SBUX - THE SINGLE DEAL

I was convinced that SBUX was going to continue down the road of innovating the coffee category by forging a more progressive “single serve” coffee machine that produces Starbucks coffee under the Starbucks name.  To me, it was all about the last mile (to steal a phrase from the telecom sector).  Why would Howard Schultz trust and enrich another coffee manufacture with the Starbucks brand?  He followed that path with Kraft and look how that partnership has turned out.

 

Looking at Howard Schultz’s February 17th memo again, following this morning’s announcement, a few of Mr. Schultz’s comments just don’t make sense.  Below, I am republishing the memo complete with Hedgeye’s views as published on the 17th of February and my thoughts from today in red:

 

 

Dear Partners,

 

For 40 years, Starbucks has been the world’s leading purveyor of premium coffee and premium coffee innovation. But at no point in our history has our innovation pipeline produced and introduced more successful, breakthrough products for multiple coffee occasions and in multiple form factors than it has during the past few years. Today, Starbucks provides the world’s finest coffee in virtually every format, including single-serve, to more than 50 million visitors to our stores and to millions more through nearly every retail and consumer channel in 54 counties around the world--every week.

 

Hedgeye - SBUX is sending a very clear message to Green Mountain “you are not in our league.”  The company is completely capable of developing its own innovative products to dominate every segment of the coffee market.

 

On Tuesday we announced that starting this fall we will also be bringing premium Starbucks Coffee offerings in a single-portion format to guests in 500,000 luxury and premium hotel rooms across the U.S. as part of a new partnership with Courtesy Products, the acknowledged leader in hotel room amenities. But because of the speculation swirling in the marketplace around Starbucks larger plans for single-serve in the U.S. and internationally, I wanted to take a moment to let you know what our intentions for single-serve are...because they are very bold.

 

Hedgeye - There are many channels of distribution and Starbucks will align itself with the partner that brings it the most economic value.

 

At the outset, let me share that while it is currently a $4 billion segment growing faster than any other segment of the global coffee industry, the single-serve coffee category in the U.S., and in much of the world for that matter, is in its very early stages of development.

 

Hedgeye – GMCR’s market cap of $5.7 billion accounts for more than 100% of its current addressable market.  There is still plenty of room within the single-serve coffee category for new market players and for product innovation.

 

And at this nascent stage there are numerous contenders but no demonstrated, long-term winners related to any format, geography or machine. 

 

Today’s thoughts: Why align yourself with GMCR’s Keurig then if it is not a long-term winning machine?

 

Let me give you a few examples to illustrate this point: In Germany, where single-serve coffee has been around for some time and almost 40% of households own a single-serve brewer (compared to only 6% in the U.S.) the long-time industry leader is an open system (meaning any coffee roaster can have access to the platform) that has virtually zero presence in the U.S., the largest consumer market in the world. On the other hand, the U.S. industry leader, the Keurig K-cup, is a closed system with U.S. patents set to expire next year--and virtually no presence anywhere in the world outside of the U.S. and Canada. This global market dynamic will change. 

 

Today’s thoughts: Hinting that SBUX will give the Keurig a presence outside of the U.S.?

 

Hedgeye - Starbucks is one of the strongest brands in the coffee segment and will shape the single-serve segment globally.  None of the single-serve brewing systems currently available to the market are good enough to be tied to the Starbucks name.

 

Now consider that approximately 80% of Starbucks customers do not yet own a single-serve coffee machine in their homes. This fact alone suggests that we are, again, at the very early stage of adoption and that Starbucks has a fantastic opportunity to introduce and deliver new single-serve coffee innovations to our customers. 

 

Today’s thoughts: How is this partnership innovative?

