You own a business that is suffering declining store traffic for consecutive quarters. Your business is being challenged by competitors that offer a quality product at a fraction of the price you charge for yours. What do you do? If you are Starbucks (SBUX) you raise prices and make the affordability gap between you and your competitors even greater? Please tell me how this make sense.
Starbucks recently announced that meeting estimates for the upcoming quarter “would be a challenge” due to higher milk and coffee prices. Now, if they were serving more people each day, this decrease in margins would be offset by the additional transactions. What this warning tells me is they are still facing stagnant or declining store traffic in addition to decreasing margins. Can anyone explain how making your product less affordable will solve this store traffic issue?
I mean, Mcdonalds (MCD) and Dunkin Donuts both serve milk and coffee so we must assume they are facing the same cost pressures, right. It would be foolish to assume only Starbucks is facing these issues. Today McDonald released results and revenue came in 12% higher at more than $6 billion, while sales at restaurants open for more than a year were up 7.4%. They also met expectations of 71 cents a share profit from operations, 26% higher than last year and Starbucks admits they are struggling . How did McDonald’s do it? They sell a quality product at affordable prices, novel. Said CEO Jim Skinner “In the U.S., we are aggressively going after the $60 billion beverage industry with the focus on coffee. We added credibility in this arena now with lots of premium coffee last March. Today, premium coffee sales are up 20%. This credibility gave us brand elasticity to expand further into specialty beverages. Currently, we are testing a wider range of offerings including hot and cold drip coffee beverages an espresso-based coffee and ice beverages. We are encouraged by the preliminary results. Including these specialty offerings, total coffee sales are up more than 30%.”
I have been pounding this point since January, Starbucks is at the peak of what they can charge for a cup of coffee. Increasing those prices will lead to further decreases in store traffic and with Starbucks now relying on more ancillary sales to customers for revenues and profits, decreased visits now have a compounding negative effect on the bottom line.
I also fully understand the hard core Starbucks “aficionados” will continue to visit Starbucks no matter what type of home equity loan becomes required to purchase a latte, it is the casual customer who is walking away in hoards and the numbers continue to back up this assertion. Goldman Sachs (GS) analyst Steven Kron said today that higher prices could reduce store traffic given the state of the consumer, media coverage and increasing competition in the coffee space. Not could Steve, will.
The only way for Starbucks to reverse this decline is to get more people into their stores. Once there they will buy more muffins, sandwiches, CD, toaster ovens, and SUV’s or whatever else they sell there now. Raising prices will not accomplish this. If the consumer is becoming more cost conscious and recent retail sales report would support this than one must assume discretionary items like a cup of coffee will be one of the first items they will pinch pennies on.
I also recognize that it is only 9 cents on some drinks (ones in cups?), but we live in a appearance is reality world out there and the last thing people want to hear nowadays are the words “price increase”. It is a turn off and the extra revenue they may get per cup is more than offset by the negative sentiment they are creating.
I have asked this question repeatedly and have yet received a decent answer. Why should I pay $5 for a cup of coffee when I can get the same thing for $2 other places and not have the DMV like “wait in line” experience?
Answer? I shouldn’t and apparently increasingly other folks are not either.
10 replies on “Starbucks Still Doesn’t Get It”
Earlier you wrote that SBUX is a matter of price for you, and you mentioned the $22 level as the highest you’d pay. Does this news make your price go lower? Or were you already discounting the fact that having screwed up already, they’re likely to screw up some more?
Customers are defecting to a lower cost product? As a student of Buffettology I am concerned. Sounds like SBUX’s competitive advantage is not so durable.
carl,
i agree, after all, it is just coffee…
matt,
i am going to post on this
Coke is still soda and sam adams is beer. Anheuser-Busch has premium beer that has done okay in taste tests, yet people are still buying Sam Adams and heineken, which are selling at premium prices. There are tons of cheap sodas on the market, yet people still buy coke.
I agree that coffee is a highly commoditized item, but you are al thinking like value investors and not consumers. 25% of all bottled water (including dasani and aquafina) are filtered tap water, yet bottled water is a Billion dollar industry. why don’t people just fill up a bottle at work or home and tote that around with them. No, instead they pay more (on a per gallon basis) for bottled water than they do for gas. now that is a joke, but one I see continuing for some time.
Starbucks is a brand. One that is achieving ROE’s in excess of 20% for the last two years. Licensing revenue is growing fast and more deals (ie Hershey) are in the works. Licensing creates the highest ROIC possible, because all of the costs to build that brand are ‘sunk’ and the costs to service licensing are minimal.
Starbucks defines many people’s lifestyles. With that cup in hand, complete with the little mermaid, people can hide from the fact that the house is in foreclosure and their savings account is zilch. yet, with this cup in hand, complete with the little green mermaid, no outsider can doubt them. How could someone doubt the wealth of someone with a $4 latte in hand. Starbucks is the kind of ‘affordable’ conspicuous consumption that people will not let go of. Aside from that, Starbucks runs alot of pre-opening expenses through its income statement, has a stellar brand, good cash flow, great international opportunites and is convincing people to leave the store with more items. “would you like a mini chocolate bar with that latte?” on top of that, the stock is down more than 40% off its highs. Starbucks has been selling overpriced coffee more than 10 years. Even through the last recession in California, we stuck with our Starbucks coffee…even before those great little drive throughs.
Starbucks may not be a permanent hold, but its not the doomsday scenario that some people think it is. At $22, I would be a buyer with a 2-3 year time horizon.
sorry all for the long post.
Hey genius, last time I checked Starbucks Coffee was not $5 a cup as you state in your “blog”. Thanks for adding further bias to the ill-informed “Starbucks is too expensive movement.”
If you compare Starbucks 12 ounce coffee to Dunkin Donuts 10 ounce, I believe they are very close in cost per ounce, if not the same. McDonalds isn’t all that much cheaper than those two for just coffee. And lets be real, McDonalds coffee sucks. Their old Folgers blend tasted better to me.
Some people love the Starbucks lattes and mochas, and they will continue to pay the $5 per cup for those. Can you buy those at Mickey D’s? Nope. Keep shorting SBUX buddy.
anon,
let’s pretend (emphasis on pretend) that you are correct and I am wrong..
please explain the fact starbucks coffee sales are stagnant while mcdonalds are exploding???
i hold nor ever have i had a position in starbucks
anon,
i agree with you beer analogy..
here is the difference, neither of those companies is promising 20% growth into the future…
starbucks can post great numbers, grow 10% forever and the stock will get decimated because it is priced for twice that
Well Todd, I’ll continue to buy this stock and you can just sit by and believe what you want. Starbucks is a blue chip company. It dwarfs other coffee hacks and will continue to dominate. What Starbucks needs to do is what other companies (such as PepsiCo) did and that is buy the competition and then close them. That’s how Taco Bell reigns supreme in the crap mexican food market. They bought and closed down the good ones.
As for your somehow weird fixation with McDonalds being good, their coffee sucks, I just had a cup the other day. You must have a burrito with it to even choke it down. Give me a break…..By the way, MCDonalds doesn’t have the same exposure to milk products because they don’t serve much that is actually made from real food. The milk you are referring to is fake half and half in those little cups….Hardly the quality cream you get at Starbucks. I suppose you prefer generic Ice cream rather than Ben and Jerry’s too right? It is called high quality and it comes at a price.
I’m not anonymous, the name is Tom
tom,
please explain the numbers if i am so wrong…
why are McDonald’s coffee sales exploding while Starbucks are not moving?