5 Things Starbucks' Management Wants You to Know

Starbucks' new, three-story flagship store in Bogota, Columbia. The chain will compete against local favorite Juan Valdez Cafe using 100% locally sourced coffee. Image: Starbucks Corporation.

In Starbucks' (NASDAQ: SBUX  ) parlance, you don't seek to understand demand, so much as you "identify new consumer need states." Regardless of the state of Starbuck's corporate verbiage, the company has become pretty good at discerning new and lucrative customer opportunities over the last few years. Below are five themes from the company's fiscal third quarter 2014 earnings conference call in late July, illustrated by quotes from Starbucks CEO Howard Schultz and COO Troy Alstead. These themes represent significant takeaways management hopes investors will digest as the company approaches its new fiscal year in October.

1. To grow, we're looking to expand in ... the U.S.

"Particularly noteworthy is that our U.S. retail store business delivered comp growth of 7%, ahead of our own expectations and a stunning achievement on a base of over 6,800 stores..."  -- Howard Schultz

Comparable store sales growth for any major retailer within the U.S. market is an accomplishment, given the sluggish economy left over from the 2008 recession. It's remarkable that Starbucks still sees the U.S. as so important to its overall growth, at a time when most American multinationals simply try to hold U.S. results at staus quo while searching abroad for new revenue. Starbucks has worked hard in its own backyard to understand what customers want and where expansion opportunities lie. While not every market centers on an addictive product like coffee, it's instructive to see a sprawling retail concern like Starbucks generate such tangible results. Through the first three quarters of fiscal 2014, the U.S. accounted for 73% of Starbucks' total revenue  -- and 74% of its operating profits. Having a secure base for future expansion in the U.S. is a sign of relative fiscal health.

2. By one measure, our business in China looks very promising

"...in China today, MSR transactions now account for over 40% of total tender, a remarkable metric, and demonstrates the loyalty of our Chinese customers and the relationship they have to this card." -- Howard Schultz

By most indications, Starbucks is winning plenty of converts in China's tea-loving culture. MSR refers to the "My Starbucks Rewards" loyalty program. The MSR program incentivizes repeat business as customers collect "stars" on purchases, which can be redeemed later for free food and beverages. Customers pre-load amounts onto physical cards or through an account on Starbucks' popular mobile app.

Management loves this program as it improves the company's already robust cash flow, and ultimately may improve margins. This is because some amounts loaded onto cards remain unspent, allowing the company to eventually realize unredeemed amounts as earned. Starbucks' deferred revenue account, which represents pre-loaded monies on MSR accounts which have not been utilized, grew by 27% in the first nine months of this fiscal year, from $654 million to $831 million.

Having 40% of transactions occur in this lucrative "loyalty" based format underscores the significance of China, which is already a key component in Starbucks' long-range plan.

Starbucks in Xintiandi district, Shanghai, China. Image by Brad & Ying under Creative Commons license.

 

3. We're serious about lunch and every other available daypart as well

"By the end of fiscal 2015, we expect the lunch program to look very different than it does today, and we will continue to evolve and enhance our lunch offerings in they years ahead."  -- Troy Alstead

Much of the time, the financial press tends to evaluate Starbuck's experiments with food in relation to other companies, for example, the impact a bona-fide lunch offering may have on Panera Bread or McDonalds. But for Starbucks, food, and especially lunch, doesn't represent an exercise to grab market share from competitors. The company is instead trying to determine how it can fill its stores with customers at every definable "daypart."

Granted, Starbucks has a lock on morning coffee. But it also wants to add breakfast traffic, lunch customers, afternoon tea drinkers (through promotion of its "Teavana" drinks and branded cafes), and also evening customers, with the recent introduction of wine and beer in some markets. Starbucks is even experimenting with a 24 hour format at a test location in Beijing. The rush to fill dayparts is of interest to long-term investors, as it answers the question of how SBUX can continue to grow once (and if ever) it over-saturates the various geographical markets it operates in.

4. "Refreshment" could be a new and robust market for us

"I would just add, it's clear to us that we have a significant opportunity in the need state of refreshment." -- Howard Schultz 

It's not by accident that Starbucks describes Fizzio, its homemade fountain drink which customers can customize, as a "preservative-free, handcrafted carbonated beverage." This is a call to millennials, who seem to be attracted to differentiated and artisanal products. Fizzio, Teavana Iced Teas, and other cold beverages show Starbucks' willingness to challenge traditional refreshment and soda providers like Coke. The company is ready to embrace younger (and many older) consumers who are avoiding Coke, Pepsi, and other soda brands which are increasingly deemed as unhealthy. Investors are likely to see some tangible numbers on the progress of Fizzio early next year.

5. We're not through with mobile payment innovation

"It's clear to us in our research that express order and pay is a big, big, idea, and a big enough idea that we can create significant incrementality if done right."  -- Howard Schultz

Starbucks' CEO Howard Schultz sees both the potential and the possible pitfalls of extending the functionality the company's extremely successful mobile app. Allowing customers to order ahead and pay before reaching their local Starbucks stores may increase the coffee maker's capacity during peak hours.

It could also throw a kink into stores' smoothly choreographed order flow, and depersonalize the interactions between customers and employees. Starbucks U.S. group president Clifford Burrows noted on the call that it's important that the introduction of "express order and pay" doesn't disrupt stores' normal production rhythms. He also pointed out that maintaining the interaction between barista and customer was a high priority to the company.

Starbucks now processes over 6 million transactions per week via mobile devices in the U.S. Potential stumbles notwithstanding, to further spur mobile transactions by adopting "express order and pay" could prove a small but vital component of revenue growth over the long-term. The company plans to test this functionality before Christmas, with a roll-out expected soon after.


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