Did Starbucks' CEO Really Say That?

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Includes: GMCR, MCD, SBUX
by: Todd Sullivan

In a recent DJ Newswire interview (sub. req.), SBUX CEO Jim Donald said a couple things that left me shaking my head. When asked about the effect that McDonald's premium coffee will have on his business, he said he expects it to be a benefit. The reason? Consumers who like McDonald's premium coffee will likely migrate to SBUX's super-premium. To quote Donald: "we see that migration happening." On its face, the statement does make sense but when you take a step back and think about it, you have to wonder - especially when you consider:

Consumer Reports recently compared coffees and came up with an interesting result. According to its tasters, Starbucks' (NASDAQ:SBUX) coffee was outdone by McDonald's' (NYSE:MCD) premium coffee offering.

Starbucks

Led by a professional tester and some employees of Consumer Reports' food testing unit, the team sampled medium plain coffees (with no sugar and cream, mind you), from two stores each of Starbucks, Dunkin' Donuts, McDonald's and Burger King (BKC). The team of taste testers deemed McDonald's premium coffee the best-tasting and the best value, at $1.40 a cup. It might surprise some people that the priciest cup of that size regular coffee actually came from Dunkin' Donuts, at $1.65. In the Northeast, McDonald's sells Newman's Own brand coffee (which is co-branded with Green Mountain Coffee Roasters (NASDAQ:GMCR)).

Let's take this one more step. If you want a cup of coffee in under 15 minutes, do you go to Starbucks? Me neither. Let's be honest, getting coffee at a Starbucks is quite often a real pain in the ass. I still have nightmares about going to order a one for my wife with a cue card knowing that the omission or addition of a single ingredient would cause me to deliver to her a piping hot cup of bile (don't think for a minute I did not notice the disapproving looks from the "barista" and those of you in line as I read the order off the card, either).

In McDonald's you have arguably the world's most efficient food and beverage distribution system. Now that machine is selling your main product and people really like it. This is good? Starbucks itself recognizes its production problems (remember, they blamed a summer earnings miss on them), which is why they are adding drive-thru windows at many locations. To enhance their offerings, SBUX has added breakfast foods and I believe are considering doing the same for lunch. What would you think if McDonald's said they viewed this as "good for our business"? Now, Starbucks does profit from the McDonald's coffee in the Northwest as their Seattle's Best coffee division supplies them, but there are no plans currently to expand this relationship. Earth to Starbucks here...

The switch to premium coffee is clearly working for McDonald's. In the last couple of conference calls, they have given huge credit to their coffee for both their increase in sales and customer counts. Contrast this to Starbucks' call in which they intimated their profit increases were mainly due to price increases on coffee and by selling customers more products once inside, not by increased customer counts. Translation: they are losing people to McDonald's.

This is what caused my jaw to drop: When asked about McDonald's premium coffee in other parts of the country, Donald said he "didn't know the details" - WHAT??!!?? Imagine the CEO of GM (NYSE:GM) saying he was not aware of what Ford (NYSE:F) was doing. Can you guess how fast WalMart's (NYSE:WMT) CEO Lee Scott would be fired if in an interview he said he "did not know" what Target was doing? The very fact that McDonald's chose "Newman's Own" branded coffee gave them instant credibility for its quality, and is responsible for the immediate acceptance it has had. How can Donald not know this?

If I was currently a shareholder of SBUX, this would make me very nervous and I would advise any new potential investor to avoid these shares now.

The hard core Starbucks customer who garners much of his or her self worth from carrying that cup with the barely exposed green logo around will never abandon them, no matter how much they are forced to pay for their "vente soy non fat half-caff white chocolate mocha latte with an extra pump." However, the casual customer will and appears to be. I look at my wife and myself (- it is always a good idea when investing to look at yourself. No matter how unique you think you are, there are lots of people who think and act very similar to you). She was once a daily visitor for Mr. Donald and SBUX. Now, she runs a very successful law practice, has three children at home under four and a very tight schedule. She no longer has the 15 - 20 minutes it takes to park, go inside and get a cup of coffee at Starbucks. Instead, she has discovered that the cappuccino from the Christmas present her thrifty husband bought her is just as good. She can take it with her in her travel mug and avoid walking through the Massachusetts winter weather to get one (that cappuccino machine paid for itself in only six weeks).

As for me, if I am driving around this winter and want a cup of coffee, rather than lug two four-year-olds out of their car seats and in wait in line for one, now that I can get a really good one from inside my car at McDonald's while listening to them sing Brooks & Dunn's "Hillbilly Deluxe," why would I choose anything else? We can't be the only two people out there like this, and judging from McDonald's coffee sales growth, we aren't.

Mr. Donald... are you paying attention?