6 - Cost Leadership - Starbucks

The focus of Cost Leadership's strategy is to reduce the cost and increase profits in highly competitive markets. If many firms are making similar products, such as Milk, one with minimum cost overheads and similar quality can make better economic margins over others and will be in a better position to handle market variation and competition. 

Although Starbucks does not seem to put much effort into Cost reduction, because they invest heavily in farmers and farming technology, and never compromise with the quality of Coffee beans, yet the out lot of efforts in reducing the cost and achieving the synergies.

In the early days, Starbucks was a coffee beans seller and there was no concept of coffee bars, as most of the coffee was consumed in household settings. Then in 1983, Howard Schultz traveled to Italy and returned the USA with the idea of having coffee bars and made this almost 100 Billion dollar company with 31,180 stores globally. Most of its business comes from brewing coffee and serving customers. The whole idea of Starbucks is not just serving the coffee but give a place to customers to sit, relax, and enjoy the coffee. Based on this idea, Starbucks designed each store filled with coffee aroma and casual sitting places appealing to customers all over the world.  (https://www.youtube.com/watch?v=XUBeH7VQaFY)

Starbucks could never be such a large corporation if it could not handle and optimize its costs and operations. We can see from the chart, that cost of Revenue is almost consistent, but the cost of Operations is increasing, the main reason for that is opening new stores very close to each other. Starbucks must fix this issue but either raising prices or closing some of the stores.

Let’s look at some of the Source of Cost Advantage for Starbucks

1.     Size Differences and Economies of Scale: Starbucks is an almost 100 Billion dollar company with rich cash and other financial resources. They are in the Coffee brewing business in the USA since 1983 and have a great head start than any of their competitors. Starbucks is the company that brought the coffee brewing business in the USA when there was no culture of Coffee bars or portable coffee cups. They achieved this success by continuous customer feedback, employee training, perfecting the roasting process, and helping farmers to improve the supply chain and supply of coffee beans.

a.      Specialized Machines: Starbucks has four hi-tech Roasting factories in the USA, one in Europe, and opening a new in China. They have automated all these roasting plants in such a way, very less manual work is required. During COVID19, they can use this in their favor as well as safe to consume brand, which many other companies cannot.

b.     Cost of Plant and Equipment: Starbucks is continually investing in opening new stores, expanding globally, and inventing new technologies for roasting and brewing. This

c.      Employee Specialization: Starbucks pays special attention to train its employees about coffee, flavors, brewing, roasting, and customer services. In 2008-2009, during the financial crisis, Starbucks closed almost 900 stores and fired almost 650 baristas. Then one day, CEO Howard Schultz closed all US locations to train almost 137,000 baristas about expresso coffee so he can deliver high-quality service to customers and remind them about what they like about Starbucks, which helped Starbucks well after the crises were over. During 2008-2009, Starbucks didn't open any new stores but paid attention to customer service and quality to improve and efficiency.   

https://www.youtube.com/watch?v=XUBeH7VQaFY&t=148s

d.     Overhead Cost: Since Starbucks is roasting coffee at a massive scale, its overhead cost goes down with every pound of coffee delivered in stores and brew-at-home products. As per one Quora post, on average Starbucks sells 388 cups of espresso per day and almost 4 billion cups annually. This helps Starbucks optimize the supply chain, get better-negotiated terms for cups and supplies, and reduce the cost of each cup served.

https://www.quora.com/Starbucks-Coffee-How-many-cups-of-coffee-does-Starbucks-sell-each-year

2.     Diseconomies of Scale: Managing international operations at Starbucks scale is not an easy task. Sometimes balance shifts and companies feel the cost increase despite the scale. At this time, they must think about disinvestments and optimize the operations, because no-one can go beyond what the market needs. Balancing the supply-and-demand is a crucial factor.

