Starbucks v McDonald'sCoffee wars

Starbucks ousts its boss and brings back its founder as a new threat emerges

Jan 10th 2008 | From the print edition

HOWARD SCHULTZ once said that he finds it painful when people compare his firm,

Starbucks, to McDonald's. The founder of the world's biggest chain of coffee shops thinks a

visit to Starbucks should involve “romance and theatre”, a far cry from the pit-stop-like

experience of eating a meal at the world's biggest fast-food chain. Yet in its efforts to expand

and attract less affluent customers over the past couple of years, Starbucks has started to

become more like McDonald's—even as McDonald's, for its part, has been moving upmarket

to become more like Starbucks.

Going head to headAP

Starbucks is now struggling with the most serious crisis in its history—much as McDonald's

did at the beginning of the decade. Last year Starbucks' share-price fell by 42%, making it

one of the worst performers on the NASDAQ exchange. In the last quarter of 2007

Starbucks recorded its first ever year-on-year decline in customer visits in America, easily its

biggest market. When analysts at Bear Stearns, an investment bank, downgraded the firm's

shares on January 2nd, they plunged by another 12%. This sealed the fate of Jim Donald,

the chief executive since 2005. On January 7th the company said it would replace him with

Mr Schultz, who stepped aside in 2000 to become chairman.

Mr Schultz is not trying to pass the buck. His company is in trouble, and much of it is self-

inflicted. “I'm here to tell you that just as we created this problem, we will fix it,” he promised.

He wants to slow down the pace of expansion and improve the “customer experience” in

America, while accelerating expansion overseas. But he says there is no “silver bullet”.

Analysts agree that Starbucks' main problem is overexpansion—as it was at McDonald's in

2001, when the chain crossed the 30,000-store mark and struggled with a dearth of

innovation, market saturation and poor control over restaurants. Howard Penney, an analyst

at Friedman, Billings, Ramsey in New York, thinks Starbucks needs to cut its rate of

expansion in America by half. “They are growing too fast in a mature market,” he says. The

firm has more than 10,600 coffee shops in its homeland, and another five or so open every

day. Starbucks had been aiming for 20,000 shops in America and 20,000 abroad, but that

goal is now in doubt.

Not all of Starbucks' poor performance is of its own making. Prices for food commodities are

at all-time highs, prompting the firm to increase prices twice in the past year. This has scared

off customers, who have been defecting to fast-food chains such as Dunkin' Donuts or

Panera Bread, which sell reasonable coffee for as little as a quarter of the price of a fancy

Starbucks brew. In November Starbucks launched its first national television-advertising

campaign in an effort to win them back.

Adding to Starbucks' woes, and further emphasising its similarity with McDonald's, the

burger chain is about to launch a direct attack of its own. This year McDonald's plans to add

Starbucks-style coffee bars to nearly 14,000 of its American restaurants—the biggest

diversification ever attempted by the company. McDonald's has already made smaller forays

into the coffee market, and with some success. Last yearConsumer Reports, a trade

magazine, rated its filter coffee more highly than that offered by Starbucks.

Starbucks should be worried, says Mr Penney, though he thinks McDonald's is taking a big

risk. About 65% of its sales in America are made in drive-through restaurants where

customers stay in their cars, placing their orders and then receiving their food through a

window. It is impossible to make a Starbucks-style “double-tall decaf hazelnut latte”, which

takes time, when impatient motorists are queuing. In Germany, a test market, some 300

McCafés are doing well, but they are not attached to drive-throughs.

Mr Schultz saw his firm's crisis coming. In February 2007 he warned of the

“commoditisation” of the brand in an internal memo to senior executives that found its way

onto the internet. “Over the past ten years...we have had to make a series of decisions that,

in retrospect, have led to the watering down of the Starbucks experience,” he admitted. He

cited the switch from hand-pulled espresso machines to the automatic variety, which helped

to speed up service but diminished the spectacle of coffee-making. The result, he conceded,

was that some customers found Starbucks coffee shops sterile places that no longer

reflected a passion for coffee.

Analysts and investors welcome Mr Schultz's return because it shows the company is taking

action to correct its drift. The main architect of Starbucks' expansion is seen as the best

person to lead a return to the firm's roots as a specialist coffee shop with a local touch.

