LEN-09-1211-001.qxd:. 6/30/10 2:58 PM Page 76 76 Chapter 1 Overview of FinancialReporting, FinancialStatementAnalysis, and Valuation of 16 consecutive years in which it achieved comparable store sales growth rates equal to or greater than 5 percent, but that string was broken with –3 percent comparable store sales growth in 2008. Unfortunately, given the economic conditions in Starbucks’ primary markets, it was not clear whether same store sales growth rates would improve in 2009. In January 2008, Howard Schultz returned from retirement and resumed his role as president and CEO of Starbucks to restructure the business and its potential for growth. Focal points of his transformation plan included overseeing the restructuring efforts, taking a more disciplined approach to opening new stores, reinvigorating the Starbucks Experience, and developing and implementing even better service and quality while cutting operating and overhead costs. In addition, the transformation plans included introducing new beverage and food offerings, including baked goods, breakfast items, and chilled foods. A key to Starbucks profit growth lies in increasing same store sales growth via new products. Starbucks regularly introduces new specialty coffee-based drinks and coffee flavors as well as iced coffee-based drinks, such as the successful line of Frappuccino® and Iced Shaken Refreshment drinks. Starbucks also planned to continue to expand the scope of its business model through new channel development in order to “reach customers where they work, travel, shop, and dine.” To further expand the business model, Starbucks entered into a licensing agreement with Kraft Foods to market and distribute Starbucks whole bean and ground coffee to grocery stores and warehouse club stores. By the end of fiscal 2008, Starbucks whole bean and ground coffees were available throughout the United States in approximately 39,000 grocery and warehouse club stores. In addition, Starbucks sells whole bean and ground coffee through institutional foodservice companies that service business, education, office, hotel, restaurant, airline, and other foodservice accounts. For example, in 2008, Starbucks (and its subsidiary Seattle’s Best Coffee) was the only superpremium national brand of coffee promoted by Sysco Corporation to such foodservice accounts. Finally, Starbucks had formed partnerships to produce and distribute bottled Frappuccino® and Doubleshot® drinks with PepsiCo and premium ice creams with Dreyer’s Grand Ice Cream, Inc. Despite Starbucks’ difficulties with store closings, restructuring charges, and negative comparable store sales growth rates, Kim could see positive aspects of Starbucks’ financial performance and condition. She noted that Starbucks had been profitable in 2008 despite the restructuring charges and falling revenues. The restructuring plan was expected to help Starbucks reduce costs, even during these difficult times. Further, she noted that Starbucks’ operating cash flows had remained fairly strong throughout this period, amounting to $1,259 million in fiscal 2008. Starbucks had a cash balance of nearly $270 million. Perhaps Starbucks could weather the economic recession and its restructuring and look to better days ahead. Product Supply Starbucks purchases green coffee beans from coffee-producing regions around the world and custom roasts and blends them to its exacting standards. Although coffee beans trade in commodity markets and experience volatile prices, Starbucks purchases higher-quality coffee beans that sell at a premium to commodity coffees. Starbucks purchases its coffee beans under fixed-price purchase contracts with various suppliers, with purchase prices reset annually. Starbucks also purchases significant amounts of dairy products from suppliers located near its retail stores. Starbucks purchases paper and plastic products from several suppliers, the prices of which vary with changes in the prices of commodity paper and plastic resin.
LEN-09-1211-001.qxd:. 6/30/10 2:58 PM Page 77 Starbucks 77 Competition in the Specialty Coffee Industry After some reflection, Kim realized that Starbucks faced intense direct competition. Kim could think of a wide array of convenient retail locations where a person can purchase a cup of coffee. Kim reasoned that Starbucks competes with a broad scope of coffee beverage retailers, including fast-food chains (for example, McDonald’s), doughnut chains (for example, Krispy Kreme, Dunkin’ Donuts, and Tim Hortons), and convenience stores associated with many gas stations, but that these types of outlets offer an experience that is very different from what Starbucks offers. In particular, Kim was aware that McDonald’s had started to expand development of its McCafé shops, which sold premium coffee drinks (lattes, cappuccinos, and mochas) in McDonald’s restaurants. It appeared to Kim that the McCafé initiative was intended to be a direct competitive challenge to Starbucks’ business. Kim also identified a number of companies that were growing chains of retail coffee shops that could be compared to Starbucks, including firms such as Panera Bread Company; Diedrich Coffee; New World Restaurant Group, Inc.; and Caribou Coffee Company, Inc. (a privately-held firm). However, these firms were much smaller than Starbucks, with the largest among them being the Panera Bread Company, with 1,325 bakery-cafés systemwide (763 franchised and 562 company-owned) as of the end of fiscal 2008. On the other end of the spectrum, Kim was aware that Starbucks faced competition from local mom-and-pop coffee shops and cafés. Kim recognized that despite facing extensive competition, Starbucks had some distinct competitive advantages. Very few companies were implementing a business strategy comparable to that of Starbucks, with emphasis on the quality of the experience, the products, and the service. In addition, only the fast-food chains and the doughnut chains operated on the same scale as Starbucks. Finally, Starbucks had developed a global brand that was synonymous with the quality of the Starbucks Experience. Recently, Interbrand ranked the Starbucks brand as one of the world’s top 100 most valuable brand names, estimating it to be worth in excess of $3 billion. FinancialStatements Exhibit 1.26 presents comparative balance sheets, Exhibit 1.27 presents comparative income statements, and Exhibit 1.28 (see page 80) presents comparative statements of cash flows for Starbucks for the four fiscal years ending September 28, 2008. Required Respond to the following questions relating to Starbucks. Industry and Strategy Analysis a. Apply Porter’s five forces framework to the specialty coffee retail industry. b. How would you characterize the strategy of Starbucks? How does Starbucks create value for its customers? What critical risk and success factors must Starbucks manage? Balance Sheet c. Describe how Cash differs from Cash Equivalents. d. Why do investments appear on the balance sheet under both current and noncurrent assets? e. Accounts receivable are reported net of allowance for uncollectible accounts. Why? Identify the events or transactions that cause accounts receivable to increases and