a.      Physical limits of efficient size: Starbucks is very aggressive for opening new Howard Schultz wanted to own all the stores, so he can serve the consistent quality and experience. But later Starbucks decided to license the operations and now Starbucks has 51% own stores and 49% licensed stores. With this speed, they Opened too many stores in proximity, making operation less profitable per store. Cost of Operations is on the rise, taking the cost advantage away from Starbucks

https://sama7160.blogspot.com/2020/09/vrio-starbucks.html

https://stockanalysis.com/stocks/sbux/financials/balance-sheet/

b.     Managerial diseconomies: Starbucks operates more than 31,000 stores and employs almost 346,000 employees. Managing such a big workforce requires a lot of policies, procedures, and reporting structure. Such a bureaucratic structure can slow the processes and innovation down.

https://www.macrotrends.net/stocks/charts/SBUX/starbucks/number-of-employees

c.      Worker motivation: At such a huge level, it is not easy to keep everyone’s morale up. It is the responsibility of managers, but not all managers are the same. For some, their job is no more important than just getting through the day and get paid bi-weekly.

d.     Distance to markets and suppliers: Since Starbucks is operating at almost 30,000 locations, it is hard for them to deliver the raw material afresh. Since Starbucks is a food and beverages company, they also must manage the freshness of their products and keep the costs minimum. As per one strategy, they use the hub-and-spoke model, where they deliver the truckloads at one location which serves nearby locations efficiently.

3.     Learning Curve Economies: Howard Schultz went to Italy to learn about the business model. After coming back to the USA, without any experience and market in he was able to establish Starbucks, so it may not seem like a tough job and I think it is not if it is only about brewing and serving the coffee. But replicating this same process at such a large scale has a steep learning curve. Since Starbucks is serving coffee since 1983, they are way ahead of their competitors.  

a.    Economies of Scale: By learning from customers' feedback, tasting new roasting processes and methods, they have learned a lot about mass scale roasting and even opened 5 hi-tech facilities with a proprietary roasting process, which is hard for competitors to imitate.

b.     Cost Advantage: Starbucks has established its training programs since day one operations. They know what works and whatnot, so they can train their baristas exactly by the needs of the customers, but not by theories or hypotheses. This helps reduce the cost, as better trained baristas are much more effective and efficient, and along with that they are trained on customer service which makes customers keep coming back.

c.   Competitive Advantage: Since Starbucks learned a great deal about the operations from farming to roasting to brewing, and serving, it is not easy for any competitor to replicate this model. Among big competitors, McDonald's and Dunkin are the only names and even they compete on cost and quality of coffee only, but not on full experience as Starbucks provides.

4.     Differential Low-Cost Access to Factors of Production: Starbucks imports its coffee beans from 30 Countries. By importing from so many countries, it helps Starbucks keeps a consistent supply of high-quality beans throughout the year because coffee is harvested at a different time in different parts of the world. It also helps Starbucks lower the risk of supplies from one country or region or part of the world for any reason, political or otherwise. Last but not the least, it also helps Starbucks to go Global, but keeping suppliers as close to demand.

https://www.businessinsider.com/starbucks-mcdonalds-dunkin-animated-map-shows-where-coffee-comes-from-2019-7

5.     Technological Advantage Independent of Scale: Starbucks is a Coffee company, so how much technology can go into it. The answer is a lot. Starbucks has dedicated high-tech research labs that use state-of-the-art technology to keep track of soil, weather conditions, pesticides, etc. Then Starbucks uses technology to keep track of all the suppliers, logistics, fleet, and demand to manage the supply chain.

Starbucks has also developed hi-tech, quite automated roasting facilities. Finally, Starbucks also uses technology and provided iOS and Android apps to customers for easy ordering and better experiences. It also uses these apps to send weekly deals, star awards, and daily challenges for earning more stars. These apps seem like complete operations in-themselves as a lot of technological components (hardware and software) goes into providing these services and require a lot of manpower to manage these apps.

https://www.supplychain247.com/article/behind_the_scenes_at_starbucks_supply_chain_operations