Business Model of Starbucks

Author- | Posted- | Updated: August 18, 2020 |

Starbucks is the premier coffee brand of the world that was formed in 1985. It is the most recognized and respected brand in the coffee industry. However, the company has achieved its strong reputation and market-leading position in the industry without investing a mega fortune in marketing. It highlights the focus of the company on quality and superior customer experience. Today, it sells its products in 81 markets and continues to focus upon disciplined expansion to grow its market share and customer base. While the US is the core market of Starbucks, the company continues to grow its presence in newer high growth markets like China. Starbucks entered the Chinese market in 1999 and since then the company has expanded its presence in China to 180 cities where it operates around 4,300 stores.

Apart from its flagship Starbucks brand, the company also sells its products and services under the following brands: Teavana, Seattle’s Best Coffee, Evolution Fresh, Ethos, Starbucks Reserve, and Princi. The company purchases and roasts high-quality coffees that it sells, along with handcrafted coffee, tea, and other beverages and a variety of high-quality food items through its company-operated stores. In 2019, the total number of Starbucks stores reached 31,256 of which 15,834 or around 51% were company-operated stores and the rest were licensed stores.

Reportable Business Segments of Starbucks:

The company has divided its business into three reportable segments that include the Americas, International, and channel development segments. The Americas segment is the largest reportable segment of all the three reportable segments accounting for the largest part of the company’s revenue. This segment includes the operations of the company in the US, Canada, and Latin America. The Americas segment accounted for around 69% of the company’s revenue in 2019, followed by International – 23% and Channel development – 8%. In 2019, the Americas segment generated $18,259 million in net revenue compared to $16,748.6 million in 2018. The international segment generated $6.2 billion in net revenue in 2019 compared to $5.6 billion in 2018.  The channel development segment generated around $2 billion in revenue in 2019 compared to $2.3 billion in 2018. The total net revenue of the company grew to $26.5 billion in 2019 compared to $24.7 billion in 2018.  Starbucks’ Americas and international segments both include company-operated and licensed stores. The Americas segment is the most mature business segment of Starbucks which has achieved a significant scale over time.

Company operated versus licensed stores:

 The Starbucks business model includes both company-operated and licensed stores. The mix of Starbucks company-operated and licensed stores in a market depends on several factors including the availability of attractive locations. Apart from that, the complexity of the local market environment, its profitability as well as the size of the market for Starbucks, and the ability of the company to leverage its local infrastructure within a geographic region also affect the mix of company-operated and licensed stores. 

How does the company operated store model of Starbucks operate?

The company operated stores are the biggest source of revenue for Starbucks. In 2019, the company-operated stores of Starbucks generated around 81% of its revenue. The company operated stores of Starbucks are generally located in areas that see higher traffic and highly visible locations. The global retail strategy of Starbucks focuses on disciplined growth by opening retail stores selectively in new and existing markets. The company also focuses on growing sales inside its existing stores. The number of total company-operated stores of Starbucks in 2019 was 15,834, out of which 9,974 were in the Americas segment and 5,860 in the International segment. The company has been able to locate its stores strategically by varying the size and format of stores according to locations.  Some of the most common location types where these stores are located include downtown and suburban retail centers, office buildings, university campuses, and in select rural and off-highway locations.

The company is continuously expanding its stores and particularly the drive-thru and alternative formats. The ‘Drive-Thru’ formats of Starbucks stores provide a higher degree of convenience and access. The alternative store formats however are focused on providing an elevated Starbucks experience for the customers. The company has divided the products sold in its company-operated stores into four categories that include beverages,  food, packaged and single-serve coffees, teas, and other products. Beverages and food are the largest two segments of products sold inside the Starbucks company-operated stores. In 2019 and 2018, beverages accounted for 74% of the retail sales of the company, and food accounted for 20%. The other two segments accounted for 1% and 5% of the retail sales of the coffee brand respectively.

How does the licensed store model of Starbucks operate?

