Global coffee-retailer Starbucks Corporation (NASDAQ:SBUX) experimented heavily with menu items in 2015, most noticeably in savory prepared foods, a category the company hopes will continue to drive traffic outside the breakfast daypart. Newly introduced items like the "Double-Smoked Bacon, Cheddar & Egg" sandwich helped sustain momentum during the company's recently concluded fiscal 2015 year, in which it set records for both revenue ($19.2 billion), and net income ($2.8 billion).
Yet if we're judging on the potential to create long-term value for the company, another contender should ascend the podium to claim the title of best menu item in 2015: Starbucks' Reserve Coffee. These are small-batch coffees, roasted in the company's elaborate "Seattle Roastery and Tasting Room," and shipped around the world to selected Starbucks stores. Reserve coffee is also available for mail order via subscription.
Starbucks opened its Seattle roastery in December of last year, the first of several the company indicates it will build in major cities globally during the next several years. These roasteries will supply 500 "Reserve stores," which will also be placed in global metropolitan areas.
Reserve stores emphasize alternative coffee-brewing methods, such as those found in the company's proprietary Clover machines, which combine both elements of vacuum and French-press brewing. Below is a picture of Starbuck's newly opened Reserve store in Covent Garden in London; notice the pour over and siphon stations placed along the curved marble counter:
Two reasons behind the elevation of Reserve coffee
It's certainly no business secret that Starbucks' consistent, caffeinated growth to date has relied upon the heavy customer traffic sustained by platform beverages: the drip coffees, lattes, and cappuccinos ordered by millions each day. So why would Starbucks even want to tamper with this successful formula?
The answer lies partly in the company's psyche. Starbucks doesn't just want to benefit from growing global coffee consumption; it wants to influence tastes and coffee culture. The chain's ubiquity has made it an easy target for scorn over the years from coffee aficionados and purists. Now, management seems to seek the admiration, rather than the derision, of those who desire an elevated coffee experience.
But Starbucks also wants to move beyond its treadmill of revenue, and nudge customers out of their morning rush-hour drip-coffee orders for an even more persuasive reason: margin. By originating from beans of limited quantity, sourced from small, select coffee farms in prized coffee-growing regions, to be then roasted in "micro lots," Reserve coffees cost Starbucks more to manufacture and distribute than its commoditized supply of standard drip coffees. But these exclusive coffees return a much higher margin to the company, as well.
While Starbucks doesn't disclose its margin on Reserve coffees, you can infer something of the profit potential by comparing a typical Reserve roast to the grocery aisle shelf price of one of Starbucks' standard-bearer coffees, like Pike Place Roast.
In my city, located in the Southeastern United States, Pike Place roast sells at $9.30 per 12 oz. bag, or $0.77 per oz., at my local grocery store. The Starbucks Reserve Aged Sumatra coffee, which is featured this month and can be ordered from the Reserve store online, runs $17.50 per 8.8 oz. bag, or $1.99 per oz.
To put this in percentage terms, the Reserve micro lot Sumatran will cost the Starbucks customer 257% more per ounce to buy and brew at home than the company's Pike Place Roast. It's not just the sophistication of the bean and roast that's creating the price differential for the customer and the additional profit for Starbucks, but the product's relative scarcity, an economic principle Starbucks has grasped, and is avidly utilizing.
A patient approach to demand creation
The gist of Starbucks' strategy is to use the Reserve roasteries, stores, and mail order subscriptions, as well as increased placement of Reserve coffees in non-metropolitan stores, as a giant demand lever. Having built the lever, the company will now slowly and firmly lean on it for years to come. You can think of it as an endless goal to introduce Starbucks' legions of worldwide coffee loyalists to an ever higher-end coffee product, educate them on alternate brewing methods, and steadily move this entire base of customers up the coffee chain.
The year 2015 was supposed to be the year the Reserve concept took flight. After launching the Seattle Roastery late last year, the company has largely hit its current-year goals. It now has more than 1,500 Clover machines in operation, has expanded the placement of Reserve coffees to "thousands" of stores, and has successfully launched the initiative to build hundreds of Reserve stores globally.
CEO Howard Schultz described Starbucks' ambition during the company's most-recent earnings conference call in late October as follows: "We continue to elevate and bring premiumization to the entire coffee category with our Starbucks Reserve Brand."
Schultz's succinct characterization explains why Reserve coffee, which can't even be purchased yet in every Starbucks location, was not only the company's best menu item in 2015, but potentially will be the most valuable one going forward.
Asit Sharma has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.