Strategy Analysis MGMT 562

Rusty Gates Margaret Hogan Liberty McCarty Anita Ramachandran Tony Reed

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TABLE OF CONTENTS

Executive Summary…………………………………………………………….3 Introduction……………………………………………………………………..4 External Analysis……………………………………………………………….5 Suppliers………………………………………………………...…….5 Customers………………………………………………………..……5 Competitors…………………………………………………………...6 New Entrants………………………………………………………….7 Substitutes……………………………………………………………..7 Opportunities and Threats……………………………………………..8 Internal Analysis………………………………………………………………..8 Strengths………………………………………………………………8 Weaknesses…………………………………………………………...9 Value Chain, VRIO Framework, Core Competencies……………….10 Key Strategies………………………………………………………………….11 Investment Recommendation………………………………………………….12 References…………………………………………………………………….13

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Executive Summary Starbucks Coffee Company, founded in 1971 is headquartered in Seattle, WA and operates in 37 countries around the world. The backbone of Starbuck’s business is its company-operated retail stores. Starbucks has employed a strong differentiation strategy in order to turn a traditional $.50 commodity into a $4 experience. This following report provides an analysis of the strategies used by Starbucks to stay on top of its growing and volatile industry. Starbucks’ governing principles are based on three strategic stances: the third place experience, creating a human connection, and providing a quality everyday experience for customers. The specific strategies used by Starbucks include: • Horizontal Integration: acquisitions of Seattle’s Best, Torrefazione Italia and Coffee People • Market Penetration: differentiation and product placement outside of retail stores • Market Development: educating the consumer about specialty coffee • Concentric Diversification: release of bottled drinks, Ice Creams, and Liqueur • Conglomerate Diversification: expansion into music and movies • Value Chain Development: the human connection gained by business ecosystem maintenance The overall level of competitive threat in the coffeehouse industry is moderate. This is due primarily to the moderate threat of green coffee supply and the moderate to high threat of competitors. These two threats carry more weight than the lower threats of buyers, substitutes, and new entrants. Competition is traditionally considered to be other specialty coffeehouses. However, when one considers other fast food retailers serving coffee, such as McDonald’s, the threat of rivalry intensifies. Many opportunities exist for Starbucks in this industry. The premium coffee market continues to grow, offering opportunities such as rural U.S. expansion and continued international proliferation. The firm may also be able to create new distribution channels for other products as it has done with music, DVD’s, and books. Premium and proprietary food offerings can be used to drive growth in order to compete with fast food restaurants, and acquisitions and joint venture/licensing agreements provide additional possibilities for brand leverage. The Starbucks brand is very strong, but more steps can be taken to ensure that it becomes an enduring global brand. Strengths of the firm lie in its tremendous brand image and loyalty, innovative business strategy, and strong financial performance over the long-term. Weaknesses lie in Starbucks’ heavy reliance on the U.S. market for sales, its image as an enormous, dominating corporation, possible overcrowding and storefront cannibalism, and the price sensitivity of other nations. This report provides a VRIO analysis based on Starbucks’ value chain, which indicates that the firm has core competencies in the areas of human resource management, marketing, and operating retail locations. Based on the analysis provided in this report we maintain that Starbucks is a strong company that is well-positioned for steady growth. We are recommending the firm as a buy with a long-term focus on returns.

