Why the Teavana/Starbucks Partnership Makes So Much Sense

The recent rash of Teavana promotions by Starbucks reveal where the coffee giant is looking to expand.

Jun 4, 2014 at 10:00AM

Starbucks (NASDAQ:SBUX), the owner of Teavana, the hippest tea company around, is promoting its new purchase in all sorts of ways. The coffee giant paid $620 million for the tea business in 2012, and until recently had made only minimal efforts to grow the brand. Now that's changing.

Once known as Starbucks Coffee, Tea, and Spices, later rebranded as Starbucks Coffee, and now down to simply Starbucks, the now coffee-centric giant is looking to expand your concept of tea beyond that basic cup of hot liquid your grandmother loved so much.

Screen Shot

(Teavana) Your grandmother wouldn't even realize this was tea.

What is Starbucks doing?

Teavana products are getting more presence in the chain's formerly coffee-centric stores. The most notable beneficiary is the company's Oprah Winfrey-branded tea line, Teavana Oprah Chai. That line is being supported by in-store displays and signs as well as tastings in some markets.

Winfrey's following, developed through years of her popular talk show, makes her an ideal candidate to promote the new Starbucks-Teavana brand. Though she is not as powerful as she once was, Winfrey's opinion still holds sway over many and should draw customers.

Starbucks has increased its overall retail presence recently and those efforts have included Teavana. Though only a limited selection of Teavana items are being sold outside Starbucks and Teavana stores, the company is likely to expand those efforts. Starbucks has built a diverse, efficient distribution system and tea is easily plugged into that pipeline.

Why tea/why now?

Teavana is not Starbucks' first foray into tea. The company already owned the Tazo brand of teas when it purchased Teavana.

In an April 2013 interview with Fool CEO Tom Gardner, Starbucks CFO Troy Alstead said, "[tea's] been a category that we have not put enough focus into. We have a fantastic brand in Tazo, but we recognize we have opportunity both through our stores and through the CPG [consumer packaged goods] channels and globally to really reignite what tea means to us.... Tea is a slower, Zen-like experience for people. It tends to skew to the afternoon. It skews to the evening. It skews to the weekend."

Tea is a way for Starbucks to gain new customers and to expose its current audience to an alternative to coffee. Teavana has its own retail stores and is more of a brand, while Tazo was/is more a name on a box.

What does an iced tea really cost to make?

Another reason Starbucks might want its customers drinking tea is that it offers the company a hedge against volatile coffee prices. Of course tea can also vary, but diversifying the company's product line offers it some protections.

Every cup of tea or coffee sold hits the company's bottom line, so I calculated how much Starbucks earns per cup of iced tea (as summer is rapidly approaching) versus its earned income per cup of drip coffee sold. As Starbucks does not report these numbers in any financial disclosure I was able to find, I had to estimate and numbers will vary around the country.

For argument's sake I decided to use my favorite Starbucks beverage as the tea measure: an iced green tea, which sells for $1.75 at my local Starbucks here in Central Connecticut.

I looked at Teavana tea prices online to determine cost. A tin of Jade Green Mao Feng (Green Tea) costs $14.98 before shipping and handling. Assuming that Starbucks would mark up its products by at least 100% -- and most companies mark up by quite a bit more -- I calculated that they would pay $7.50 per tin. (This is a very rough cost calculation.)

According to the Teavana website, each tin holds about 25-30 teaspoons of tea, or 12-15 balls of tea, assuming Starbucks brews its tea at the recommended double strength for each cup of iced tea.  Even assuming one can only make 12 cups of tea per tin, the math shows a rough cost of $0.62 cost per cup of tea.

Starbucks likely pays well less than this per cup, but even my clumsy and conservative calculations show that tea has a hefty margin.

What does a cup of coffee really cost to make?

If tea has a good margin, then coffee is spectacular.

I chose a cup of iced coffee in comparison as it is also brewed at double strength. A pound of Starbucks House Blend retails on the Starbucks website for $11.95. Assuming the same mark-up in retail, Starbucks most likely pays $6 or less per bag. As the FAQ section on the Starbucks website  tells us "a 1-lb bag of coffee yields approximately 64 5-oz cups." I calculated the price point of each cup of iced coffee to cost Starbucks $0.17 to produce.

My local Starbucks charges me $2.15 pre-tax for said cup. That means the mark-up on my tall cup of drip coffee is about 12 times what it cost to make my coffee.

Starbucks makes more money on coffee than tea using these numbers, but tea still has a high enough margin to be worth it for the company. It's also likely that selling high-end tea opens Starbucks up to non-coffee-drinking customers.

Tea is of worldwide importance

Diversifying its brand is a smart move for Starbucks, and tea is a natural thought as a beverage alternative to coffee. It attracts a different customer, and is a simple way to retain visitors who regularly buy coffee but are searching for something different.

Additionally, the U.S. tea market has displayed steady growth over the last two decades. "The tea industry ... has seen the total wholesale value of tea sold in the USA grow from under $2 billion to well over $10 billion today," according to the 2013 State of the Industry report by Teausa.com. Outside the U.S., of course, is a far larger tea market, valued at about $90 billion, according to Starbucks CEO Howard Schultz.

Offering a high-quality tea may attract more customers than marketing itself as solely a coffee shop, particularly abroad, as the way coffee is made and consumed varies from culture to culture.

Starbucks has about 3,100 stores abroad, according to the 2013 annual report. The coffee giant conducts only 25% of its business outside the U.S. Alstead has stated that Starbucks wants to increase that number and promoting Teavana teas in-store might be exactly how to capture a bigger market share.

Though coffee drives more revenue for Starbucks, tea will likely draw new customers. Once they are comfortable with the brand, many will return and become repeat customers. In Teavana, Starbucks has found an opportunity to expand beyond the niche it occupies now and broaden the scope of its market share.

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Kate Cimini has no position in any stocks mentioned although she does make use of the Starbucks complimentary wifi every now and again. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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