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Starbucks Is Already in Front of the Next Big Trend in Retailing

One day not so far into the future, you will have no need for cash, credit cards, or even a wallet. All you will need to purchase your triple venti soy no-foam latte is your mobile phone.

Actually, that day has already arrived. Few people realize it, but Starbucks (NASDAQ: SBUX  ) is already leading the next big trend in retailing: mobile payments. Traditionally, consumers paid with cash or credit card, so the only way for retailers to track buyer habits was to hand them a separate rewards card -- rewards cards that were jammed into overstuffed wallets or forgotten at home.

Mobile payments eliminate the hassle of carrying a separate card, reduce transaction fees, boost customer discounts, and enable Starbucks, Dunkin' Brands (NASDAQ: DNKN  ) , and other retailers to track customer activity. It's a win-win for consumers and retailers -- and Starbucks is leading the way. This will not only have big ramifications for consumers, it also represents a game changer for shareholders in Starbucks and Dunkin' Brands as well.

How Starbucks benefits
After transforming the coffee industry, Starbucks is on the verge of transforming retail transactions. Business Insider estimates that more than $1 billion in Starbucks purchases were transacted via mobile devices in 2013 -- about 4% of total U.S. mobile payments.

Starbucks' mobile-payment application incorporates its rewards program, so it automatically tracks customers' Stars and card balances.

Source: Starbucks

The most beneficial aspect of the mobile-payment app from Starbucks' perspective is that it allows Starbucks to monitor and analyze customer behavior -- whether those customers are buying a latte at a Starbucks location or buying packaged Starbucks coffee at a grocery store. This information allows it to give targeted discounts and rewards in an attempt to forge new habits.

Starbucks' mobile app may eventually enable customers to order and pay for their beverages before arriving at the store, allowing busy professionals to quickly grab a cup of coffee on the way to work without having to wait in line. This could create problems -- such as customers who are in line wondering why they have to wait for mobile orders to be made -- but it also has enormous potential to improve the Starbucks experience.

Other innovations, like near-field communications and quick-response codes, promise to enhance the checkout experience even more.

The potential of mobile payments is underscored by Starbucks' recent management changes; former CFO Troy Alstead was recently promoted to the newly created chief operating officer, allowing CEO Howard Schultz to focus on mobile payments and other innovations.

Dunkin' Brands, Starbucks' most formidable competitor in the U.S., also sees the potential of mobile payments. Like Starbucks, Dunkin' Donuts' mobile app incorporates a loyalty program, DD Perks. Customers earn 5 points for every dollar spent, receive a free medium beverage when they join the program, on the customer's birthday, and for every 200 points earned, and also receive targeted coupons.

Why customers want it
Starbucks and Dunkin' Brands can only receive the benefits of tracking customer behavior if customers actually adopt mobile payments. Customers need more than the simple ease of not having to use a credit card in order to make the switch. Dave Banks, CIO of a 600-store grocery chain and an early adopter of mobile payments, tells CSP Magazine that the key is to lure customers with large discounts. He then goes on to say, "[P]eople are getting more comfortable paying by using [mobile] phones in general, but they're really looking to save money."

Most retailers have razor-thin margins, leaving little room for discounting above and beyond what they already offer customers. However, mobile payments cut out the middle man -- credit card companies -- allowing retailers to pass those savings on to customers.

Apparently, Starbucks' rewards are enough to entice customers to make the switch to mobile; more than 11% of payments to Starbucks are already being made with mobile devices -- and we're still in the early innings of the mobile-payment revolution. Dunkin' Brands, on the other hand, only recently launched its mobile app; it has yet to be seen whether Dunkin' Brands can replicate its larger rival's mobile-payments success.

Foolish takeaway
In the age of big data, it is no surprise that Starbucks and Dunkin' Brands want to track customer behavior down to every last purchase. Combined with information scraped from social media pages and other online databases, purchasing patterns can provide retailers with insights that lead to more targeted advertising and a better understanding of their customers. Rewards can also drive customer habits, encouraging them to always buy their latte at Starbucks so they can earn rewards.

Consumers can enjoy the discounts, rewards, and convenience of mobile payments while also receiving more relevant product offers.

Mobile payments are the future of brick-and-mortar retailing, and Starbucks is out in front. Shareholders should rejoice.

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Ted Cooper

Ted Cooper is a value investor based in Texas. He does not ride a horse to work.

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