Online Extra: Starbucks' Plan to Brew Growth

Despite a rapid expansion in the U.S. and abroad, CEO Orin Smith says plenty of territory is yet to be conquered
The BusinessWeek 50

It's hard to imagine that America's cities could hold any more Starbucks (SBUX ) coffeehouses than they already do. But the $4 billion, Seattle-based caffeine juggernaut disagrees, and it's finding more room in cities as well as suburbs and rural areas. And while some fear that Starbucks' success is far less certain in international markets –- Europe, Asia, the Middle East –- than in the U.S., CEO Orin Smith begs to differ. Stores abroad are gaining acceptance, he says, while the customer base here is widening beyond his expectations.

"There's no question that our viewpoint on how big the market in North America is over the last 12 months has broadened," Smith says. He stopped short of predicting store growth totals beyond the previously forecasted peak of 10,000 in North America and 15,000 overseas. However, his comments suggest that new stores in the U.S. –- its biggest market –- are far from tapped out.

In a phone interview on Mar. 12, BusinessWeek Online Reporter Amy Tsao spoke to Smith about his outlook for Starbucks. Following are edited excerpts of their conversation:

Q: You have some tough sales comparisons coming over the rest of the year.


Our comparable-store numbers [sales for stores opened at least one year] for the last three years have all been difficult by any historical standards. And yet, we're easily elevating the comp-store growth to new heights for a company of this size and the age of our stores.

I wouldn't say the likelihood of outdoing the comp-store growth in this next Christmas season, of 11%, is something that's probable. But we're encouraged that we can maintain historical numbers, 3% to 7% comparable-store sales growth, which is very good.

Q: How have you been doing that?


We have improved speed of service in a number of different ways. Technology, additional labor, better deployment of labor, all things have been a factor in moving people more swiftly through the lines. We have also added new product, which has had some impact. The debit card and now the Duetto debit/credit card have also had some impact.

But I think the factor that is of most interest is that we are appealing to a broader demographic than we once did.

Q: Why do you think Starbucks is more appealing?


It seems as if in the last 12 months we've taken a step in [our appeal]. Instead of the smooth curve that it has been, we've taken a big jump and now are in a much bigger demographic.

When you look at where the comparable-store growth is coming from, it's not price. It's all traffic. There's just more people in our stores during all parts of the day than there has been before. Some of that is coming from more frequent visits by existing customers, but the majority of it is coming from new customers.

Q: What's your view on store expansion now?


[In North America,] it's much bigger than we thought it was. You can see this as the older stores' sales are growing at mid to high single digits, and average store volumes are increasing dramatically.

The returns on capital for new stores are as high as they were in the mid-1990s, when we had 600 stores. You almost always have your highest returns in the early years of a concept's existence because you go into the best markets and you go into the best real estate.

We're getting returns now that are equivalent to what we got in our early days, which means we can have far more stores because we're well above our threshold for cost of capital.

Q: What's next for brand expansion?


Whole-bean coffee in supermarkets -- we think we have much more opportunity in that category. We're working now with Kraft (KFT ) and expect we're going to reenergize our efforts in that category going forward.

We've got about 90% of the [bottled coffee-drink] market. This has much greater growth left. And we're now looking at international markets and expect that within the next year, we'll probably announce at least two new markets outside of the U.S. where we will be offering this kind of product.

We're also trying a strategy that we haven't engaged in before, which is having multiple coffee brands.

Q: Have you given much thought to low-carb items?


Yes. In the food category, we're looking at everything right now. There's so much going on with this obesity issue that we're looking at what the effect should be on our product lines. We will be introducing lower-calorie product, but it's not transformative at this point.

Q: What do you think of other companies like Dunkin' Donuts' and McDonald's (MCD ) efforts to improve their coffee products?


I'm always concerned when anybody ramps up anything in my territory. We will respond to whatever kinds of competitive threats that we have. Now having said that, Dunkin' has made a very hard push in the Northeast, but I can tell you that our stores in the Northeast are doing better than they ever have. So at this juncture, I'm not reading any serious threat from that -- which doesn't mean it couldn't materialize.

McDonald's has flirted with better coffee in their stores for quite a while. They've even tried to develop concepts that would compete directly with us, going beyond traditional restaurants. They haven't been at all successful with those concepts.

Q: If your appeal is broader, do you see your customer base overlapping with that of a chain like McDonald's?


At this point, our customers don't overlap that much. We see ourselves as providing a total coffee experience -- not just a cup of coffee. So that's one dimension of it. I'm also confident that McDonald's will not provide the same quality level we do. That just won't happen. But I do believe they can upgrade from where they are, and it's possible that they can create some more business.

Q: International stores are going to be profitable for the first time this year. What helped turned the corner?


We're simply maturing. Not that we're getting close to maturity, because we're just scratching the surface internationally, but the markets are getting larger now.

Our partners have learned more, they're more sophisticated in operating the coffeehouses. So many markets are just doing so much better than they once were. That continues quarter after quarter.

Q: At what point does international growth expansion become more important than U.S. growth?


It's more than five years out. I might have said something different a year and a half ago, but the growth in America is so strong and the implications of the kind of growth we have are so great that our view of how long America will grow rapidly has changed dramatically.

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