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Introduction Starbucks Coffee Company, founded in 1971 as a humble coffee shop in Seattle’s Pike Place Market, has since grown into a dominant multinational corporation operating in 37 countries and serving over 40 million customers every week. At the end of fiscal 2005 Starbucks owned and operated nearly 5,700 coffeehouses around the world and licensed an additional 3,200 locations, generating $780 million in profit on revenues of $6.4 billion. The firm has employed a multitude of well-focused strategies in order to capture the bulk of its growing market and remain on top of the competition. The mission of the firm: Establish Starbucks as the premier purveyor of the finest coffee in the world while maintaining our uncompromising principles while we grow. The six principles guiding this mission are to (1)Provide a great work environment and treat each other with respect and dignity, (2)Embrace diversity as an essential component in the way we do business, (3)Apply the highest standards of excellence to the purchasing, roasting and fresh delivery of our coffee, (4)Develop enthusiastically satisfied customers all of the time, (5)Contribute positively to our communities and our environment, (6)Recognize that profitability is essential to our future success. Starbucks is continuously striving to provide a great work environment through strong management and benefit packages that surpass industry standards. The firm has also made a point to hire a workforce of diverse personalities ensuring that each employee is outgoing and helpful. In the words of one Starbucks employee in Tigard, Oregon, “we are all encouraged to be upbeat, friendly, personal, and outspoken. The corporate office holds yearly gatherings that foster these outgoing personality traits. The energy is contagious.”i Quality is essential to the firm at all levels of the value chain and Starbucks makes various efforts to boost the health of its business ecosystem. Lastly, Starbucks is focused on growth and profitability for its long-term future. The Starbucks mission and principles are encompassed by three major strategic stances: the third place experience , establishing a human connection, and providing quality everyday experiences. The third place experience is created by Starbucks’ unique ambience. Tom Barr, VP of Food for Starbucks said, “ambience is very hard to communicate. Usually if someone is asked why they love a particular store they would not say ambience as the first thing. Customers might say they don’t care about the ambience; that they just want their coffee fast. Ninety percent of people that walk into a store will never stop to read the paper or sit outside with their dogs. But in the back of these customer’s minds there is something that says ‘I wish I could do these things and I’m glad that such a place exists.’ There is a subconscious signal that this is a good place to be. That is the power of the third place.”ii Starbucks also strives to maintain a human connection through ecosystem management, sustainable practices, supplier networks maintenance, firm transparency, and innovation. Lastly, Starbucks’ customers aren’t united by demographics, but rather by a desire to seek quality everyday experience. Company-operated stores are the backbone of Starbucks’ business. This is where the third place experience is most prevalent. The goal of the retail stores is to offer a place outside of the home and office for customers to relax and gather. Last year Starbucks opened 735 new retail storefronts. Ten percent of Starbucks’ business is in licensing the brand to other locations (i.e. Fred Meyer). While employees at these licensed stores are required to follow Starbucks’ detailed operating procedures, they do not receive all of the benefits of a company-operated store employee. The firm also has licensing arrangements with Kraft Foods and SYSCO to market, distribute, and promote food items to grocery stores and warehouse clubs. Partnerships have emerged from these licensing arrangements. The famous Frappacino drinks are bottled and distributed

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through Pepsi Co., Starbucks ice cream products are made possible through a partnership with Dreyer’s Grand, and the new Starbucks coffee liqueur is made by Jim Beam Brands Co. Other initiatives, representing less than 1% of Starbucks’ business include music, movies, and the Starbucks Duetto Visa credit card. External Analysis Suppliers Due to its large size, Starbucks can exert significant pressure on its suppliers. However, it chooses not to abuse this power as it is not in its best interest. Starbucks does not operate by a model in which it ‘squeezes down’ its suppliers.2 It treats the relationship as a partnership. Some of the suppliers have grown up with Starbucks and have built their businesses around its growth. “We believe that if we take actions to push our weight around and that causes our supplier to go out of business then we have served no one.”2 Starbucks has high operating standards for its suppliers and needs to ensure they make a reasonable profit so that the suppliers are able to meet these expectations. These high standards include environmental policies such as energy conservation, excessive packaging, and farming methods as well as employee benefits. Starbucks understands the importance of the health of the overall supplier “ecosystem.”iii Green Coffee, dairy, paper products, and personnel are the major inputs into the Starbucks operation. Coffee is a commodity and a volatile industry. In a recent coffee crisis, prices dropped so low that many farmers were unable to stay in business. Starbucks is completely dependent upon its supply of coffee and demands a very high quality bean. It mitigates risk to ensures its supply through agronomy programs it has developed in coffee producing regions. It works with the farmers teaching valuable farming methods and bringing prospective farms up to par. It is growing its supply base as it grows its retail base.2 Again, it is important to keep these farmers in business and Starbucks pays a premium to ensure this. Dairy and paper product suppliers are a minimal threat. Starbucks watches dairy prices closely and sources from multiple vendors. Starbucks exerts some pressure on paper products suppliers for sustainability purposes. It introduced the first paper drinking cup manufactured from 10% recycled material. Overall, the threat exerted by suppliers is moderate due, mostly, to the instability of the green coffee industry and the scarcity of the high quality bean that Starbucks demands. Customers The threat of customers is low for Starbucks due to: a low likelihood of backward integration, differentiated products, diversified customer base, and Starbucks’ ability to shape consumer tastes. The percentage of Americans drinking specialty coffee daily increased from 9% to 16% between 2000 and 2004.iv Also, there is a perception that coffeehouse products are of superior quality than other venues.4 The survey indicates that the specialty coffee market is growing in the U.S. and Americans will continue to buy coffeehouse products. It is unlikely that customers will integrate backward by making coffee at home to replace coffeehouse products. Starbucks brand and products are highly differentiated which lowers the threat of customers. The brand has become well-known in the U.S. and abroad. One of Starbucks’ self-proclaimed differentiators is its third place experience, yet survey results question the value of its ambiance. Roughly 70% of survey respondents who visited a coffeehouse in the last week listed convenience and quality as reasons to choose one coffeehouse over another.4 Only one third of respondents use the coffeehouse as a point of socialization or as workspace which are cornerstones of the third place experience. The survey results suggest that Starbucks’ dominance is based on the quality of its coffee and its ubiquity, rather than the Starbucks third place experience. Starbucks executives disagree and claim that the Starbucks atmosphere is one of the most important reasons that customers come in.2 Customers may be less likely to identify something like ambiance as a reason for going to a coffee shop because it is less tangible. Ambiance is subtler and more difficult to articulate than convenience, quality, or service in a survey.

