Dec. 9, 2025.  One strategy of competitive advantage is to afford a unique experience that is preferred by the customer.  Food or beverages are good examples of the type of product that can represent this type of familiar, sought after experience because they are intimately experienced by the user, and can become part of the customer’s personal life habits.  In order to possess a competitive advantage the food or beverage must be of a quality unique enough so that it cannot be easily duplicated.  In order to possess pricing power, the quality must be both unique and recognized as being outstanding.  For food/beverage purchased in a restaurant, the atmosphere, clientele and location of the restaurant are part of the experience.  The restaurant environment is controlled to convey a specific experience and this strengthens the consistent branded experience.   Lacking this complex tool to control the customer experience, the packaged beverage industry is extremely competitive.  Brands fight to establish a vivid appeal based on their packaging or advertising.

However, the packaged beverage industry can have relatively high margins.  Assuming the product’s appeal can secure pricing power, margins can be healthy for what is essentially a relatively cheap product based on commodities (sugar, coffee, flavorings…) with some degree of intellectual property in the recipe.  Meanwhile, the restaurant bears the costs of real estate which can be high in sought after locations, as well as costs of the retail operation which are relatively high, particularly for fresh or very high quality product.  So the packaged product is relatively profitable, but struggles to make more than a fleeting connection with the customer.  Meanwhile, the restaurant can foster a bonding experience with the target customer, but bears the costs of real estate and the retail operation.

What if a company could have both appealing restaurants which served delicious and excellent beverages and foods, and also widely marketed packaged products?  The restaurant experience could establish a bond with the customer.  The relatively higher margin packaged product could benefit from the bond that was forged in the more deliberately pleasurable experience of the restaurant.  This bond could never be duplicated in the grocery, supermarket or convenience store aisle.  The company would therefore have a competitive advantage over rivals who do not have that restaurant experience brand building mechanism.  It is said that Brand confers a competitive advantage.  In fact a strong Brand results from a superior product, including the experience by the customer of the product.  What a  strong Brand does make possible is pricing power.  In the present example, the unique restaurant experience enables pricing power for the packaged product.

This is a strategy that Starbucks is using to continue developing its brand experience, while building out a relatively high margin packaged good product that will extend Starbucks sales far more widely than would be possible merely by increasing the number of its restaurants.  Of note, roughly 80% of coffee is drunk out of restaurants, at home.  This market must be addressed with packaged coffee and coffee beverages.

There is another issue with relying solely on a strategy of expanding the base of restaurants in order to grow sales.  A high rate of restaurant expansion risks impairing the quality of the experience, through poorly trained staff or mediocre product.  In order to maintain the quality experience which is crucial in order to nurture the relationship with customers, the quality of the restaurant experience must be preserved and itself nurtured.

Starbucks could leverage the café experience into packaged products to increase earnings over the long term.

SBUX has made several moves recently to increase its store sales, including premium delivery services, ordering in advance on a mobile app to shorten store queues, and strengthening food offerings and adding non-coffee refreshments including wine, to increase sales at various day times.

These speak to an outstanding ability to continue adapting to pursue growth.  But can Starbucks stores retain their Starbucks character if they increase food sales volume enough to become a staple for travelling motorists, as McDonalds is?  Surely in the future, profitability of store sales growth will increasingly depend on increasing volume and lowering costs.  For now, the highest store sales growth is in Asia, where Starbucks are mobbed.  But surely this is due to their novelty, and not something that can be expected to continue indefinitely.

As store sales level off in the future,  it is Starbucks’ Channel Development segment packaged products that will keep earnings growing much farther into the future than would be the case if we were speaking of a pure restaurant company.

Starbucks has a somewhat unique advantage in that it has two distinct ways of approaching the customer.  One is centered in the “Starbucks Experience” of the retail and franchise stores, where pricey, hand crafted, customized coffees and refreshments as well as snacks are offered.  The coffee is of the finest quality, with matching price, and roasted in a specific way that often accentuates a certain “burnt” character.  The store atmosphere is managed, pleasurably social but relaxed, inspiring yet cozy, alive with the fragrance of fresh brewed coffee, and moreover reflects its local community.    The other approach is embodied in the channel development reportable segment (there are four reportable segments:  Americas; Europe, Middle East, Africa (EMEA); China/Asia Pacific (CAP) and Channel Development).  This reports sales from the Consumer Packaged Goods and Foodservice operations.  Channel Development sales include ready to drink versions of some of those same premium beverages (such as Frappuccinos®, Doubleshot®, Refreshers; Tazo® tea and Starbucks branded single serve products, notable the K-cup; roasted packaged coffee, Tazo teas; and standardized brews of its Seattle Coffee mass market brand and other products sold to foodservice accounts.  These are sold in ,  grocery stores, warehouse clubs, specialty retailers, convenience stores, cafeterias, hotels, restaurants and other mass market venues.

