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Starbucks' Growth, Brand and Cultural Issues

May 01, 2008 | About:
Dividend Growth Investor

Vitaliy Katsenelson

73 followers
After I wrote a piece on Starbucks (SBUX) raising questions about its future success in international expansion and questioning the growth premium built into the stock, I got a lot of great emails that really made me think (the best kind!).

About the stock: I saw a lot of value managers that I respect loading up on it, even at $5 higher. As price keeps declining, the stock is definitely becoming more interesting, however, I have not done enough research to figure at what price it turns into a buy.

I still have many questions that need to be answered, but here is a little story that really tells you about the quality of SBUX’s brand: A couple of weeks ago I guest-co-hosted a radio show in Denver. I decided to bring a gift to my co-host. It was 9am on a sunny Saturday, and coffee seemed like the right choice (for a very modest gift), plus I had an excuse to get one for myself. I stopped by a Starbucks, one of three that I encountered on my two-mile journey to the radio station. The show went well and my co-host appreciated the gesture.

Here is the thing, though. According to consumer surveys, McDonald’s (MCD) has better coffee. But I would have looked silly if brought a McDonald’s coffee instead. Some may disagree about the taste, but Starbucks went into our dictionaries as quality coffee.

For example, it’s hard to go wrong giving a Starbucks gift card, but people may look at you funny if you give them a McDonald’s gift card.

I know the issues about Starbucks – the McDonald’s entrée, the copycats, recession sensitivity, too many locations, international expansion worries. I’d have to have a better grasp on them before I buy the stock, but one thing is definitely clear to me – SBUX has a unbelievably strong brand, at least in the U.S.

After looking over readers’ feedback, I came to the following conclusion about SBUX’s international expansion: so far SBUX has succeeded in places where coffee-drinking is not deeply ingrained into the culture. In fact, the less coffee is ingrained on country’s culture the, the higher the chances of SBUX’s success.

I was amazed how many SBUX stores I saw in London. The U.K. is not a traditional coffee drinking nation – tea is the national drink. Japan falls into the same category. However, SBUX will have to climb a steep mountain in a good part of Europe (including Austria, Italy, Turkey, etc.) where coffee drinking is deeply ingrained in the culture.

Ironically, it seems that SBUX’s international success will depend on converting non-drinkers into drinkers.


Geoff from Austria wrote this brilliant note, I tried to shorten it, but it was so good I had hard time cutting it.

Vitaliy,

You seem to have come to the conclusion that SBUX has failed in Austria. I must admit that I think rather the opposite is true. When SBUX opened their first shop in Vienna 2001, nobody thought they would be able to make it more than a few months. Everyone was convinced they would be gone in less than a year, as has been the case with many U.S. restaurant chains.

Burger King (BKC) initially failed and only returned a decade later, Subway went under, Pizza Hut (YUM) left for good and lots of others had the same fate. So I really wouldn´t judge Starbucks’ progress as failure. It may seem slow by U.S. standards, but 11 profitable locations in just 6 years is not bad at all for Austria.

Geoff went on to sum up some fascinating cultural differences:

- Pace. Everything is much slower here. If you want to have a coffee, you want to enjoy it, not just pour it down as fast as possible. Also, people consider their preferred coffee house a “living room away from home” where they meet friends, read the papers or just watch other people.

- Culture. Eating or drinking while walking in the streets is considered extremely bad behaviour - no wonder “coffee to go” is no big success here. The only exception: an ice cream cone is perfectly ok now - at least for the younger generations. Older people often still strongly dislike it.

- Mentality. Mainstream Americans are income maximizers - they try to earn as much as possible in the time given. In contrast, mainstream Europeans (maybe with the exception of the U.K. and some of the new eastern EU members) are benefit maximizers. Since the tax system and social expectations don´t provide much incentive for extra efforts and income is more or less fixed anyway (you won’t get much more money if you work more, faster, better or more efficiently in most jobs) achievable income is perceived as constant and thus people try to minimize efforts and maximize non-monetary benefits (little work effort, early retirement, holidays, long weekends etc.). No need to buy overly expensive coffee while rushing to work and nobody drinks coffee in the car (most European cars don´t even have cup holders). It just doesn´t pay to rush.

Actually, many people don´t even have or use a car to go to work, as public transportation is often much faster, cheaper and more convenient, especially in the cities. - And I guarantee you, you wouldn´t want to enter the crowded subway with a paper cup of boiling coffee in your hand.

- Cups. Austria has a very long tradition when it comes to coffee houses. We are used to drinking from decent, solid cups. Paper or plastic cups might be acceptable in emergencies or for a quickly improvised sports event, but certainly not for a coffee house. Even if you get your coffee in a “real” cup or mug the experience is spoiled for most when there are paper cups on the tables around you.

- Quantity. Like almost everyone outside the U.S., we are not used to huge portions, be it food of beverages and also don´t consider it such a good thing, in fact, many of us feel a bit intimidated by it. Whenever I´m in the States I wonder how people can actually eat and drink the amounts offered as “small” or “regular”, and when I look at the soda cups marked “small” - “medium” - “large” I think in terms of “huge” - “bucket” - “barrel.”