The licensed stores constituted around 49% of the total Starbucks stores in 2019. They accounted for around 11% of the net revenue of the company in fiscal 2019. While the licensed stores generally have a lower gross margin, they offer a higher operating margin as compared to the company-operated stores. Under its licensed store operations model, the company receives a margin on branded products and supplies that it sells to its licensed operators apart from royalty on retail sales. The licensed operators bear the operating costs and capital investments which more than offsets the lower revenues that the company receives from its licensed stores. As a part of its licensed store arrangement, the company leverages the expertise of its local partners and also shares its operating and store development experience. Sometimes, the only access to the desired retail space is possible through licensed partners. Most of them are experienced retailers with an in-depth knowledge of the local market and access to perfect locations. As a part of the licensing arrangement, the company sells coffee, tea, food, and related products to licensees which they sell to customers. Starbucks, in turn, receives royalties and license fees from the licensees. Apart from that, the company also sells certain equipment like coffee brewers and espresso machines to its licensees for use in their business operations. However, the employees working for the licensed partners of Starbucks inside the licensed stores are required to follow the same procedures and attend similar training classes as the employees working inside the company-operated stores. The company also operates stores based on the traditional franchising model in some of the international markets.  The financial results of these stores are included with the other licensed stores in the annual report of the company. 

Other Sources of Revenue:

The other revenues of the company are primarily recorded in the channel development segment of the company. It includes the sales of packaged coffee, tea, and ready to drink beverages to customers outside its company-operated and licensed stores. Before Starbucks established the global coffee alliance during the fourth quarter of 2018, its revenues included domestic and international sales of packaged coffee, tea, and ready-to-drink products to grocery, warehouse club, and specialty retail stores and through institutional food-service companies. However, since the establishment of the alliance, its other revenues include product sales to and licensing revenue from Nestlé under this arrangement and the amortization of the up-front prepaid royalty. The company has also entered into collaborative relationships with companies including  PepsiCo, Inc., Anheuser-Busch InBev, Tingyi Holding Corp., Arla Foods, and others. However, their results are excluded from the global coffee alliance. 

How Starbucks sources its raw material?

The company has maintained rigorous quality standards to ensure that the coffee sold inside the Starbucks stores is of the highest quality. The company controls substantially all of the coffee purchasing, roasting, and packaging and the global distribution of coffee used throughout Starbucks operations. Starbucks purchases green coffee beans from various coffee-producing regions throughout the world. After that, it roasts them to its standards for many blends and single origin coffees. The company has managed strong supplier relationships to maintain a continuous supply of good quality coffee. It also operates nine farmer support centers that have agronomists as well as sustainability experts as their staff. These experts work with the coffee farming communities to promote the best practices in coffee production designed to improve coffee quality and yield. The company purchases other products sold inside the stores like tea and ready to drink beverages from several specialty suppliers and usually under long term supply contracts. It purchases food products from national, local, and regional sources. 

Business Performance of Starbucks During 2019

The total net revenues of the company grew in 2019 compared to the previous year. In fiscal 2019, the net revenue of Starbucks grew to $26.5 billion compared to $24.7 billion during 2018. Growth in revenue was mainly driven by the growth in revenue across the company-operated stores. Over the past 12 months, the company opened net 947 new stores that drove the growth in incremental revenue apart from a  5% growth in comparable-store sales. Comparable store sales grew mainly due to a 3% increase in average ticket and a 2% increase in comparable transactions. Revenue of the company also grew from licensed stores driving a small increase in overall revenue of around $223 million.

 The consolidated operating income of the company also grew in 2019 compared to the previous year. In 2019, the consolidated operating income of the company increased to $4.1 billion compared to $3.9 billion in 2018. The operating margin of the company however fell a little compared to the last year to 15.4% in 2019 from 15.7% in 2018. 

Earnings per share of Starbucks decreased in 2019 compared to the previous year. In 2019, the EPS of Starbucks declined to $2.92 compared to $3.24 in 2018. Capital expenditures of the company also declined in 2019 compared to the previous year. In fiscal 2019, the capital expenditures of the company declined to $1.8 billion compared to $2 billion in 2018. However, Starbucks returned $12 billion to shareholders in fiscal 2019 compared to $8.9 billion in fiscal 2018.

