50-The Future of Starbucks

In 1903, Horatio Nelson Jackson did something remarkable. He made the first automobile trip across the United States, from San Francisco to New York City. His trip took 64 days. This time includes the waits for parts after the car had broken down. There were few roads in those days. Automobile travel was challenging in the extreme. Jackson drove a Winton Tourer automobile that he had named the “Vermont” after his home state.

Not many of us today know of the Winton and its producer, the Winton Motor Carriage Company. Winton was one of the first American companies to sell motor cars. It incorporated in 1897. By 1900, the company was the largest manufacturer of gas-powered automobiles in America. In its day, the “Vermont” was state-of-the-art.

The company continued successfully through the 1910s, focusing its marketing on upscale consumers. However, during that period, dozens of new automobile companies started up, creating intense competition. New competition led to falling sales for Winton in the early 1920s. The Winton Motor Carriage Company stopped automobile production in 1924.

Winton’s experience has something to say to Starbucks. Starbucks is the dominant leader in today’s coffee café segment. They have shown the world how to make a lot of money on a product that had heretofore been a commodity. For years the company grew its revenues and profits by opening new stores and by raising prices with impunity. Those days are now at an end. Its fancy coffees can cost $3 to $5 each, and now it has real competition.

After dithering for a number of years, major fast-food companies, such as McDonald’s, Burger King and Dunkin’ Donuts, attacked the premium coffee market with a vengeance. (See the Symptom & Implication, “Competitors in formerly undeveloped markets have begun meeting one another” on StrategyStreet.com.) This attack was easy. Starbuck’s prices were so high that each new competitor had margin enough to provide an excellent drink at much lower prices than Starbucks.

This competition is now serious business. The new competitors have pushed Starbucks into the Performance Leader category, at the high end of its own industry. The new competitors have become the Standard Leaders in the industry. (See the Symptom & Implication, “While still growing, some competitors are losing share” on StrategyStreet.com.) Even worse, the new Standard Leaders are comparable to, or better than, Starbucks in quality. Recently, Consumer Reports hired tasters to sample medium cups of black coffee from several competitors, including McDonald’s, Burger King, Dunkin’ Donuts and Starbucks. McDonald’s, not Starbucks, won that test.

The Winton Motor Carriage Company, too, was pushed into the Performance Leader end of its industry as companies such as Ford, Oldsmobile and others produced good quality cars for far less money. It lost out on economies of scale. Winton could not command enough of a price premium against its larger competitors to make a good profit.

Any high-end, Performance Leader, competitor should look at Price Points below them for competition. This lower-end competition may not offer the same quality but its much lower price for “acceptable” quality will skim off a significant part of the Performance Leader’s business. The lower-end competition will force more restrained pricing and real attention to unit costs on the Performance Leader.

Starbucks is not going the way of the Winton Motor Carriage Company. It will survive, and even thrive, because it has established itself as a quality brand name. But in order to thrive, it will have to be a very different company in the future. Its growth will be moderate, at best. In the future, its new stores will meet much tougher criteria for segments that have the need for, and are willing to pay for, high-end coffee drinks. Its pricing is virtually certain to decline to close some of the gap with the new Standard Leader competitors. It will evolve into a company who understands its unit costs far better than it does today. (See the Symptom & Implication, “Competition is beginning to focus resources on market segments as market growth slows” on StrategyStreet.com.)

Posted 9/29/08

Update:

There have been 2 opposing forces affecting the premium coffee market over the last 10 years. First, there is the entrance of several new competitors, in the coffee shop, quick service restaurant and grocery markets. 2nd, the premium coffee segment has grown far faster than the market as a whole. Throughout this time, Starbucks has grown profitably and faster than the overall market. It has continued to garner good reviews for the quality of its coffee, though it is not alone in that virtue.

The new entrants in the coffee shop market had an effect on Starbucks and its approach to the market. The 2 largest new entrants were Dunkin and Tim Hortons. Still, Starbucks controls 40% of the coffee shop market, as measured by number of stores. One effect of these coffee shop competitors has been to hive off some of the price sensitive former customers of Starbucks, leaving the company with much less price sensitive customers. In recognition of the price pressure exerted by these new coffee shop entrants and by the other less expensive new alternatives, Starbucks restructured its pricing scheme. It retained skim pricing for non-price-sensitive consumers and introduced penetration pricing for its expansion into more price-sensitive market segments. Now, local Starbucks stores price their product mix in relation to the stores of their local rivals.

Starbucks has surely benefited from the fast growth at its end of the market. But, more than that, they have proven to be an astute company when it comes to pricing its products for various customer segments. See HERE for more thoughts on the impact of pricing.

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