McDonald's, by contrast, having just recovered from its own overexpansion, is venturing into

a whole new market. May the best latte win.

From the print edition: Business

Business.viewWoke up, smelled the coffee

The Starbucks turnaround is going surprisingly well

Sep 29th 2009

IT COULD certainly pass as a stand-alone Seattle neighbourhood coffee house. There is an

eclectic mixture of old wooden tables to sit at, and pictures by local artists adorn the walls.

Wine and beer are on sale, too, along with cheese and meat plates. It feels cosy and not at

all corporate. The only clue to the true identity of 15th Avenue Coffee and Teais the small

print on the door: “inspired by Starbucks”. For “inspired by”, read “owned and operated by”.

These facts ensured that the store opened in July to a triple-shot of controversy, with

protesters outside its doors—no doubt to the delight of Starbucks.

Starbucks in disguiseAFP

Apparently it was cheaper to fit out this experimental store—and similar, locally-customised

ones in Paris and Tokyo—than a conventional outlet. And although it would be too

expensive to refit all Starbucks branches in this “inspired” way, the coffee retailer plans to

draw on its experience here to give them a more personal, local feel, as it tries to recapture

the pleasant café atmosphere which originally made its name.

This is but one part of the strategy initiated by Howard Schultz after he returned in January

2008 to run the firm he had made great but which had by then entered a seemingly

inescapable spiral of decline. Investors approve: having fallen below $8 last November,

down from an all-time high of nearly $40 in 2006, shares in Starbucks have risen above $20,

a bit higher than they were when Mr Schultz took charge for the second time. So far this

year, they are up by nearly 120%, while the S&P 500 index is not quite one-quarter higher.

Mr Schultz has left no bean unturned in his effort to turn Starbucks around. His successor as

chief executive, Jim Donald, had overseen a suicidal rapid worldwide expansion of the chain.

On his return, Mr Schultz's first step was to reverse this, closing poorly performing outlets.

The next was to change the way things were done within the stores, to improve the

efficiency of everything from the process by which an order is passed from customer to

barista to new systems to minimise waste milk. This has reduced annual operating costs by

around $500m so far, and has helped win a reprieve for around 30 stores that had been

scheduled to close but now seem viable.

There has been greater emphasis on the quality of service

At the same time, there has been greater emphasis on the quality of service. The chain

closed every store for a day to teach the staff to make a better espresso. To preserve

morale, the firm has resisted the temptation to cut its generous health-care benefits. It took

10,000 store managers to a pep rally in New Orleans, where among other things they did a

combined 50,000 hours of community service and were entertained by Bono of U2.

To freshen the brand, Starbucks is also encouraging its customers to be better citizens. It

offered free coffee on the day of Barack Obama's inauguration in exchange for a promise to

do volunteer work in the local community. The firm has also cosied up to the “fair trade”

movement, trying to put behind it the humiliating defeat it suffered when it took on Oxfam

and other non-profits over an attempt by Ethiopian coffee growers to assert intellectual-

property rights over their beans. Now Starbucks raises money to help victims of HIV/Aids by

selling coffee under Bono's brand, RED. And it has pledged to build sustainable long-term

relationships with its farmers. To this end Mr Schultz recently travelled to Rwanda, where the

firm has opened an agronomy office and a farmer-support scheme to help spread best

practice.

Regular customers have been bombarded with offers through a sophisticated social-media

campaign. Starbucks boasts one of the most popular corporate Facebook fan-pages, with

4m “friends”, and 300,000 followers on Twitter. It is also trying to shed its recent image as a

purveyor of unhealthy dairy and sugar products (make mine a venti double-caramel latte with

whipped cream). The menu has been revamped, to remove trans-fats and artificial dyes, and

add salads and banana-based smoothies.

Starbucks has had to fight off intensifying competition from McDonald's, and the effects of

the downturn, by offering cut-price "value meal" combinations of drink and food. At the same

time, in fancy stores such as 15th Avenue Coffee and Tea, it has been courting coffee

connoisseurs with an elaborate machine that makes individual cups from the finest beans

through a mechanised equivalent of the Japanese tea ceremony (well, sort of). Instead of

getting rid of Starbucks' popular hot snacks, as Mr Schultz had initially threatened, to avoid

unpleasantly cheesy odours, the recipe has been altered to use less pungent cheese and to

ensure that it does not drip onto the oven and burn.