Analysis of Starbucks Operations Based on the 4Vs Model

Operations and operational processes are like the fundamental building blocks of organizations that decide the productivity of the organization and the quality of their output as well. Focusing on operational efficiency helps businesses find faster growth both domestically and internationally as well as maximize output. Many times, if the efficiency of processes is low then it is mainly because the company has adopted a poor operational design. Processes across business organizations and industries can differ significantly and that is why all processes need to be managed differently. Some of the leading differences between various processes are due to the types of technologies and know-how involved. Different processes require different production equipment as well as different skills and know-how. However, apart from these things, the difference also lies in the nature of the demand for the products and services these processes produce. There are four particular characteristics of demand that have a significant impact on process management and which are as follows:

  • The volume of the products and services produced
  • Variety of products and services produced
  • Variation in the demand for products and services.
  • Degree of visibility that customers have of the production of products and services.

Volume of products and services:

Does the business being discussed produce a large amount of the same products and services or many items in small volumes? If the volume of output is high, it indicates repeatability or high-level familiarity of the process. Many times since a large business produces more and more of the same thing, it helps the business gain significant expertise in a particular area. The company may also acquire a significant competitive advantage compared to the smaller ones.

Starbucks is the largest coffee brand in the world and the company specializes in high-quality coffee. It sources quality coffee from suppliers in various corners of the world. While the company has brought a large range of flavors for its customers, the company has become the leading brand of coffee because of the extraordinary taste of Starbucks coffee. The company sources premier coffee from suppliers and then roasts it before selling to customers all around the world. In this area, the company has also gained significant expertise as well as a strong competitive advantage as the premier coffee roaster of the world. Roasting is a major part of Starbucks operations and the company has gained significant efficiency in this area which is a leading factor behind its industry-leading position. It roasts various types of coffee beans including the premier Arabica coffee which is found at great heights. The company sells these coffee flavors in its Starbucks stores located throughout the world. The product mix of Starbucks is not limited to only coffee but the company also sells teas as well as some food products.

Variety of Processes as well as products and services produced:

Variety denotes the various types of operational activities being performed by a company. The level of operational complexity can be higher in the case of the mixed model manufacturers that have to continuously switch between various processes. In that case, apart from a large range of inputs required for producing the output, the company would have to deal with the additional complexity of matching customer requirements to the products or services. The high variety processes are generally more costly as compared to the low variety processes.

While Starbucks is mainly a coffee brand, it does offer significant variety to its customers throughout the globe. The company serves a large range of coffee drinks inside its stores and apart from coffee, the company also sells teas as well as some food products. Starbucks is a premier coffee brand that targets mainly the affluent consumers needing good quality coffee and some premium space to relax. Variety is an important factor that drives the demand for  Starbucks products worldwide. In case the company offered limited variety, that would have ended up leaving a large segment of its customers bored. It is why the company continuously tests and releases new offerings that bring with them some new flavor and variety. In fact, the company serves a quite varied menu so that it can attract customers from diverse segments. However, the large variety of flavors also engages the customers since they would always love to try something new and the menu does not fall short in this regard. Variety truly matters in the coffee industry. It is because people would not love to remain stuck to just one flavor and even if people have their favorite flavors, the same is not everyone’s favorite. From Matcha Sweet Cream Latte to Dark Caramel Latte and Vanilla Latte and many more flavors of coffee that fall in various categories from Espresso to cold Brew and Frapuccino, the menu of Starbucks is sufficiently varied to delight its customers in all its geographical markets. Therefore, the variety of coffee flavors is also a driver of popularity and demand for the company.

The main operational processes at Starbucks include roasting and brewing. However, roasting is not a very complex process and Starbucks has developed its own roasting style to bring out the right flavor from the coffee beans. Apart from having gained significant expertise in this area, the company has also gained a strong competitive advantage in this manner. There are not many processes that the company would need to switch from one to other and therefore there are no related operational complexities for it either. The other significant processes for Starbucks include sales and customer service. The company trains its baristas to make great coffee and also to offer its customers the best in class customer experience. These are the most important factors driving its popularity apart from coffee flavors.

