Starbucks Coffee Company: A Strategic Analysis

Starbucks Coffee Company: A Strategic Analysis By Oleg Nekrassovski Introduction Starbucks saw great potential in the emerging market for its products in India, and has expressed intentions to expand its operations into India. However, the company remained hesitant about entering India, as the Indian market was perceived to present a number of challenges for Starbucks (Mankad and Thadamalla, 2012). One challenge, for a more cautious approach to market entry, was choosing an appropriate partner for a joint venture in India. Another, perhaps the most important challenge, was that the Indian hot beverage market was dominated by tea, while coffee lacked popularity (Mankad and Thadamalla, 2012). Data Analysis Strengths Coffee consumed outside the home, was rated better than tea consumption outside the home. Also, in many of India’s weak coffee markets, the coffee served outside the home, was criticized for its bitter and/or inconsistent taste (Mankad and Thadamalla, 2012). However, there was a strong rise in coffee consumption in India, since 1996. Trendy coffee bars, that started to replace conventional, old-fashioned Indian coffee houses, started to emerge in the late 1990s (Mankad and Thadamalla, 2012). Weaknesses It was said that many consumer health groups around the world were planning to campaign against Starbucks because of its high-calorie and high-fat products; which they claimed could lead to increased risk of obesity, heart diseases and cancer (Mankad and Thadamalla, 2012). Opportunities Indians’ knowledge levels of coffee generally appeared to be relatively weak. While respondents to an India-wide survey on coffee consumption indicated that they would be willing to consume more coffee outside the home, if they were reassured of coffee’s health benefits, and if coffee was more readily available outside. And according to one Starbucks official, the company was actively researching alternatives to its high-fat products (Mankad and Thadamalla, 2012).

1

Threats Tea dominated India’s hot beverage market. India was both the world’s largest consumer and the world’s largest producer of tea. In fact, over 20% of the global tea consumption took place in India, while up to 29% of the world’s tea was produced there. Tea was consumed twice a day by most Indians, in the morning and in the afternoon (Mankad and Thadamalla, 2012). It was widely believed to have health benefits, and was easily and extensively available. Milk was a close second, most popular hot beverage in India. Even though coffee could be considered third in the hot beverage market, the amount of it consumed was negligible when compared to the top two most popular Indian hot beverages (Mankad and Thadamalla, 2012). Alternatives One problematic challenge, which expanding Starbucks’ coffee chain into India could present for the company, was the expected strong competition to its coffee from traditional Indian beverage – tea. There is number of alternative approaches that the company can pursue in order to overcome this challenge:

Option-1: Starbucks can avoid the question of competition between tea and coffee altogether and follow the recommendation of Christine Day (president of Starbucks Asia Pacific Group) by simply advertising its coffeehouses as places for hanging out, eating and drinking, and seeing and being seen (Mankad and Thadamalla, 2012). Advantages: The uniqueness of Starbucks’ outlets may temporary attract people who like variety when it comes to the places they frequent for eating, drinking and socializing outside the home. Disadvantages: Starbucks will face strong competition from almost every other Indian eatery, bar, tea shop, and rival coffee chains; which may prove overwhelming.

Option-2: Starbucks can add a large selection of various types of teas, that are popular in India, to its menu. Advantages: Even those Indians who only drink tea will come to Starbucks’ outlets.

2

Disadvantages: This approach is unlikely to allow Starbucks achieve any significant competitive advantage as its outlets will face stiff competition from countless tea stalls that are found on every street corner in India (Indian tea culture, n. d.).

Option-3: Starbucks can attempt to greatly increase the popularity of coffee consumption in India, so as to make the volume of coffee consumption equal to that of tea, through various possible methods. Advantages: Given that around a half of all non-free beverages consumed in India is tea, while coffee forms no more than 2% of the total consumption of non-free beverages in India (Mankad and Thadamalla, 2012), successfully carrying out this approach, will enormously expand India’s coffee market while allowing Starbucks to dominate it. Disadvantages: This option is more time consuming and will require a much larger investment of resources.