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With over 40 million customers a week and no typical demographic profile, Starbucks’ has a wide customer base which diversifies risk. Tom Barr, the VP of Food for Starbucks explains that the customer can be defined as anyone seeking a quality everyday experience and this person could be anybody from a construction worker to a grandmother to a soccer mom.2 However, eighty percent of Starbuck’s revenue comes from regular customers who visit an average of 18 times/month.v So while we can’t pin the customer down, we do know that this devoted following holds significant weight for the company. If regulars were alienated in some way, then it would present a problem for Starbucks. The company has taken a $.50 commodity and turned it into a $4 experience. While transitioning this market, Starbucks has been able to keep its premium products from being perceived as exclusive luxury goods. When a company is able to drive consumer preferences and play a significant role in the moving a product upscale, consumers pose little threat to the company. Competitors Defining the basis of competition for Starbucks is difficult. Starbucks brought specialty coffee to the mainstream and now it can be found at convenience stores and gas stations (see pie chart at right). Competition seems to lie along two axes: product and venue. If competition lies in the product, coffee, then all of the places that coffee is consumed may be a competitor. If competition lies in the coffee experience, then Starbucks may be in competition with only coffeehouses. Analysts typically identify Dunkin Donuts and smaller chains like New World Restaurants, Deitrich Coffee and Caribou Coffee as Starbucks’ competitors.vi In our interviews, Starbucks executives identified two main competitors: Dunkin Donuts and McDonalds.vii The coffeehouse segment has experienced rapid growth from 2000 to 2005 (see graph). The number of retail outlets for coffee has expanded from 12,600 in 2000 to over 21,000 in 2005.4 Starbucks’ expansion is at an average of 32% per year and independent and small chains are expanding at about 13.5% per year.4 The market shows no sign of saturation in North America. The market is predicted to increase by 84% from 2005 to 2010, led by a compound annual growth rate of 17.6% in the coffeehouse segment.