Variation if demand of products and services:

In fact, this is one of the most challenging aspects of business operations. It is easier for businesses to manage the processes when the level of demand is predictably constant. However, when demand can fluctuate significantly then managing processes becomes a lot more complex. If demand is predictably constant, it is easier to gear resources to efficiently cater to the existing demand, Moreover, businesses can plan operational activities including marketing and sales or after-sales services in advance.

On the other hand, if the level of demand varies significantly or can be highly variable or even unpredictable, then resources will need to be adjusted over time. What is even worse is that if demand can soar unpredictably, extra resources need to be devoted to the process such that it provides a capacity cushion that can easily absorb the unexpected demand. Let’s take a simple example of seasonal variations in e-commerce. Demand for a large range of products surges suddenly during the festive season including gifts, electronics, home decor products as well as fashion products. Businesses like Amazon need to remain ready to cater to the fast surge in demand that happens during the festive season.

However, compared to the technology or retail businesses, the level of uncertainty or fluctuation in demand is generally much lower in the case of a coffee brand. It is because the demand for coffee remains predictably constant during most seasons and even if it is the summer season, Starbucks offers several flavors suited for the season to maintain demand and sales. Moreover, the demand for coffee does not significantly increase or decrease during the holiday season. It is because even people can use it as a gift product, coffee is not mainly a gift product. So, due to low variations in seasonal demand and sales, the company has to face low operational complexity. The one specifically outstanding thing about Starbucks is that the company does not invest a major fortune in marketing and promotions. Instead, it mainly relies on brand equity, publicity, and word of mouth to grow sales and revenue. Such companies focus more on brand image and customer experience to grow their influence in the market than marketing and promotions.

Visibility of processes:

This is also a rather complex aspect of business operations to grasp. It denotes that aspect of business operations that is easily visible to the customers. The businesses that work with consumers directly may have more visible processes. For example, the healthcare and retail industry have more visible processes. However, the same is not true about an automobile business. Customers generally do not have a very clear view of the production and distribution processes of automobile brands. They cannot peep into everything that goes on before the finalized cars reach the showrooms. This is the only aspect of automobile operations that they are generally familiar with. It is also true about businesses like Apple inc. However, when it comes to businesses like Amazon or even Facebook, these are highly customer-facing businesses or customers have very high visibility into their operations. These are also some businesses for which transparency and accountability matters a lot. Customer trust and business accountability have continued to gain significance in the modern era. It is also applicable in the case of a coffee brand like Starbucks whose most visible aspect of business operations is its store operations. The company carries out its sales as well as marketing from its stores. Since store operations are the most visible aspect of its business, they also have the most significant influence on demand apart from product quality. It is why Starbucks places a significant focus on customer experience and trains its baristas to provide great customer service. Apart from that the company also strives to provide its customers with a store environment that helps them relax and enjoy their coffee.

Five Operational Performance Objectives

To run an organization, a well-defined set of operations performance objectives is essential.  There are five basic performance objectives applicable to all types of business operations. These five basic operations objectives include cost, dependability, flexibility, quality, and speed. There are both internal and external implications of these five performance objectives.  Moreover, the internal effects of these performance objectives have a definite impact on cost.

Quality:

This is the first leading operational performance objective. It refers to consistent performance according to your customer’s expectations. Quality also affects customer satisfaction to a significant extent. However, the meaning of quality can vary across industries and businesses. Suppose there is an automobile business and there is another technology business. The same quality standards would not apply to each of the two businesses. Quality can acquire different meanings in different settings or industry environments. While in some industries, the level of staff friendliness is a leading parameter on which to measure quality, product efficiency is the main indicator of quality for another. However, no matter whatever industry a business belongs to, customers appreciate quality cannot be denied. Quality can, therefore, bear a direct and major influence on customer satisfaction as well as organizational performance. Nevertheless, quality is also related to a company’s image and apart from making certain things easier for the business like customer acquisition, it can also increase an organization’s profitability. When looked at in the context of the coffee industry, quality denotes many things including product and service quality, staff friendliness, store environment, as well as more things like the image of the business as well as organizational culture.

