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The Brand Coaches:
Warning! The Bell Curve is Sounding
By David J. Morris & Lon LaFlamme

There isn’t room for amateurs in the specialty coffee business anymore! The Brand Coaches explore the challenges currently facing the Starbucks Coffee Company, and what this means for smaller, independently owned coffee businesses.

For the past 10 years retail specialty coffee has sailed higher and higher through azure blue skies. Like the stock market in the mid to late 1990s, no matter what you did, you made money. Coffee taste could be inconsistent; service could be no more than fulfilling the order. Drive-thrus in the Northwest weren’t much bigger than photo mats and makeshift coffee houses still managed to drive great profits.

While there have been occasional industry skeptics challenging the forecast for unlimited growth potential of retail specialty coffee businesses in North America, Starbucks lit the endless path to seemingly endless growth. By the look of the statistics Americans were just getting started in their quest for great coffee in a relaxed “third place” environment.

According to the Specialty Coffee Association of America’s 2005 retail report, 15% of America’s adult population makes that latte or mocha a daily habit. Over 60% of adults dished out their discretionary income for “occasional” consumption. These consumption statistics barely shifted in 2006, fueling some industry forecasts that growth potential in the specialty coffee industry isn’t unlimited and may have a ceiling, regardless of a strong or weak economy.

Until 2007, retail specialty coffee was one of the hottest categories in franchising. It didn’t even make the top 25 list last year.

In the not so distant past, if you controlled your cost of goods (28-32%) and operating expenses generally within industry norms, you could comfortably expect a net profit of nearly 17% for coffee houses and a whopping 22% for stand alone drive-thrus. With that kind of return promise independents and franchise chains of coffee houses and drive-thrus sprouted up in nearly every state in the country.

The Times They Are a Changing
Like any emerging industry there is a growth bell curve. By looking at the recent turn of profits downward with Starbucks, our unique singular bell (whether for the health of the industry or not), could well be past the apex of industry growth and beginning on the downside of the bell curve. The downside of all industry bell curves is closure, acquisitions and consolidations into fewer independent and major chains.

Geography also plays a significant role in independent specialty coffee businesses realizing full net profit potentials. West of the Mississippi, drip coffee sales tend to be less than 20% with the business being driven by the craving for mochas and lattes. The average customer ring can easily total over four dollars, thereby the fun turn of phrase “fourbucks” when referring to Starbucks. East of the Mississippi drip sales can average higher than 50%, taking a dramatic toll on the average ring.

Thousands of specialty coffee businesses east of the Mississippi thriving in the shadow of the Mermaid have been perceptive enough to welcome a Starbucks nearby to break old habits of ordering drip for high margin mochas and lattes. Starbucks is sounding the bell curve alarm.

With stock prices down 50% at the time of this writing, same store sales sagging and the test rollout of the $1.00 eight-oz coffee with free refills to combat McDonalds and Dunkin’ Donuts was the first real knee jerk we have witnessed from Starbucks. News accounts have Starbucks founder and marketing genius Howard Shultz grabbing back the CEO helm while attributing quick bold “back to basics” changes to the sagging U.S. economy. After decades of seemingly unstoppable growth, Starbucks has taken action to do what none of us in the industry could have imagined: cutbacks of over 600 employees and more than 100 North American coffee house closures.

Starbucks with unprofitable stores? A lowering of projected store openings and lower overall profit estimates for 2008. Can you imagine such a thing?

Like you, The Brand Coaches are trying to track Shultz’s discount coffee test strategy that runs in the exact opposite direction of his previous announced commitment to “return to basics of what built this great brand.” Remember Howard, what you taught the world, “We will never give up our affordable little luxuries.” Starbucks has never compromised on quality or price. Those millions of mochas and lattes have been sold at a premium price without need for apology. Today’s coffee house has replaced the local cocktail bar as our “third place” for rich conversation, quite meetings and intimate conversation.

Starbucks went from the $1.00/cup test in the greater Seattle area to announcing the purchase of $11,000 Clover single cup espresso making machines being tested in Seattle and a few other cities. Each new premium cup of exotic coffee is individually brewed. That’s a departure from the large pots of coffee from which $1.55/cup is pulled today. The premium coffee is selling for $2.50/cup.

Starbucks is reorganizing from an East and West division into four national divisions: Western/Pacific, Northwest/Mountain, Southeast/Plains and Northeast/Atlantic. The company’s testing pendulum is swinging from one extreme to the other as it seeks out what strategy will get the brand back on its unprecedented profitable growth.

Look for significant menu changes to address a leaner menu and beverage demand as well as a lot of other moves that will try to mirror what many of you are already doing in single locations.

While Starbucks’ mission has always been to crush the mom and pop coffeehouses across North America, it is a safe assessment to say that the best business-building opportunity a single location owner has is to open as close to a Starbucks as possible.

As Seattle’s Best Coffee chain founder Jim Stewart reported, “Let Starbucks do all your marketing and mocha and latte habit forming for you, then watch your own profits soar.” According to Taylor Clark, author of a new hardback release titled Starbucked (a must read,) that is exactly what has happened.

The Brand Coaches need to emphasize that you can only take customers away from Starbucks if you match and surpass their food and beverage consistency and customer service. Yes, we have seen Starbucks drive independently owned coffee houses out of business, but usually the business would have failed anyway.

According to recent figures from the Specialty Coffee Association of North America, 57% of the nation’s coffeehouses are still mom and pops. Just over a five-year period from 2000 to 2005 the number of mom and pops grew by 40%, from nearly 9,800 to nearly 14,000 coffeehouses. Starbucks tripled in size in that timeframe - a boom for all concerned.

End of the Growth Boom?
Yes, Howard, the weak economy has affected Starbucks sales as well as soft sales for independents in recent months. The Brand Coaches also believe that North America could be beginning to reach a coffeehouse saturation point (the drive-thru industry is still young East of the Mississippi.) Only those businesses that stand on exceptional customer relationship building, consistent beverage creation quality and a relaxing and highly personalized “third place” environment will survive the next five years.

The bell curve has sounded. The days of amateurs in the retail specialty coffee business are over.

Recognizing the challenges most of our Brand Coach column readers are and will be facing, we commit to being as specific as possible in giving you proven actionable branding and marketing ideas to help you protect and build a profitable independent coffee business.

Tea & Coffee columnists David J. Morris and Lon LaFlamme provide brand and profit building consultation to a number of coffee, retail and b2b businesses across North America. For more information on the Brand Coaches go to: www.thebrandcoaches.com.

Tea & Coffee - April, 2008
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