While the entire coffeehouse market is growing, Starbucks is gaining more market share when compared to other coffee shops. Of the 8,400 new coffeehouses from 2000 to 2005, nearly 5,000 units were Starbucks stores.4 As indicated by the graph at right, Starbucks has increased its coffeehouse market share to 73% in 2005. If we expand the market to include donut shops, then Starbucks 2005 market share shrinks to 43% and Dunkin Donuts has 23%. Starbucks is the dominant competitor in terms of coffeehouses and the coffee experience. However, rapid growth is drawing competition from

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other restaurant chains including McDonald’s and Burger King, whose new coffee offerings in 2005 and 2006 will present increased competition for established coffeehouses and donut shops. McDonald’s has even begun to rent DVDs at some of its locations following in the steps of Starbucks’ expanded product lines.viii It is this fragmentation of the specialty coffee market into new avenues of distribution that we see as a threat to Starbucks. The competitive threat for Starbucks is moderate to high due to the increasing number of firms competing along undefined lines. New Entrants There is room for new entry into the coffeehouse market, but new entrants face formidable barriers to entry to compete with Starbucks directly in the coffeehouse segment. Starbucks has developed significant know-how, skills, and information that would take years for new entrants to create. It is able to interact creatively with customers and partner with suppliers by harnessing this knowledge. Secondly, the company has many of the best geographic locations in major metropolitan areas and suburbia locked up. The cost of duplicating Starbucks’ real estate would be very high. Starbucks has a similar lock up with many of the fair trade growers as well as other suppliers of high quality beans. There are only so many fair trade coffee farmers to work with and Starbucks has strong relationships with most of them.2 When an incumbent has much better access to raw materials, the cost of competition increases. With more experience, Starbucks has streamlined its processes behind the counter, learned how to open stores effectively, and has become skilled in working with suppliers to be as efficient as possible. This learning curve advantage is significant to new entrants that wish to compete on a large scale. As one of the strongest brands in the world delivering a unique experience, Starbucks’ products and brand are highly differentiated. People know Starbucks and are comfortable with the meaning behind it. Furthermore, the company has developed a loyal customer base that is willing to trust the new products including books, movies, and DVDs. Given Starbucks’ scale and competitive positioning, there are formidable barriers to entry. It is unlikely that a competitor with substantial financial resources will choose to compete head on with Starbucks. This is not to say that Starbucks should be comfortable. The market is difficult to define and complacency may allow a disruption to occur from a low-end player or new channel of distribution which Starbucks may not be prepared for. The threat of new entrants is low, yet Starbucks should be vigilant. Substitutes Similar to rivals, the threat of substitutes exists on two levels. The first is the product level. Even the product can be further divided into the need for a caffeine boost and the need for a special drink. So, encompassing both of these, substitutes for coffee include tea, soft drinks, energy drinks, smoothies, etc. Starbucks addresses the threat by selling non-coffee products beverages in its stores as well. It acquired Tazo Tea in 1999 to incorporate a high quality tea into its product line. Sodas and Frappacino blended drinks are also sold. The second level on which substitutes exist is at the coffee shop itself. The experience customers receive at the coffee shop can also be obtained at bars and cafes. The experience is providing people a place to hang out and visit with friends. If the sought after experience is to sit and read a book or newspaper then the library or bookstore would provide a decent substitute. Starbucks aims to be a community place or a third place. In this regard, community centers and churches are substitutes. They are places where community members congregate outside of work and home to feel close to and interact with other members of their community. However, the product of coffee is such an iconic, everyday good that when a person wants coffee, that is usually what they will consume and so the threat of substitutes is relatively low. A similar situation exists for the coffee shop. Even though other places to hang out exist, a person wanting that particular environment is likely to choose the coffee shop over the other substitutes, therefore, the threat is low.