Starbucks is outstanding in most of the aspects of quality discussed above. From product quality to store environment, customer service, and many more factors, Starbucks has proved itself a leader. Starbucks is an international business and apart from its customers in the United States, it is also present in many more markets where it strives to offers its customers great coffee as well as a superior in-store experience. Product quality remains one of the major drivers of sales for Starbucks. However, prices are not a determinant of quality for Starbucks since its consumers are from mainly the affluent class and winning to spend extra in order to enjoy superior quality coffee. Customer experience on the other hand is definitely an important aspect of quality for the business that directly affects its image and influence. So, overall there are many elements that together define quality for a large coffee brand like Starbucks. It is a premium coffee brand that charges premium prices for its products and in exchange offers superior quality coffee as well as a superior in-store environment for its customers.  

One leading aspect of quality that Starbucks is well known for is its customer service. This is an important area of focus for Starbucks and the company has made it a part of its core organizational culture. Apart from selling a large and varied menu that includes coffee products, teas, and food products, Starbucks has also built a strong reputation in terms of customer service and organizational culture. The company is known throughout the United States and in its other markets too for its unique organizational culture and focus on customer experience.

Speed:

As the industry has evolved with the growth of digital technology, speed has become more and more integral to business performance and growth. In fact, you cannot imagine operational performance without speed. Now in nearly every industry speed matters just as much as quality or prices. Customers want that products are delivered to their doorsteps faster. In this era, where a large range of services are delivered and consumed online including a large range of technology and entertainment services, speed matters a lot and sometimes it can be a leading differentiating factor for a company. A company that brings ideas to the table and products to the shelves faster than its competitors usually finds itself ahead of the others in the market.  In some industries where services have to be consumed instantly, speed matters more than ever. Apart from that, in some industries, businesses need to keep the shelf filled with the latest items in order to engage their customers and it is also a reason that speed is so important. In the coffee industry, while speed may not be as central to its operations as the transportation industry or the retail industry, it is still something relevant to the business of a coffee brand.

In the coffee industry, speed is not a central concern since people would like to have a cup of coffee while they are relaxing. However, despite that speed is a sign of efficiency and Starbucks has optimized its value chain in a manner that things move at a faster pace than normal. From the suppliers to the roasting facilities and then to the Starbucks stores and warehouses coffee needs to move fast till it reaches the hands of the customers.

Dependability:

Dependability or reliability is in itself considered a sign of quality in this era. Dependability, reliability, or trust are synonymous with brand equity which is an important strength for any industry-leading brand including Starbucks. How dependable your business is or how much your customers trust your brand affects your brand equity. However, there are several factors that affect dependability in each industry. For example, while the quality of raw materials and the final product will have a direct impact on the dependability of a business, in the other it is the timeliness of delivery of services that will affect dependability. Keeping the promise you made to your customers also affects dependability. There is another factor that has kept growing in importance for businesses as well as customers in the twenty-first century and which also affects dependability is the overall level of customer experience. Brands that offer a superior customer experience overall are considered to be more dependable by the customers. Apple and Amazon are two great examples that have maintained very high-level customer loyalty because they deliver superior customer experience. The coffee and beverage industry is also seeing higher competition in recent years and to retain its competitive position, companies have to maintain their focus on customer experience and trust.

Starbucks is known as an ethical and accountable brand and it is not just a branding strategy but a core part of the company’s business philosophy. The company is also known for its unique organizational culture whose focus is customer service as well as employee empowerment. Only great quality products are not sufficient in this era to attract and retain customers. The level of competition in the coffee and beverage industry is quite high and in order to beat the competitive pressure, the companies also focus on other aspects of their operations. It is also essential to maintain strong customer relationships in order to maintain a very high level of customer loyalty. The company trains its employee to offer superior customer service. Another important thing about Starbucks is its unique organizational culture. Employee empowerment and employees’ satisfaction is a central focus of the company’s organizational culture. If Starbucks is a highly dependable or trusted brand then the reason is that the company has taken the trust of the employees as well as the customers seriously. Starbucks apart from being the leading coffee retailer of the world is a highly trusted and respected retail brand and it has successfully built a unique identity that differentiates it from the other coffee brands.

Flexibility:

Flexibility means the ability to change what, how, and when operations do. There are four types of flexibility in general that are applicable to business operations. They include product/service flexibility, mix flexibility, volume flexibility, and delivery flexibility. Product/ service flexibility means the ability to introduce new or customized products or services. Mix flexibility means the ability to widen the product/services mix to cater to the customer needs better. Volume flexibility denotes the ability to change the output level to produce different quantities of products/services over time. Delivery flexibility on the other hand means the ability to change the timing of delivery. Overall, flexibility is an important aspect of operational performance and superior flexibility also denotes superior performance. Flexibility can also acquire different meanings in different industrial environments. For example, in a healthcare environment, the ability to introduce new types of treatment and to widen the range of available treatments or the ability to adjust more patients and reschedule appointments can all be a sign of flexibility. However, in the case of the automobile or retail industry, flexibility can mean different things.

As in the case of Starbucks, its flexibility is reflected in the large  range of coffee products it offers as well as its international expansion. Starbucks sells a vast range of coffee products and the company has continued to expand its range of coffee flavours over years in order to cater to the needs of a larger customer segment domestically as well as internationally. Overall, Starbucks is a highly flexible company. Its flexibility is driven by several factors including its sales distribution network, its physical infrastructure, a large pool of talented employees as well as its ability to understand customer needs and deliver a superior and seamless customer experience.

Cost:

Cost in terms of operations performance mainly means the operating expenses incurred by businesses. However, the proportion of various operating costs can vary from industry to industry. For example, staffing costs may represent the largest costs for a transportation company but the costs of raw material may be the largest group of operating costs for an automobile brand. In the case of most companies, if their operating expenses are low, they can also keep the prices low for their customers. Not all companies compete in the market on the basis of price. Some companies compete on product quality, other companies compete on the basis of customer service and others on the basis of marketing or all of these factors. However, even the companies that do not compete on the basis of prices, they too are interested in keeping their operational costs low. If a company reduces its operating expenses that will help it increase its profits because a penny saved equals a penny gained. The way in which operations need to be managed in order to keep operating expenses low requires focusing on areas where the company incurs the highest operating expenses.

The largest category of operating expenses incurred by the Starbucks company is its store operating expenses. The second-largest category of operating expenses for Starbucks is the cost of sales. During fiscal 2019, the store operating expenses of the company were $10.5 billion and the cost of sales was $8.5 billion. The company sources best in class raw material from suppliers in various corners of the globe. However, apart from its raw material, the main costs are related to store operations and human resources.   The company employs a mix of company-operated and licensed stores to serve its various geographical markets. The number of company-owned Starbucks stores was 15,834 in 2019 and that of licensed stores was 15,422. In order to manage the costs of raw material efficiently, the company maintains strong supplier relationships.

Conclusion:

The business model of Starbucks has several sources of competitive advantage. While its business model is outstanding, its core strength is its focus on quality and supply chain management. The company does not invest a lot in marketing but still continues to remain the most recognized and respected brand in the coffee industry. Continued focus on outstanding quality and customer experience has led to strengthening competitive advantage and growth in revenue. Its supply chain innovation strategy has helped the brand manage its vast international business empire successfully. As a result, the company earns a strong word of mouth and has to invest nearly nothing in promotions.

Abhijeet Pratap

Abhijeet has been blogging on educational topics and business research since 2016. He graduated with a Hons. in English literature from BRABU and an MBA from the Asia-Pacific Institute of Management, New Delhi. He likes to blog and share his knowledge and research in business management, marketing, literature and other areas with his readers.