Coffee Shop Industry - A Strategic Analysis

Research Paper (undergraduate), 2007

36 Pages, Grade: 1,0

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Table of content

1. Definition of Industry
1.1 General Overview of the Industry
1.2 Customer Overview
1.3 Overview of Industry Profitability Factors

2. Industry’s dominant economic traits – overview

3. Competitive Forces that impact competition (Porter Model)
3.1 Competition within the Coffee Shop Industry
3.2 Substitute Products
3.4 Power of Suppliers
3.5 Power of Customers

4. Driving Factors that are causing the industry’s structure to change
4.1 Expansion/Growth
4.2 Product/Service Innovation
4.3 Collaboration/Partnership
4.4 Image/Lifestyle
4.5 Technology

5. Competitive positions & possible strategic moves of key companies
5.1 Starbucks
5.2 McDonald’s
5.3 Dunkin’ Donuts
5.4 Caribou Coffee
5.5 Coffee Bean & Tea Leaf
5.5 Peet’s Coffee

6. Key factors that determine success in the future
6.1 Product and Service Innovation in the Future
6.2 Technology
6.3. Education About Coffee
6.4 Cooperation
6.5 Quality Control, Consistency
6.6 Meeting Demand
6.7 Role of Regulations

7. Attractiveness of the industry
7.1. Factors in favor of an attractive industry
7.2. Factors in favor of an unattractive industry
7.3. Conclusion
7.4. Most likely future scenario

8. Appendix

1. Definition of Industry

1.1 General Overview of the Industry

The coffee shop industry in the U.S. includes 20,000 stores with combined annual revenue of about $11 billion. Major companies include Starbucks, Dunkin’ Donuts, Caribou, Coffee Bean and Tea Leaf, and Diedrich (Gloria Jean’s). The industry is highly concentrated at the top and fragmented at the bottom: the top 50 companies have over 70 percent of industry sales.

Coffee is one of the world’s largest commodities. The top green coffee producing countries are Brazil, Colombia, and Vietnam. Many grower countries are small, poor developing nations that depend on coffee to sustain local economies. The U.S. is the world’s largest importer of green coffee beans and the largest consumer of coffee. With the exception of Hawaii and Puerto Rico, the United States’ climate cannot support coffee trees.

Coffee consumption is highest in the Northeast, where over 60 percent of the population consumed coffee daily in 2005, according to the National Coffee Association (NCA). Per capita consumption is highest in the Central U.S., where coffee drinkers average 3.7 cups per day[1].

Major products sold by coffee shops include beverages as well as complimentary food items. Beverages include brewed coffee and tea; espresso drinks (cappuccinos, cafe lattes); cold blended beverages; bottled water; soft drinks; and juices. Food products include pastries, bakery items, desserts, sandwiches, and candy. Many coffee shops sell whole or ground coffee beans for home consumption. Some coffee shops sell coffee or espresso-making equipment, grinders, mugs, and other accessories. Most coffee shops serve high-quality, premium coffee known as specialty coffee.

1.2 Customer Overview

The typical and most committed coffee drinkers are 25 to 45 year old, affluent, educated adults. While baby boomers have driven the success of coffee shops, specialty coffee appeals to a diverse adult demographic, including college students and young adults. Larger companies may also sell coffee beans wholesale to commercial customers, such as grocery stores and restaurants.[2]

1.3 Overview of Industry Profitability Factors

Consumer taste and personal income drive demand. The profitability of individual companies depends on the ability to secure prime locations, drive store traffic, and deliver high quality products. Large companies have advantages in purchasing, finance, and marketing. Small companies can compete effectively by offering specialized products, serving a local market, or providing a personal level of customer service. The industry is extremely labor-intensive: average annual revenue per worker is $40,000.

Coffee shops depend greatly on customer traffic and are most often located in areas with convenient access for pedestrians or drivers. Typical locations include downtown or suburban retail centers, shopping malls, office buildings, and university campuses. Store format and size vary by site, as some locations offer more space than others. Caribou Coffeehouses range from 200 to 3,000 square feet, with an average store 1,200 to 1,600. For small spaces like airports and grocery stores, some chains offer a kiosk format, without seating.

Retail prices for coffee shop beverages vary. The retail price for an espresso-based drink can exceed $4. Due to the cost volatility of green coffee and dairy, retail prices often fluctuate. A pound of roasted coffee beans may retail for between $10 and $20. A pound of high-end or “reserve” coffee, like some Peet’s coffees, can retail for between $50 and $80 per pound[3].

Coffee shops depend highly on part-time employees, and most workers require few skills. Many employees make just above the minimum wage, and pay can be significantly below the average for all U.S. workers. Starting wages for Starbucks’ employees are about $8 an hour. Some Starbucks’ employees are forming unions to negotiate better wages, hours, and benefits.

A typical chain coffee shop may have one manager and 10 to 15 workers; independents have six to seven. New employees may go through training courses and receive in-store training to ensure superior customer service and product consistency. Master roasters oversee coffee roasting to develop trademark blends and flavors. Baristas receive training to operate commercial grade espresso machines used to make specialty drinks.

Sales are seasonal, with a peak during fourth quarter, driven by the winter holiday. In addition, poor weather can affect sales by decreasing store traffic. For large companies, inventory amounts to between 40 and 80 days sales. Accounts receivable runs between 20 and 30 days sales, mainly due to commercial customers. Accounts payable runs between 30 and 60 days sales. Companies may use contracts to buy green coffee and dairy products. Gross margins range between 40 and 60 percent, and higher commercial sales tend to decrease margins. Chains use comparable store sales to measure growth.

Most companies lease store locations for a fixed term. Rent for coffee shops in malls may include a fee for shared area maintenance. Companies compete for prime locations, sometimes with other retailers, and negotiating power may be limited. Chains periodically close underperforming stores, and set aside a reserve for remaining lease payments.

Franchise and license agreements typically include an upfront fee, payments or royalties based on percentage of sales, and renewal options. Master license agreements may allow licensees to grant sublicenses to third parties within a territory.