Some of these factors have had a greater impact than others. Yet overall, in the most difficult

economy in its history, especially for high-end products (and this, remember, is a firm

nicknamed Fourbucks due to its high prices), Starbucks seems close to halting its decline.

Same-store sales have not quite stopped falling, but the rate of decrease has slowed

significantly, while cost-cutting and other efficiencies have increased margins. As analysts at

Goldman Sachs put it, "Starbucks appears to be making the right moves to transition into a

‘staying power' phase where its strong competitive position could sustain a premium

valuation.”

If the economy recovers quickly, the operational changes in Starbucks' stores mean that a

large part of the additional demand will go straight to the bottom line. Another potential

source of profits growth is the firm's new instant-coffee brand, Via, which was launched

nationwide in America and Canada on September 29th. Mr Schultz says his technologists

have helped him achieve his long-term ambition of finding a way to make instant coffee that

does not taste stale. To add to profits, Via, which costs 99 cents a sachet, will have to sell

well but not cannibalise Starbucks' existing customers, who pay several times as much for

ready-made drinks.

Earlier this year it was common to liken Mr Schultz to Michael Dell of the eponymous

computer-maker, another founder who had returned to his firm and failed to revive it. This

was in sharp contrast to Apple's co-founder, Steve Jobs, who showed that a boss could

return to the site of his greatest achievements and do even better. Michael Dell continues to

struggle: shares in his firm are still only worth around three-quarters of their value when he

returned to the top job in early 2007, and around one-quarter of the all-time high in March

2000. Mr Schultz's second act, by contrast, looks increasingly likely to be judged a success.

ColombiaBitter grounds

The woes of coffee farmers

Sep 15th 2012 | BOGOTÁ | From the print edition

 The coffee federation has got rusty

THANKS to decades of diligent brand-building, Colombian coffee sells for a premium in the

world market. But nowadays most coffee served in the country is brewed from beans grown

in Ecuador or Peru. Output in Colombia, once the second producer after Brazil, hit a 35-year

low in 2011 of 7.8m 60kg bags, down from an average of 13m in the 1990s. Although it will

rise to 8.5m bags this year, according to the National Coffee Growers Federation, the

federation’s own target of 14m bags in 2014 looks challenging.

The more than 500,000 small-scale coffee farmers are restive. Last month thousands

marched though Manizales, the capital of the coffee-belt, demanding more government help

and a shake-up of the federation. Although the collapse in the harvest was partly due to

unusually heavy rains over the past three years, the farmers face other problems. As well as

fungal rust, a plant disease, and insect infestation, these include price volatility and the

strength of the Colombian peso, which renders production unprofitable.

Some relief is at hand. Younger, disease-resistant trees are starting to bear fruit, the weather

is drier this year, and the central bank is intervening to drive down the peso. But some

Colombians believe the coffee federation is also part of the problem. It is still a big buyer of

the crop, at a guaranteed price. If Colombia is to regain its share of the world coffee trade,

the federation should stick to branding and technical help, freeing producers to respond to

price incentives in a market overseen by a new regulator, argues ANIF, a Bogotá think-tank.

From the print edition: The Americas

Coffee in Central AmericaFair enough

Taking the quality route to survival

Mar 30th 2006 | mexico city and san josÉ | From the print edition

Heading for your skinny frappuccinoReuters

MAKING good coffee is not a simple business. Coffee bushes must be grown in shade—

neither too much, nor too little. A hillside is best—but it mustn't be too steep. After three

years, the bushes will start to produce bright-red coffee “cherries”, which are picked,

processed to remove the pulp, and spread out to dry for days, ideally on concrete. They are

milled again to separate the bean, which needs to rest, preferably for a few months. Only

then can it be roasted, ground and brewed into the stuff that dreams are quelled with.

In Mexico and parts of Central America, as in Colombia and Peru further south but not in

Brazil, most coffee farmers are smallholders. They found it especially hard to deal with the

recent slump in the coffee price. The price has since recovered: the benchmark price applied

to mild coffee now ranges from $1.11 to $1.14 per pound. That is roughly double its rock-

bottom level of August 2002.

