Will Global Growth Help Starbucks?

The U.S. coffee giant has big plans overseas, where it assumes less risk, but foreign outlets' narrowing profit margins pose a problem

Can steaming expansion abroad offset tepid performance at home? That's what Starbucks is hoping. Even as it prepares to shutter 600 underperforming U.S. outlets (BusinessWeek.com, 7/1/08), the Seattle-based coffeehouse chain plans to open almost 1,000 new foreign stores this year, from Paris to Beijing to Mexico City.

Starbucks (SBUX) expects that within three years, more than 40% of its outlets will be outside the U.S., compared with 29% today, with a planned 3,500 foreign openings from 2009 to 2011. Just last month, the company announced plans to team with SSP, a British operator of food-service concessions, to open 150 new outlets in airports and railway stations around Western Europe. "International operations are a growth engine," says a spokeswoman at Starbucks' European headquarters in Amsterdam.

Growth, sure, but what about profits? Operating margins at Starbucks' foreign stores averaged 8.1% last year, compared with 14.6% in the U.S. During the quarter ended Apr. 30, foreign margins narrowed to an anemic 3.6%. The company attributed the decline in part to higher operating costs, especially store rents. Analyst David Palmer of brokerage UBS (UBS) reckons that "substantially all" of Starbucks' profits are generated by its U.S. operations, which account for 85% of its $9.4 billion in annual revenues.

Vigorous Expansion Outside Western Europe

Still, the push for international growth makes sense. In the U.S., about two-thirds of Starbucks outlets are wholly owned by the company, while the remainder are operated by licensees who pay fees to the company for use of its brand name. But outside the U.S., the situation is reversed, with almost two-thirds of stores run either by licensees or by partnerships in which Starbucks owns stakes ranging from 18% to 50%.

Because licensees and partners cover a big chunk of startup and operating costs, "there's inherently less risk for Starbucks" in such arrangements, says Sharon Zackfia, a restaurant-industry analyst with William Blair & Co. in Chicago. For example, Zackfia estimates that the 623 Starbucks outlets in mainland China, Hong Kong, and Taiwan produce "marginal, if any" profits. But Starbucks owns only 162 of them. At the others, "even if the licensee isn't making money, Starbucks still does," Zackfia says.

Starbucks is more vulnerable in some other countries, though. It owns all but a handful of its 646 British outlets, exposing it to that country's weakening economy and high real-estate costs. Across much of Western Europe, relatively high labor costs and expensive central-city real estate squeeze the bottom line, too. That's why Starbucks' most robust foreign expansion has been in regions such as Asia, the Middle East, and Latin America, where labor and real estate are generally cheaper.

Even so, the Starbucks habit is clearly catching on, even in countries with long-standing café traditions. Parisian Judith Sebillotte, stopping into a Starbucks a few blocks from the Champs-Elysées, complains about the prices: "It's €4 (about $6) just for a cappuccino," she says. "Ridiculous!" Still, she comes by about three times a week. She's not alone: Starbucks has opened 43 French outlets since entering the country just two years ago (BusinessWeek.com, 4/20/06). For now, the giant of coffee chains looks set to keep percolating overseas.

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