2. Industry’s dominant economic traits – overview

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3. Competitive Forces that impact competition (Porter Model)

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3.1 Competition within the Coffee Shop Industry

- 20,000 stores with annual revenue of ~ $11 billion
- Highly concentrated at top and fragmented at bottom – Starbucks ~ 75% of sales
- Major companies: Starbucks, Caribou Coffee, Coffee Bean and Tea Leaf, Diedrich (Gloria Jean’s), Peet’s Coffee
- Competitors can also be found in other industries (convenience stores, gas stations, quick service, fast food restaurants, gourmet food shops, donut shops, filter ~ / specialty coffee machines for home use) e.g. Dunkin’ Donuts and McDonalds
- Competition through special offers (new tastes), outstanding service/ environment (internet, music, comfortable seating areas, short waiting queues), loyalty programs (bonus cards ensuring frequency of visits) and for premium locations (retail centers, university campuses, etc.)

Conclusion - Competition within the Coffee Shop Industry ➔ Strong competition within the industry for new customers, premium locations, etc. but overall the industry is saturated, settled and stable which allows almost all of the competitors to yield very good margins (40 to 60 percent)[4]

3.2 Substitute Products

- Competition with other drinks that are not the main focus of by coffee shops: Soda, Juice, Water, Beer, Sports Drinks
- Competition with other products, people are spending their money on: Ice Cream, Cigarettes, Sweets
- Consumers have limited discretionary budget to spend on consumer goods, such as cigarettes, beer and also coffee; coffee shops are therefore fighting for a fraction of this budget

Conclusion – Substitutes in the Coffee Industry

➔ Very strong power of substitute products as especially young people might prefer other products, such as beer, cigarettes or soda

3.3 Barriers to Entry

- Rather low entry barriers: easy to open a single small café

- Rent a place, remodel, install the equipment, get license as needed[5]

- However there are high entry barriers for the specialty level or big league/chain players

- High up-front investment needed to grow significantly (distribution system: shops, equipment, premium locations; marketing: creation of brand awareness & brand recognition, customer retention)
- Strong brand recognition of major players, especially Starbucks
- Partnerships with large, international companies also serve as potential entry barrier for new competitors – Starbucks with Pepsi/ Jim Beam/ Dryer’s Grand Ice Cream/ Barnes & Noble or Caribou Coffee with Apple[6] (See Exhibit 2).
- Economies of scale (purchase advantages; centralized HR and Marketing) realized by big players, especially Starbucks ➔ cost disadvantage for new entrants

Conclusion – Barriers to Entry in the Coffee Industry

➔ Small barriers to entry for small regional chains / cafés, but their expansion is relatively slow due to the increasing speed of the expansion of the major players

➔ High barriers to entry into the industry for big players due to high industry concentration on top, huge brand recognition of major brands and high up-front investments are needed

3.4 Power of Suppliers

- Volatile Raw Material Costs[7]:
- Particular dependence on supply of higher-priced Arabic beans (premium coffee) – as imported mostly from developing countries, price varies along with the economical and political situation of the export country
- Dairy products, whose retail prices vary a lot, used for specialty drinks
- Coffee Shop Chains have contracts securing price stability
- For most coffee-exporting countries (over 60 ) that is their only “source of cash”[8]
- Higher world market demand and higher prices for differentiated (Gourmet and specialty coffees) and sustainable coffee (organic, fair trade, eco-friendly or shade grown) than for coffee commodity:
- Farmers not agile enough or don’t have the means to switch production
- Companies are helping communities to make the change (train them, purchase at fair trade prices[9] and provide technical assistance)[10]

Conclusion – Power of Suppliers in the Coffee Industry

➔ Very limited power of suppliers as they depend on producer’s help and sell a commodity.

3.5 Power of Customers

- High dependency of coffee shop chains on frequency of customer purchases
- Most customers appreciate the nice atmosphere in the coffee shops
- Preferences of customers are very likely to switch as they might get bored with / tired of the same flavor (relatively low brand loyalty)
- Shopping behavior is very likely to be influenced by budget constraints, weather conditions or health concerns in the general public
- Interested in continuous product innovation or seasonal specialties
- Essential for success – word of mouth and frequency of purchases[11]

Conclusion – Power of Customers in the Coffee Industry

➔ Very strong power of customers as coffee shops depend on word of mouth and customer retention Furthermore a customer’s opinion, preferences and shopping habits can be influenced easily which creates a big threat for the companies.

4. Driving Factors that are causing the industry’s structure to change

4.1 Expansion/Growth

A significant driver in the coffee shop industry is growth in the form domestic and international expansion. The key channel of distribution in this industry is “company-operated stores located in high-traffic, high visibility centers,” and industry competition is structured around vying for market share by opening new retail shops in cities around the world.[12] Starbucks, for example, opens on average three stores a day and has already made significant inroads into countries like Japan, the UK, Australia, the Middle East and Latin America. Such expansion is considered the number one growth driver for the company which plans to grow from 12,000 stores to 30,000 stores in 10 years.[13] Dunkin Donuts has responded to this challenge by stating its plans to grow from approximately 4,400 stores to 15,000 in the same period, Caribou Coffee has confronted Starbucks in the international arena and now has a store in Dubai.[14]

4.2 Product/Service Innovation

A second driving force in this industry is tied to product innovation. Serious coffee shop contenders now offer a product selection broader than the traditional cup of coffee. National chain and even local coffee shops boast menus including coffees, teas, hot chocolate, pastries, bottled water, and even sandwiches. A factor which contributed to Starbucks’ ability to surpass early coffee house entrants, such as Gloria Jeans, has been the company’s extensive R&D.[15] For example the company has been able to sustain and grow its customer base by launching a new seasonal drink each year and also via its $400 million bottled drink business. Importantly, product innovation for Starbucks includes not only factors regarding customer acceptance but also the extent to which the product would fit into a store’s “ergonomic flow.”

Equally critical to the structure of the coffee industry has been the role of service innovation. An example of such innovation which has been hugely successful was the introduction of SVCs – store value cards.

