Starbucks : The Way Forward High School Group

Team Members: Raunak Agarwal Kota Furusho Philip Leitner Euan Wang.

Starbucks – Brewing Success over the Years. Starbucks with sales of USD 36 mn is the largest specialty coffee chain in the world It operates more than 38,000 (80% company operated) in 80 countries globally 74% of the sales are from N.America with China being the biggest market internationally (~12% of annual revenues) Company has exhibited a CAGR of 9%+ in revenues over the last 10 years Starbucks also enjoys stable healthy margins given its strong pricing power and brand value.

Starbucks – Brewing Success over the Years. Beverages account for 60% of revenues and food for ~18%. Rest is others (packaged coffee, ready-to-serve beverages etc) Cold beverages now represents ~70% of the mix and ~60% of the beverages are customized Starbucks has pioneered digital adoption with its mobile app. Mobile orders now account for 30%+ of US transactions MOP (Mobile Order & Pay) drive-thru and delivery now make up ~75% of the business Strong earnings growth along with consistent dividends and buybacks has made it the darling of investors It currently has a market cap of USD 100 bn + (doubling its market cap in 10 years) and trades at 25x Price Earnings.

Starbucks – No Longer “Grande” : Why?. Quarter Results Key Reasons (Brief) Guidance Street Reaction Q1 2024 EPS $0.90 vs consensus at $0.94, driven by lower than expected revenue and higher COGS (Cost of goods sold) US miss was attributed to boycott driven by post about Middle East and tough comps in China given rising competition and slowing consumer Tempered F24 Global comps growth to 4-6% from 5-7%, although EPS guidance was maintained (reassuring investors) Slight miss made investors cautious, however market reaction was muted as most dismissed this as a one-off Q2 2024 EPS $0.68 vs consensus at $0.80, driven by lower than expected revenue and higher operating expenses US pullback attributed to slowdown of occasional users and consumer weakness. China slowdown was attributed to significant increase in price competition amongst slowing consumer Major reset of F24 guidance with Global comps growth lowered to flat to down single digit and EPS guidance was lowered to flat to up single digit (spooking investors) Major reset making investors realize that Q1 wasn’t a one-off but the company is facing some structural issues. Stock was down ~16% on the news Q3 2024 EPS $0.93 vs consensus at $0.93, driven by slightly lower than expected revenue in China. Expenses more or less in line ensuing margins in line with consensus expectations Continuous slowdown in occasional users and consumer weakness in US. China weakness was driven by significant increase in price competition, slowing consumer and deflation dynamics in China F24 guidance was reiterated reassuring investors than things aren’t worsening further The management reassurance on the F24 guidance was a sigh of relied for investors. Stock exhibited a minor relief rally post results.

Key Reasons for Underperformance. Confused Brand Identity : Starbucks used to be a place where people could hang out together in a cool environment and have quality coffee. Change in business model in response to customer demand from a predominately sit-down coffee shop to a mostly drive-thru and mobile takeout chain has diluted the experience for its occasional customers, which have driven the decline in sales. Consumer Pullback: The overall economic climate, marked by inflation and high interest rates, has led consumers to be more cautious about spending, leading to decline in sales. Struggling customers no longer want to shell out for high-priced coffee drinks, unless they see value in the coffee and the experience. Higher Prices : Average check at Starbucks has grown by almost 50% in the last 5 years driven by rising inflation (Higher cocoa prices, rising wages driven by labour shortages etc). Even though ~30% of that has come from mix and premiumization, but still the hikes have come at a time when consumer is struggling and the in-store experience has been dwindling, further impacting sales Long Wait Times: While Starbucks boasts strong mobile order and pay sales, a significant number of potential customers abandon their orders (mid-teens as per company estimates) due to long wait times and unavailability of product. This is a missed opportunity for sales..

Key Reasons for Underperformance. Perception Problem with Gen Z : One demographic where Starbucks has been struggling to reach recently is surprisingly Gen Z (specifically 18-24-year-olds), given their fiscal challenges, as well as some politically motivated boycotts around the Israeli-Palestinian conflict. Increased Competition: Starbucks is facing stiff competition from other coffee houses (eg Dunkin’ Donuts etc and local coffee chains) that offer similar or better quality coffee and amenities, making it harder for the company to maintain its growth trajectory, thus impacting margins. Competition has also been more innovative with their food/beverage offerings Struggles in China: Starbucks' ambitious expansion plans in China have been hampered by competition from local players like Luckin Coffee, which has a larger number of locations. China’s economic slowdown as well as deflation dynamics has not only impacted comps growth but also unit growth has been negative, further impacting margins. Employee Discontent : The company has also been dealing with employee discontent and heavy unionization efforts. Baristas are also having a hard time creating signature custom beverages at a satisfactory pace..