With this two pronged strategy, on one hand, painstakingly building its brand, and on the other, selling it in every conceivable venue, Starbucks could be the Ritz Carlton of coffee shops, and a Coca-Cola like supplier of products that signify the Starbucks experience to consumers in the full diversity of their everyday circumstances (“at home, at work or on the go”).

In my view there are two primary keys to the destiny of Starbucks as a long term growth company.  One is preserving the integrity of the Starbucks coffee shop experience, and enriching this to be unique and expressive of the fullest potential of its beverages.    The other is continuing to grow the packaged product business in a cost effective way, preserving control of the brands, recipes and intellectual property, while partnering with manufacturing/bottling or distributing companies to achieve wide distribution.

These two mutually dependent arms are linked by the brand.  The power of the brand to influence consumer behavior relies on the richness and authentic service of the coffee shop experience in which is it rooted.  Years ago, after the Starbucks salted caramel hot chocolate drink had been withdrawn from stores, I commented to a Barista at my local Starbucks that my little son had loved it, and its taste had reminded me of a childhood desert that I could not quite place.  She reflected dreamily for a moment and then hopefully volunteered that “but we can still make it for you from scratch”.  As long as Baristas can make the drink that you dream of for you “from scratch”, Starbucks brand is thriving.  Thus, an office worker drinking a k cup at work is not just drinking ready hastily brewed ready to drink coffee at her desk.  She is thinking of the cozy bustle and aromas of the Starbucks coffee shop and associated pleasant memories. This experience is the crucial basis for the influence of the Starbucks brand. Without the experiential basis of the imperfect, authentic, aromatic Starbucks coffee shop, the Channel Development goods is just another brand of manufactured beverages fighting for consumer attention on the supermarket shelf.

Starbucks retail stores and Channel Development have business models that strengthen each other.  The greater margin of branded packaged drinks can allow the coffee shop business model to provide more luxury and focus on serving each specific customer as fully as possible (Ritz Carlton), freed from the need to maximize volume and commoditize service order to grow profits.  In fact, in order to preserve the authentic quality of the coffee, shop, it may be advantageous to avoid a rate of growth in shops that would lead to the perception of commoditization in the environment, furnishings, or service.

Continued nurture of the actual Starbucks store experience should tend to diminish the dependence on advertising as brand building.  This is borne out by a review of relative advertising expenses of Coca-Cola and Starbucks.  Coca-Cola spent 6.8%, 7.0% and 7.6% of revenue on advertising respectively for 2012, 2013 and 2014.  Whereas Starbucks spent 1.3%m 1.3% and 1.2% of revenue in the same years.

While a company that does not depend on its own retail stores may achieve a higher gross profit, the experientially based Starbucks brand may be more robust than one built purely as an image in TV commercials, billboards and package logos.  The brand may be significantly less affected by changing consumer trends, as it is anchored in the actual daily experience of the coffee shop, where customers can be educated as well as observed.

Perhaps the living spring of Starbucks branding has contributed to recent growth in Channel Development.

Analysis of channel development and total Starbucks consolidated revenue and operating income over the past 10 years from 2005 to 2014 reveals that Channel Development revenue has increased by 6.2 times, from $249.3 million to $1.546B , more than double the rate of growth of total Starbucks consolidated revenue which has grown 2.58 times  from $6.3936B to $16.4478B.

Today Channel Dev revenue and operating income rank second among the Starbucks segments,  but still only 9.4% of total consolidated revenue.  Operating income at 557.2 million is 18% of total OI of 3081.1 million.

Channel Development sales are made mainly via joint ventures and licensing arrangements with large consumer products business partners. This operating model leverages the business partners’ existing infrastructures and as a result, the CPG segment reflects relatively lower revenues, a modest cost structure, and a resulting higher operating margin, compared to the Company’s other two reporting segments, which consist primarily of retail stores.  As such, Relative operating costs for the channel Development segment are much smaller than for the retail store segments, because store related costs are absent.  As a result,  operating income/total revenue ratio in the channel development segment has always been higher, currently has the highest operating margin of all Starbucks segments, now almost double at 36%, that of Starbucks as a whole at 18.7% .  Channel Development products are now sold in 39 countries.

