Monday, May 16, 2005

Baristas serving a double shot of - liqueur?

Starbucks, seen as a homely refuge, a place to read a book and listen to a bit of mediocre jazz, says its mission is “To establish Starbucks as the premier purveyor of the finest coffee in the world while maintaining our uncompromising principles as we grow”. Starbucks currently is in 32 countries, has approximately 700 company-operated drive-thru locations and 5215 stores worldwide. Starbucks strategy is to reach customers where they work, travel, shop and dine typically in high-traffic, high-visibility locations. The Company’s retail sales mix by product type is comprised of approximately 77% beverages, 14% food items, 5% whole bean coffees and 4% coffee-making equipment and accessories. Approximately half of the stores carry a selection of “grab and go” sandwiches and salads. The comforting and classy leading specialty coffee retailer is known around the world for its relentless takeover of local community-based coffee shops. The company has seen compound annual EPS growth of 41% over the past four years and last-year EPS up 44% on revenue growth of 25%. Looking forward, consensus analyst estimates call for EPS growth of 24% this year and 21% next year. This is impressive to say the least for a company that started in 1985 and went public in 1992 at $17 per share, or a split-adjusted price of $1.0625 for the Company’s four subsequent 2-for-1 stock splits to a current price of almost $56.
So how is there a talk of selling alcohol at Starbucks? Actually this is not a new phenomenon: In the port city of Kobe, Japan, people head to a Starbucks kiosk to buy lattes, cappuccinos -- and beer and wine. This outlet quietly began selling such beverages two years ago and is the only Starbucks in the world offering alcohol. In 2003 shareholders of Starbucks Coffee Japan Ltd. approved a change to the corporate charter allowing the sale of booze at any outlet. In the Kobe store, Starbucks offers Red Hook beer and Columbia Crest and Staton Hill wines, alcohol brands from its home state of Washington. In 2004, the Company entered into an agreement with Jim Beam Brands Co., a unit of Fortune Brands, Inc., to develop, manufacture and market a Starbucks-branded premium coffee liqueur product in the United States. The Starbucks liqueur, which resembles Kahlua in texture, taste and alcohol content (20% by volume, 40 proof), will come with a premium price tag that should be familiar to devotees of its coffee. A 750-ml bottle will cost $23, compared with $17 for Kahlua. It will also be available in 1 liter and 50-ml bottles. A 1.5-oz serving of the liqueur has one-fifth the caffeine content of a "tall" serving of Starbucks coffee. The Company conducted tests of this product in two U.S. markets in the fiscal fourth quarter and expects to introduce the product nationally during the fiscal second quarter of 2005 in retail locations licensed to sell distilled spirits, such as restaurants, bars and retail outlets where premium distilled spirits are sold. The Company states that it will not sell the liqueur product in its Company-operated or licensed retail stores.
So is idea of Starbuck selling alcohol in its cafes a good one? Starbucks sales in Japan have slowed due to stiffening competition from newcomers such as like Seattle-based Tully's Coffee and local coffee chains like Pronto and Doutor run by mega Japanese beverage companies. There is a need to drive growth through diversified products. The results from the Starbucks café at Kobe could have provided some pointers. There are no indicators that the option of providing liquor there has led to loss in sales, at least in the short term. However, Japanese customers are known to eagerly embrace new ideas and new fashions and therefore the Kobe café’s sales have to be monitored in long term to determine efficacy of the new strategy. It will test aspects of Japanese culture which are different than those in the West. Japanese go out for drinks in combination of dinner. They rarely take alcohols alone at bars and restaurant without any food. Starbucks would need to serve higher volumes of foods to be successful in serving alcohol. Many Japanese drinkers also smoke while drinking. One of Starbucks’ main selling points is to offer best quality coffee including smell of it, hence do not have smoking areas. In addition, local beer and wine drinkers in big cities like Tokyo rather go to local pubs and fashionable restaurant for dating and business meetings. Finally the competition in local pub and restaurant is harsh. As an example, Pronto, operated by mega liquor distributor Suntory Ltd and the largest coffee company UCC, has café time (until 5:00 pm) and bar time (after 5:00pm). Starbucks will have to keep its differentiated image intact to charge its high premiums.
Whether Starbucks should introduce liquor in the cafes in US is even more debatable. The first hurdle will be due to differences in liquor-license laws between states. Further, extensive customer tests need to be done to ensure that the loyal Starbucks customer is not driven by rowdy liquor guzzling clientele. The consistency of serving liquor in a cafe that associates very strongly with coffee is unclear. Further, the competing firms such as Tully’s could capitalize on dilution of Starbuck’s focus.
The option of being able to sell liquor with its high margins and the growth of sales of premium spirits is sure attractive. Starbucks could ride some of this growth by offering a few coffee-based alcoholic drinks, such as Irish coffee and other coffee-based cocktails. As an analyst at UFJ Tsubasa Securities Co. stated, "One possible compromise is to offer a few coffee-based alcoholic drinks, such as Irish Coffee (hot coffee with a shot of whiskey and a dab of cream). It's easy to see Starbucks offering coffee-based cocktails.”
The other potential growth options would be to intensify its efforts to penetrate and dominate the Chinese market. Starbucks believes that, over the years, China will overtake the United States as its largest market (S&P 500 report). It should therefore concentrate on its expansion program there to establish dominant market position in time for the 2008 Beijing Olympics. Another way for Starbucks to diversify its business and gain a foothold in the “share of throat” products is to take up stake in liquor and soft drink companies as well as chain restaurants.

Kamal Jha, Kenji Yaguchi and Ali Kandaih

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