Shake Up In The Coffee Market

Let’s look at the Starbucks situation first. On the surface, it looks to be in the kind of trouble almost every foodservice operator would love to find his or her operation in. Yes, the stock price has tanked—down 48 percent over the past year—but so what? Everything else seems to be order: same-store sales still increase every quarter, cash flow is abundant and the company still plans to open 2,500 new stores this year, 1,600 of them in the U.S. Go check out the morning scene at any of the chain’s 15,000 current stores and you’ll see the same thing: Long lines.

Usually, when a foodservice company’s stock price takes a tumble, even though business is still pretty good, financial shenanigans are to blame. Or, sometimes, product quality has gone south or the company’s offerings have somehow gone out of style. None of these statements can be applied to Starbucks, however. The balance sheet is pristine, and the coffee is as good as ever.

So how come Schultz got mad and came back? Somewhere along its ride on the fast track, Starbucks lost its mojo. Schultz himself pointed it out in a famously leaked memo last spring in which he decried the addition of automated espresso machines (so much for hand-crafted drinks) and flavor-locked bags of beans (which negate the wonderful roasted coffee smell that once permeated Starbucks units). Worse, he noted, crowded, cluttered and dirty stores had further removed the “romance and theater” from the Starbucks experience. Other Starbucks watchers think the addition of drive-through windows and Egg McMuffin-like hot breakfast sandwiches give the units a fast-food-like feel. Say what you want about the “romance and theater” factor, but it’s the key reason Starbucks has been able to charge as much as it does for its coffee drinks.

It all adds up to dilution of both the Starbucks brand and the Starbucks experience. Schultz warned in his memo that Starbucks was voluntarily making itself more vulnerable to competitors, each of whom were likely to price their product lower than Starbucks does.

Enter McDonald’s, which has built its 14,000-U.S.-store fast food empire on three pillars: great real estate, premier marketing and cheap food. It has recently made a successful push into the brewed coffee market, even finishing first in a drip-coffee taste test conducted by Consumer Reports. Adding espresso-based drinks to capture part of the huge market Starbucks had created? Hey, if they can make the drinks with a push-button machine and sell them through a drive-thru, it’s right down McDonald’s alley.

The company moved fast. It has already installed barista-staffed coffee bars in 800 units and plans to take the program systemwide by the end of 2009. McDonald’s espresso bars are staffed by dedicated baristas, yet are even more automated than the Starbucks version. The baristas pump out cappuccinos, lattes, mochas and something called the Frappe, an iced drink akin to Starbucks’ Frappuccino. In the 800 test units, drink prices range from $1.99 to $3.29, nearly a dollar per drink less than the equivalent item from Starbucks. However, there is significantly less choice in drink size and flavorings—just three—than customers would find at a Starbucks.

McDonald’s thinks it will take in $1 billion annually from its new espresso drink program. “The advantage we have is convenience: we have more convenient locations than any restaurant in America,” says McDonald’s spokesman Walk Riker. “And we have terrific value.”

True enough. But yet to be answered is the question of how well this barista bar venture fits in at a McDonald’s unit, where the ambience is often less welcoming than even the grubbiest Starbucks unit. The idea makes sense on paper, but we’ll soon find out how many real-world espresso drink aficionados yearn to hang out under the golden arches.

In the meantime, opportunities to make hay in the big-ticket espresso drink market abound like never before. Note that it’s not the critics of Starbucks who are saying that the quality of the experience provided by company stores is no longer what it was; it’s the founder. And while espresso drinks at McDonald’s will be less expensive than a comparable item at Starbucks, the McDonald’s experience is, well….going to be the same McDonald’s experience we already know.

Which leaves plenty of room for everyone else. One thing the Starbucks phenomenon did was create a huge market for specialty coffee drinks, peopled with customers who, if we can believe Schultz, no longer consider Starbucks the ideal “third place” between work and home. McDonald’s isn’t going to be anyone’s third place either, unless that person is eight years old or younger.

We wish we could tell you exactly how to tap into this newly-up-for-grabs market. How you’ll do it depends on your location, your hours of operation and a number of other factors particular to your operation. But we are telling you we agree with Schultz: The hordes of coffee drink customers thought to be lost forever to Starbucks are now in the market for a new place to buy their drinks. Why not get your share?