Saturday, December 23, 2006

Innovations Brewing At Starbucks

Imagine this:

A Card that brought in greater than $2.17 billion in revenue since 2001.

A Card that gets renewed or in this case reloaded over 38 million times and counting.

A Card that customers "hang on to" literally, and carry around in their wallets (and are even proud to show it).

A Card that will find over 15 million new card owners this holiday season (possibly one of the top holiday gifts).

A Card that will bring in more than $170 million in sales, and more than 10 percent of the company's revenue in a quarter.

A Card that revolutionized the gift card industry which is worth $24.8 billion, and growing $6 billion each year.

This must be a credit card!


Welcome to the world of coffee and the Starbucks Card!

Starbucks Corporation (NASDAQ: SBUX) is one of the top 18 innovators in The Innovation Index. SBUX is up 18% for the year owing to the many innovations it brews each year including the highly successful Starbucks Card that it introduced five years ago and catalyzed the industry of gift cards (as of the last Innovation Index weekly report). Starbucks is on an exponential growth tear for the last five years, having grown revenue from $2.6 billion to $7.8 billion in the last five years, with CAGR of 24.10%. How does Starbucks do this? Besides opening new stores at every major intersection where there is a shopping center, at exclusive mall locations, grocery stores, in office complexes, even residential complexes both locally and internationally, and very soon perhaps in residential neighborhoods (if Starbucks has its way), Starbucks has literally created a world of exclusive coffee drinkers overnight who can't have enough of their $2.50 lattes. All these growth has also created complaints against Starbucks from the organic lobby and coffee growers over the world complaining of unfair trade practices.
Starbucks latest quarterly earnings grew to $2 billion, up 21% from $1.659 billion in the year ago period. The report reveals many innovations driving revenue growth of over 20% year over year:

1. Starbucks opened 1,040 new stores, including opening of and planned stores in Egypt and Cairo. Further, the innovator is planning to open 2,400 stores in fiscal 2007, and around 700 stores overseas. Starbucks has perfected the innovation process around selecting a new store location, opening the store in record time, and generating superior margins and cash flows within two years.

2. The quarterly Company-operated retail revenues increased 22% to $1.7 billion, from $1.4 billion for the period year period. The increase was primarily attributable to comparable store sales growth of 5% for the quarter compared to the year ago period. The increase in comparable store sales was due to a 4% increase in the number of customer transactions and a 1% increase in the average value per transaction. This was led by innovations across the beverage menu as well as food offerings - increased selection, price changes, and better packaging.

3. Specialty Services revenues increased 16% to $309 million, compared to $267 million for the prior year period.

4. Licensing revenues increased 21% to $223 million versus the prior year period. This was primarily due to higher product sales and royalty revenues from the opening of new licensed retail stores and, to a lesser extent, growth in the licensed grocery and warehouse club business.

5. Foodservice and other revenues increased 5% to $86 million, versus the year ago period. This increase was primarily due to growth in the U.S. foodservice business, partially offset by lower entertainment revenues which included revenue from the sales of Ray Charles' Genius Loves Company CDs outside of Starbucks retail stores in the fourth quarter of 2005.

It is evident that new revenue growth is not just created by opening of new company operated stores, but by higher sales at existing stores, specialty services, licensing, foodservice and entertainment sales.

Starbucks Innovation pipeline in 2006 and beyond

Starbucks is literally planning to transform the Coffee Vending industry, expand reach in Canada and U.K., and accelerate roll-out of warm breakfast offerings in the U.S. with various partners as per the "innovation pipeline" announcement in October, 2006.

Gerry Lopez, president of Global Consumer Products Group at Starbucks, announced that Starbucks wants to "transform coffee vending with its plans to offer superior hot latte and cocoa beverages through the Starbucks hot vending initiative" in partnership with PepsiCo. Lopez also announced an expanded relationship with Kraft to distribute coffee in Canada and the United Kingdom as well as plans to roll out Starbucks™ Coffee Liqueurs to Canada later this month in partnership with Beam Global Spirits & Wine, Inc.

Innovations beyond the stores

"Through the Starbucks hot vending initiative, Starbucks aims to transform the hot coffee vending experience by creating a new, high-quality hot drink segment within the estimated $900 million ready-to-drink beverage category in the U.S. The planned introduction of Starbucks hot vending will mark a significant advancement within the vending industry. Unlike any other coffee vending experiences in the market, the Starbucks vending platform utilizes proprietary heat-on-demand technology, developed by PepsiCo, which will offer customers yet another convenient way to enjoy Starbucks on-the-go."

Why is this hot vending initiative innovative? "Through research and product testing, Starbucks and PepsiCo learned that the common complaints about existing coffee vending included lack of consistent, high-quality coffee, as well as issues with messy and hot-to-hold cups. To tackle these obstacles, Starbucks and PepsiCo developed this revolutionary approach to hot coffee vending. With a simple swipe of a payment card (or with cash), a high-quality, hot latte or hot cocoa is served up in a ready-to-drink package in less than a minute. Utilizing proprietary packaging, each hot beverage will come in a convenient 9 fluid ounce recyclable steel can with an insulating label, designed to keep the beverage warm, enjoyable, and still comfortable to the touch." Starbucks is planning to recreate the quality and experience of drinking coffee at a Starbucks location with the convenience of savoring it anywhere, and paying for it with cash, Starbucks Card or with a major credit card such as MasterCard®, Visa®, American Express® or Discover®. Hot beverage offerings will include Caffè Latte, Vanilla Latte, Caffè Mocha, Caffè Mocha Light, and Hot Cocoa. Expect Starbucks to hit another home run with this innovation and create another revenue jump in 2007.

