Should Starbucks Have Been More Cost Conscious During the Boom?

Bloomberg’s “Starbucks Pushing Landlords for 25% Cut in Cafe Rents” got me thinking about when is the right time for a growth company to start being concerned about operating costs? For years Amazon (AMZN) told us not to worry about profits while they were in a hyper growth phase and they turned out to be right. As the online retailer matured, its investments in efficient operations have lead to sustained profitability. Now I believe that the Kindle e-book reader is a loss leader that too will become sustainably profitable.

Both the basic Amazon and the Kindle have invented their own ecosystems, in a way very much like Apple’s (AAPL) iPod and iPhone. The Kindle can download e-books wirelessly from anywhere. Starbucks has also created its own ecosystem, based on the combination of its captive prepaid card and competitively addicting coffee. The key difference between these players goes beyond industry. Amazon and Apple are constantly pressured for increased efficiency to provide competitive consumer pricing whereas Starbucks (SBUX) was counting on steadily increasing consumer pricing.

Home Depot (HD), Starbucks and Whole Foods (WFMI) all are recovering from the growth at any cost syndrome. Just like the home builders during the bubble, their attitudes were that they had a limited amount of time to dominate their markets.

During many Home Depot conference calls this past decade, management said it was okay for a new store to cannibalize an older one down the block as long as the two together had increased sales and total profits. Lower margins were the price of expansion. By the time former CEO Robert Nardelli left, retired plumbers and other craftspeople had been replaced by inexperienced salespeople in a desperate attempt to save costs. Likewise Circuit City sacrificed its most knowledgeable and best performing salespeople as a desperate attempt to cut costs before bankruptcy.

As Home Depot’s new CEO has stopped its expansion and is improving the customer experience with new experienced craftsmen and better skilled salespeople, Starbucks can take solace that it has never sacrificed its talent. But Starbucks was a big player in the game of cannibalizing its existing stores with new stores. They would often open stores on opposite sides of the same street or multiple floors in the same mall to the catch that marginal customer.

Starbucks and Whole Foods both belonged to the cult of pay any price for the best locations. This has always puzzled me because both were prestige bands capable of driving traffic to the benefit of any shopping center or mall. During the boom, many mixed use developments touted these retailers as amenities to their condos, offices and apartments. Why didn’t Starbucks and Whole Foods use this leverage to achieve advantageous leases years ago?

As the economy worsened, both Starbucks and Whole Foods started playing hardball with landlords of their abandoned and future stores in development. They had buyer’s remorse just like preconstruction condo buyers in Miami and Las Vegas. They are trying any means from legal to economic threats to break leases.

Bloomberg reports Starbucks is now directly negotiating with landlords, and realtors are telling their landlord clients that they should capitulate. Quiznos (with over 1000 restaurants) has successfully reduced rents by 15% to 20% by offering landlords extending leases. Starbucks is looking for more.

These are all very different companies that all shared enormous growth. All but Amazon were profitable early on, and all but Amazon disregarded costs for growth. History has already told us the winner of this race. Only Amazon has managed its fixed costs and efficiency from the start.

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Comments

[dsrtwriter:]

I certainly believe that Starbucks has leverage here with landlords and should use it. A Starbucks is a traffic driver to any upscale strip shopping area, and should command a lower rent than its neighbors.
The one positive Starbucks has usually done is to insist on attractive architectural design for the stores it develops. If I were them I would insist on a 25% cut or else leave a location.

With real estate down, Starbucks should consider actually purchasing premium locations. Maybe even buying out a location from a strapped landlord.

Jun 02 12:44 PM

[Moon Kil Woong:]

Start bucks could help itself by spending more time improving their coffee as well. After trying to lower cost by buying its own plantations they can no longer pick the best beans to use. This has made their coffee rate lower than McDonalds. I don't mind paying some for ambience but really, even lower cost rent won't save you from a deviation from your "percieved" core competency.

I think Michael Steinberg hit on the fact that Starbucks was a hypergrowth scheme reliant on cult marketing and prestige branding and raising prices. In fact, their strategy reminds me a lot like Mrs. Field's cookies that crumbled except I can say their cookies were a lot better than Starbuck's coffee ever was.

Jun 29 05:06 AM

[beandog:]

Kwongman, what are you smoking? MCD coffee is better than Starbucks'? I had a cup of mocha latte at MCD and I almost threw up after the second sip. Go try it yourself, because I don't think you have.

-Beanie


On Jun 29 05:06 AM Moon Kil Woong wrote:

> Start bucks could help itself by spending more time improving their
> coffee as well. After trying to lower cost by buying its own plantations
> they can no longer pick the best beans to use. This has made their
> coffee rate lower than McDonalds. I don't mind paying some for ambience
> but really, even lower cost rent won't save you from a deviation
> from your "percieved" core competency.
>
> I think Michael Steinberg hit on the fact that Starbucks was a hypergrowth
> scheme reliant on cult marketing and prestige branding and raising
> prices. In fact, their strategy reminds me a lot like Mrs. Field's
> cookies that crumbled except I can say their cookies were a lot better
> than Starbuck's coffee ever was.

Jul 11 09:41 PM