1-Year Turnaround Strategy. 1. Put new management in place : Starbucks Board has already taken the most important step towards brand revival by appointing Mr Brian Niccol as the new CEO. He comes from Chipotle where he took over as CEO in early 2018 during a challenging period marked by food safety scandals and declining customer trust. He implemented a series of strategic changes that revitalized the brand, enhanced operational efficiency and digital transformation. These initiatives led to doubling of sales under his tenure. He has shown expertise in both operations and marketing, both of which are very crucial for Starbucks. The new CEO should get his new management team in place at the earliest. 2. Improve in-store experience : Starbucks used to be a place where people gather and have quality handcrafted coffee. Company needs to accelerate innovation and tweaks to store-design by reallocating capital budgets from new stores to existing ones. Replace wooden chairs, classroom like seating to a much friendlier environment with sufficient cushioned seating thus creating a homogeneous in-store experience. 3. Accelerate deployment of Siren Craft System : Baristas need tools and time to craft great drinks every time. Rapid deployment of Siren Craft System (Process improvement system) along with investments in equipment could reduce wait times by 30-40 sec. Current target is deployment in ~10% of stores by FY24 and ~40% by FY26. This needs to be brought forward..

4. Introduce few innovative menu options : Key here is to offer something innovative to the customer (seasonal beverages, bundled offerings, introductory pricing on new offerings etc) while simplifying its core menu at the same time. Reducing complexity in the menu will also reduce waiting time. Customers should feel the brand is changing thus attracting the younger cohorts as well as the occasional customers. 5. Ensuring that morning rush, dinks and food are delivered on time : ~10% efficiency improvement can lead to ~5% increase in sales. There is a mid-teens demand which is unmet given higher wait times. Process improvement driven by capex could help meet a part of this unmet demand leading to increased sales and happy customers. 6. Scrap one year guidance but illustrate a clear vison ahead : Scrapping guidance will give the new CEO and his management team time to refocus the company and detail a clear vision to internal and external stakeholders. Market is likely to look through the noise given his track record and regard F25 as a transition year..

7. Slowdown investments in China : Competition in China is likely to remain elevated and rising geopolitical risks aren’t going to fade away irrespective of the election outcome. The company needs to scale back its ambitions in China in the short-term. It would make sense to refocus the energy and resources on its key market of North America over the next year or so. 8. Elevate the brand image and deliver value to the customers : The company needs to tell Starbucks story again reminding customers of the brand's coffee expertise, role in communities, unique experiences etc.. Key is to reinforce brand’s premium position, focus on being experiential not transactional, thus justifying brand’s value. New CEO has already created a role of a Global Chief Brand Officer to oversee product, digital customer insights, creative and store concepts etc..

Long-Term Growth Strategy. Alternatives for China : Same store sales growth has been sluggish and deflation trends have led to almost a 40% fall in in EBITDA/store from peak levels in Q1 2021. The company should consider either a full spin-off, licensing of the business (in-part or full) or a JV (Joint-venture) in China as slowing consumer, increasing competition and deflationary trends will continue to drive China profitability lower..

Long-Term Growth Strategy. International expansion : Starbucks should continue to use its brand power to expand globally through various strategies ranging from organic growth to partnership to licensing etc. International expansion will require it to balance its global brand consistency with local responsiveness. This approach will allow the company to adapt its offerings, store designs, and marketing strategies to meet the unique preferences of each market while maintaining its core brand standards..

Conclusions. Starbucks still is a very popular brand with over $36 bn in sales and a loyal customer base globally What Starbucks needs to do is strengthen its market position by streamlining operations and enhancing the customer experience. Simplifying mobile ordering, enriching in-store interactions, and focusing on a core menu, the brand can reduce frustration and elevate customer satisfaction. Additionally, cultivating a strong brand identity and communicating it well should ensure that Starbucks remains a beloved destination for coffee lovers worldwide and enjoys long-term stable growth.

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