Starbucks Quickly Becoming a High-End McDonald's

The basic revenue formula for restaurants is customer traffic times average ticket price equals revenue. Normally, there is a trade-off between the two; more people go to McDonald's (NYSE: MCD  ) than Starbucks (NASDAQ: SBUX  ) because fewer people want to pay a premium price for food and beverages. McDonald's gets relatively high foot traffic but has low prices. Starbucks charges higher prices but does not have a constant stream of customers coming through the doors.

It is usually easier to boost customer traffic than it is to raise prices. McDonald's attracts customers throughout the day by offering separate menus tailored to breakfast, lunch, and late-night cravings. The idea is to offer customers a convenient value option whenever they need it. People have a reason to go to McDonald's whether it is 10 a.m. or 10 p.m.

Starbucks, on the other hand, attracts most of its customers in a tight window: the morning coffee crunch. A 2010 article in USA Today reported that U.S. Starbucks locations conduct 70% of all transactions before 2 p.m. If it wants to continue growing same-store sales in the saturated U.S. market, Starbucks needs to give customers a reason to return in the evening.

Starbucks to become a high-end McDonald's
Fortunately for investors, Starbucks is doing exactly what it needs to do to drive customer traffic outside of the breakfast daypart. For instance, since the 2010 article in USA Today, the company has introduced beer and wine to its beverage lineup in addition to bar food, like bacon-wrapped dates and truffle macaroni and cheese. The hope is that customers who rush to Starbucks in the morning to get their caffeine fix will want to come back and unwind with a glass of wine at the end of the workday -- a time when Starbucks has traditionally made relatively few sales.

Starbucks also seeks to boost its lunchtime traffic by offering gourmet sandwiches. Its ongoing rollout of La Boulange sandwiches and pastries provides yet another reason for customers to return to Starbucks in another daypart.

Most importantly, the strategy is working. Starbucks makes 50% more transactions per hour than it did in 2009. Still, there is plenty of room to grow. Food accounts for just 20% of Starbucks' revenue, with three-fourths of transactions made without food attached. Over the last three years, food has contributed up to 2 points in same-store sales growth each quarter. With the La Boulange rollout only about 25% complete, U.S. stores still have a long runway for growth.

Alcohol, too, is still in its early stages at Starbucks. Beer and wine are sold in only 26 U.S. locations but will eventually be present in 1,000 of its roughly 4,500 U.S. stores.

Already, Starbucks' most loyal 20% of customers visit a location every other day. Its loyalty program is reinforcing consumer habits to consistently visit Starbucks locations. If Starbucks can get those customers to come not just every day but multiple times per day, then U.S. same-store sales growth will explode.

McDonald's may extend breakfast hours
While Starbucks expands its menu to include lunch and evening items, McDonald's is considering extending its breakfast hours to appeal to customers who want breakfast during the lunch hour. This is consistent with principles designed to serve as many needstates in as many dayparts as possible. If people want breakfast for lunch, McDonald's will serve it to them. The idea is to increase foot traffic at all parts of the day. It is a slightly different strategy than Starbucks' but could be effective nonetheless.

Bottom line
Starbucks is quickly becoming a high-end McDonald's; it sells food and beverages that appeal to different people in different moods at various times of the day. Customers like the convenience of going by McDonald's at 9 p.m. to order a late dinner. A different set of customers like to unwind with a glass of wine at Starbucks after a long day of work. The more needstates and dayparts that Starbucks serves, the higher its revenue will grow. It is still in the early stages of catering to all of its customers' needs and therefore has a long runway for growth.

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8/29/2014 4:00 PM
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Starbucks CAPS Rating: ****
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