But the volatility of their income makes it hard for farmers to invest to sustain their crop, says

Fernando Celis of the Mexican National Organisation of Coffee Growers. The slump forced

many small farmers to switch to other crops, or migrate to cities. Mexico's exports of coffee

are less than half of what they were six years ago.

For farmers, one way out of this dilemma is to decouple the price they are paid from the

international commodities markets. This is the aim of Fairtrade, a London-based

organisation which certifies products as “responsibly” sourced. Fairtrade determines at what

price farmers make what it considers a reasonable profit. Its current calculation is that the

appropriate figure is 10% above the market price.

Worldwide, sales of Fairtrade-certified coffee have increased from $22.5m per year to $87m

per year since 1998. This is still only a tiny fraction of the overall world coffee trade, worth

$10 billion annually. But there are plenty of other niche markets for high-quality coffee. Some

small producers can charge more by marketing their coffee as organic—a switch which

takes five years or so—or “bird-friendly” because, unlike large, mechanised plantations, they

have retained shade trees.

Starbucks, the Seattle-based coffee-bar chain, says it uses a similar formula to that of

Fairtrade in buying its coffee. All is bought at a “fair price”, says Peter Torrebiarte, who

manages Starbucks' buying operation in Costa Rica.

Some niches can be large. Only 6% of world output is of top quality, but in Costa Rica and

Guatemala the figure rises to 60%, says Mr Torrebiarte. Starbucks bought 37% of Costa

Rica's entire coffee crop in the 2004-05 season, according to Adolfo Lizano of the country's

coffee institute.

Mexico lags behind its neighbours in extracting higher prices. But 95% of the coffee in

Mexico is arabica—the type of bean demanded by connoisseurs—rather than lower-grade

robusta. Almost all of it is grown at altitude, which also improves quality. So Mexico, too, has

the potential to compete on quality rather than price. Only by following the path forged by

Costa Rica and Guatemala, says Mr Celis, can Mexico's coffee growers survive in the world

market. For their part, discerning coffee drinkers can satisfy their palate and their conscience

at the same time.

From the print edition: The Americas

CoffeeExcellence in a cup

A competition promotes trade in coffee based on quality, not just quantity

Jan 25th 2007 | VIÇOSA | From the print edition

ONE morning last month in an airy hall at the Federal University of Viçosa, Brazil, the only

sound to be heard was a chorus of zestfully inelegant slurping. Twenty-four black-aproned

judges were wielding their distinctive tasting spoons at the Cup of Excellence competition,

searching for the country's best coffee.

“My objective is to differentiate coffee,” says Susie Spindler, who started the competition in

1999 and now conducts it in seven Latin American countries. The competition is open to any

grower in each country, tasting and scoring is systematic and blind, and the winning beans

are sold worldwide in an online auction. By focusing on quality and transparency, Ms

Spindler has not just ferreted out sublime coffees from some unexpected sources, but has

connected the best growers to buyers who are prepared to pay for quality.

With global exports worth $9 billion in 2006 supporting some 25m coffee-growing families,

coffee is an important source of income for many countries. But although the trade is

profitable for importers and roasters, it has confounded governments and NGOs hoping to

use the bean to stimulate developing economies. The collapse of trade barriers, a jump in

production and a tendency by the largest roasters to treat coffee as a uniform commodity

caused prices to fall to historic lows.

But a countervailing trend led by Starbucks and other “specialty” roasters has introduced

drinkers to coffee differentiated by origin and type. Small roasters such as Stumptown,

based in Portland, Oregon, are taking this approach further, borrowing concepts such as

terroir, vintage and appellation from the wine world, taking the utmost care in roasting and

preparation, and emphasising quality. “It's a different world,” says Joel Pollock, Stumptown's

head roaster and one of the judges in Viçosa.

As a result, the coffee trade has bifurcated in the past decade into commodity coffee, sold in

large quantities at a low price, and specialty coffee, where quality rules. There is little middle

ground. Growers producing unexceptional coffee must either cut costs to compete with big,

mechanised farms—impossible for most—or improve quality. The benchmark “C” price is set

at the New York Board of Trade, and varies depending on the weather, the level of demand,

and other factors. The aim of Cup of Excellence and other schemes is to enable high-quality

coffees to differentiate themselves and command a premium over the C price. In Brazil, for

example, investments in quality can increase a farmer's profits by 50%.