Starbucks, Caribou Coffee and Peet’s Coffee now offer customers pre-paid cards which not only shorten transaction times for customers but can also bring in new customers via gift cards and supply stores with valuable customer data. Schultz, CEO of Starbucks, has called this innovation “the most significant product innovation since Frappuccino.”[16]

Service innovation is also impacting the industry in that companies are now required to offer a diverse set of services including music, drive-through services and newspapers to stay competitive. For example, to compete with Starbucks’ alliance with T-Mobile which offers wireless capabilities to its customers, Caribou now offers free wireless Internet access (for up to an hour) to its customers.[17]

4.3 Collaboration/Partnership

A further critical driver, which ties into the industry’s focus on growth and product/service innovation, has been collaboration and partnership. Starbucks was the first to realize the benefits of partnering when it reached out to powerhouse brands like Pepsi, Barnes and Noble, Nordstrom, Kraft and United Airlines to create new products, reach new customers and enter new channels of distribution like grocery, cruise lines and the airline industry. Caribou has followed suit and partnered with General Mills to produce a breakfast bar, USAToday to provide a news services to its customers, and most recently, Coca-Cola, to directly compete with Starbucks ready-to-drink iced coffees.[18] (See exhibit 2 regarding major competitors and their partners.) These alliances, in short, allow for innovation, channel extension and even geographic extension (in the case of Starbucks’ alliance with Japanese retailer Sazaby.)[19]

4.4 Image/Lifestyle

Additionally this industry is increasingly impacted by consumer’s perception of what a brand stands for. When Starbucks was first created, its CEO’s vision was to create a “third place” for Americans. Americans already spent considerable time at home and work and his vision was to provide a third place for Americans to not only drink coffee but to invest significant personal time. For this reason, industry marketing efforts are closely tied the image/lifestyle projected by the chain.

For example, in an effort to respond to Starbucks’ dominance, several competitors have attempted to differentiate themselves from the “upscale, pseudo-European” store by projecting different lifestyle brands. Caribou Coffee, for example, projects a more rugged image via its stores’ mostly wooden interiors which feel like “an Alaskan lodge.”[20] Further, the corporation promulgated its alternative lifestyle by associating itself with Apple during its 2006 "Wake Up and Smell the Music" promotion. Caribou’s CEO described the partnership as synergistic due to the fact that “We're both challenger brands.”[21]

Additionally, it is believed that Dunkin’ Donuts recent success has been tied to consumers’ perception of the chain standing for simplicity and value. As Starbucks’ prices continue to climb and many of its coffee processes become automated, one industry expert noted “it's hard now to know what Starbucks stands for….That isn't a problem with Dunkin' Donuts.”[22] Even further, Peet’s Coffee niche has been tied to delivering a super premium brand, via mostly whole bean coffee, and selectively opening stores to ensure that the company is “not another Starbucks.”[23] In close, the image consciousness of this industry will continue to drive marketing efforts as well as other areas such as product and service selection as players differentiate their brand.

4.5 Technology

A further driving force is the role of technology. Line management is a significant issue for coffee houses as often the demand is concentrated in the early mornings. For example, Starbucks has been able to achieve customer service efficiency by introducing automatic espresso machines. According to Michelle Gass, Chief Merchant of Global Product, Starbucks, efficiency is a key driver in customer satisfaction as customers “want their beverage in under three minutes.”[24] Interestingly, however, it appears these efficiencies must be balanced with creating a mystique around the coffee experience and having an awareness of the consumers’ price-value ratio. For example, Starbucks customers, who pay a premium for coffee, seem to miss the elaborate process of brewing and drink creation. Starbucks’ CEO recently expressed a concern that the brand was becoming “watered down” and such gains in efficiency threatened to commoditize the brand.[25]

Dunkin Donuts, however, has seen less resistance to its technological innovations as its products are generally cheaper and its brand is tied to simplicity. For example, rather than relying on baristas to create its new line of espresso-based drinks, Dunkin’ Donuts hired an expert to design an “idiot proof $8,000” machine which makes cappuccinos in less than a minute and at a lower price than competitors. One customer noted that both the Starbucks and Dunkin’ Donuts’ drinks taste good “but Starbucks takes too long.”[26]

Finally technology is impacting this industry in the form of increasingly sophisticated home brewing machines which are able to at least replicate, if not beat, the quality of coffee prepared at many of these stores.[27] Though it is unclear of the impact of these machines on the coffee players, this is an area of increased growth and one for these competitors to monitor.

5. Competitive positions & possible strategic moves of key companies

5.1 Starbucks

Starbucks, the world’s number one coffee retailer, has over 13,000 coffee shops in more than 35 countries. The outlets offer coffee drinks, food items, beans, coffee accessories and teas. Starbucks owns about 17,500 of its shops, which are located in about 10 countries (mostly in the U.S.) while licensees and franchisees operate the remaining outlets. Starbucks does 78% of its store volume in beverages, with 12% in food, and 5% in whole beans.[28] The company does not compete on price but rather on the complete experience customers get while visiting the coffee shop. Embracing its value beyond extraordinary coffee, Starbucks tries to make a business out of human connections, and celebration of diversity and culture.[29]

Starbucks focuses its retail selection on the “best places in town” and its outlets can be found in the centre of almost every famous city in the world ranging from Cologne to Los Angeles. As mentioned, the firm focuses on high-traffic, high-visibility locations. While Starbucks selectively locates stores in shopping malls, it tries to focus on places that provide convenient access for pedestrians and drivers.[30]

Starbucks’ strategy

Starbuck’s overall goal is to establish its brand as one of the most recognized and respected ones in the world. Therefore the enterprise plans to continue the rapid expansion of its retail ~ and grow its specialty operations and to selectively pursue other opportunities to leverage the brand through the introduction of new products and the development of new channels of distribution.[31]

In continuance with its history of partnerships, Starbucks and Concord Music Group announced on March 12th of this year the formation of a new record label “Hear Music” which will distribute recordings at Starbucks locations. This partnership is another step in Starbucks’ entertainment strategy that links to the company’s focus on atmosphere and image.[32]

Last fall, addressing McDonald’s attempts to lure customers away, Starbucks announced its plans to offer hot breakfast sandwiches in an appeal to fans of the Egg McMuffin and establish them also in the breakfast and afternoon snack segment.[33].