 

Hedgeye – Starbucks wants to own the category and will work to revolutionize the single-serve coffee brewing platform.  Below I outline my prediction of what the new Starbucks machine will be like (if not at first, then with later versions: 2.0, 3.0 etc.).  While some of these attributes seem fanciful, they all have founding in both Starbucks’ quest for control and the overall direction of the category (possibly run using Android):

  • The design of the machine will evoke the design and feel of the Starbucks store and experience.  I would think black and green, as well as the Siren logo. (experiences)
  • The name will also likely evoke the store.  “My Barista”, “The Siren”, or other names along those lines are likely.  (experiences)
  • The experience will be customizable, perhaps a touch screen or another user interface that allows the user to provide the machine with specific instructions as to the composition of the coffee they would like. (customization)
  • A “menu” (like a playlist in iTunes), where one can save a recipe or style of coffee for repetitive use and save it with a name like, “Jim – morning coffee”. (customization)
  • Connection to the internet via home computer system to allow the sharing of “menus” and reception of coffee ideas from Starbucks and fellow machine-owners.  This also allows a direct tap into social networking for the new machine.  (community)

We began our journey into the single-serve market with Starbucks VIA, introducing consumers to a delicious cup of coffee in an instant, soluble format. With Starbucks VIA, we also introduced them to a brand platform designed and built to facilitate an ever-evolving pipeline of new products. And Starbucks VIA’s success is undeniable: more than $180 million in system-wide sales in its first year.  This remarkable achievement for a new product was due not just to the premium quality and taste of Starbucks VIA.

 

It was also due to the successful implementation of a new business model where we bring the assets of the Starbucks brand--our coffee knowledge, our broad retail footprint, the passion of our store partners and our ability to reach and personally connect with millions of people--to create trial, sampling and awareness on a scale that very few, if any, retail companies can accomplish.  With Starbucks VIA, we showed how we can now migrate products through our growing presence in grocery, drug, mass, club and online channels to drive the expansion and globalization of the single-serve segment of the coffee industry.

 

Hedgeye - VIA was a good start, but Starbucks still needs and plans to take it to the next level.  VIA proves that the company can develop its own product and successfully market it globally.

 

There are many single-serve systems and solutions and even more in late-stage development. We are committed to supporting and participating in those that enable us to better and more conveniently serve our global customers, wherever they are and however and whenever they want our coffee. 

 

Finally, let me touch on a subject we are increasingly asked about: Green Mountain Coffee’s Keurig K-cup system. With specialty distribution arrangements and some aspects of its cartridge technology protected by patents for the next 18 months or so, Green Mountain has done a very fine job introducing single-serve brewer technology to the U.S. market.  And as a result it has emerged as an early leader. But as I have said, these are very early days, and history has demonstrated time and again that patents alone do not determine market winners--deep customer engagement, best-in-class experiences and quality do.  

 

Today’ thoughts: Why highlight the fact that the patents will expire soon?  What edge will SBUX have by partnering with GMCR after that point?  I feel like Mr. Schultz was purposely trying to throw people off with these comments…maybe he didn’t want to deal with increased GMCR speculation prior to today’s announcement.

 

Hedgeye - This was the sucker punch.  CEO Howard Schultz typically uses colorful adjectives to describe the success of the Starbucks business (e.g. exceptional, unequivocal, solid).  The fact that he said GMCR has done a “fine job” was a clear signal to me that he is not a handshake away from partnering with the company.  The GMCR storytelling is getting out of hand.  GMCR’s announcement on its last conference call that it has a double secret new machine was purely a defensive move because they are desperate to work with SBUX.

 

The single-serve segment of the coffee industry is poised for a sea change of innovation. We will win by delivering quality in the cup, every time, and by capturing the hearts and minds of millions of loyal customers, in the U.S. and throughout the world.

 

Hedgeye - Take it from someone who knows firsthand - don’t bet against Howard Schultz!

 

Thank you for defining and delivering our Starbucks Experience to our customers, every day. I have no doubt that we will continue to reinvent this category and provide customers with yet another premium coffee experience.

 

Hedgeye - Our 2010 coffee strategy continues to be positive on SBUX and PEET and cautious on GMCR.

 

Today’ thoughts: Given today’s announcement, it feels like the whole point of this memo was to say that Starbucks can market anything globally through “deep customer engagement, best-in-class experiences and quality” and that is what the company plans to do with the Keurig to make it a better product.


I still don’t see how this new partnership is innovative or how SBUX is revolutionizing single-serve this way…unless there is more to come.

 

Howard Penney

Managing Director


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