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Overall Threat and Opportunities The overall level of competitive threat in the specialty coffee industry is moderate. This is due primarily to the moderate threat of green coffee supply and the moderate to high threat of competitors. These two threats carry more weight and do not offset the lower threats of buyers, substitutes, and new entrants. Competition, when McDonald’s is considered, is intense and the possibility of high quality green coffee supply problems due to the volatility of the coffee industry are both large enough threats to be of concern. There are many opportunities for Starbucks in this industry. The premium coffee market continues to grow offering many opportunities including rural U.S. expansion and continued international proliferation.4 Starbucks can use its ubiquity to provide new distribution channels for other products as it has done with music, DVD’s, and books through its Starbucks Entertainment division. It can also use its premium and proprietary food offerings as a growth driver to compete with Dunkin Donuts and McDonalds.ix Acquisitions and joint venture/licensing agreements provide additional possibilities for brand leverage. The Starbucks brand is very strong, but more steps can be taken to ensure that it becomes an enduring, global brand. Internal Analysis Strengths Brand Image: Starbucks is one among very few companies that has successfully created awareness for the specialty coffee category while maintaining supremacy of brand. Ranking among the top 100 global brands, a recent Business Week survey pronounced Starbucks as having the second highest one-year gain in brand value, on a global scale, as indicated in the adjacent tablex. Using cost effective and innovative marketing strategies, Starbucks has successfully created a brand that resonates with almost every segment of the population. It hardly relies on advertising and instead its omnipresent cafes, word-of-mouth and appeal of storefronts serve as powerful brand ambassadors the world over. It has been able to build this reputation based on the quality of the products, consistency of service, and an overall excellence in catering to customer satisfaction. As one Starbucks customer expressed, “before Starbucks, the common cup of coffee could best be described as a hot, brown liquid. A drink to be endured for its jumpstart your day benefits of caffeine. What once was something to be endured, Starbucks made into something to be enjoyed. Something to experience.”xi Another aspect of the Starbucks brand that makes it very unique is the intimacy of the brand despite its ubiquitous presence. Jeremy Abbot, Bethany Village Starbucks store manager commented, “when our customers visit a foreign country like China, they step into a Starbucks to feel at home.”xii Innovative Business Strategy: “But the essence of Starbucks is not about the coffee, although it’s great coffee. It’s about the coffee-drinking and the coffeehouse experience,” says Hayes Roth, Vice President of Marketing at Landor Associates, a consultancy that has advised Starbucks on branding strategy.xiii That comment sums up the unique and powerful combination of Starbucks strategy, the coffee, the customer, the employees, location, service, and the ambience. What’s more important is that this successful recipe calls for all of these to work in harmony with each other, not just in isolation. Starbucks store manager and Coffee Master, Darla Blazer remarks with much enthusiasm and fervor that she could not have found a better place to work. She is passionate about her job and the environment created by the executives is one of collaboration and teamwork. When Darla looks to hire candidates for her store she follows the motto “hire the personality, train the skill.”xiv This is true company wide as it strives to ensure diversity in culture and personality throughout the firm in order to provide the best service to their customers and keep them coming back. The ubiquitous locations seek to be the third place one would want to go to besides home and work.

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Starbucks Financials - Comparison Data

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Company Industry Market

Company 62.90% 15.30% 57.70%

Industry 33.30% 12% 31.30%

Market 14.40% 2.40% 7.10%

ROE ROA ROIC

Strong Financials: The Starbucks name has become common place in the U.S. and internationally. This popularity is coupled with financial success. As the adjacent figure (data is for year ended Sep-2005)xv indicates, Starbucks has reported steady revenues and earnings over the past five years and the past fiscal year, 2005, was no different. During the fiscal year ended October 2, 2005, all areas of Starbucks business, from U.S. and international company-operated retail operations to the Company's specialty businesses, delivered strong financial performance. As indicated in the table, Starbucks has not only shown strong results, it has surpassed market and industry benchmarks in all categories. For fiscal year 2005, the company reported a 24.6% CAGR in revenues totaling $6,369.3 million, a 20% increase in revenue, operating income as a percentage of total net revenues increased to 12.3% from 11.5% in fiscal 2004, and net earnings increased by 27%, compared to fiscal 2004. These results demonstrated the company's ability to improve operating margin while at the same time making strategic investments in the core retail business and in emerging specialty channels.xvi Weaknesses Reliance on U.S. Market: Starbucks is a global company and has a presence in 37 countries However, the total revenues derived from the U.S. market made the lion’s share of its revenues at 83.7% in 2005. Given its significant presence globally and the opportunities for further expansion, the company needs to be looking at generating a greater proportion of revenues from outside the U.S. Large Corporate Image: Starbucks continually struggles with backlash despite efforts to seem more connected with the community. In the U.S., its ubiquitous presence and acquisitions have destroyed local coffeehouses. They are perceived by many as the Walmart of the coffee sphere. While Dan Bowlin, owner of a privately owned coffee shop in Hillsboro, admires Starbucks for its marketing prowess, he sees it as an extreme example of capitalism.xvii Some see its international growth as corporate colonialism, which can mean the destruction of local cultures and experiences. Overcrowding & Cannibalism: Starbucks currently operates over 6,000 stores in the U.S. and plans to increase that number to 15,000. Such expansion can and has resulted in overcrowding or clustering of stores. People now are faced with limited choices. This can lead to frustration, boredom, and rebellion on the part of customers, giving way to competition that can provide a unique experience with quality coffee. In addition, such clustering of stores can lead to cannibalism, where the company has to incur the costs of setting up and running two units when the revenue is equivalent to that of one. Expensive Price: Starbucks and other coffeehouses have caused the price for a cup of coffee to increase to $3-$4. While this price has become acceptable in the U.S., it will pose a significant barrier in emerging markets and countries where one can get a good cup of coffee for a fraction of the price and where the buying power of consumers is much less. Such high prices will make Starbucks more of a luxury good in markets such as China and India, unlike in the U.S., where a its coffee is something everyone has come to enjoy and accept.