5.2 McDonald’s

McDonalds (which history began in 1954) is the leading global foodservice retailer with more than 30,000 local restaurants serving nearly 50 million people in more than 119 countries each day.[34] In 2006 the company reached a record high of $21.6 billion in revenues. McDonalds competes on price, ubiquity, convenience, service and through offering quality food products.

Besides hamburgers McDonalds is also proud on its hot coffee and believes that the high temperature (brewed at 195-205°F) is a major reason for the billion cups sold per year for $1.35 each.[35]

McDonald’s’ strategy

Recent strategic changes within McDonald’s are increasing its potential for rivalry with pure coffee house retailers like Caribou and Starbucks. First, McDonald’s improved the quality of its coffee and launched a premium roast version on March 6th 2006.[36] Furthermore McDonalds is looking into “day-parts” penetration as a growth strategy. While currently owning the breakfast segment the company wants to take over the afternoon segment.[37] That is also the reason why, on March 1st 2007, McDonalds has announced that it will serve specialty coffee beverages like vanilla lattes and caramel cappuccinos at outlets across the U.S. It is pricing espresso-based drinks between $2 and $3, undercutting Starbucks offerings. This move is consistent with McDonald’s overall strategic shift away from its traditional burger-and-fries offerings and toward more “upscale” food. The specialty coffee drinks will be served from push-buttons machines, which are faster than Starbucks’ labor intense hand-made approach.[38] Even further threatening to coffee competitors is McDonald’s recent ability to increase its service and improve its stores by slowing down its expansion and reallocating funds.

5.3 Dunkin’ Donuts

Dunkin’ Donuts (founded 1950, headquarter in Canton, Massachusetts) is the world’s largest coffee and baked goods chain, serving over 3 million customers a day. 2006 the enterprise had revenues of $4.7bn ($4.3 bn in the U.S.).[39] There are more than 7,000 shops worldwide (5,300 in the U.S.). The company is opening 700-1000 additional shops every year.

Dunkin’ Donuts has forged a strong identity as a coffee destination with ample seating and a diverse menu that grows incrementally following its slogan: “America runs on Dunkin”. Already, 57% of the chain's sales, and the most profitable product group, are beverages. The company sells about 500 million cups of coffee a year for $1.65 each.[40] Dunkin’ Donuts is pursuing the following key strategies: multi-branding concept development, Dunkin’ brand vitalization, product innovations, accelerated brand development, improved operational effectiveness and talent acquisition. Dunkin’ Donuts retail outlets are operated in a franchise format either through operating agreement, license agreement or joint venture.[41]

Dunkin’ Donuts’ strategy

The company’s current plans are to widen its specialty coffee offerings and offer them on a broader basis nationally. Therefore Procter & Gamble signed an agreement with Dunkin’ Brands on March 1st 2007, to launch Dunkin’ Donuts coffee at U.S. retailers (e.g. grocery stores, mass merchandisers, club stores).[42]

Additionally Dunkin’ Brands CEO Jon Luther emphasizes the company’s strategy to be a faster, cheaper, user-friendlier alternative to Starbucks. He is convinced that there is a market opportunity especially among a younger audience that is enamored with Starbucks frothy beverage menu but daunted by its prices. Addressing this issue Dunkin’ Donuts installed espresso machines in prime locations, capable of delivering inexpensive coffee in 44 seconds. The company purposely leaves the fancy CD burning stations, mood lighting and comfortable chairs to the competition and focuses, instead, on speed. The company tries to reach a rate of one shop to every 15,000 - 20,000 people in their target markets. According to the CEO Dunkin’ Donuts coffee business industry is basically a “game” that relies on ubiquity. However, that is an important, but not the most critical, issue because high margins in the coffee business will allow the company to buy key sites.[43]

Additionally the enterprise aims at improving its level of service and cross shop consistency in service; a goal that is especially challenging because of the franchising structure. CEO Luther in 2003 to his 2700 franchisees: "We're changing this game, we're raising the stakes, if you don't like it, get out."[44]

5.4 Caribou Coffee

Caribou Coffee was founded in 1993 and its headquarters is located in Minneapolis (Minnesota). Today it is the second largest specialty coffee company in the U.S. with 416 outlets (2005) in 18 states and the District of Columbia. The revenue in 2005 totaled $198 million. Caribou's cafes feature mountain-lodge-style decor with exposed beam ceilings, leather chairs, and roaring fireplaces. The company’s motto is "Life is short. Stay awake for it." Caribou Coffee successfully competed against the omnipresent Starbucks in a number of U.S. states.

Caribou’s strategy

The company emphasizes the quality and freshness of their products (Coffee is packaged immediately after roasting, and it is not sold more than 21 days after roasting or more than seven days after the opening of the package). Caribou competes by offering a slightly different roast of coffee and a warmer, more relaxing in-store environment compared to the Starbucks shops with a rather sleek, urban atmosphere.

