Starbucks: Handcrafted Sodas?

The Wall Street Journal reports that Starbucks is testing handcrafted sodas at locations in Atlanta, Georgia, and Austin, Texas.   The article states that the flavors of soda include spiced root beer and lemon ale.  The sodas are created using a carbonation machine in the Starbucks stores, and a grande size drink sells for $2.95 at these locations.

What do we make of this newest product line extension for Starbucks?  As the article explains, the move clearly constitutes another attempt to drive sales at off-hours, i.e. in the afternoon and evening.  Moroever, it offers another way to drive same-store sales growth, a key metric for any restaurant or retailer.   

The move does come with some risks.  Naturally, customers must enjoy the product, or it could harm the Starbucks brand.  In addition, continued menu extensions add complexity to the operations of a particular location.  Can Starbucks maintain speed and customer service as the menu expands?   With food items expanding as well, Starbucks must watch the issue of complexity carefully.  The good news:  Starbucks understands the power of experimentation.  It is testing the concept in two locations, and presumably, it's gathering a great deal of data.  That data include customer feedback, barista input, and information about the impact that the new products are having on the speed of service.   What happens if customers love the soda, but service slows?  That could be tricky.  At that point, Starbucks will work to streamline operations as much as possible to increase throughput.   They have done quite a bit of that type of work in the past few years.  Still, I notice considerable differences in speed across locations.  Part of the difference can be accounted for by the fact that some store layouts are clearly not as conducive to streamlined, efficient operations.   Part of that is due to local differences in the way locations are managed.  

One final point about the notion of testing and experimentation.  Sometimes, companies find that such small tests go quite well, but national roll-outs then falter.  Why?  The tests are not truly representative of what will happen during a full-scale expansion.  Senior managers supervise the tests very carefully. Extra resources are deployed.  The test becomes something more than a test... it's actually a "proving ground" or "demonstration" rather than a true controlled experiment.  

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Starbucks, Price Decreases, & Game Theory

Business Week has an interesting article about the recent decision by Starbucks to cut prices on its coffee sold in grocery stores by $1 per bag.  According to the article, "Last quarter the company collected about $380 million from sales outside its cafés at an operating margin of 25.5 percent. At that level, the coffee empire is making a profit of about $2.55 per bag. Take away $1 per, and Starbucks would have to sell 65 percent more bags to book the same amount of profit." 

Wow... could Starbucks really generate that many more sales to make up for the lost margin?  Unlikely.   The article tries to offer another explanation, citing Columbia Professor Rita McGrath.   Here's an excerpt:

It’s not clear Starbucks will sway that many customers quickly. But the company could be betting on widening income inequality—what academics call “the hourglass economy.” The theory is: Major retail growth has been—and will continue to be—at the low and the high ends of the socioeconomic scale. Starbucks already has plenty of $6 barista-brewed drinks to capture the top of that market, but a bag of $10 coffee is very much in the middle, according to Rita McGrath, a professor at Columbia Business School.

I respect McGrath's work a great deal.  She's a terrific strategy scholar.   However, I don't understand this point.  How is cutting the price of a bag from $10 to $9 enabling Starbucks to tackle the "low end of the market"?   That's some view of the low end!  The article continues by citing the fact that lower-end rivals such as Maxwell House, Folgers, and Dunkin' Donuts have cut prices this year as costs of coffee beans have fallen significantly.  Here's another excerpt:

And here’s where a little game theory comes into play...By committing to lower prices (and not using coupons or sales), Starbucks is sending a signal, McGrath says. It’s serious about the low end of the market; Dunkin’ Donuts, Folgers, and other competitors can either trim their margins further or give up volume. Either way, they lose. So does Starbucks, at least in the near term. But with savvy hedging and customers lining up for expensive lattes—including increasing crowds in China—it can stand the pain for a while. And it is betting it is more efficient than its competitors. As McGrath says: “If you can run economically enough to make money at the lower price, you’re simply taking money out of your competitors’ pockets.”

Again, I'm not sure that I understand or agree completely.    If Starbucks was clearly the low-cost competitor, I might understand this explanation.  It would be using its scale economies and cost efficiencies to attack its higher cost rivals.  However, do we really believe Starbucks is the low-cost player in this market?  That seems unlikely.   Perhaps another explanation is that, after Dunkin' and others cut prices this year, the gap between Starbucks and its lower-priced rivals became too large.  Starbucks' differentiated, high quality product could justify higher prices, but not that much higher.  The gap in price had simply exceeded the difference in perceived value (or willingness-to-pay) between Starbucks and other coffee rivals in the grocery aisle.  If it didn't address that issue, it would have ceded a great deal of volume to competitors.  Differentiated players always have to be careful that their price premium doesn't grow too high, exceeding the excess value that customers perceive in their product vs. rivals' products. 