But Brazilian growers are relatively well off. For poorer farmers in less developed countries,

even modest investments that would greatly improve their coffee can be out of reach. In

such places, targeted assistance can help. “Quality coffee can be a significant driver in

ending poverty,” says David Browning of TechnoServe, an NGO that promotes

entrepreneurship among the rural poor. The tasting expertise and price-discovering

transparency of Cup of Excellence can, he says, uncover “remarkable global competitive

advantages” in some regions. Starbucks'CAFE practices, Fair Trade and other schemes can

have a similar effect in some countries by providing technical and management assistance,

improved facilities and access to credit.

With just under 800 bags of coffee (of 60kg, or 132lb, each) in its Brazil auction, Cup of

Excellence is insignificant alongside worldwide production of around 100m bags a year. Yet

it is influential. Trade in the best coffees is now distinct from the C market. But old habits die

hard: “I don't take my eyes off the C price,” says Paulo Almeida, who won first prize in

Brazil's Cup of Excellence competition in 2001 and went on to sell his coffee for $700 a bag,

doubling his farm's income. The new diversity of buyers gives farmers a chance to maximise

revenue by selling their coffee through many channels simultaneously: their best through

internet auctions, a specialty grade through Fair Trade or other co-operatives, a commodity

grade to big exporters and the rest to local markets. “It's a matter of finding the right market

for each bean,” says Mr Pollock.

All of this, says Ms Spindler, “changes what is possible for coffee.” Certainly it has changed

things for Fazenda Esperança, the top producer in this year's contest in Brazil. In the online

auction on January 16th, 21 bags of its coffee fetched almost $40,000 from Japanese and

Taiwanese bidders—more than ten times the C price.

From the print edition: Business

The Economist explainsExplaining the world, dailySponsored by 

The Economist explainsWhy are coffee-growers unhappy?

Jul 15th 2013, 23:50 by E.H.

COFFEE has many devoted drinkers. Its appealling aroma and caffeinated kick mean that

83% of all American adults drink it, 63% of them on a daily basis, according to a survey from

the National Coffee Association. Yet despite the strong demand for coffee, some suppliers

are unhappy. In Brazil, which produces a third of the world's coffee beans, farmers are

striking over falling prices and burning sacks of coffee in protest. Why are coffee-growers

feeling the strain?

There are two main varieties of coffee bean: arabica and robusta. The former, which

accounts for around 60% of the world's crop, is considered superior and fetches higher

prices; the latter is a hardier crop, resistant to leaf rust, but has a more bitter taste. Most of

the beans produced in Brazil are of the arabica variety. But these beans now fetch around

$106 a 60kg bag, less than half of what farmers could get for them a couple of years ago.

Farmers in Colombia and Ethiopia, who also produce arabica beans, are suffering too. The

reason is that production of coffee, and of cheaper robusta beans in particular, is booming.

Vietnam has gone from growing almost nothing a decade ago to producing 25m bags of

robusta beans a year today. The result is an oversupply of coffee.

This hurts producers of arabica in particular, for several reasons. First, consumption in the

developed world—American, European and Japanese drinkers consume more than half the

world's coffee—is flat, and the recession has squeezed the profits of big food companies

such as Nestlé and Kraft. They have taken to blending cheaper robusta beans into their

products to maintain their margins, causing the price of robusta to fall more slowly than that

of arabica. In the developing countries such as China, Indonesia and Brazil, meanwhile,

where the emerging middle classes are discovering the joys of coffee and the market is

growing by around 5% a year, robusta is the bean of choice. To make matters worse for

arabica growers, falling prices have been accompanied by rising costs: coffee is still largely

picked by hand, and wages are rising fast in Brazil and Colombia. Many Brazilian and

Colombian farmers invested to boost production of arabica in response to the high prices of

2011, which has added to the oversupply and further depressed prices. And good weather in

Brazil means that this year's crop has turned out to be unexpectedly large. That is why

Brazil's farmers are striking, and are demanding more protection, in the form of fatter

subsidies, from the state.

