How Starbucks Makes Money (SBUX)

In the late 20th century, coffee was merely a beverage, not a lifestyle brand with its own inescapable culture. Then Starbucks (SBUX) began spreading across the United States and the entire world, and neither caffeine delivery nor the retail real estate industry would ever be the same again.

Whether you’re a loyal Starbucks customer or not, you’re probably familiar with the broad strokes of the company’s history. Starbucks was founded in Seattle in 1971, expanded to a few dozen stores (in Seattle, Vancouver, and Chicago) by the late 1980s, then metastasized seemingly overnight into a 25,000-store colossus.

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On July 26, 2018, Starbucks released Q3 fiscal 2018 earnings. The company reported that consolidated net revenues reached $6.3 billion, an 11% increase from the same quarter of the previous year. Active Starbucks RewardsTM membership in the U.S. increased 14% Year-Over-Year to 15.1 Million.

Beans, Water, and Fire

The Starbucks concept is about as low-tech as modern business gets, and the corresponding margins are delicious. Even an unadorned black coffee at Starbucks sells for quadruple its underlying costs. So what’s the company’s secret, and how did a glorified neighborhood espresso bar invade 70 countries and turn the consumption of coffee an activity unto itself and an $22 billion business?

From Humble Beginnings

The company divides its operations primarily geographically, into the Americas; Europe, the Middle East and Africa (EMEA); China/Asia Pacific; and something called Channel Development, which the corporate-speak way of saying “everything other than retail stores.” Channel Development includes the packaged ground coffee you get at the supermarket, and the single-serving Frappucino bottles at the convenience store.

With 25,085 stores, it’s a given that Starbucks has to franchise, right? Wrong. Starbucks has a very, very limited number of franchisees in the United Kingdom and South Africa, and doesn’t accept franchise submissions in North America. But that doesn’t mean that every one of those stores is company-owned in the strictest sense. Seventy-nine percent of revenue comes from company operated stores, meaning thousands of stores operate under licensing agreements. The airport kiosk, the bookless corner of your neighborhood Barnes & Noble (BKS), the stand-up service counter at the entrance to Safeway – all of those locations help Starbucks pervade the minds of its customers, and make it inescapable. 

In 2012, Starbucks acquired the specialty tea store, Teavana, for $620 million. On July 28, 2017, however, Starbucks announced it would close all 379 Teavana locations due to poor sales and little chance of improvement.

The licensed stores are familiar on Starbucks’ home continent, if not dominant. They comprise 42% of the company’s total of 15,607 North American stores. But in the rest of the world, licensed stores are in the majority – including 55% of the company’s 6,443 stores in China/Asia Pacific, and 80% of stores elsewhere. Add it all up, and company-owned stores predominate by only the slimmest of margins, 50.6% to 49.4%. 

Dollar for Dollar

Not exactly. The company’s own stores accounted for 79% of total FY17 revenue of $22.4 billion. Starbucks company stores encourage loitering, which might seem counterintuitive. But company store customers end up buying a lot of coffee on their extended visits, more than the people who fill up at the licensed stores with the intention of getting their drink on and getting out. Licensed stores’ operating margins are higher than conventional stores’. Also, the relative numbers have something to do with the licensed stores being located in North America, where the sedentary act of buying coffee and then settling in for a long and relaxed linger is well-established. Coffee drinkers in the rest of the world, at least outside of Vienna, have yet to adopt that behavior en masse.

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The company also owns other brands that the uninitiated might think compete with Starbucks: Seattle’s Best and Teavana, among others. At the retail level, the dominant majority of Starbucks’ revenue comes from drink sales. Beverages account for 73% of the sales mix. Pastries, sandwiches, and other food account for a historically consistent 20% of sales, with the remainder almost evenly split between packaged coffee/tea and “other” – e.g. espresso machines, and mugs.

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Built For the Future

Starbucks’ revenue continue to rise, faster than you’d expect for a company that appears to have permanently saturated most parts of North America. But it’s a big planet, and double-digit growth is standard for Starbucks overseas. Total revenue has been increasing in China/Asia Pacific in the past few years. North American revenue continues to make up most of the total annual stake. Starbucks cites premium single-serve products as the catalyst here, and why not? Modern single-serve coffee machines retail for more than machines that can brew 12 cups at a time, a circumstance that would seem to stand classical economics on its head. People enjoy paying for cachet, even when it makes no sense to do so. By and large, those are your Starbucks customers. 

The Bottom Line

Wholesale coffee prices are falling, thereby broadening the company’s margins. Depending on where you live and how early you wake up, packed drive-thrus are a common sight at Starbucks throughout the world. The people in the cars are devoted to Starbucks’ particular varieties of high-margin whole-bean coffee. The company has expanded seemingly overnight, and has continued to grow in the last year. 

Related: Starbucks: A Victim of its Own Innovation? (SBUX)

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