The Middle East is the first region Caribou Coffee is seeking to expand internationally. The company believes that there is a small but growing market for American branded coffee houses.[45] Another strategic approach has been to develop partnerships with other retailers, such as Eatzi's, or building stores next to Bruegger's Bagels, Blockbuster Video and Border's Books. The company also sells its coffee in upscale grocery stores, such as Lund's and Byerly's in the Twin Cities and Heinin's in Cleveland.[46] Furthermore, Frontier and Maxjet airlines serve Caribou coffee, and the company recently inked a deal with Life Time Fitness.[47]

5.5 Coffee Bean & Tea Leaf

Coffee Bean & Tea Leaf was founded in 1963, with its headquarter is located in Los Angeles. In 2005 the company had 400 outlets and revenues of $150 million. The strategy of Coffee Bean is “Keep Innovating”. The company is known for its extensive selection of coffees and teas, as well as its reputation for innovation, e.g. the ice-blended coffee drink and the chai latte. Coffee Bean has also made a push overseas, finding niches in Starbucks-free markets such as Israel. With nearly all of its drinks certified as kosher, the company has opened several locations in that area.[48]

5.5 Peet’s Coffee

Peet’s Coffee, whose headquarter is situated in Emeryville, California, was founded in 1996. In 2005 the company had 120 outlets and revenue of $175 million. Peet's strength is the taste of its coffee, which appeals to java connoisseurs. The company roasts its beans in small batches, replaces brewed coffee every 30 minutes, and never re-steams milk. "Peetniks" often drink Peet's at home too, and about half the company's sales come from whole beans, which carry higher margins. Peet's beans are also sold in more than 4,000 grocery stores.[49]

Though no chain has approached Starbucks global scale, the coffee shop industry is increasingly competitive. While many consumers still favor Starbucks coffee, it’s rather the in-store experience than the product portfolio that makes the company stand out. With the coffee selection improving elsewhere it is unclear how many customers will continue to pay premium prices if that experience is no longer unique.

Experts expect the price-value equation of the competitors to change in the future.[50]

6. Key factors that determine success in the future

6.1 Product and Service Innovation in the Future

Several key factors within the coffee shop industry are essential components that will likely lead to success or failure of market participants. As already highlighted in the “Driving Factors” product and service innovation are necessary in order to stay competitive in the market and attract new / keep existing customers successfully. Many customers focus on the special atmosphere each store has and which is characterized by the location, music, interior design, seating or whether internet access is provided.[51] Particularly for specialty coffee shops it is important not to sell only the beverage but the whole experience. Coffee shops have to establish a unique image that prevents customers from buying products from another shop or use home-brewing systems which are also on the rise in American households.[52] In addressing the increased level of competition, every company’s focus should be on differentiating from the rest of the market in every possible business segment (products, atmosphere, location, image etc.)

6.2 Technology

Furthermore it is important to have state-of the art technology in the shop in order to serve high quality and differentiated products. Advantages of high level technology and machines are shorter waiting times for the customers and the ability to create a variety of fresh, new and unique flavors.

On the other hand it is essential that the level of automation and machinery is well chosen and that there is a clear plan how to integrate the new machinery into the business.[53] Even though there is an increase in efficiency it might mean a loss of identity and differentiation for some stores, such as Starbucks, which focuses on a special spirit in their shops.[54]

6.3. Education About Coffee

Coffee shop companies should start or continue to educate the consumers about coffee, its ingredients, quality differences, and about the movements in the market, such as “Fair Trade” or “organic coffee”. This could be beneficial for developing a relationship with the customers which in turns leads to greater brand loyalty. Informed customers are able to make educated decisions and will be less likely to switch just based on gut feeling. Furthermore this education might motivate coffee buyers to pay a higher price for better products.[55]

6.4 Cooperation

Several companies have proven already that a key factor in the future will be the ability and willingness to cooperate with other market participants without losing control of the business.[56] Therefore it is important to pursue a full range of alliance opportunities: partnerships for innovation and cost reduction but also geographic expansion and co-marketing deals.[57] Finally such partnerships might become tickets to the “global game” as Coca-Cola and Microsoft already proved.

6.5 Quality Control, Consistency

Besides the cooperation with other partners in the industry the coffee shop companies have to ensure that the quality of products and services as well as the cleanliness of the location are consistent and at the desired level from shop to shop (including especially franchisees and licensees) so that the consumers can build trust in the brand.[58] Furthermore the role of the “barista” should not be underestimated and great commitment should be recognized and rewarded. The barista is the personality and sole representative of the specialty coffee supply chain to the consumer. They not only can make drink suggestions or recommendations, but their skill can be the difference between an everyday latte and an amazing specialty coffee experience.[59]

6.6 Meeting Demand

In addition to that companies in the coffee shop industry have to make sure that they can meet the increasing future demand. Per capita consumption of total volume is predicted to reach 2.9kg by 2010, up from 2.8kg in 2005. Constant value retail sales are expected to grow 10% over the forecast period to reach over U.S.$ 6.5 bn. Therefore the market participants should support their suppliers in providing differentiated, quality beans and focus on business strategies that try to prevent farmers from running into debt and poverty.[60] In addition to that companies are supposed to pay attention to the growing demand for specialty coffee, which means they have to ensure that the right product innovations are added to the revised product portfolio at the right time. The compound annual growth rate 1992-2002 was 10% for specialty coffee and therefore over 3 times the rate of the total coffee production (2.9%). However, shifting into the specialty segment is no panacea, since it is a rather small part of the overall market – only 7.8% of the total production volume in 2002.

6.7 Role of Regulations

The trend of stricter regulations in the coffee industry started already, e.g. with new organic rules[61] (Appendix, Exhibit 9) and is expected to become even more severe in the future which underlines the fact that coffee shops have to cooperate with their suppliers in order to control the quality of their products along the value chain. Companies should participate mainly for ethical reasons in campaigns such as “Fair Trade” (Appendix, Exhibit 9). In addition to that, if these social movements gain more attention in the market, the companies could also benefit from the positive public relation associated with the social commitment and engagement.[62]

To sum it up, coffee shops have to target their customers effectively in terms of product portfolio, company image and atmosphere as well as advertising and coffee shop location while paying attention to the partners along the value chain and look out for beneficial cooperation within and between industries.[63]

7. Attractiveness of the industry

7.1. Factors in favor of an attractive industry

Industry is still growing: “Premium coffee continues to grow as a result of café culture”

Consumers are expected to maintain increasing levels of coffee consumption between 2005 and 2010. U.S. coffee retail volume sales are predicted to increase by 7% over the forecast period. Per capita consumption of total volume (retail and foodservice) is predicted to reach 2.9kg by 2010- The espresso-based drink market is showing a 68% increase since 2000.[64]

Growing demand for specialty coffee[65]: Consumption of specialty coffees has increased by 10 percent a year since the early 1990s, compared with 2 percent for the overall market. If this trend continues, demand for them could conservatively be expected to grow by 5 percent annually—an additional 2.5 million bags by 2007. This is a very positive development as specialty coffee might be perceived less as a commodity. Furthermore sales are generally strong.[66] (Appendix, Exhibit 1).