As recounted in the recent Annual Shareholders’ Meeting, recent Channel Development growth is driven particularly by K cups. Starbucks K cups have achieved better than market growth rate since launch in late 2011 and Starbucks has achieved a leading market share, sales grew 34% from 2013 to 2014.  More broadly, since 80% of coffee is drunk in places other than coffee shops (mainly at home), Starbucks leadership aims to expand into this market.  single-serve is the fastest growing segment of the at-home coffee market in the U.S., which is led by K-cup packs. Packaged coffee is another important product in home brewed coffee.  While grocery store coffee sales are increasing at 10% annually, Starbucks packaged coffee sales are growing at 18%, with a 22% share of the U.S. premium coffee market, which is the leading market position in both premium roast and ground and the single-serve categories.

The expansion of single serve and packaged coffees is fueled by introduction of innovative flavors and high quality varieties such as single origin coffees.  The market for Ready to drink coffee beverages, followed by packaged coffee, for home consumption, is large and growing internationally as in US.  Starbucks aims to be the market leader in premium coffee market globally.  In fact, as described by Michael Conway , president of the Channel Development segment at Shareholders Meeting.  Starbucks aims to double international ready-to-drink business over 5 years. One of the biggest opportunities is in China, where the ready-to-drink coffee beverage market is a $6 billion category and is forecast to grow by 20% over the next 3 years. The China stores have been extremely popular and foment an awareness of and desire for Starbucks products, as well as serving as distribution centers hitherto. today, you can buy bottled Frappuccino is distributed in SBUX retail stores and grocery or convenience stores.

Starbucks is aggressively ramping distribution of ready to drink coffee in China.  At the Annual Shareholders Meeting, Mr. Conway announced a strategic partnership with Tingyi, one of China’s largest beverage players with products in over 1.1 million stores in China. Tingyi will provide local manufacturing, sales and distribution throughout while Starbucks will contribute “coffee expertise” (presumably IP including recipes) and brand recognition.

Tingyi Holding Corp launched in 1992, its Group of Subsidiaries produces and distributes instant noodles, beverages and instant food products in PRC.  Since 2012 the Group has had an exclusive alliance with PepsiCo to manufacture, bottle, package and distribute PepsiCo drinks in PRC.  According to its 2013 financial statements, the Group has leading market shares in instant noodles, ready to drink teas, bottled water, juice and egg rolls.   It held a number 2 market share in carbonated drinks with Pepsi.

The Group distributes via an extensive network of sales offices, warehouses serving over 30 thousand wholesalers and over 110 thousand direct retailers.  The Group leadership aims to strengthen its logistics and sales network in the PRC to attain market dominance.

A brief review of the 2013 Tingyi financial statement reveals that because of the need for substantial capital investment, while revenue has more than doubled from $5B in 2009 to $10.9B in 2013, profit was unchanged at approximately $500 million. In that time, property plant and equipment, lease payments, debt more than doubled.

This insight shows why it makes sense for Starbucks to partner with Tingyi while avoiding the expense and hazards of building out a competing world-class distribution network.

Channel Development aims to grow top line by 60% and nearly double profit by 2019.  It aims to “connect people to Starbucks around the world where they live, work and play. ”  That is, it allows the widest possible number of consumers to experience the Starbucks brand, in the full range of their daily activities.

There are likely issues in the future perhaps related to differing tastes in different regions, competition by other already existing or new brands.  The expansion of ready to drink Starbucks beverages is scarcely a sure thing.  However it is perhaps slightly less of a gamble than the prospect of established a booming coffee shop business in a nation of culturally devoted tea drinkers, which Starbucks has already achieved.

Cash return (Free Cash Flow/ Enterprise Value) of 3.1%, is not impressive. The PE is 28.2.  Excluding 2012, average PE in past 10 years was 32.4.  Given the rate at which Starbucks is increasing earnings, although there is no margin of safety in the sense that the stock is not undervalued, future performance, assuming the company continues to perform as it has, should give a corresponding rate of return, subject to the vagaries of the market.   Most likely best would be to wait for a dip in the market if one’s intent is to obtain a market beating return.  Alternatively one could invest a relatively small sum with a plan to wait an extended period for the investment to achieve a return powered by the Starbucks earnings machine unaided by the starting boost of a favorable price.

Between 2005 and 2014, revenue increased from $6.369B to $16.448B, net income from $494 million to $2.068B, and because of regular share buybacks, EPS grew from $0.61 to $2.71, for an average annual growth rate of 13.23% .