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Firm Infrastructure Human Resource Management

Procurement Inbound Logistics

Operations Outbound Logistics

Marketing Retail Sales

Value Chain, VRIO, and Core Competencies

Our VRIO analysis based on the value chain illustrated above indicates that Starbucks has core competencies in the areas of human resource management, marketing, and in operating its retail locations. These competencies are discussed in further detail below. Human Resource Management: Starbucks has created an environment and an organization around its employees, one of its most important assets and sources of sustainable advantage. The empowering corporate culture, above industry standard employee benefits, and employee stock ownership programs have aided in crafting an exceptional workforce that takes pride in its work and is treated with dignity. This culture is apparent in all levels of the organization from the baristas and managers, all the way to the executives. Store Manager Darla Blazer is happy to be a part of the team and strives to perpetuate that culture by ensuring that the contentment and participation of her entire staff is second only to ensuring that the customers are well served. The culture towards employees is laid back and supportive. Employees are empowered by management to make decisions without management referral and are encouraged to think of themselves as a part of the business.14 While the company has both functional and product based divisions, there is transparency and participation from the ground up. Marketing: Starbucks has created a brand that exudes an understanding of people’s values, lifestyles, and needs. The company’s attention to the experiential factor has been pivotal to its success. In fiscal 2005, Starbucks spent $87.7 million on advertising including billboards, online advertising, and signs at Safeco field. That's about 1.4% of its 2005 revenues which is far less than other firms such as Coca-Cola and Pepsi. Instead of big bucks, they resort to old-fashioned charm and appeal. For instance in New York, Starbucks is handing out subway passes and in Boston and San Francisco it is giving away free cab rides as

VRIO Framework Valuable Rare Difficult to Imitate

Exploited S or W Competitive Implications

Firm Infrastructure (Finances)

YES NO NO YES S Temporary Advantage

Human Resource Management

(culture)

YES YES YES YES S Sustainable Advantage

Procurement YES Y/N Y/N YES S Temporary Advantage

Marketing YES YES YES YES S Sustainable Advantage

Sales/Retail Locations

(Customer Relations)

