1 Reason Starbucks Will Outshine McDonald's in 2014 and Beyond



Starbucks (NASDAQ: SBUX  ) is the unquestionable leader in the coffee industry. Its high-quality brews and inviting store atmospheres command a premium from its affluent customer base. Competition from McDonald's (NYSE: MCD  ) and other entrants into the coffee space is putting pressure on Starbucks to justify its premium prices. However, Starbucks' near-perfect adaptation of the McDonald's model will enable it to fend off its rivals for years to come.

Starbucks improved the McDonald's model
McDonald's was a pioneer in the global restaurant chain concept; it took one store model and replicated it around the world. It built its brand by serving the same menu and providing the same quality of service at all of its locations. As a result, a McDonald's customer in New York can expect the same experience that he gets when he visits a McDonald's in London. The consistency and reliability of service has made McDonald's the world's largest -- and most profitable -- burger chain.

Starbucks unwittingly copied the McDonald's model and added a twist. Like local burger chains, local coffee houses are hit-or-miss in terms of quality; a busy professional would not know how quickly his or her beverage would be served or what it would taste like. Starbucks' baristas go through extensive training to ensure the service is uniform across all locations. This is a powerful advantage that draws people to Starbucks.

The twist comes from the product quality. McDonald's is decidedly low-end when the entire spectrum of restaurants is considered. Starbucks, on the other hand, has managed to grow into an international chain while still serving high-quality coffee. This allows it to charge a premium and earn high margins. Although the company does not break out profit margin by product, one coffee executive claims that a $7 ultra-premium Starbucks coffee costs the company only $1.30 to produce.

Premium quality attracts an affluent customer base -- and those who wish to join the affluent. Chinese customers pay even more than Americans for their Starbucks coffee; in China, Starbucks is seen as a status symbol, an indication of success. No matter where in the world you are, McDonald's is not a status symbol. Starbucks gets an edge because it is higher up the affluence chain, which enables it to charge a premium even if McDonald's were to make the same brew.

Of course, McDonald's could never replicate Starbucks' lineup of drinks. McDonald's has 20 different McCafe drinks, seven of which are smoothies or shakes. Starbucks' basic menu has dozens of coffee-based drinks and 87,000 possible combinations.

McDonald's cannot match the quality or variety of Starbucks' offerings any more than Starbucks can serve cheap fast-food at a 30% operating margin. Starbucks bought 545 million pounds of coffee in 2012. It has relationships with farmers all over the world and a global supply chain to deliver the ingredients efficiently. McDonald's has a similar supply chain to serve its 34,000 locations in 118 countries, but it will never command the premium that Starbucks earns on its coffee -- McDonald's is positioned in consumers' minds as a low-end value chain, while Starbucks is glorified as a high-end chain.

Bottom line
Starbucks generated nearly $3 billion in cash from operations during 2013. Because of its scale and premium brand image, Starbucks will undoubtedly generate more than $3 billion in 2023. How many other restaurant chains can have the same conviction?

The quality of Starbucks' coffee is not a competitive advantage; any local chain can serve coffee that is at least as good as Starbucks'. However, no other company can enter the place in consumers' minds reserved for consistently high-quality coffee served faster than a Happy Meal -- it is already occupied by Starbucks.

Will Starbucks help you retire rich?
It's no secret that investors tend to be impatient with the market, but the best investment strategy is to buy shares in solid businesses and keep them for the long term. In the special free report, "3 Stocks That Will Help You Retire Rich," The Motley Fool shares investment ideas and strategies that could help you build wealth for years to come. Click here to grab your free copy today.


Read/Post Comments (0) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2777672, ~/Articles/ArticleHandler.aspx, 11/21/2014 1:03:00 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement