With more than 20,000 coffeehouses spread over 60 countries, Starbucks (NASDAQ: SBUX ) has built a very profitable coffee empire. Impressive marketing efforts, continuous menu innovation, and strategic geographical expansion helped Starbucks grow its revenue quickly; in fact, revenue reached $13.3 billion last year. Furthermore, Starbucks enjoys one of the highest operating margins in the industry thanks to its strong branding.
The attractive combination of high margins and aggressive revenue expansion has caused Starbucks' value to increase enormously. How did Starbucks manage to create a strong coffee empire despite increasing competition from traditional players such as Dunkin' Brands (NASDAQ: DNKN ) , and the emergence of challengers like Panera Bread (NASDAQ: PNRA ) ? More importantly, how long will Starbucks' dominance in the coffee world last?
Source: Starbucks Investor Relations
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The Coffee empire
A business needs to have plenty of competitive advantages to become an empire. First, Starbucks directly controls every important step of its business, from buying high-quality coffee beans to designing its franchise decor. This allows Starbucks to minimize its operating risks. For example, by being one of the most important buyers of coffee arabica in the world, the company has enormous influence over its suppliers and it can ensure competitive prices, superior quality, and the necessary quantities at the right time.
Second, Starbucks creates a unique atmosphere surrounding its products based on four key factors: quality, service, ambiance, and culture.
The company maximizes quality not only by buying high-quality coffee beans, but also by equipping its coffee houses with excellent coffee machines.
To ensure perfect service, the company trains its baristas for over 30 hours. Baristas become very professional, not only at making coffee, but also at handling as many as 200 customers per hour.
In terms of ambiance, Starbucks has carefully chosen its color combination, couches, and lights to create a great place for coffee-lovers. The company keeps its customer loyalty high by promoting a genuine passion for coffee that goes beyond a cup of cappuccino. Starbucks promotes coffee rituals, love for organic ingredients, environmental friendship, and millennial values.
Finally, Starbucks is constantly innovating its menu and starting new businesses, such as selling energy drinks or coffee machines. The company has recently focused on strengthening its sandwiches and bakery business. That's why last year the company shelled out $100 million to acquire La Boulange Bakery, which specializes in traditional pastries. More recently, the company launched a £2 breakfast offer in the U.K. to capture price-sensitive customers.
Starbucks' sandwiches and bakery compete directly against Panera Bread, which was recently downgraded by Morgan Stanley based on research suggesting that a third of Panera's customers think menu prices are high. The truth is that although Panera may have an excellent menu offering, its brand is not as strong as that of Starbucks. Panera is not synonymous to bakery, but Starbucks basically means coffee in more than 50 countries. Furthermore, Panera does not have the same scale advantages that Starbucks enjoys thanks to Starbucks' amazing global supply chain. With more than 17,000 locations worldwide, Dunkin' Brands has economies of scale that are as strong as Starbucks. Both companies face similar challenges. Just like Starbucks wants to become more than a coffee shop, Dunkin wants to become more than a doughnut shop. Dunkin wants to attract more coffee lovers, and is also expanding its menu to include sandwiches and other high-margin offerings that go well with coffee. Interestingly, Dunkin is strong in the east side of the U.S. while Starbucks is very powerful in the west. Since both companies plan to infringe upon the other's territory, competition will get fiercer. If Dunkin can change its image to attract more coffee lovers while retaining doughnut fans, it could see an acceleration in revenue growth at the expense of Starbucks.Final Foolish takeaway
Few companies are more innovative than Starbucks. From offering unique decor to controlling every step of its supply chain, the company has plenty of competitive advantages in motion to protect its business. Furthermore, although Starbucks has thousands of locations all over the world, the market does not seem saturated. Previous success in China and Japan, where the company recently opened its 1,000th store, suggests that the company can raise its penetration ratios in those countries as high as its penetration ratio in the U.S. market.
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