Recommendations Option-1 Maximum possible revenue Starbucks has a habit of opening up one store at a time in new markets to test their potential, and average revenue for a successful, new Starbucks store is around US$1 million (Choi, 2012). However, this store will likely face extremely strong competition from almost every other Indian eatery, bar, tea shop, and rival coffee shops. Hence, expecting maximum revenue of around US$750,000 per year, from this store, seems reasonable. And with a stake of 50% in the joint operation of this store, Starbucks’ revenue from this store will be about US$375,000. Expenses Starbucks has a habit of opening up one store at a time in new markets to test their potential, and it costs them around US$450,000 to build a new store (Choi, 2012). In addition, operating one store costs about US$43,130 (US$1 billion /23,187 stores) per year; while the average cost of goods sold in one Starbucks store is about US$517,530 (US$12 billion /23,187 stores) per year (Annual Financials for Starbucks Corp., n.d.; Statistic Brain, 2014). Hence, yearly expenses on one Starbucks store (assuming straight-line depreciation of the store’s tangible 3

assets over 10 years) will be US$605,660. And with a stake of 50% in the joint operation of this store, Starbucks will have to invest about US$302,830 into this store, yearly.

Option-2 Maximum possible revenue If this option allows Starbucks to open and stay profitable with 50 stores across India (as it did in the first two years of its operations in China), while maintaining a stake of 50% in the joint operation of these stores; and its average revenue from each of these stores will equal to that of the average for its new stores (around US$1 million), then its yearly revenue from these stores will be around US$25 million. Expenses With 50 stores across India and a stake of 50% in the joint operation of these stores, Starbucks will have to invest about US$ 15.14 million into this venture, yearly.

Option-3 Maximum possible revenue Using data from the year 2000 (Mankad and Thadamalla, 2012), if consumption of coffee in India reaches that of tea, an average of about 44 liters of coffee will be consumed by each person yearly. Since there were about 950 million people in India, in 2000, such a consumption of coffee would mean that around 41.8 billion litres of coffee were consumed yearly in all of India. Assuming that Starbucks manages to capture 80% of the coffeehouse market, which would constitute about a half of all coffee consumption in India, about 16.7 billion liters of coffee will be consumed in Starbucks’ coffeehouses yearly. Assuming that a typical cup of coffee at Starbucks in India will be sold for US$1, while containing 1/3 litres of coffee, Starbucks’ yearly revenue, just from the coffee it sells in India, will be around US$50 billion. Expenses Given that an average yearly revenue for a successful, new Starbucks store is around US$1 million, while the total maximum possible revenue for this option will be US$50 billion; about 50,000 Starbucks coffee shops will be required to sell all that coffee and generate that much revenue. Assuming Starbuck’s complete ownership of these stores, and that the yearly 4

expenses on each of these stores will be US$605,660; Starbucks will have to spend about US$30.28 billion on this venture, yearly, just on running these stores. However, making the volume of coffee consumption, in India, equal to that of tea, through various methods, will require a very large investment, prior to opening all these stores. Assuming straight-line depreciation of this very large investment over 10 years of subsequent operations; it seems reasonably safe, to set US$50 billion as an investment for this purpose. This will pin Starbucks’ yearly expenses, for this option, at about US$35 billion.

Table 1: Evaluation of Alternatives - Summary Option-1 Maximum possible 375,000 revenue (US$/year) Expenses (US$/year, 302,830 assuming straight-line asset depreciation over 10 years) Maximum possible 72,170 income (US$/year)

Option-2 25 million

Option-3 50 billion

15.14 million

35 billion

10 million

15 billion

Thus, it is clear from Table 1, that, at least in the long-term, Option-3 is the optimal option for expanding Starbucks’ coffee chain into India.

Implementation Plan Starbucks will obviously have to borrow the required US$50 billion, from various lenders. And when it comes to using that money to make the volume of coffee consumption, in India, equal to that of tea, several complementary approaches are recommended: 1. Given that one of the main reasons for heavy tea drinking, across India, is tea’s strong roots in Indian culture (Indian tea culture, n.d.), it will be valuable to give coffee a cultural position, in Indian culture, equal to that of tea. This can be carried out through intense advertising campaigns which will portray common, pleasant social scenes of Indian culture, where tea is present, but replace the tea in these scenes with coffee. After all, according to classical conditioning, repeated pairing of a pleasant stimulus (e.g. a picture/video of a pleasant social scene) with a neutral stimulus (e.g. coffee), will lead to the development of equally pleasant feelings towards what originally was a neutral stimulus (Cherry, n.d.). Since, 5

