Coffee Is Great, But It's Not Why You Should Buy Starbucks

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Depending on who you ask, the coffee industry is between 500 and 1200 years old. Most agree the first coffee drinkers came from East Africa, specifically Ethiopia. Coffee then made its way up into the Arab world through Egypt before arriving in Italy and the rest of Europe.

Coffee spread throughout the world relatively quickly (this was before the internet or modern infrastructure). How could it not? Not only is the beverage delicious, it gives you a great boost in energy for herding sheep or harvesting crops (or whatever it is people did 500 to 1200 years ago).

So if coffee is such a mature industry, how could so many companies that operate in the sector provide investors with even remotely good prospects for growth? Today’s modern coffee shops, while they all deliver relatively similar beverages have found ways to differentiate themselves by offering something besides coffee.

The Third Space

Why would anyone pay $7 for coffee at Starbucks (NASDAQ: SBUX) when they could make a similar cup at home for pennies on the dollar? Starbucks and coffee shops around the world provide what Howard Schultz and others refer to as a “third space.” A place between home and work, where people can gather, talk, read, work, and relax in a comfortable environment.

It’s not just about getting people in the doors anymore. With 54% of Americans drinking coffee on a regular basis, and a growing international demand in developing nations, the coffee drinkers will find their way into a coffee shop from time to time. Coffee shops need to provide an environment that keeps them there and keeps them coming back.

Starbucks focus on the third space is one of the reasons they became ubiquitous with coffee shops. With the company’s recent acquisition of Teavana (NYSE: TEA), Starbucks could do the same for tea (an industry even older than coffee) as it did for coffee. Currently, Teavana shops don’t offer patrons a place to sit and relax, and while most have a bar serving various specialty drinks, there’s potential for much more.

Non-Coffee Consumables

Most people have a favorite restaurant. Everybody has their reasons why they love to eat at a particular restaurant, but usually it boils down to one thing – the food. The environment and ambiance could be spectacular, but if the food doesn’t cut it, people aren’t coming back.

Dunkin’ Brands (NASDAQ: DNKN) has done a great job pushing coffee through its doughnut shops. One of the leading coffee brands, Dunkin’ Donuts’ focus on quality doughnuts brought customers in the door time and time again. The company generates more than 50% of its revenues from coffee sales these days, and it’s not uncommon, in today’s health conscious environment, for patrons to forego the doughnuts altogether.

Being Everywhere

The strength of a coffee company is heavily reliant on branding. Why do people buy Starbucks over the competition? Branding. Building a strong brand is really very simple. All a company has to do is be everywhere. 

Starbucks wants to be the first thing people think of when they think of coffee whether it’s in the supermarket, the mall, the street, or at home. It does this buy oversaturating and self-cannibalizing, putting a shop seemingly on every street corner in densely populated areas. It puts its coffee on the eye-level shelves at grocery stores. It sells you a coffee maker to easily make specialty espresso drinks at home.

Green Mountain Coffee Roasters (NASDAQ: GMCR) built a great brand around single-serve coffee makers. As much as Americans love to drink coffee, seemingly very few know how to make a good cup. Keurig K-cups became the brand for “home brewers” with limited know-how. When Keurig hit the market, it found a great deal of success by partnering with Starbucks and Dunkin’ to sell coffee to people where they already shopped for it. Essentially, they found a way to be everywhere coffee drinkers that didn’t know how to make it at home were.

Buying Coffee

My favorite coffee company and brand for 2013 is Starbucks. The recent Teavana acquisition provides them with numerous opportunities to expand both Teavana’s offerings by changing the environment and Starbucks stores by offering more specialty tea drinks. It also has a strong loyalty program that will keep customers coming through the doors and buying their products in supermarkets. An increasing focus on the international market also provides the company with great growth prospects (although the accounting can get tricky sometimes), and the company might even be looking to leverage its brand in the wine and smoothie industries in the near future.

Coffee shops today aren’t selling coffee so much as a brand. Starbucks is by far the leading brand in the space, and as more people start drinking coffee around the world, it’s poised to take the majority share of an expanding market.

adamlevy owns shares of Starbucks. The Motley Fool owns shares of Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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