Starbucks (SBUX) is easily the biggest name in coffee. The company began as a simple coffee shop in Seattle in 1971, but the Starbucks we know today really began when Howard Schultz—the mastermind behind the Starbucks brand—took over the company in 1989. Since then, the Starbucks corporation has grown to sell its products in almost 30,000 locations worldwide and has one of the most recognizable brands on Earth. Schultz left Starbucks to in 2018. In 2018 the company operated in 78 markets and was worth over $24 billion.

The story of Starbucks’ success is a story of branding. In the eyes of the public, Starbucks has successfully converted what was once a mere beverage into a symbol of productivity and refinement that has become integral to a hip and modern lifestyle. This branding is Starbucks' greatest asset and perhaps its greatest weakness. Its future success hinges on its ability to ensure this brand remains desirable to consumers. If consumer desire shifts, it could be difficult to Starbucks to alter its well-established brand quickly and effectively.

On November 16th, 2018, when Starbucks released its 10-K and annual report, it had a market capitalization of $85 billion. 2019 has been good to Starbucks so far. At the time of this writing, its market cap was $107 billion, its highest ever. According to Ycharts, Starbucks has a current ratio of 2.2 and a return on equity (RoE) of 384%. Growth, however, is shrinking. According to the company's Q1 2019 filings, 2019 Starbucks had revenues of $6.3 billion—a 4.5% YoY increase, down from 10.42% in 2018.

The Business Model

According to its annual report, Starbucks makes most of its money, 91%, by selling coffee and other products at its many locations. The remaining 9% come from an assortment of other revenue streams, of which the largest is the sale of ready-to-drink beverages through various channels.

Key Takeaways

  • Starbucks operates in 78 markets with almost 30,000 locations.
  • Starbucks makes 91% of its revenue from sales in stores.
  • Starbucks’ greatest strength is its brand.
  • In Q1 2019, Starbucks’ revenue growth fell to 3% from 10.42% in Q1 2018.

Company-Operated vs. Licensed Stores

Although Starbucks is a global brand whose products can be found in grocery stores and convenience stores, it still makes 80% of its money from its over 15,000 company-operated stores. In most cases, these stores aren’t franchises. With a few exceptions in smaller markets, they are all owned and operated by Starbucks. On one level, Starbucks makes this money by selling its customers food and beverages, mainly coffee. But to stop there is to overlook the company’s true value. Starbucks isn’t really selling coffee, it is selling the opportunity to participate in the coffee shop culture it has commodified. This usually entails the act of drinking coffee in a well-designed space, working on a laptop that is connected to the shop’s free Wi-Fi, and occasionally getting up to buy a pastry when peckish. People don’t really pay Starbucks for coffee, they pay to drink coffee at a Starbucks. This is what the company calls the “Starbucks Experience.”

Starbucks also sells products at an additional 14,000 licensed stores, but these locations have much lower gross margins, and only contribute 11% of the company’s revenue. At these locations, Starbucks sells coffee, tea, food, and related equipment to licenses for resale. To ensure its brand is communicated adequately in all locations, Starbucks requires employees of its licensed stores to attend its training classes as well.

Starbucks makes 80% of its revenue from the 15,000 coffee shops it owns and operates worldwide.

The remaining 9% of Starbucks’ revenue comes from an assortment smaller streams including ready-to-drink beverages sold outside of Starbucks’ stores and the sale of packaged coffee to various foodservice businesses. In May of 2018, Starbucks announced it would give Nestlé (NSRGY) limited rights to sell ready-to-drink Starbucks branded products. However, the revenues from this partnership are still minimal.

Coffee Supply

Unsurprisingly, Starbucks’ income relies on its ability to source high quality coffee at low prices. 74% of Starbucks’ retail sales are in beverages, which are mostly coffee-based. Starbucks buys green coffee beans from various coffee producing regions around the world, like Brazil, Vietnam, and Colombia. It then roasts, packages, and distributes the coffee itself. Starbucks purchases the majority of its green coffee with fixed-price purchase commitments in which prices are determined prior to the delivery date. Prices are based on the current price of coffee in the commodity market. In Sep. 2018, Starbucks had committed to purchasing $1.1 billion in green coffee. Of this, $996 million is made up of fixed-price commitments. The remaining $166 million are price-to-be-fixed commitments, in which price will be determined at a future date.

