Starbucks (SBUX 1.09%) has long been an icon of premium coffee, as shown by its relatively high prices. Yet the company has been successful in gaining massive market share, regardless of prices higher than that of Dunkin' Brands Group's (DNKN) Dunkin' Donuts coffee shops. Starbucks raised prices at its U.S. stores earlier this year and just put through a price bump in the U.K. Let's take a look at how effective Starbucks' strategy of raising prices has been.
Image: Starbucks
In the U.K., average prices on drinks at all locations were increased slightly, by about 10 pence ($0.16). While there have been no announcements of another price increase coming to the U.S. anytime soon, looking at the trend in rising prices, it's likely that there will be one in the not-too-distant future.
The most recent rise in Starbucks prices in the U.S. happened in June, when prices on most drinks rose about $0.05 to $0.20. Prices on goods such as retail store bags of ground coffee also rose around 8%.
Starbucks has made small incremental price increases regularly in the last five years. Now consumers will spend about 17% more for a regular medium coffee at Starbucks (about $2.10) than at Dunkin' Donuts (about $1.79).
However, Starbucks is not looking to compete on price. Instead the company has used innovating marketing, architecture and design, location, and customer-focused technology as ways to get more traffic and to keep customers paying higher prices.
Price hikes, sales, and profit-all seem to be rising together
Regardless of price hikes nearly every year in the last five years, the company is still able to drive more customers, more sales, and more profits. In fiscal year 2014, ended Sept. 30, the company reported revenues in the U.S. up 9% year over year. This was not only driven by increased spend per customer, but also by increased traffic. Thanks to rising sales, the company was able to report income of $3.1 billion in 2014, up 25% from 2013.
These impressive 2014 increases follow a trend of five years of nearly consistent growth. In terms of comparable-store sales, this recent quarter marks the 19th quarter in a row of at least 5% growth, year over year. Regardless of rising coffee and dairy prices in the recent years, the company has still been able to raise sales faster than costs and continually outperform. For investors, the stock has outperformed as well, up more than 260% over the last five years.
Why Starbucks is worth the price, both the coffee and the stock
Regardless of rising prices, already at a premium over competitors like Dunkin' Donuts, Starbucks is still increasing traffic through its strategy of giving customers much more than just a cup of coffee. Through innovative marketing and a focus on customer experience, Starbucks has been able to create incredibly strong brand loyalty and, as shown by the price increases, a high level of pricing power.
This brand loyalty and pricing power, helping to create higher visitation in 2014 and higher comparable-store sales, has helped the company to remain very profitable regardless of the company itself paying more for some of its ingredients. For these reasons, Starbucks' stock price, like its coffee prices, seems only poised to go higher. Though the stock itself is also selling at a premium now, at a P/E of 28, according to S&P Capital IQ data, that is still less expensive than that of Dunkin' Brands Group at 30 times earnings. Pricing power is a reason to believe that Starbucks can continue improving its sales and profits in 2015, and the analyst-estimated 2015 year-end P/E of 21 looks even more attractive.