High margins: International coffee prices decreased dramatically over the last decade (in 1999 coffee traded at $1 U.S. per pound vs. less than 50 cents in 2001)[67] while actual selling prices of coffee did not go down which led to increased profits in the industry.[68] Retailers earn approximately 25% of a $2 cup of coffee.[69]

Popularity of the product: Coffee is the second largest commodity next to oil and more than half of the world’s adult population drinks coffee several times a week[70]

Diversity of functions of coffee shops: Coffee shops have a great potential because they are different things to different people: place to buy a variety of coffee flavors, place to converse with friends, read a book or take a break from work. Therefore coffee shops can address a variety of issues when promoting their outlets.

Growth potential for companies by franchising and licensing: Franchising Coffee has become a popular low-risk alternative to setting up an independent store. Furthermore specialty coffee is the fastest growing franchise segment in America.[71]

7.2. Factors in favor of an unattractive industry

Dominance of big companies: Starbucks has significant early entrant advantages in the market and especially in the franchise area The company is able to benefit from the central location of its outlets, it’s brand value, economies of scale, powerful partnerships and cooperations with suppliers or other companies in the industry.

High investments to start franchise: A potential franchisee has to provide a significant amount of money in order to qualify for opening a shop of a “high level” franchiser, such as Dunkin’ Donuts, McDonalds or Starbucks (Appendix, Exhibit 8).[72] Furthermore some chains demand individuals with a certain background, e.g. Dunkin’ Donuts specifically states on their website that “Applicants for franchises should have a minimum of five years experience in managing people in a business environment and strongly prefer individuals with at least three years managerial experience in a multi-unit food service/hospitality environment.”

Rather low investment for independent coffee shops: Setting up a single and independent coffee shop, in contrast to franchising, a significant smaller amount of capital is needed which in turn leads to low entry barriers. For opening a coffee drive-through the investment ranges approximately from $60,000 to $250,000 while a coffee shop requires $60,000 to $350,000.[73]

Besides that eating-and-drinking places are by nature extremely labor-intensive. Sales per full-time-equivalent employee were $57,032 in 2005 and notably lower than other industries.[74]

Additionally coffee companies have to overcome the loyalty of the customer to local coffee shops and the increasing threat posed by sophisticated home brewing machines. More and more U.S. consumers attempt to replicate the coffee house experience at home through the purchase of premium coffee & the equipment with which to brew it.”[75]

Increasing power of substitutes: Per capita consumption of coffee dropped to about 17 gallons in 2000, down from 36 gallons in 1970, while soft drink consumption grew from 23 to 55 gallons, over the same period - an increase of more than 140 per cent.

Different drinking habits of following generations: There is a sharp jump in the number of regular coffee drinkers between the 18- to 24 and the 25- to 34-year-olds (29 % vs. 60 %). Therefore the coffee industry needs to address young adults and change the drinking habits as they enter the working world and establish own households.[76]

Further risks of the industry:[77] Shortage in supply, or an increase in the price of coffee beans could adversely affect net sales; Risk of fluctuations in the cost, availability and quality of non-coffee raw ingredients; Risk of adverse public or medical opinions about the health effects of consuming certain products (caffeine, sugar etc.) that could harm the business.

7.3. Conclusion

Based on the analysis above we conclude that the coffee shop industry is a very attractive market (high margins, growing demand) for the companies that are already established, such as Starbucks or Dunkin’ Donuts, however, smaller independent companies may not be able to compete significantly.

7.4. Most likely future scenario

As indicated, Starbucks brand is likely to weaken in the future due to its high growth and efficiency focused strategy which eliminated the “romance” of coffee brewing.

Starbucks’ stock price in the last 5 months (

This strategy has commoditized its high price point product and likely will drive consumers to other competitors such as Dunkin’ Donuts who offer a more favorable consumer price-value ratio. Therefore the other “big” market participants, who now offer a similar experience at a lower price, will be able to increase their market share and lure away Starbucks’ customers.

8. Appendix

1. Trends in the coffee industry
2. Coffee Industry Partnerships
3. A closer look at Starbucks
4. Starbucks Gift Card
5. Dunkin’ Donuts Coffees and Teas
6. Caribou Coffee- menu extract
7. Coffee taste test, surveys etc.
8. Additional information about franchising
9. Sustainable Coffee

1. Trends in the coffee industry[78]

Abbildung in dieser Leseprobe nicht enthalten

Retail Sales of Coffee by Type: % Value Growth 2000-2005

Abbildung in dieser Leseprobe nicht enthalten

Sales figures- the American Coffee Industry[79]

Abbildung in dieser Leseprobe nicht enthalten

2. Sample of Coffee Industry Partnerships

Abbildung in dieser Leseprobe nicht enthalten

6. Caribou Coffee- menu extract

Abbildung in dieser Leseprobe nicht enthalten

7. Coffee taste test, surveys etc.

In a coffee taste run by Consumer Reports magazine in February 2007 McDonald’s, Starbucks’ and Dunkin Doughnuts’ coffee was tested. The magazine proclaimed that McDonald’s beverage was the cheapest and the best.[80]

Also in Feb 2007 marketing powerhouse Brand Keys’ latest Customer loyalty survey looked at Dunkin’ Donuts and Starbucks. The result was that the former one edged out Starbucks for the first time. A reason might be the increased level of automatic machines and bagged coffee at Starbucks which leads to a loss in uniqueness. Customers can’t observe anymore how the coffee is handmade in front of them.

