When you order a cup of coffee from Starbucks (NASDAQ:SBUX), there are literally thousands of forms your final beverage can take. And while Starbucks is just one company actively participating in the customization super trend, it often finds ways to up the ante and deliver impressive results in the process.
In the accompanying video segment from the Industry Focus: Consumer Goods, Motley Fool analysts Vincent Shen and Asit Sharma break down just one instance of how the leading coffee chain has moved to customize offerings for coffee drinkers -- and its relevance to Starbucks' long-term growth rate.
A full transcript follows the video.
This podcast was recorded on Oct. 4, 2016.
Vincent Shen: We're going to go to the world of coffee. That's, of course, one of the biggest names there now, if not the biggest, Starbucks. Between what I feel is a pretty sizable menu, when you walk into a store and you look at it, tons of options. Then, you have the different options for what kind of milk you want. There's flavor shots, and they also offer different temperature levels. I don't think I'm missing anything else there. That has to be hundreds, if not thousands, of different options for your final drink and what it tastes like when you get it at Starbucks. How does this play into the customization trend that we've been discussing?
Asit Sharma: Starbucks as a retail organization is inherently about customization. This is the novelty of the anti-McDonald's. Before the show, Vince and I were talking about, 15 or 20 years ago, the lack of options, and how ubiquitous that McDonald's cup of coffee was. If you think about extremes on the sides of the pendulum, this is the opposite extreme of the customization pendulum. There are literally so many customization options, Starbucks could choose to rest on those laurels, but it doesn't. It's always trying to push customization one step further. There are two paths to customization that we're going to talk about today. One is pretty expensive per store, and the other is almost costless. We'll talk about the costless option for Starbucks at the end of the episode, and let you, the listener, try to figure out what we're talking about. What customization option does Starbucks offer that costs them almost nothing?
To get back to this first path, several of you who are coffee snobs or connoisseurs like myself probably remember when Starbucks acquired a machine called a Clover. This was back in 2008. I had tried this coffee out in Toronto several years ago. It's a machine that used to retail at $11,000. If you think of a coffee machine that's a little bit bigger than the size of a laser printer, this is quite an expensive piece of equipment. But what this machine does is, it allows the barista to work with the customer for brew time, down to the second, and how much exposure the water has to the actual coffee grounds. You can dial in a precise temperature. This is the Holy Grail, for many people, of customization for coffee. It's a vacuum type coffee process, and it's extremely delicious when it's done right. But I will say, it takes some experimentation to get this right. Each cup runs you $3 to $4 for that small size, the tall size, at Starbucks.
Shen: I'm impressed. I remember hearing a bit about the news, in terms of how they were adopting this Clover system, how costly it is. I'm not as big of a coffee drinker, so I will defer to your expertise and your preferences here. But I understand in this world, whether it's with sneaker heads in Nike shoes, or coffee, or so many other things out there, there is some aficionado out there who likes it down to the most minute detail. That's playing out with the trend that we're seeing with some of these companies.
Sharma: Exactly. Starbucks is using precisely the same strategies that Nike uses. They're educating the customer, they're giving the customer a sense of product design. In doing that, they're trying to increase that lifetime value. Now, fellow coffee snobs, I know that in your cities, you're going to local coffee shops and hanging out drinking great coffee. But how many times have you been in transit and stopped at a Starbucks? For some of us, we might as well go for the Clover option if they have it, because it's closer to what we're used to having. And Starbucks is well aware of this. They know that not everyone is going to be a Starbucks loyal customer for life. But as they moved us all up this chain of premiumization, that is customers who, years ago, were drinking that McDonald's cup, and now come in and ask for all sorts of variation on their coffees, as you were talking about, Vince, that increases their profit.
And I would like to take just a second to say something about both Nike and Starbucks, which is important to know if you're an investor. Each of these companies, for a large global conglomerate, has an incredible growth rate. I think Starbucks has been growing at a compounded annual revenue growth rate of about 11% over the last several years. Nike's most recent quarter, they grew total revenues 8%. This is very difficult to do when you're in the billions and billions of dollars of revenue.
How does customization play into this? We talked today about that incremental profit that both companies make when you start to customize your order. That's the first go-around. Customization, initially, is incremental. But as time goes on, it becomes part of the company's recurring revenue base. So, when Vince finally gets won over to highbrow coffee drinking, and comes in every day and orders that same premium cup of coffee, they've turned that first time incremental experience into their revenue base. That's how these companies manage to grow revenues even as they scale up, again, into the billions of dollars.