YES NO YES YES S Sustainable Advantage

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a way of passing out good cheer for the holidays. “If you make an emotional connection with them, you’ve captured their heart. That’s what creates brand loyalty”, said Brad Stevens, Starbucks’ top marketing executive. xviii Such creative marketing has served and will continue to serve as a source of sustained advantage for them. Sales/Retail Locations: Service is the distinguishing factor that sets Starbucks apart from its competitors. With approximately 85% of Starbucks’ business revenue coming from its retail storefronts, it is crucial that it makes service a cornerstone of its brand. As mentioned by Gina Woods, Product Manager in the Starbucks Entertainment division, the retail locations serve as the backbone of the organization and the headquarters is there to serve the retail locations and facilitate their smooth operations.8 Starbucks’ penchant for consistency, customer service, and casual yet pleasing experience has made its locations one of the most sought after meeting spot for people of all ages. These tie back to the hiring practices of Starbucks that ensures that it searches for people who "get" what a great customer experience is all about. Both Darla Blazer as well as Jeremy Abbott, store managers of Starbucks retail locations, insist on providing the greatest experience they can provide to everyone who walks in the door and they accomplish that by hiring people who are passionate, ethical, and want to make a personal connection with the customers.12/14 While there are other firms that may be able to hire similar people, the combination of employee empowerment, quality work atmosphere, and passion for brand excellence makes Starbucks’ sales strategy a sustainable competitive advantage. Key Strategies Starbucks has been extremely successful to date. It has been able to transcend different demographics in order to capture huge market share while at the same time changing the way that customers view coffee. It has been able to change a regular cup of coffee to an experience beyond the coffee itself. In order to do this, and do this well, Starbucks has pursued many different strategic actions. All of these actions can be categorized into the following broad strategies. Horizontal integration: Starbucks has used this strategy to control its competition and reach new customers. It has used the acquisition of Seattle’s Best, Torrefazione Italia, and Coffee People to accomplish this. Market penetration: This strategy has been used increase the market share of products that are currently offered. Starbucks has focused heavily on developing the quality everyday experience and differentiation of the experience as a third place to enjoy its products. Starbucks has also sought to expand the methods of delivering its products outside of the traditional coffee shop. It has opened licensed retail locations inside of grocery stores and formed alliances with SYSCO, PepsiCo., U.S. Foodservice, and Kraft Foods to distribute products to grocery stores and other food retailers. Market development: Starbucks developed the specialty coffee market in the U.S. by educating the American consumer and essentially transformed a commodity into a specialty item that people are willing to pay top dollar for. It has become the new front porch of Americana providing a community connection that its customers desire.2 The company has developed this market from scratch and continues to as it expands into international markets. Concentric diversification: In order to expand its sales, Starbucks has begun releasing new, but related products. Starbucks has developed products such as the Frappacino and Double Shot, acquired companies such as Ethos water, and formed alliances with Dryers Ice Cream and Jim Beam. Conglomerate diversification: Starbucks has also sought out opportunities that are unrelated to its traditional product offerings. The Hear Music campaign is an alliance with iTunes and XM Satellite radio to offer music produced by Starbucks, and Alleah and the Bee as its first film production. Value chain development: Starbucks has put a tremendous amount of money and effort into developing the partners in its value chain. While it is not vertically integrating, Starbucks is committed to developing

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the human connection with its suppliers and supporting its ecosystem. The fair trade initiative is one example of this type of commitment. Investment Recommendation Starbucks has had tremendous growth and success to date. Its investment in developing relationships with suppliers and alliance partners has been critical to continually expanding the market and Starbucks’ share of this market. With a strong financial position, the firm has been able to acquire its competitors to prevent fierce competition and price wars. Management has also been able to capitalize on investments that they have made. In 2005 Starbucks had a return on assets (ROA) of 16.46% and a return on equity (ROE) of 23.88%. These ratios are more than twice those of others coffee companies, and substantially higher than

other specialty restaurant companies. Starbucks’ P/E ratio is the highest in the industry, indicating that investors are expecting substantial growth from Starbucks. This growth will be critical to the future success of Starbucks and is expected to come from international expansion. Part of this international expansion will inevitably come from China. A significant risk in this expansion is the spending power of customers in these emerging markets. An article from Reuters details the current conditions in China: “Fu Mei takes her 6-year-old grandson to a McDonald's restaurant in Tianjin -- the third largest urban area in Mainland China -- about once a week. But after spending 14 yuan ($1.79) on a Filet-o-Fish sandwich for the boy, she and her husband cannot afford to eat there themselves.”xix Obviously Starbucks will be challenged to charge the $3.25 for the average cup of coffee in these economic conditions. However, Starbucks’ history of support for its suppliers and employees could help to boost conditions in its markets in China. This process will take time, and will most likely not produce quick returns, therefore, we recommend Starbucks as a buy with a long-term focus on returns.