Distribution Innovations

"Starbucks also announced the expansion of its relationship with Kraft to distribute Starbucks® coffee to a wide variety of retail channels across Canada and the United Kingdom. This will mark the first time Starbucks® coffee will be available through these channels in the U.K. For Canada, the expanded relationship with Kraft will allow Starbucks to further strengthen its presence within grocery and other channels.

Since 1998, Kraft has been Starbucks strategic partner in distributing Starbucks® coffee to a wide variety of retail channels including grocery, drug, mass merchandising and club stores in the U.S. Expanding into two new countries allows Starbucks to build on the success of the relationship and allows the Company to leverage Kraft’s extensive distribution network."

Starbucks formula is to create a world of coffee drinkers through massive distribution. It is innovations such as the expanded partnership with Kraft that will bring Starbucks even closer to a store near you, and generate higher sales for Starbucks in 2007.

Niche Product Innovations

"Starbucks Coffee Company and Beam Global Spirits & Wine, Inc. are rolling out Starbucks™ Coffee Liqueur and Starbucks™ Cream Liqueur (in Canada). The mixable and versatile liqueurs, which will be positioned beyond the traditional cordial profile, are the first of their kind to feature 100 percent Starbucks® coffee, which is then blended with the finest spirits. These products will be available wherever wine and spirits can be found, not at Starbucks retail stores."

As if coffee drinking was not sufficient, now Starbucks wants to participate in the booming liqueur industry in partnership with established brand such as Beam. Watch out Kahlua. Starbucks is about to invade your decades long hold on the coffee liqueur. And why not? Customers will want more Starbucks coffee in their liqueurs too.

Innovations within Starbucks Stores

"Because Starbucks is committed to providing its customers with the most innovative beverage, food and merchandise offerings found anywhere, the Company announced an expanded warming rollout for food.

Noting that “great coffee deserves great food,” Michelle Gass, senior vice president for Category Management at Starbucks, revealed plans to greatly accelerate the Company’s roll out of its Warming program for food, including breakfast sandwiches, in its Company-operated retail stores. The Company began testing a warm breakfast sandwich assortment in 2004 and closed that fiscal year with 97 stores offering Warming. That number has grown to approximately 640 stores today and the Company has projected that by the end of fiscal year 2008, there will be approximately 6,500 stores offering Warming.

“Food is becoming a central part of the Starbucks Experience and a key driver for our growth,” Gass said. “During the last four years, we’ve seen growth of our food sales outpace our total store sales growth. We attribute this to our focused effort to provide higher quality food options, for different day parts, that can meet the high standards that we place on our beverages.””

In 2006, Starbucks introduced new whole bean coffee and packaging, Starbucks® Pike Place Blend and Starbucks® Anniversary Blend for a limited time throughout the U.S. and Canada to commemorate the Company’s 35th anniversary. Starbucks has launched more than 20 new beverages in the last two years with the most recent addition, the Maple Macchiato.

Starbucks is expanding beyond coffee, and this has to make the food industry queasy. Although today, Starbucks is offering breakfast and lunch sandwiches, and brand new beverages such as Maple Macchiato and various health food bars in its own stores, it is a matter of time before Starbucks offers the ready food and sandwiches to regular grocery and convenience stores. After all, the hot vending machine will already provide Starbucks shelf space and entry into convenience stores. What will happen to Starbucks revenue growth? Are we witnessing the beginning of a new food disruption in the making? It is innovations such as Warming which complement coffee that create higher same store sales growth each quarter.

Innovations in Entertainment

The Starbucks Hear Music™ Coffeehouse are created for specific markets, "not only through the architectural design, but also with music selected by the Hear Music content team with regional preferences in mind. The unparalleled combination results in a compelling third place destination for customers to connect over coffee as well as explore, discover, personalize and buy quality music in a warm and inviting environment."

The Starbucks Hear Music™ Coffeehouse "offers customers the ability to browse through the extensive physical CD inventory, which includes a music selection that has been hand-picked by the Hear Music content team to appeal to the local and regional tastes (of a particular location). Customers can also explore a digital inventory of more than one million digital tracks featured on the more than 25 Hear Music™ media bars throughout the store."

Failed Innovations

Starbucks recently announced that it is leaving the Jewel food stores in Chicago area beginning early 2007. Dominick's, Jewel's primary competitor, is planning to add more Starbucks stands in their stores. Perhaps the relationship between Starbucks and Jewel soured due to distribution margins or product placement or both. Starbucks does not always win on all the new initiatives. However, as is evident, even here when Jewel food stores is no longer going to carry Starbucks cafes (and their terms), Dominick's is already planning to add more Starbucks throughout its stores.


Starbucks is one of the top 18 innovators on The Innovation Index. Starbucks has become a pervasive coffee brand throughout the world, and the company is cleverly exploiting the Starbucks brand to launch new innovations in complementary and adjacent industries accounting for the solid revenue growth. The world according to Starbucks begins with a fresh hot Starbucks Caffè Latte made at your neighborhood Starbucks store, or from a hot vending machine at the convenience store using your very own Starbucks Card, a delicious breakfast sandwich or a health bar loaded with almonds (made by Starbucks), another trip to quench that caffeine thirst in the afternoon from the Starbucks store next to your workplace (and another Starbucks sandwich or brownie snack), listening to your favorite music created on a CD burned at the Starbucks Hear Music™ Coffeehouse as you drive to work and back and while you relax, and finally a late evening postprandial Starbucks™ Coffee Liqueur. Starbucks wants you to become that frequent customer who spends upwards of $10 each day on a combination of their handcrafted coffee beverages, sandwiches, cookies and music. Starbucks monthly allowance anyone?

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