8 Additional information about franchising

Dunkin’ Donuts : McDonalds

Abbildung in dieser Leseprobe nicht enthalten

- Potential franchisees have to make sure that they choose the right franchiser which means analyzing the viability of the opportunity, the level of training and support offered to the franchisee, the track record and financial stability of the franchisor, the success rate of the franchisees, etc.
- High level franchiser offer the franchisee a lot of help and are highly involved even after the shop is opened. Additionally the franchisee benefits from the established brand name and business knowledge of the company.
- In turn he/she has to pay for the support by giving a certain percentage of the revenue back to the franchiser (contribute to the advertising budget etc.)
- There are downsides to franchising. Foremost is the high cost of entry. The top franchise opportunities require considerable investment on the front end, usually more of an investment than if the entrepreneur started a similar venture on his own. The franchisee might also be required to buy supplies from the franchisor, including inventory, paperwork, software, computer systems, and anything else the franchisor decides that they should supply. Furthermore the franchisee can’t control the business himself/herself, the franchisor does.[81] [82]

9. Sustainable Coffee

Organic, Shade and Fair trade coffees- collectively known as sustainable coffees – fill a market niche that is often rewarded with a premium price and can provide superior environmental, economic and social benefits to producers.

The survey was based on a list of more than 9000 coffee related firms supplied by the Specialty Coffee Association of America and the Coffee Association of Canada.

The survey included (sample is greater than 2098 due to multiple answers):

- 1558 retailers
- 570 roasters
- 312 wholesalers
- 120 distributors, and
- 94 importers

More than two-thirds of the specialty coffee industry believes that certification of sustainable coffees will be important to their business in the future. Similarly, about 2/3 were in favor of a simpler way of communicating sustainability in the marketplace, in effect a super seal incorporating criteria from Organic, Shade, and Fair Trade coffees.

What are the main inferences that can be drawn from this study?

- The sustainable coffee segment is growing very fast.
- Industry is already benefiting, in terms of increasing sales and higher prices, from the product differentiation, improved quality and price premiums of sustainable coffees.
- The specialty coffee industry appears to understand that their future is intimately linked with the sustainability and quality of their supply.
- If industry is unclear over definitions, so are consumers. Providing education and information will be critical factors in expanding these market niches.
- Standardized terminology and consumer-friendly certification can help prevent confusion and erosion of support for this market segment.
- The industry is optimistic about the future of sustainable coffee.

The specialty coffee market in brief

The U.S. handles about 1/4 of global coffee imports (2.45 billion pounds). Canada imports nearly 400 million pounds. The U.S. specialty coffee industry is responsible for only approximately 17% of the total U.S. green coffee imports mentioned above but its $7.8 billion sales represent approximately 40% of the $18.5 billion U.S. coffee market2. Total U.S. retail sales of specialty coffee beverages were $5.3 billion in 2000 while retail sales of specialty coffee beans reached $2.5 billion. It is the only segment of the coffee industry that has shown consistent and notable growth3 and is the largest specialty coffee market in the world. According to the International Coffee Organization (ICO) and the SCAA, most potential specialty coffee markets are far from saturated. Specialty coffee sales continue to expand by 5% to 10% per year according to conservative estimates4. The North American specialty market therefore represents one of the largest and most vibrant coffee markets in the world. Its ability to develop strong new trends and influence global consumption is well documented. These reasons and its historic role as a market for many of the producing countries that are at the forefront of developing certifiably sustainable coffee production, make it the ideal target for the first large-scale industry survey of sustainable coffees.

The following terms served as brief and very basic definitions for the survey:

- Organic coffee is produced with methods that preserve the soil and prohibits the use of synthetic chemicals.
- Fair Trade coffee is purchased directly from cooperatives of small farmers that are guaranteed a minimum contract price.
- Shade coffee is grown in shaded forest settings and is good for biodiversity and birds.

Abbildung in dieser Leseprobe nicht enthalten

There is considerable confusion about what the three terms Organic, Fair Trade and Shade actually mean. Failure to promote or educate about standardized terminology will very likely lead to the deterioration of terms such as “Shade coffee” until they are as meaningless to a consumer as the word “natural”.

Factors that make sustainable coffee valuable to business

When asked how important each of the following 7 factors is in making sustainable coffee valuable to their business, the quality issue was confirmed as primary by 91.9% of the respondents who believe it is a v ery important factor.

1. Specialty quality or taste (91.9%)
2. Opportunity for differentiation (57.1%)
3. Customers are asking for it (51.9%)
4. Better profit margins (50.9%)
5. Personal beliefs about chemical-free agriculture (46%)
6. Personal beliefs about biodiversity or the environment (37.6%)
7. Personal ethics about fair trade for the growers (36.9%)

Nearly 9 out of 10 companies report that sustainable coffee sales either increased or remained the same last year. Hardly any reported reduced sales. Most expect this positive trend to continue over the next two years.

In the next two years less than 2% expect any decreases and nearly 95% expect sales to either remain the same or increase.

Abbildung in dieser Leseprobe nicht enthalten


[1] First Research Industry Profile ,, December 28,2006


[3] First Research Industry Profile ,, December 28,2006

[4] First Research Industry Profile: Coffee Industry


[6] Isabel Isidro, Learning from Starbucks: 10 Lessons for Small Businesses,, Oct. 5, 2004.

[7] First Research Industry Profile: Coffee Industry.

[8] First Research Industry Profile: Coffee Industry.

[9] Minimum Price of $1.26 per pound; farmers are given credits by companies – source: Mergent Coffee Industry, Aug. 2006,

[10] Mergent Coffee Industry, Aug. 2006, at 4.

[11] First Research Industry Profile: Coffee Industry.

[12] Youngme Moon and John Quelch, Starbucks: Delivering Customer Service, Harvard Business Review, July 10, 2006 at 3.

[13] Dunkin' Donuts Escalates Java Wars, MarketPlace,

[14] Id.

[15] Starbucks: Delivering Customer Service at 8.

[16] Stanley Holmes , Starbucks’ Card Smarts, BusinessWeek, March 12, 2002.

[17] Caribou Coffee Offers Free Wi-Fi Service For Customers, Bus. Wire, Aug. 28, 2006.

