Even after a decline from their April highs, coffee futures are still up 55% this year. Even before the effect of this seeps down to customers' wallets, the average price of coffee at quick-service restaurants has already increased 2% to $2.29 nationwide through the end of March this year.
Higher coffee prices affect Starbucks (SBUX +1.47%), Dunkin' Brands Group (DNKN +0.00%) and McDonald's (MCD +0.97%) differently. However, Dunkin' Brands Group has been the first of the three to budge after CEO Nigel Travis recently stated that the company needed to address higher coffee prices.
Can Dunkin' Brands Group's Dunkin' Donuts brew higher coffee prices like Starbucks can?
Credit: Dunkin' Brands Group and Starbucks
Recent earnings and coffee dependency
In its most recent quarter , Starbucks posted record revenue with an increase of 9.1% to $3.9 billion, which resulted in net income rising 9.4% to $427 million. Despite 3% ticket growth, 2% traffic growth, and U.S. same-store sales growth of 6%, the story at Starbucks is not just coffee anymore.
Starbucks CEO Howard Schultz stated that balanced revenue and profit growth occurred across all reportable segments. In recent quarters, the company has focused on growing its Teavana and Evolution Fresh businesses while also adding more food to its Starbucks menu.
Dunkin' Brands Group saw its revenue increase 6.2% to $171.9 million in its recent quarter . However, net income fell 3.5% to $23.0 million on debt and refinancing transaction costs.
The story at Dunkin' Brands Group contrasts with that at Starbucks to some extent. Same-store sales growth has been in a downward trend for Dunkin' Brands Group since the first quarter of 2011.
Also, a higher dependency on not just coffee (in comparison with Starbucks) but also on the Eastern U.S. has been, and will be, an Achilles' heel for the company in the future. With just 225 stores to the west of the Mississippi River out of its 7,746 stores in the U.S., bad East Coast weather will continue to play a part in the company's earnings.
McDonald's has had same-store sales growth issues in the U.S. for over half a year. In the first two weeks of April , its free coffee promotion didn't produce growth for the month's same-store sales.
However, unlike Starbucks and Dunkin' Brands Group, McDonald's problems don't revolve around its coffee. For McDonald's, coffee is still a work in process that it plans to expand along with its breakfast lineup while the company focuses on its bigger menu items and overall brand.
Even though Arabica exports are expected to be 5% higher in 2014 from Brazil to 33 million bags, it might not be enough to satisfy demand. Credit: Pixabay
Can Dunkin' Donuts handle higher coffee prices though?
The licensing partner that sells Dunkin' Donuts-branded coffee in supermarkets has already raised prices by an average of 9%.
However, CEO Nigel Travis believes the company can make up for the impact on its coffee margins by increasing the prices of doughnuts and sandwiches. This could present other larger problems though.
First, Dunkin' Donuts isn't the only doughnut store in the world. Because doughnuts can be bought by the dozen for $5 or $6, higher prices could quickly move out of the price range that most consumers are comfortable with paying.
Second, the company's sandwiches, and specifically its breakfast sandwiches, currently compete in the 'breakfast wars' that involve several fast food chains like McDonald's. In a market segment where breakfast items are separated by just pennies, Dunkin' Donuts could lose out on this hot market if it moves its breakfast menu prices much higher.
Then there is the issue of how Dunkin' Donuts has fallen behind Starbucks in terms of coffee purchasing and its DD Perks Rewards program, which is similar to the My Starbucks Rewards program.
Dunkin' Donuts franchisees have just started to buy coffee for 2015. In contrast, Starbucks has locked in its coffee needs through the end of 2014 and achieved 40% completion for 2015. Even though the DD Perks Rewards program has just reached 1 million members, Starbucks has surpassed 8 million members in its program.
8 million reward members, one-third of transactions on a Starbucks Card, and 14% of transactions on a mobile device = Loyalty. Credit: Starbucks
Why higher coffee prices fit into Starbucks' master plan
Starbucks may be able to leverage higher coffee prices better as it continues to expand beyond coffee shop saturated North America. The company recently announced plans to open stores in the same Latin American regions where it has purchased coffee for decades. With 740 stores in 12 Latin American countries already, turning coffee-exporting countries into Starbucks consumers will make Starbucks less dependent on U.S. tastes and prices.
The My Starbucks Rewards program is bigger than its 8 million members. The program will provide a predictable revenue stream for years to come as program members represent 25% of all transactions in U.S. stores. It is unlikely that longtime members will jump ship due to higher coffee prices, especially with the program's perks.
The revenue streams of Teavana and Evolution Fresh may soon be joined by revenue from La Boulange, a bakery company that Starbucks acquired in 2012. Starbucks has used La Boulange in its own store menus. However, this past week, the first La Boulange restaurant opened up in Los Angeles, California.
While the new "evenings" menu and alcohol sales show how Starbucks is finding growth outside of coffee, it recently revealed plans to keep coffee drinkers coming to Starbucks for years to come.
Over the next three years , more than 100,000 Powermat charge pads will be installed in 7,500 company-owned stores in the U.S. These pads will allow customers to wirelessly charge their cell phones. So even if coffee prices eventually rise at Starbucks, it will still have an edge over the competition.
Bottom line
Higher coffee prices will continue to impact everyone involved in the business. Between Starbucks and Dunkin' Brands Group, Starbucks is by far the least dependent on coffee. The size of its business and its entrance into other market segments has created a hedge against higher coffee prices in the future.
Of the fast food chains, McDonald's may have the most leverage in getting the best deal on commodity costs. However, breakfast makes up 25% of its U.S. sales. With a long-term goal of having a coffee lineup comparable to top coffee shops like Starbucks in the future, McDonald's may also struggle on coffee margins if costs keep rising.
