Starbucks Invades the Grocery Aisle: What It Means for Your Investment

There is a Starbucks (NASDAQ: SBUX  ) within 20 miles of 80% of Americans, but the ubiquitous coffee company is not done expanding yet. It is taking its premium concept to the grocery aisle with a twist that elevates it above Kraft Foods (NASDAQ: KRFT  ) , J.M. Smucker (NYSE: SJM  ) , and other competitors.

Taking the "Starbucks Experience" to the grocery aisle
Starbucks' interest in selling packaged coffee in grocery stores is not new. The company began selling private-label coffee in Costco in 1989. In 1998, Starbucks signed a distribution deal with Kraft that enabled it to get its packaged coffee into grocery stores nationwide.

Grocery aisles are extremely competitive because consumers can easily compare the price and qualities of products sold side-by-side. Even Starbucks' premium coffee is not immune to pricing pressure. Cheaper brands like J.M. Smucker-owned Folger's coffee and Kraft's Maxwell House are formidable competitors; Starbucks reduced its packaged-coffee prices in 2013 in lockstep with competitors who were taking advantage of low arabica prices. Still, Starbucks managed to increase its packaged-goods operating margin by 4.5 percentage points in the fourth quarter despite the price reduction.

Starbucks increased its share of the grocery aisle from almost nothing in 1998 to nearly 13% in August 2012. It now stands third among at-home coffee producers in the grocery channel, behind only J.M. Smucker (24% share) and Kraft (18% share).

Despite its success in the channel thus far, Starbucks has yet to reach Howard Schultz's goal of building "a major multibillion-dollar business in the grocery industry." Revenue from packaged coffee and tea sold in grocery stores totaled slightly more than $1 billion in fiscal 2013, a mere 7% of the company's total revenue. But the company's big push into the channel may be about to change that.

One of the key reasons Starbucks ended its distribution deal with Kraft -- a move that cost nearly $3 billion -- was that Starbucks wanted to control its product display to avoid cheapening its brand. Instead of being just another option alongside the other brands, the company launched the Starbucks Signature Aisle.

The Signature Aisle is a section at the end of an aisle that is dressed up with a large mermaid logo and top-to-bottom Starbucks coffee bags luring in customers. The shelves are color-coded to indicate the type of roast and whether or not it is decaf.

Everybody wins with the Signature Aisle
The Signature Aisle was already in 100 stores in October and is targeted to be in at least 400 stores by October of this year. There is reason to believe it will grow much bigger in the future. Nearly half of U.S. coffee drinkers consume more coffee at home than they do away from home. Premium coffee is a high-margin product for grocery stores and grocers say the setup attracts customers to the aisle -- lifting sales for all coffee products. Just as strip malls invite Starbucks to build a location to draw traffic, grocers may invite the Signature Aisle to drive up profits for everyone.

Although everyone wins when more customers come down the coffee aisle, Starbucks is in the best position to capture customers. Not only does it have the most visible shelf space, customers can earn My Starbucks Rewards points by choosing Starbucks in the grocery store. Kraft and J.M. Smucker cannot match that offering.

A must-have channel
Starbucks is nearing saturation in the United States; 8,000 of its 10,200 company-owned stores are located in the U.S. Its U.S. store count grew by less than 3% in fiscal 2013. Although same-store sales may increase as a result of Starbucks' expanded food menu, the company needs a new source of growth to fuel growth in its biggest market. The Starbucks Signature Aisle grabs attention and maintains the company's status as a premium brand.

Though the grocery roll-out is still in its infancy, investors should not take Schultz's goal of building a grocery powerhouse lightly. China, La Boulange, and Teavana may be hogging the stock market's attention, but tackling the grocery aisle will enable the company to dominate all channels of the premium coffee market -- a major boon for investors.

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