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Drinks MarketWatch BFCM0374/ Published 03/2010

Datamonitor. This brief is a licensed product and is not to be photocopied Page 29

COMPANY SPOTLIGHT: STARBUCKS

Starbucks, Arla Foods collaborate to sell RTD drinks in Europe

Starbucks has entered into an agreement with Arla Foods for the manufacture, distribution and marketing of

Starbucks-branded premium ready-to-drink coffee beverages in Europe.

Arla Foods will manufacture, distribute and market Starbucks premium milk-based ready-to-drink (RTD) coffee beverages

that are made with the same Arabica coffee blends that are used in the handcrafted coffee beverages available at

Starbucks retail stores around the world.

Rich DePencier, vice president of Starbucks global consumer products international, said: "Starbucks global consumer

products business allows us to extend the Starbucks experience to consumers beyond our retail stores while broadening

our distribution channels globally. The success we have had bringing ready-to-drink coffee products to consumers in North

America and Asia demonstrates the global potential of the business and we are proud to join with Arla Foods to bring our

premium RTD beverages to consumers in Europe."

Business Background

Starbucks specializes in coffee and other related beverages. The company sells coffee, Italian-style espresso beverages,

cold blended beverages, and complementary food items, a selection of premium teas, and coffee-related accessories and

equipment. As of September 2008, the company operated 9,217 company operated stores and 7,463 licensed retail stores

worldwide.

Starbucks operates in three segments: the US, international and global consumer products group (CPG). The company

also reports its revenues by product type: beverage, food, coffee-making equipment and other, and whole bean coffees.

The US and international segments both include company-operated retail stores and certain components of specialty

operations. Specialty operations within the US include licensed retail stores, foodservice accounts and other initiatives

related to the company's core business.

International specialty operations primarily comprise retail store licensing operations in more than 30 countries and

foodservice accounts in Canada and the UK. As of September 2008, the international segment had a total of 3,134 licensed

retail stores. The largest markets within the international segment based on number of retail stores, currently are Canada,

Japan and the UK.

The CPG segment includes packaged coffee and tea as well as branded products sold worldwide through channels such

as grocery stores, warehouse clubs and convenience stores. In FY2008, Starbucks coffees and teas were available in

approximately 37,000 grocery and warehouse club stores, 33,000 of which were in the US and 4,000 in international

markets. The company operates primarily through joint ventures and licensing arrangements with consumer products

business partners.

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Table 2: Key Facts

Address: Products include:

2401 Utah Avenue SouthSeattle Italian-style espresso beverages

Washington 98134 Cold blended beverages

USA Fresh food like sandwiches and pastries

Telephone: 1 206 447 1575 Premium teas

Website: www.starbucks.com Coffee-related accessories and equipment

Ticker: SBUX (NASDAQ National Market)

Employees: 176,000

Turnover: $10,383m

Financial year end: September

Source: Datamonitor D A T A M O N I T O R

SWOT Analysis

Table 3: SWOT Analysis

Strengths Opportunities

Strong brand equity lends a competitive edge Strategic transformation initiatives in FY2009

Wide geographic presence Launch of Starbucks VIA Ready Brew instant coffee

Strong research and development capabilities ensure product quality Licensing agreements

Weaknesses Threats

Class-action lawsuits threaten brand image Consumer spending adversely impacted by global economic

Heavy restructuring and store operating expenses impact profits downturn

Increased minimum wages in the US

Increasing health consciousness among American consumers

Source: Datamonitor D A T A M O N I T O R

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Strengths

Strong brand equity lends a competitive edge

The Starbucks brand is the company's core strength. Starbucks has built a reputation globally for the quality of its products

and its consistently superior consumer experience. Since 1971, Starbucks has been committed to ethically sourcing and

roasting high quality arabica coffee in the world. The company was ranked 85th amongst the 100 Top Brands 2008 by

Business Week. Owing to its premium brand, Starbucks enjoys a high degree of customer loyalty and gains a significant

competitive advantage over lesser known coffee brands.

Wide geographic presence

Starbucks has been operating outside the US since 1987. The company has operations in the Asia Pacific region, China,

the Europe Middle East Africa (EMEA) region, and Latin America. As of September 2008, the company operated 1,979

company-operated retail stores and 3,134 licensed retail stores in these international markets.

