Monday, December 08, 2008

Starbucks Struggles Continue

Last week the news broke that the coffee shop giant was continuing its slump. The story follows in a moment.

But first, the question is this a result of the economy? The recession that we have been in for the past 12 months? Or is it their business model?

Here's the positive stuff I can say about Starbucks:

  • They popularized specialty coffee drinks and made it fashionable to spend 3, 4, 5 bucks for something that we used to drink straight, (maybe with cream & sugar), for 1 buck.
  • Many local coffee shops should be grateful for the promotion of coffee shops in general due to the branding and growth of Starbucks.
  • Starbucks demonstrated that there was room for growth in the food business and that word of mouth really works.
So what happened?

  • Most local coffee shops offered free internet. They became meeting places, out of office offices for those of us that use laptops.
  • Starbucks rode the wave of free spending and then when business slowed consumers reduced their trips to Starbucks, they were forced to reverse course.
  • Because everything was sold at a higher price point and their business model was built on those higher margins, they did not have a lower price "Value Menu" to keep customers coming in.
  • Besides local shops, which Starbucks probably didn't consider as competition, new competition popped up in the form of established and healthy chains that added specialty coffee based drinks to their menu. Namely Dunkin Donuts and McDonalds.
  • Brand extension pulled financial resources away from their core business.
  • Changing their house blend coffee drew mixed reaction, on the par of Coke changing to a sweeter formula several years ago, (New Coke vs. Classic Coke.)
  • And finally, the internal changes were made public as they tried to put a positive spin on things that should have been done behind the scenes such as shutting down for a few hours to retrain their employees earlier this year.
Here's the story from last week:

* Starbucks does not expect to meet Wall St view for Q1

* Says company did not hit bottom in Q4

* Sees FY09 savings of over $400 mln, double prior view

* Shares down 1 pct, paring earlier gains (Adds comments on quarterly outlook, bullet points)

By Lisa Baertlein

NEW YORK, Dec 4 (Reuters) - Starbucks Corp (SBUX.O: Quote, Profile, Research, Stock Buzz), whose sales are slowing as U.S. consumers buy fewer premium coffee drinks, said on Thursday it does not expect to meet Wall Street estimates for the current quarter and would double its cost cuts for the full year.

Company executives, speaking at an analyst day in New York, also warned that Starbucks' results had not hit a bottom in the prior quarter, as previously suggested.

Chief Executive Howard Schultz noted that consumer spending patterns were erratic in a U.S. recession and said the holiday selling environment was tough.

The coffee shop operator's shares, which had jumped as much as 9 percent earlier in the day, pared their gains after the outlook was announced. They were up 1 percent in afternoon trading.

"We do not expect to meet current consensus estimates for this quarter," said Starbucks Chief Financial Officer Troy Alstead.

In the first nine weeks of the fiscal first quarter, which began in late September, Alstead said sales at U.S. stores opened at least a year fell 9 percent.

"We did see some deterioration of comp growth" in the fiscal first quarter, which ends in December, he said.

Analysts on average were expecting earnings of 22 cents a share on revenue of $2.77 billion for the quarter. Starbucks did not provide its own forecasts for the quarter or fiscal year.

Starbucks also said it would save another $200 million from cost cuts this year by making in-store labor more efficient, streamlining its supply chain and managing waste such as excess steamed milk or brewed coffee that is not sold after 30 minutes. The savings are in addition to a previously announced $205 million in fiscal 2009 cost cuts from closing stores and cutting jobs.


Analysts gathered at the meeting said they were looking for more clarity from Starbucks on plans to lower fixed costs and preserve profits as sales fall amid the biggest U.S. financial crisis since the Great Depression.

Starbucks is more focused than ever before on cutting costs "out of necessity," Alstead said.

Now that Starbucks is opening fewer stores, it is also looking to improve efficiency in each store, said Cliff Burrows, president of its U.S business. One plan includes reconfiguring store space so fewer workers are needed to serve customers.

Other developments include 20 percent off Starbucks gift cards sold at Costco Wholesale Corp (COST.O: Quote, Profile, Research, Stock Buzz) and a loyalty program offering discounts to paying participants. But the company is not discounting the drinks on its menu or changing its fundamental strategy.

"This is not the time to throw the baby out with the bathwater and say we need to shift our strategy," said Schultz. "We need to find a balance."

Looking ahead, Schultz forecast 2009 would be more difficult than the second half of 2008.

"Keeping our core customers during these hard times has to be job No. 1," said Terry Davenport, Starbucks' senior vice president of marketing, since it would be more expensive to get them back. Executives said that, while Starbucks was not losing customers to the recession, some were visiting less often.

Meanwhile, fast-food chain McDonald's Corp (MCD.N: Quote, Profile, Research, Stock Buzz) is pushing its own espresso drinks, which cost less than those at Starbucks.

Starbucks said last month it expected sales at established restaurants to decline in the fiscal year ending in September 2009. In fiscal 2008, the company shut 205 of the 600 stores slated to be closed by the end of fiscal 2009. It closed 61 restaurants in Australia in August.

At the end of the fourth quarter, there were more than 11,500 U.S. Starbucks stores and more than 5,000 abroad.

Starbucks shares were down 10 cents at $8.54 in late afternoon trading on the Nasdaq. (Reporting by Lisa Baertlein; Writing by Martinne Geller; Editing by Gunna Dickson and Andre Grenon)

Read more here.

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