The Coffee Wars Cool Down

By Tom Gibbs - March 20, 2012 | Tickers: KO, JMBA, MCD, PEP, SBUX | 0 Comments

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“Premium” is likely to be the most widely marketed buzzword in the quick service restaurant sector in the 2010s thus far.  McDonald’s (NYSE: MCD)expanded its McCafe line to include premium iced and frozen coffee drinks to compete head-to-head with the more entrenched players in the space including Starbucks (NASDAQ: SBUX) and Dunkin’ Donuts.  Likewise, all three of the burger giants have recently revamped their premium burger menu items with beefier (both price and food quantity) choices like McDonald’s Angus Deluxe, Wendy’s Dave’s Hot ‘N Juicy Double, and Burger King’s Bacon & Bleu hamburger as a direct response to popular up-and-coming chains like Five Guys and Shake Shack. 

Finally, in most recent news, Starbucks will be leveraging the brand name of its $30 million Evolution Fresh acquisition to further expand into the premium smoothie and fruit juice segment. 

Premium has come to mean much more than “great tasting” products with “high quality” ingredients being sold at a “premium price,” but instead is more of a self-induced shift of these quick service restaurants to become more things to more people at more hours of the day.  With the quick serve food and beverage market becoming increasingly saturated, all retailers in the space (although McDonald’s and Starbucks, to a lesser extent) have faced certain relevancy issues.  An expansion into more complementary product lines gives consumers a reason to make more frequent visits during a given week, or even more visits at different time parts of the day.  Likewise, even for those who traditionally do not eat at quick serve restaurants, such offerings may hit a sweet spot and elicit the all-important first visit. 

Starbucks’ Latest Venture

Starbucks, as highlighted in a recent article (LINK), has recently made meaningful tweaks to its core product offering.  The corporation’s announcement of its move further into the $8 billion single serve premium coffee market last week caused a concern to both Green Mountain Coffee Roasters and Nestle, which are both incumbents in the space. 

This news has been quickly overshadowed, however, with today’s opening of Starbucks’ first Evolution Fresh juice store in Bellevue Square, WA.  Investors have little information about the corporation’s growth plans for the new store concept, although Wednesday’s annual shareholders meeting will undoubtedly shed more light on management’s plans. 

Despite the anticipation of future top line growth, what should investors be making of the new venture?

• Tight Squeeze

The vast majority of new restaurants (both sit down and quick serve concepts) tend to fail due to the huge amount of saturation in the space.  Not only are consumers constantly hit with stimuli from different food serving retailers, but there is also the continuous pressure (for many) to save money by preparing their own meals and snacks at home.  Consumers in the premium juice and smoothie market have no lack of choices – supermarket chains are now flooded with pre-packaged smoothies from subsidiaries owned by large snack makers like Coca-Cola (NYSE: KO) and PepsiCo (NYSE: PEP), quick serve restaurants like McDonald’s and Panera now have their own juice offerings, and stand-alone pure play smoothie chains like Jamba Juice (NASDAQ: JMBA), Smoothie King, Planet Smoothie, and Tropical Smoothie Café are very prevalent. 

Starbucks may have a decent product with its Evolution Fresh line, which was founded by the same creator as the Naked Juice line that sold to Pepsi in 2006, but its renowned brand name in the coffee market is not likely to give the new store concepts the boost they need to gain relevancy in the highly fragmented space.  One can raise the argument that Starbucks would be almost better off if it leveraged its existing 17,000 Starbucks stores to expand the premium juice and smoothie line.  An in-store move would save hundreds of millions in capital expenditures (depending on how vast the Evolution Fresh store concept grows), and samples given to consumers in the extremely high traffic stores can give the product superior recognition and possibly a degree of customer captivity.  Such a move does ignore any brand dilution that may extend from a further step away from Starbucks’ core coffee product, as was recently argued with its expansion into beer and wine offerings.  However, with so many existing players and poor performance among those already in the market (i.e. publicly-traded Jamba Juice), Starbucks management will need to announce a pretty compelling marketing plan at Wednesday’s meeting to retain shareholder confidence. 

• The Robustness of Growth

As mentioned, little is yet known about Starbucks’ growth plans for the Evolution Fresh brand on a stand-alone basis.  However, investors should hope that the growth is slow, strategic, and brand preserving.  Both Jamba Juice’s history and Starbucks’ historical growth patterns offer suitable examples.   During Howard Schultz’s eight-year hiatus from Starbucks’ CEO role (2000 – 2008), the company experienced its most robust growth phase.  As depicted, the corporation’s sales on a per-store basis drastically decreased as thousands of stores were build per year over the same time period, hinting that new stores were most likely not built in the most optimal locations.  Whether or not the new stores cannibalized existing stores to a certain extent or the new locations were constructed in relatively low traffic areas, the result is easily understood – the return from the swift growth became increasingly less attractive as the growth phase progressed.  Schultz’s return, the closing of more than 900 stores, and the slowing of new store growth over the past several years has reversed the trend.

Dollars in Thousands.  Net Stores = Stores Opened - Stores Closed

Smoothie market incumbent Jamba Juice also got caught up in an excessive growth phase between the decade ending 2008.  The corporation expanded its footprint nearly tenfold over the period, with most of the growth in the corporation’s native California, and revenues have dropped by more than 8% per year since 2008.  Jamba Juice has recently followed a similar path as Starbucks, and has spent more than $30 million in shareholder funds (one-fifth of its market cap) in closing down and relocating inefficient stores over the past three years.  The premium juice retailer has focused on franchising most of its existing stores to push some of the store-operating cost burdens along to willing franchisees, although not enough time has passed to determine whether or not the initiative will be extremely successful in the long run.

Until Starbucks management can relay to shareholders the dynamics behind Evolution Fresh’s growth plans, as well as a compelling marketing strategy that will differentiate the new entrant from the other players in the highly fragmented space, there should be relatively muted excitement regarding the coffee king’s pursuit of the smoothie and premium juice market. 

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