatively contained.

The other dimension of market risk is competitive pressure. Starbucks holds an industry-leading position and is therefore somewhat insulated from competitive threats — it is more likely to win a competitive battle than to lose one. However, the company faced a serious challenge in the mid-2000s when McDonald's made a concerted effort to enter the coffee business. McDonald's and Dunkin' Donuts both captured meaningful share of the U.S. market, particularly when combined with the economic downturn that made premium coffee feel like an unaffordable luxury. Starbucks' business suffered, and the company was forced to close hundreds of stores. Having successfully responded to McDonald's, Starbucks now faces lower competitive risk than it did a decade ago, but the potential damage from a well-resourced new entrant remains significant. It is also worth noting that market conditions are entirely unfavorable for Starbucks in certain geographies — the company exited Israel, never attempted to enter Italy, and has struggled in Australia.

Political, Economic, and Interest Rate Risk

One might expect that political risks surrounding coffee shops are fairly routine — mostly regulatory matters concerning food handling and service — and for the most part that is true. However, Starbucks did encounter difficulty in China when government officials launched a campaign against the company, criticizing its prices as part of a broader effort targeting prominent foreign businesses (which usually focused on Japanese firms). Starbucks has also faced protests in various countries where it is perceived as a symbol of cultural imperialism, and was ultimately pressured into closing its store near Beijing's Forbidden City, which was quickly replaced by a Chinese-owned coffee shop. Political risk appears moderately high in terms of likelihood, but the financial cost is typically low — a few protests, the occasional store closure. There are also minor legal risks pertaining to daily operations and nuisance lawsuits, which manifest regularly but rarely cost the company significantly. Political risk also encompasses more extreme scenarios such as nationalization and armed conflict. Argentina's nationalization of a Spanish oil company in recent years illustrates that such actions, while rare, do occur. The Forbidden City closure is itself a mild form of nationalization by political pressure. War seems a distant risk, but Starbucks once had operations in Syria, so it is not an impossible scenario.

Starbucks positions itself at the premium end of the coffee market. While it offers what many consider an "affordable luxury," it nonetheless sells a product with many readily available substitutes. During the economic slowdown of 2008 and 2009, Starbucks saw its business decline as consumers traded down to less expensive options — either cheaper coffee shops or brewing at home. This demonstrated that a meaningful segment of the company's customer base is price-sensitive during economic downturns. Since then, the economy has largely recovered, boosting the company's fortunes, but Starbucks remains exposed to this risk in the event of another recession. The risk should be considered high, with potentially severe outcomes. Another economic slowdown will occur eventually, and when it does, the company will likely again struggle with profitability. The one mitigating factor is that this is a long-run risk rather than an imminent one.

Closely tied to economic risk is interest rate risk. Rising interest rates can have a significant impact on borrowing costs, particularly if rates increase at a moment when Starbucks requires additional external financing. This risk is not acute at present, but it warrants monitoring.

References

Davis, A. (2014). Building a climate-resilient coffee economy for Ethiopia. Kew Gardens. Retrieved April 18, 2016 from

Investopedia. (2016). Inherent risk. Retrieved April 18, 2016 from http://www.investopedia.com/terms/i/inherent-risk.asp

Investopedia. (2016). Risk and diversification: Different types of risk. Retrieved April 17, 2016 from http://www.investopedia.com/university/risk/risk2.asp

MSN Moneycentral. (2016). Starbucks Corp. Retrieved April 17, 2016 from http://www.msn.com/en-us/money/stockdetails/financials/fi-126.1.SBUX.NAS

Starbucks 2015 Annual Report. Retrieved April 17, 2016 from