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According to a report from The Wall Street Journal last year, in China, a Starbucks (NASDAQ: SBUX ) grande latte costs $0.64 in raw materials. That covers the cup, lid, sleeve, sweeteners, milk, and espresso. Clearly, the biggest costs are the milk and the espresso. For illustrative purposes, let's make an assumption that the other pieces cost around $0.14 -- the cup being the biggest chunk of that. That means Starbucks is spending $0.50 on milk and coffee. While these numbers are quoted for China, they work out surprisingly close to the same prices in the U.S.
In a grande latte, there are two ounces of espresso, with 14 ounces of steamed milk. The exact costs don't make or break the point, but for argument's sake, we're going to assume milk makes up $0.35 of the cost, and espresso makes up the final $0.15. Knowing all that, if you were looking to make more profit per drink, where would you shave off costs?
The value of going short
One of Starbucks' public secrets is that they offer things not listed on the menu. The most surprising of these is the existence of an additional size -- the eight-ounce "short" drink. The short is Starbucks' ticket to increased coffee profit.
In a short, one shot of espresso mixes with seven ounces of milk. That means that the product cost -- based on our earlier estimates -- is around $0.25. I'm here to tell you that a short latte doesn't cost the consumer 50% of a grande's price -- in fact, it runs closer to 66%. So, why doesn't Starbucks make more out of the short size?
The answer is the same reason real estate agents sell houses and not lemonade instead -- pure cash.
Margin versus cash
Even though the short drink generates a higher margin, it generates less pure cash -- about 45% less cash. At the end of it all, the prize goes to the one who holds the cash, not the one who spent the least. That doesn't mean expanding on the short line is a bad idea, though. What Starbucks could do is sell the product as a premium experience, charging even more for it.
As a coffee drinker, the beauty of the short latte is that the espresso comes through more clearly, but is still balanced by the milk. Starbucks could use the short latte to highlight its higher-end bagged coffees, charging more for the drink and generating cross-sales of the bagged product for home consumption.
Starbucks plays the long game
Over the past year and a half, Starbucks has focused on growing its options. It acquired a bakery and a tea retailer, pushing out its options beyond the basics of coffee. That's a great way for the business to expand its top and bottom lines, but it does risk the brand losing sight of its core competency.
There are plenty of other ways for Starbucks to address its core, of course. The company just launched a new line of instant espresso drinks that's sure to be a hit with consumers who picked up the surprisingly drinkable Via branded instant coffee. An increased focus on the short game would be another good step and could help stores compete with high-end brands, as well.
Is Starbucks a "hold forever" stock?
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