If Starbucks, on the other hand, is truly just going for share at the low-end of the market, then I don't understand the logic of the strategy.  Why would a differentiated player cut its margins and try to compete directly with low-cost players?   Why compromise its premium positioning?  I don't think Starbucks is doing that... I don't see them getting into a price war in the grocery aisle just to inflict pain on their rivals.  The coffee industry is an attractive one, particularly at the higher end of the market.  Why would a market leader spoil that market by triggering an unnecessary price war?  That would be bad strategy. 

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Backward Integration at Starbucks

Source: Wall Street Journal

The Wall Street Journal reports that Starbucks has acquired a 600 acre coffee farm in Costa Rica.  You might ask: Why is Starbucks backward integrating?  They probably do not think they can operate the supply chain more efficiently through vertical integration.   They certainly aren't going to obtain a significant amount of coffee beans through one 600 acre farm.  What are they doing?

They are learning, experimenting, and innovating.  It's a terrific reason to engage in partial/limited backward integration.   Starbucks CEO Howard Schultz explained, "We are talking about doing innovative things we would not be able to do without this farm."   Craig Russell, a Starbucks senior vice president, explained that the company would try to identify ways to address a fungus problem that is affecting coffee farm yields in Central America: "It's a dynamic situation and we will absolutely use this farm for testing different methodologies and ways to use new types of coffee trees we've developed that have become more disease- and rust-resistant."   Finally and most importantly, Starbucks intends to share what they learn about the fungus with other farmers, so that coffee bean production improves overall for the industry.   

This example demonstrates that a small bit of vertical integration (backward) can be very effective as a means of innovation and experimentation.  Many companies simply view vertical integration from the perspective of its immediate effect on the bottom line.   Ironically, many of those efforts actually decrease profits much to the chagrin of senior executives.   Of course, many of those efforts are not small experiments.  They are bold moves down without a good pilot to test the concept.  In this case, a small bit of experimentation could yield large improvements in profits over time.  

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Jimmy Kimmel: New $7 Cup of Coffee at Starbucks

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Making Customers Wait Can Be a Costly Problem

Gad Allon, Awi Federgruen, and Margaret Pierson have conducted an interesting piece of applied research regarding the fast-food business, with implications for a wider range of industries.  They examined the fast-food drive-thru industry and took a look at the relationship between willingness-to-pay and wait time.   They found that, "Both the price and waiting time parameters have a significant impact on the consumer’s decision.  These results confirm … that in the fast-food drive-thru industry customers trade off price and waiting time. In particular, to overcome an additional second of waiting time, an outlet will need to compensate an average customer by as much as $0.05 in a meal whose typical price ranges from $2.25 to $6. This corresponds with an hourly cost rate of approximately ten times the (pre-tax) average wage of $18/hour and nearly 30 times the (pre-tax) minimum wage in Illinois in 2005.”

Most importantly, the scholars did not just show that people value their time, but that they value their time waiting in line VERY highly.  The research shows that people strongly dislike wait time while at the restaurant, and they value that time more heavily than they do the travel time to the restaurant.   As Allon notes, "The waiting time once in line is considered pure waste.”

Some firms should pay special attention to this study.  In particular, firms that do a fair bit of customization for customer orders need to be wary of wait time effects.  Take Starbucks, for instance.  They offer customers the opportunity to customize their drinks in many different ways.  One such customer with a highly specialized order can really lengthen wait times at their drive-thrus.  I always kid my wife about her tendency to use the Starbucks drive-thru. On numerous occasions, I've hopped out of the car, walked into the Starbucks, and come back into the car while she is still in line.   You might argue that a customer faces the same risk of being held up inside the Starbucks.  However, we have to remember that the customers inside the store are different in their wants and needs.  They have chosen to enter the store rather than go to the drive-thru. That decision suggests that they may not value speed as highly.  They may intend to sit down for a few moments, or they wish to use the restroom.  Therefore, the delay in wait time is not as problematic inside the store as it is in the drive-thru.  

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Reasserting your Brand

Author and consultant Nick Tasler has a good article on Business Week's website regarding how firms can reassert their brand after a rocky period.   He uses Starbucks' turnaround recently to illustrate his points.  Starbucks realized it had strayed from its coffee roots and diluted its brand equity.   It had to clarify the brand's positioning.  Starbucks did so by trying to reassert itself as the "coffee authority."  Tasler argues that firms must take three steps to reassert their brand.


1. Decide what your equivalent is to being “the coffee authority.”   What do you want to be known for in the market?  For what do you want to be known as a leader?

2. Decide what you should start doing more of to reassert your authority.  What innovations can you bring to market to burnish your reputation as a leader in a particular market space?   Where should you invest to rebuild your competitive advantage? 

3. Decide what you should stop doing in order to reassert your authority.   What activities should you stop doing because they dilute your brand, distract management attention, and make you far too similar to other players in the market?  

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