advertisement tends to be very expensive, allocating US$25 billion to this undertaking seems to be reasonable. Naturally, the Marketing Department, of Starbucks Asia Pacific Group, will be responsible for leading and coordinating this advertising campaign. 2. Since the perceived health benefits of tea is one of the key reasons for it being the most popular hot beverage in India, making coffee take an at least equal position in Indian beverage market, will require aggressive advertisement of coffee’s health benefits. And there are many scientifically demonstrated, potential health benefits of coffee consumption (Coffee, n.d.). Though cheaper than the type of advertisement proposed in the previous point, mass advertisement of health benefits of coffee would still be expensive. So, allocating US$10 billion to this enterprise appears reasonable. Naturally, the Marketing Department, of Starbucks Asia Pacific Group, will also be responsible for leading and coordinating this advertising campaign. 3. Demonstrating the goodwill of the company, and, more importantly, compelling the population of India to acquire taste for Starbucks’ coffee offerings, while learning to enjoy spending time in Starbucks’ coffee shops, are also necessary if the goal of making coffee as popular as tea, across India, is to be achieved. It is recommended that this is carried out by opening multiple Starbucks stores, across India, which will offer, free of charge, one cup of coffee and one other item from the menu, to each customer, per day. Given that running one Starbucks store costs about US$605,660 per year; 10,000 stores can be opened across India, from the start, and serve free coffees (as specified above) for one year. This approach will be easily sustainable for one year, even if no customers will spend money to receive additional items, as it will cost US$6 billion. The obvious, large additional benefit of this approach is that 1/5 of all the stores that Starbucks needs to open to realize maximum revenues from operating in India, will already be open before profit-making begins. Naturally, the Operations Department, of Starbucks Asia Pacific Group, will be responsible for leading and coordinating this approach. 4. Since Starbucks’ coffee will still face strong competition from tea, reducing the demand for tea across India, is also recommended. India is one of the largest tea producers in the world, with over 70% of the tea produced in India being consumed within India itself (Sanyal, 2008). Hence, it is recommended that the demand for tea across India be reduced by increasing the cost of labour on India’s tea plantations. The increased cost of labour will inevitably lead to an increase in the price of tea, either by forcing the tea producers to pass the higher labour costs onto customers, or by reducing the production (and hence the supply) of tea. It is recommended that the cost of labour on India’s tea plantations be increased by recruiting, retraining, and accommodating India’s tea plantation workers for work as baristas in the 10,000 of Starbucks’ already opened coffee shops, across India, and in the additional 40,000 shops that will soon open. This will be easy to accomplish and will, as an additional benefit, 6

create a lot of goodwill towards Starbucks across India; because doing this will greatly increase the welfare of India’s tea plantation workers. After all, compared to the poor treatment and lack of benefits India’s tea plantation workers habitually receive from their employers (Bearak, 2014), working as a Starbucks barista will be like heaven. The US$9 billion, remaining from the initial implementation budget of US$50 billion, should be sufficient to accomplish the recommended recruitment, retraining, and accommodation of India’s tea plantation workers for the roles of Starbucks baristas. Naturally, the Human Resources Department, of Starbucks Asia Pacific Group, will be responsible for carrying out this endeavour.

7

References Annual Financials for Starbucks Corp. (n.d.). Retrieved July 27, 2014 from MarketWatch: http://www.marketwatch.com/investing/stock/sbux/financials Bearak, M. (2014, February 13). Hopes, and homes, crumbling on Indian tea plantations. The New York Times. Retrieved from http://www.nytimes.com/2014/02/14/world/asia/onindian-tea-plantations-low-wages-and-crumbling-homes.html?_r=0 Cherry, K. (n.d.). What is a conditioned stimulus? Retrieved July 26, 2014 from http://psychology.about.com/od/cindex/g/condstim.htm Choi, C. (2012, December 6). Starbucks to open 1,500 new US stores by 2017. The Christian Science Monitor. Retrieved from http://www.csmonitor.com/Business/Latest-NewsWires/2012/1206/Starbucks-to-open-1-500-new-US-stores-by-2017 Coffee. (n.d.). Retrieved July 26, 2014 from Wikipedia: http://en.wikipedia.org/wiki/Coffee Indian tea culture. (n.d.). Retrieved July 26, 2014 from Wikipedia: http://en.wikipedia.org/wiki/Indian_tea_culture Sanyal, S. (2008). The Indian renaissance: India’s rise after a thousand years of decline. London: World Scientific Publishing. Statistic Brain. (2014, July 12). Starbucks company statistics. Retrieved July 26, 2014 from http://www.statisticbrain.com/starbucks-company-statistics/ Mankad, R. and Thadamalla, J. S. (2012). Starbucks Coffee Company: The Indian Dilemma. In: Wheelen, T. L., and Hunger, J. D. (2012). Strategic management and business policy: Toward global sustainability (pp. 5-1 to 5-22). Boston: Pearson.

8