[18] Coke and Caribou Join Forces to Sell Line of Coffee Drinks, Atlanta Bus. Chronicle, Nov. 30, 2006.

[19] John D. Cook, Tammy Halevy, and C. Brent Hastie, Alliances in Consumer Goods, The McKinsey Quarterly, 2003 No. 3.

[20] Starbucks: Delivering Customer Service at 6-7.

[21] Coffee CEO Podcast Relays Power of Branding and Music, PRNewswire-FirstCall, March 16, 2006.

[22] Tom Van Riper, Dunkin' Donuts Edges Starbucks,, Feb. 27, 2007.

[23] Blanca Torres, Peet's Future is Percolating, Contra Costa Times, March 8, 2007.

[24] Nicola Groom, Exec says Starbucks Strategy Unchanged, Reuters, March 7, 2007.

[25] Id..

[26] William C. Symonds, A Java Jolt For Dunkin' Donuts, BusinessWeek, Dec. 20, 2004.

[27] Coffee-US, Euromonitor International: Country Sector Briefing, Aug. 2006 at 9.

[28] Article: It’s not about the Doughnuts;; December 2004

[29] In February 2007 Howard Schultz (Starbucks’ chairman) wrote a memo to top company managers of the company that soon became public. He lamented the cumulative effect of company decisions associated with expansion: more efficient automatic machines that diminish the “romance and theatre” of the earlier-era and block the visual sight line the customer previously had for the intimate experience with the barista. (“The Starbucks Stops Here”;

[30] Starbucks’ Financial Statements 2004.

[31] Starbucks’ Financial Statement 2004.

[32] Starbucks’ Homepage;

[33] “Supersize that Latte? McDonald's to Offer Upscale Coffee Drinks”;

[34] McDonalds’ Homepage;

[35] McDonalds hot coffee (;


[37] McDonalds, Starbucks Growth Strategy; (

[38] “Dunkin Donuts Edges Starbucks” (; 27 February 2007.

[39] “It’s not about the Doughnuts”; (; December 2004.

[40] “The truth about McDonalds hot coffee"; (; July 2006.

[41] Homepage Dunkin’ Donuts (


[43] “It’ not about Doughnuts” (; December 2004.


[45] Caribou’s Financial Statement; 2006.

[46] “Caribou Coffee taking on king of the hill”; (;

[47] “Grinding Out Success Next to Starbucks”; (; December 2006

[48] Id.

[49] Id.


[51] “Mergent coffee industry”, Page 5.

[52] However many U.S. critics claim that the purportedly “premium” coffee is still significantly inferior to the coffee house beverage they are meant to compete against. Resource: Mergent coffee industry, page 4, 11.

[53] Resource: National Coffee Association of USA


[55] “2007 Tea and Coffee Industry Forecast” (

[56] These days, global corporations routinely tie up 20 percent or more of their assets in alliances. As analyzed by McKinsey the most alliance-intensive enterprises over all industries delivered average total returns to shareholders nearly four times larger than the rest.

[57] Resource: Mc Kinsey Quarterly Report about the Coffee Industry

[58] As the Starbucks employee, who works in an affiliate of the corporation describes in the articles, there are differences between shops because the franchised stores buy the product and train employees differently, as compared to the stores linked to the corporation. (;

[59] “2007 Tea and Coffee Industry Forecast” (

[60] Especially the years of great surplus (60%) of coffee beans- 2002 / 2003- further drove down prices as farmers competed for the remaining market share. Many farmers were forced to lower prices so that their sales could not cover the cost of production, beginning a cycle of poverty and debt.

[61] Organic coffee is grown without prohibited synthetic substances. The regulations require an organic plan, correct use of land and a very strict, detailed record keeping. Retailers have to change their labels and identify their certifier. The financial load per pound could be 2 to 4 cents up towards 17 cents for a small roaster. The organic rules went into full effect in Oct 2002. Customers will now have a higher level of confidence in knowing the product is organic. (

[62] Fair trade is an organized social movement which promotes standards for international labour, environmentalism, and social policy in areas related to production of Fair-trade-labelled and unlabelled goods. The movement focuses in particular on exports from developing countries to developed countries. “There is an undeniable and increasing interest. However, Fair-Trade labelled coffee still only represents 1.2% of the West European market (Roel Vaessen- European Coffee Federation, Netherlands)

[63] Resources: Mergent coffee industry and Mc Kinsey Quarterly report about the coffee industry

[64] “It’s not about Doughnuts”; (, December 2004

[65] Mc Kinsey Quarterly and US Coffee report

[66] Industry Forecast; (

[67] Global Trade; (

[68] Id.

[69] Nestlé told its shareholders in 2001: "Trading profits increased, and margins improved thanks to favourable commodity prices."

[70] “Success over a cup of coffee”; (;

[71] “Eccellente Gourmet Coffee”; (

[72] “A Review of Dunkin’ Donuts”; (

[73] “How to start a successful coffee shop”; (

[74] Restaurant Industry Facts,

[75] Coffee US Report;

[76] “Grounds for a New Strategy in the coffee industry”; (; June 2001

[77] Financial Statement Caribou Coffee 2006.

[78] McKinsey Report about the Coffee Industry

[79] Industry Data; (

[80] “McDonald's java beats Starbucks, Dunkin' Donuts”; (; February 2007

[81] “Franchising Pros and Cons”; (

[82] Sustainable Coffee Survey of the North American Specialty Coffee Industry, 2001.

36 of 36 pages


Coffee Shop Industry - A Strategic Analysis
Strategic Mgmt. innerhalb des MBA - Studiums
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Coffee, Shop, Industry, Strategic, Analysis, Strategic, Mgmt, Studiums
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Diplom-Kauffrau (FH), Master of Business Administration Michaela Altmann (Author), 2007, Coffee Shop Industry - A Strategic Analysis, Munich, GRIN Verlag,


  • Thabani Nyoni on 5/10/2015

    well researched, thank you for your valuable contribution

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