Starbucks Coffee International (SCI) opened its first store outside North America in Tokyo, Japan in 1996. Since then,

Starbucks has offered its services in nine countries throughout the Asia Pacific region, including Australia, Indonesia,

Japan, Malaysia, New Zealand, Philippines, Singapore, South Korea and Thailand. Additionally, the company operated

more than 660 Starbucks locations throughout Greater China, a region including China, Hong Kong, Macau and Taiwan.

Starbucks also operates in several countries in the EMEA region, of which the UK represented the largest market,

accounting for nearly 700 of the 1,500 locations throughout the region. Within Latin America, Starbucks operates in seven

countries including Argentina, the Bahamas, Brazil, Chile, Mexico, Peru and Puerto Rico.

In line with its long term strategy, Starbucks continues to expand its presence globally through licensing partnerships. For

instance, in March 2009, the company, in partnership with Kraft Foods, planned to launch packaged Starbucks coffee inFrance and Germany. A strong geographic presence reduces the business risk associated with specific markets, and also

expands the company's revenue generating capacity.

Strong research and development capabilities ensure product quality

The core strength behind Starbucks's brand is the quality of its products. The company has a strong research and

development team which is responsible for the technical development of food and beverage products and new equipment.

The company recently launched Starbucks VIA Ready Brew instant coffee developed using its proprietary technology to

preserve the coffee's freshness.

Starbucks invests substantial amount of resources on technical research and development activities including customary

product testing and product and process improvements. In FY2008, Starbucks spent approximately $7.2 million on

technical research and development activities, an increase of 10.7% over 2006. Starbucks's focus on quality and product

innovation helps sustain the brand value of the company.

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Weaknesses

Class-action lawsuits threaten brand image

Starbucks has been involved in certain lawsuits. A class-action lawsuit was filed by a former employee in 2004, alleging

that the company violated the California Labor Code by allowing shift supervisors to receive tips. In March 2008, Starbucks

was ordered to pay California baristas more than $100 million. The company was ordered to pay back tips, with interest,

that the company had handed over to shift supervisors. Similar suits have been filed in Minnesota and Massachusetts.

In February 2009, another class-action lawsuit was filed against the company by an employee for laptop data breach. In

connection with this lawsuit, Starbucks offered its employees one-year's free credit monitoring and protection for its lapse in

security. Such incidents erode consumer trust and can significantly erode Starbucks's brand value.

Heavy restructuring and store operating expenses impact profits

Starbucks's profitability took a hit in 2008 because of restructuring expenses. In spite of more than 10% increase in revenue

in FY2008, Starbucks's operating profit took a hit. The company recorded an operating profit of $503.9 million during

FY2008; this represented a 52.2% decline over 2007. The drastic decline was mainly the result of restructuring charges,

primarily related to the significant US store closures; higher cost of sales including occupancy costs and store operating

expenses. Consequently, the net profit declined annually by 53% in FY2008. If Starbucks is unable to successfully

implement its transformation initiatives and continues to suffer declining profits, it would affect the company's growth plans

and also hamper investor confidence.

Opportunities

Strategic transformation initiatives in FY2009

Although Starbucks anticipates declining comparable store sales for FY2009 due to the ongoing global downturn, the

company has put in place certain significant actions to streamline its businessincluding underperforming store closure

plans, restructuring of the Australia store base, new store openings in key international markets and certain new food and

beverage offering.

Starbucks intends to align the company's cost structure to its current business strategy with a planned $500 million

structural expense reduction in FY2009. The company plans to close approximately 395 underperforming company-

operated stores in the US by FY2009. Starbucks also planned to restructure its Australian business by closing 61 company-

operated stores, focusing on the remaining 23 stores in three key metro areas. In addition, the company also plans to

reduce approximately 1,000 open and filled positions to rationalize its infrastructure for the reduced number of stores. As

per company estimates, the combination of the US and Australia store closures and head count reductions will result in a

pre-tax benefit to operating income of approximately $200-210 million in FY2009.

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Starbucks plans to be cautious in its approach to new store openings, as it factors in the current global economic climate.

