It's been nearly a decade since the infamous McDonald's (NYSE:MCD) coffee lawsuit. An elderly woman leaving a Mickey D's drive-thru window, trying to add some cream and sugar into her steaming cup of joe, mishandled the coffee and suffered third degree burns. She sued the world's largest restaurant chain and won. It was a $2.7 million award that was ultimately reduced to $480,000 on appeal. Both parties eventually settled out of court.
In retrospect, there is one amazing McNugget to this hot molten java story that rarely gets mentioned. That errant cup of coffee? McDonald's was charging just $0.49 for the stuff! Flash forward to the amazing growth of Starbucks (NASDAQ:SBUX) and its elasticity -- if not audacity -- to charge $2 for a cup of coffee or even more for flavored bean water.
There is money in them there beans. Lots of money.
Too bad McDonald's is still nursing its wounds.
The Starbucks story
When Howard Schultz was inspired by the stylish espresso houses in Milan more than two decades ago, he convinced his bosses at Starbucks in Seattle to adopt this ambitious coffee bar culture. The ported concept worked. Spectacularly, thanks to the company's heady expansion after going public a dozen years ago.
Starbucks opened 1200 stores worldwide last year. It is looking to tack on 1300 more in 2004, wrapping up its fiscal year as a global empire with more than 8500 locations. The chain knows what it's doing. Same-store sales have grown by at least 5% during each of the last 12 years.
Forget the pastry treats, the whole bean coffee and even the coffee-making equipment you see selling at your local Starbucks. Seventy-seven percent of the company's retail business comes from its beverages. Yet while there is no denying that Starbucks is making a cozy living charging more than pocket change for its double lattes, running the store doesn't come cheap. Forty cents of your retail dollar goes to cover operating expenses at the store level. A slightly bigger chunk is consumed by the cost of sales and related occupancy expenses. Ultimately, just a dime trickles down as operating profit for the company -- and that's before the taxman starts to nibble, leaving just $0.06 to $0.07 of actual net income on the dollar.
Still, Starbucks stacked those nickels to the tune of $4.1 billion in net revenues last year.
Coffee business, anyone?
Wake up and smell the coffee, already!
Companies that would have been logical joe millionaires slept right through the Starbucks revolution.
Consider the poor handling of the specialty coffee trend by 7-Eleven (NYSE:SE). This is the company that dreamed up every possible Slurpee combination and unleashed that tub of carbonated overindulgence known as the Big Gulp at its nearly 20,000 worldwide locations. When it came to coffee, however, you could get any kind you wanted. As long as it was black.
Unlike Starbucks, just 5% of 7-Eleven's sales come from its coffee products. Late to the game but still looking to play, the leading convenience store chain is finally giving coffee the Slurpee treatment. Cherry Crème. Vanilla Nut. No, these aren't the latest sweetened frozen slush concoctions. These are the bold new flavors, along with Toasted Pecan and Irish Crème and more, that 7-Eleven is turning to in order to help grow its moribund coffee sales. Almond Amaretto Cappuccino anyone? Yes, 7-Eleven has finally woken up and smelled the specialty coffee.
But should it have tapped the snooze bar instead?
7-Eleven is commanding a fraction of Starbucks prices for its specialty blends, but it has to. The Starbucks experience isn't so much about the quality brew as it is the opportunity to leisurely sip it down in an inviting establishment. Where are you going to go with that 7-Eleven French Vanilla Cappuccino? Swigging it outside next to a guy asking for pocket change while he chugs out of a paper bag isn't entertainment. It's loitering. 7-Eleven has the latest magazines all racked up. That doesn't make it a threat to Barnes & Noble (NYSE:BKS). Even if the bulk of the morning traffic is takeout at Starbucks, putting 7-Eleven at some form of even keel, there is still some degree of allure that comes with the brand name.
Allied Domecq's (NYSE:AED) Dunkin' Donuts is in a more enviable position. It has seats. It also claims to be the leading dispenser of coffee, pouring nearly three million cups a day. More importantly, it's got folks like our own Dayana Yochim to swear by the chain's quality coffee. Dunkin' Donuts' brews are so in-demand that the company has launched a home and office delivery program.
In September, the chain started serving espressos. That's significant because, as Starbucks already knows, while traditional coffee may rule the morning, 40% of espresso-based beverages are sold later in the day.
Krispy Kreme (NYSE:KKD), the makers of dreamy decadent doughnuts whose inspiring growth story earned it a recommended slot in our popular Motley Fool Stock Advisor newsletter, has also got a whole latte love to give. While it won't be replacing its "Hot Doughnuts Now" signs with "Hot Coffee Now," the company is now stocked up on signature roasts, espressos, and frozen blends.
Brew ha has
McDonald's got burned doling out hot coffee. But what's it dishing out now that coffee is hot?
Coffee. Just coffee.
While the company would be a natural to throw its clown hat into the specialty coffee ring, something tells me that the words "mocha espresso" and "ball crawl" just don't sound right in the same sentence.
No, the real competition for Starbucks may very well come in the form of rival coffee bars. The Colombian Coffee Federation, backed by 560,000 coffee growers in Colombia, will be testing a Juan Valdez branded concept stateside later this year. The farmers, who receive $1.26 per pound of coffee under fair-trade deals, are looking for a bigger piece of the specialty coffee action and will try their hand at running a coffee bar business.
Unlike smaller rivals who underestimated the power of Starbucks and either closed down, were absorbed or simply subsist without thriving, Juan Valdez will have an intriguing advantage in that it owns the supply through its co-op of interested farmers. Yet the beauty of vertical integration is often no match for savvy marketing. It can also backfire if it appears to be a conflict of interest to the industry leaders. It was a glut of supply that prompted the organization to encourage fair-trade pricing amid heavy discounting in the first place.
So where does that leave you? Will you be ordering a bag of popcorn with your frozen cappuccino the next time you're at Wal-Mart (NYSE:WMT)? Are you going to try your luck with syrup concoctions the next time you're hankering for a 7-Eleven hot dog?
Starbucks educated the market. Unfortunately, the market's still got a latte to learn.
Rick Aristotle Munarriz is not an avid coffee drinker, though he can't pass on a good piece of tiramisu. He owns shares in Krispy Kreme. He penned The Five People You Meet in 7-Eleven. Rick's stock holdings can be viewed online, as can the Fool's disclosure policy.