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Citations i Murrieta, Tasia. Interview by Tony Reed. 17 Nov. 2006. “In-person Interview with the Store Manager of Tigard, Portland Starbucks.” ii Barr, Tom. Interview by Margaret Hogan and Liberty McCarty. 17 Nov. 2006. “Telephone Interview with Vice President of Food for Starbucks.” iii Iansiti, Marco and Levien, Roy. “Strategy as Ecology.” Harvard Business Review. March 2004. iv Mintel Report. “Coffeehouses and Donut Shops.” U.S. February 2006. v Rae, Jeneanne. “The Importance of Great Customer Experiences and the Best Way to Deliver Them.” Business Week. 27 Nov. 2006. pg. 32. vi Hoovers and Yahoo Finance websites. http://www.hoovers.com/company-information/--ID__15745--/free-co-factsheet.xhtml and http://finance.yahoo.com/q/co?s=SBUX. Accessed 3 Nov. 2006. vii Woods, Gina. Interview by Margaret Hogan and Liberty McCarty. 16 Nov. 2006. “Telephone Interview with Product Manager for Starbucks Entertainment.” viii “Strategy: The Golden Arches Rains McDVDs On Consumers.” Brandweek. 20 Nov. 2006. ix LexisNexis Academic. “Starbucks Coffee Company Outlines Core Strategies to Continue Delivering Long-Term Shareholder Value in Sixth Biennial Analyst Conference.” Business Wire. 5 Oct. 2006. http://web.lexis-nexis.com/universe. x “The top 100 brands 2006” BusinessWeek 6 August 2006 xi Website: http://brandautopsy.typepad.com/brandautopsy/starbucks_tribal_knowledge/index.html xii Abbott, Jeremy. Interview by Anita Ramachandran. 6 Nov. 2006. “In-Person Interview with the Store Manager of the Bethany Village Starbucks, Portland.” xiii Website: http://www.brandchannel.com/features_effect.asp?fa_id=78. Accessed 12 Nov. 2006. xivBlazer, Darla. Interview by Anita Ramachandran. 14 Nov. 2006. “Phone Interview with the Store Manager of the One World Trade Center Starbucks, Portland.” xv Hoovers online report. “Starbucks Financial Report”, Sep 2005 xvi Summary of Starbucks Corporation, Yahoo!Finance, website: http://biz.yahoo.com/e/051216/sbux xvii Bowlin, Dan. Interview by Anita Ramachandran. 16 Nov. 2006. “In-person Interview with the Owner of Cappuccino Corner, Hillsboro.” xviii The Oregonian. “Starbucks passes out good cheer for good deeds”. The Oregonian. 11 Nov 2006. 17 “US Restaurant Chains Seek Big Returns in China.” Reuters 22 Nov. 2006.

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Bibliography Abelson, Jenn. “Mickey D’s goes uptown.” The Boston Globe. 26 Oct 2006. Anders, George. “Starbucks Brews a New Strategy.” Fast Company July 2001, Issue 49: 144. Datamonitor Report. “Starbucks Corporation.” May 2006. www.datamonitor.com. Farrow, Ross. “New Starbucks will go head to head with House of Coffees.” Lodi News-Sentinel. 10 Nov.

2006. Fineman, Josh. “Burger King latest to move away from trans fats.” The Contra Cost Times. 1 Nov. 2005. Flight, Georgia. “Grinding Out Success Next to Starbucks.” Business 2.0. Oct. 2006. Vol. 7, Issue 9. Frey, Christine. “Starbucks to Buy Seattle’s Best Coffee.” Seattle Post-Intellegencer. 16 April 2003. Gilbert, Sarah. “Starbucks buys Coffee People stores, hippies mourn.” Bloggingstocks:SIRI 18 Sept. 2006. Holmes, Stanley. “What’s Behind Starbucks’ Price Hike?” Business Week Online. 25 Sept. 2006. Macarthur, Kate. “Coke, Nestle take aim at Starbucks.” Advertising Age. September 2006. Overholt Alison. “Do You Hear What Starbucks Hears?” Fast Company. July 2004. http://www.fastcompany.com/magazine/84/starbucks_schultz.html Starbucks Corporation 2005 10-K.

http://ccbn.10kwizard.com/xml/download.php?repo=tenk&ipage=3844138&format=PDF “Success Stories” JCK. July 2006. Pg. 163 Other Primary Research Fujinari, Yumi. Interviewed by Liberty McCarty. 1 Nov. 2006. “Personal Interview with Peet’s Coffee Store Manager.”