- Price. Starbucks’ products are outrageously overpriced, especially for the kind of quality they deliver here in Austria. Even if the quality were better, they would simply be too expensive for the majority of “average Austrians.”

Average real wages are lower than in the U.S., but taxes and social security fees much higher (1/3 of gross income is stripped for social security, the rest is taxed at rather high rates - progression starts at the very bottom with 38.5 % and ends at 50% for those with “obscenely high” gross incomes of EUR 50,000 a year or more.). From what is left we then pay 20% VAT on almost everything. You may have noticed that cars are generally much smaller here - that´s because they are more expensive to buy due to extra taxes, gas is about US$ 7.50 / gal (EUR 1.25 / liter, and that is still a bargain compared to most other European countries…!) and there are rather high yearly taxes for the possession and circulation of motor vehicles.

Of course, there is also a bill for parking, insurance, repairs, highway tolls etc. Then there are the local fees for water, garbage disposal and even a few hundred Euros license fee per year for the mere permission to own a radio or tv set (cable or satellite fees are extra of course), co-payments (or full payment) for medical treatment, and tons of other expenses we have very little control over. Over the last decade nominal incomes have stagnated (or even decreased in some sectors) with real incomes on a constant slide and massively eroded purchasing power.

So, after all necessary and unavoidable expenses the average family barely has enough left (a few hundred Euros a month) to cover basic necessities like food, clothing and some minor saving for retirement (which of course is also taxed at 25% per year). - Why on Earth would these people spend EUR 4-6 for a paper cup of coffee if they can get the same or better quality for a third of the price? As money managers, we tend to deal with people at the upper end of the income scale and that gives us some extra breathing room even during economic downturns and harder times - but I can assure you there are many, even here in one of the statistically richest countries of the world, who have full 48.5 hour jobs, work overtime as much as possible and live in tiny apartments who just cannot afford EUR 3-5 for a cup of coffee.

- Local regulation. Business is still highly regulated in Austria when it comes to opening a shop. It is close to impossible to open a café at a location where there was a textile business, a book shop or some other type of business before as the following business is usually required to be of the exact same type. This limits the number of possible attractive tourist hotspots.

Either there was no gastronomy at these places before and thus no license available or there are already such businesses who don´t want to leave because it´s a profitable spot. So a new entrant could either try to buy out an old business owner or bribe the authorities for a change of license type, which is not an easy task nowadays as the public acceptance of corruption has significantly decreased over the last two decades. Once in a while (about every 10-15 years) local business structures are evaluated by the authorities and minor adjustments in the types of allowed businesses in a certain street or zone may be made, but this clearly takes a lot of patience and efforts too, without any guarantee for success. It was certainly not easy for Starbucks to open its first shop in Vienna (across the Opera), as this was the Air France headquarter in Austria before.

- Competition. You wrote “SBUX, along with other high quality companies with strong competitive advantages…” - while I can understand that characterization for the U.S. market, this is definitely not true for the Austrian (and Italian, Turkish) market. The only two advantages they have is the recognized brand and financial capacity to buy or rent even extremely expensive locations at tourist hotspots. They only compete on name recognition but fail on price, quality and service. - And that is not an easy achievement, considering the kind of lousy customer service we have to endure here day in day out. There are a number of copy cat franchise chains that offer exactly the same products with just minor variations in names and logos for less than half the price of Starbucks, there are the traditional Viennese coffee houses and lots of Italian ice cream and coffee shops. So, apart from name recognition and some of the most expensive shop locations in Austria, I really cannot see much of a competitive advantage.

Tourists who want to eat and drink abroad exactly what they eat and drink at home and some desperate non-smokers who have to find a place meet and talk, but apart from that there’s not much interest from the locals.


I asked a friend, a money manager who now lives in London but spent 15 years in Japan, about what is going with SBUX there. Here is his reply:



In Japan, coffee shops probably came in after the war and were extremely successful, where you could sit for an hour and have a chat with a client and so on.

Starbucks came in the ’90s (probably 500 branches in Japan by now) – mostly city areas. They are sexy and they have had some success, then weakened and have been doing well recently with some 70 stores opened last year. Starbucks Coffee Japan trades on 30 times earnings and 3 times book.

It is often given free rent in new office buildings for the first few years as it attracts corporations to rent in such office buildings.

About the author:

Vitaliy Katsenelson
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.9/5 (10 votes)

Comments

DaveinHackensack
DaveinHackensack - 6 years ago
Vitaliy,

I am surprised to hear that Starbucks opened stores in Austria; I had heard that they avoided Italy because they didn't think they could compete with the established coffee/espresso culture there, so I'm surprised they would try to compete in Austria, which also has a strong cafe culture.

It makes sense that Starbucks would be popular in Japan; I think it's popular in NYC for a similar reason: a lot of people have such small apartments, that the local Starbucks becomes their de facto living room -- they study there, meet friends and first dates there, etc.

Let us know when you think Starbucks's stock is a value.
kfh227
Kfh227 premium member - 6 years ago
SBUX has no barrier to entry. 15 years ago, most would think that Dunkin Donuts would be the only major coffee house and look what that got them.

Someone can just as easily dethrone Starbux. It's not a question of if, only a question of when.

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