Farmers who grow arabica beans tend to be specialists, and do not plant other sorts of crops

(which is the usual way for farmers to insulate themselves from volatile prices for a particular

crop). Prices for sugar cane, a potential alternative, are also low. Aficionados' demand for

the fanciest coffees, which fetch higher prices, is healthy, but for farmers to move upmarket

takes time and expertise. Indeed, discerning coffee drinkers are also feeling the pinch,

because the Central American countries where the finest coffee is grown, including

Guatemala, Nicaragua and El Salvador, have been hit by leaf rust, which could wipe out

30% of this year's crop. So even while arabica beans fetch low prices on commodity

markets, the price of the fanciest beans is going up. A storm in a teacup it ain't.

Business.view

Oxfam versus StarbucksAnd, this time, Oxfam may be in the wrong

Nov 7th 2006

A GROWING number of coffee drinkers seem to prefer their morning grande skinny latte without a foul-tasting double-shot of social injustice. Coffee has become a big testing ground for what it means to be an ethical consumer. The hugely successful Fair Trade brand allows many coffee addicts to get their fix with a clearer conscience, safe in the belief that no farmers have been exploited in the growing of it.

So no wonder that Starbucks, an up-market global coffee chain, has reacted like a scalded barista to criticism from Oxfam, a development charity. Oxfam says that Starbucks is depriving farmers in Ethiopia of $88m a year, by opposing the Ethiopian government's efforts to trademark three popular varieties of local coffee bean. At least 60,000 customers worldwide have contacted Starbucks with expressions of concern, prompting the company to post leaflets in its stores defending its behaviour. It accuses Oxfam of “misleading the public”, and insists that the “campaign needs to stop”.

This is not the first time that Starbucks has tangled with ethical consumption advocates. It sells plenty of Fair Trade branded coffee: indeed, it claims to be North America's biggest purchaser of Fair Trade beans. But it also buys other beans, without a stamp of approval from these arbiters of fairness―not least because there are too few Fair Trade beans to meet its customers' demands.

Starbucks also has questions about the different standards of fairness applied by the Fair Trade brand custodians in different parts of the world. It doubts even that the strategy of the Fair Trade movement, to secure farmers a premium over the market price for their beans, is the best basic approach. Starbucks prefers a code known as the CAFE practices (Coffee and Farmer Equity), which aims to help coffee farmers develop sustainable businesses through a mixture of technical support, microfinance loans, and investment in infrastructure and community development where the farmers live.

So far from being a bloodthirsty exploiter happy to keep farmers in poverty, Starbucks emerges as a responsible firm approaching difficult questions in a thoughtful way. It wants to help its suppliers improve their lot. It is certainly no cheapskate. Starbucks says that last year it paid an average price of $1.28 per pound, 23% above the New York Board of Trade's benchmark “C” price, for all its coffees.

Grounds for disagreementAFP

Starbucks's enlightened behaviour makes good business sense. The firm has positioned itself at the quality end of the market, where ethically-minded consumers are concentrated. It has absolutely no incentive to behave badly. Strikingly, another quality coffee producer, Illy Café, has similar issues with the Fair Trade movement, and also prefers to build sustainable coffee farming rather than indulge in simplistic Fair Trade posturing.

So what of the Ethiopian trademarking question? Starbucks argues that trademarking coffee beans contradicts standard approaches to intellectual property, and may introduce legal complexities that deter firms from buying the trademarked beans, thereby

hurting farmers instead of helping them. Starbucks favours a system of regional certification, much like the appellation contrôlée system in French wine, which would allow beans to be branded consistently without creating legal problems. This, too, seems plausible and sensible: the Ethiopian government, one of the most economically illiterate in the modern world, would do well to take Starbucks's advice.

As for Oxfam's involvement, it will be interesting to see how this battle of global brand versus global NGO develops. Starbucks has loyal customers who may well be prepared to hear out the firm's side of it and judge the case on its merits. Given the weakness of Oxfam's arguments, Starbucks may yet emerge with its reputation enhanced, and Oxfam with its credibility damaged. Is it too much to hope that this battle may be a turning point in the war over corporate ethics, and that it will cease to be enough merely for an NGO to throw mud at a company, to have that mud stick? The Economist will drink a grande extra wet triple-latte to that.