Internationally, Starbucks is planning to open approximately 700 net new stores in FY2009, two-thirds of which are

expected to be licensed.

Starbucks is looking for new ways to meet customers' needs for value as well as quality, in the current difficult economic

times. For example, in March 2009, Starbucks introduced a selection of popular coffee and breakfast pairings for $3.95; this

offer provides customers with an average savings of as much as $1.20, and with ethically traded coffee and quality

ingredients.

These strategic initiatives are expected to help the company contain costs and earn considerable revenues even in a

difficult economic environment.

Launch of Starbucks VIA Ready Brew instant coffee

Starbucks entered the $17 billion instant coffee market with the launch of Starbucks VIA Ready Brew instant coffee in

March 2009. Starbucks VIA Ready Brew replicates the body and flavor of Starbucks coffee in an instant form. Unlike many

instant coffees which use chemicals and by-products, Starbucks VIA Ready Brew is natural roasted coffee, made without

preservatives. In developing Starbucks VIA Ready Brew, the company developed a proprietary (patent-pending) technology

to preserve the coffee's taste, quality and freshness. This instant coffee is currently available at Starbucks, Target stores

and Barnes & Noble Cafs in Chicago and Seattle in the US. The launch of the new innovative instant coffee is expected to

bring incremental revenues for the company in the near term.

Licensing partnerships

Starbucks licenses the rights to produce and market its branded products through partnerships, both domestically and

internationally. In August 2008, Starbucks, in partnership with PepsiCo and Unilever entered a licensing agreement for the

manufacturing, marketing and distribution of Starbucks super-premium Tazo Tea ready-to-drink (RTD) beverages including

iced teas, juiced teas and herbal infusions in the US and Canada. The company entered a similar agreement with Unilever

to distribute Starbucks ice cream in September 2008.

Starbucks has also licensed the rights to produce and distribute Starbucks branded products to two partnerships in which

the company holds 50% equity interests: The North American Coffee Partnership with the Pepsi-Cola Company develops

and distributes bottled Frappuccino beverages and Starbucks DoubleShot espresso drinks, and Starbucks Ice Cream

Partnership with Dreyer's Grand Ice Cream develops and distributes superpremium ice creams. Through these licensing

partnerships, Starbucks would leverage the partners' capabilities to enhance its presence in existing markets.

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Threats

Consumer spending adversely impacted by global economic downturn

As a retailer dependent upon consumer discretionary spending, Starbucks will face an extremely challenging FY2009. All

major western including the US, the UK, Germany, France, Italy, Spain, Japan and Australia are in the grip of recession

and are forecast to remain so through 2009. Even the key emerging market economies are currently experiencing

downturns, including China, Middle East and Brazil.

The global economic downturn has led to a severe decline in consumer confidence. Consumers also have less money for

discretionary purchases as a result of job losses, foreclosures, bankruptcies and reduced access to credit. A decrease in

consumer confidence and the resultant curbed consumer spending would result in decreases in customer traffic and

average value per transaction. Starbucks's business is highly sensitive to changes in customer traffic, and the current

economic downturn would put downward pressure on the company's margins.

Increased minimum wages in the US

In recent times, tight labor markets, increased overtime, government-mandated increases in minimum wages and a higher

proportion of full-time employees have resulted in an increase in labor costs, which could materially impact the company's

operating margins. The federal minimum wage rate in the US, which remained at $5.15 per hour since 1997 reached $6.55

per hour in July 2008. It is expected to further rise to $7.25 an hour from July 2009. Starbucks employed about 143,000

people in the US, as on September 2008. Increased labor costs would increase overall costs and affect the company's

operating margins.

Increasing health consciousness among American consumers

Starbucks's products contain caffeine, dairy products, sugar and other active compounds, the health effects of which are

the subject of increasing public scrutiny. It is suggested that excessive consumption of caffeine, dairy products, sugar and

other active compounds can lead to a variety of adverse health effects.

Particularly in the US, there is increasing consumer awareness of health risks, including obesity, due in part to increasing

publicity and attention from health organizations, as well as increased consumer litigation based on alleged adverse health

impacts of consumption of various food products. Increasing health awareness among American consumers could

significantly reduce the demand for the company's beverages and food products.

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