Markets

Starbucks operates in 78 markets around the world, but the U.S. is by far the company’s largest. As of Sep. 2018, there were 8,575 company-operated Starbucks coffee shops in the U.S., and an additional 6,031 licensed stores. These make up 49.8% of all Starbucks locations. China is second, with 16.76%.

49.8% of all Starbucks coffee shops are in the U.S., the company's biggest market. China is its second biggest with 16.76%.

Future Plans

More Stores, New Products

Starbucks has faith in its “Starbucks Experience,” so its strategy going forward consists largely of what it calls “the disciplined expansion of our global store base.” This includes adding more stores in markets that have already proven their worth, like the U.S., and expanding more aggressively in higher-growth markets, particularly China. To maintain consumer interest in its new stores, Starbucks is also continually pursuing the development of new beverages, particularly seasonal beverages à la the outrageously successful Pumpkin Spice Latte. These new beverages serve primarily to boost Starbucks’ brand by creating media buzz and engagement with with the Starbucks brand on social media. For instance, in April, Starbucks introduced a new “Summer Menu,” which included the aggressively polychromatic “Tye Dye Frappuccino.” This concoction brought about a blizzard of online articles and instagram posts. The future health of Starbucks’ brand relies on its continued ability to release such products on a regular basis.

To maintain the popularity of its coveted brand, Starbucks must continually roll out new products that generate ample buzz on in the press and social media. These products must be visually exciting to encourage customers to post photos online.

New Features for the Digital Consumer

Starbucks also plans to roll out new features that increase customers’ engagement with the brand. Beginning this year, the company has ramped up its advertisement of the Starbucks Rewards loyalty program on social media platforms. This seems to have been a success, because the active member base of Starbucks Rewards increased by 14% in Q1. In addition, Starbucks partnered with Uber Eats (UBER) this year to introduced a delivery service that allows customers make online orders that are delivered to them. In April, Starbucks partnered with Alibaba-owned (BABA) Ele.me to expand this service to China, which has given it a crucial leg up over Luckin Coffee, its biggest Chinese competitor.

Key Challenges

The biggest risks to Starbucks' future success is competition with growing companies that could diminish the popularity of its brand relative to others. While Starbucks is the undisputed king of coffee in the U.S., it is also facing increasingly tough competition in international markets—most notably from U.K.-based Costa Coffee and Luckin Coffee (LK) in China.

The Biggest Obstacles Abroad

Costa Coffee is the UK’s biggest coffee chain, where it has over seven times as many stores at Starbucks. While it is unlikely that Costa will ever dethrone Starbucks in the U.S., it is poised to give the company a run for its money in international markets, particularly in China. Costa was acquired by Coca-Cola (KO) in January 2019 for $4.9 billion. In April, Coca-Cola announced plans to roll out a line of ready-to-drink coffee beverages, something the company wouldn't be able to do without Costa's coffee know-how. Coca-Cola’s plans for Costa's coffee shops are currently confidential, but the soda giant’s international reach will likely make Costa a serious threat to Starbucks in developing markets.

Luckin Coffee, China’s biggest coffee chain, is challenging Starbucks in the world’s largest market. It has seen rapid growth since its founding in 2017. As of March 2019, Luckin had 2,370 stores in China and plans to add 2,500 more by the end of 2019. Unlike Starbucks, Luckin’s stores are smaller and focus on coffee to-go for China’s growing white-collar class, while still offering prices about 25% lower than Starbucks’. This undermines the dominance of Starbucks' coffee shop model. Luckin’s lower prices, heavy promotional discounts, and alternative branding are its greatest weapons against Starbucks. But with a market cap of $2.9 billion, it is still small fish compared to Starbucks' $107 billion—it remains unclear whether Luckin’s savviness will be enough to unseat the coffee giant.