The Coffee & Snack Shop Industry: An AnalysisUniversity of Massachusetts, Amherst, MBA Students

Class: Organizational Strategy and Planning

April 2012

Contents

Introduction:............................................................................................................................................2

Current State of the Industry (beyond Revenue):....................................................................................2

The Competitive Forces: Porter’s Five-Forces Model for Analysis:..........................................................3

Force 1: Rivalry among sellers.....................................................................................................3

Force 2: The threat of new entrants............................................................................................3

Force 3: Pressure from sellers of substitute products.................................................................4

Force 4: Pressure from supplier bargaining power......................................................................4

Force 5: Pressure from buyer bargaining power..........................................................................5

Industry Players:......................................................................................................................................5

Future state of the industry (driving factors for change).........................................................................6

Likely strategic moves of rivals................................................................................................................6

Greatest competitive advantage - The Retail Coffee Experience:............................................................7

Summary:................................................................................................................................................7

Resources:...............................................................................................................................................8

Appendixes:.............................................................................................................................................9

Introduction: About six in ten adults drink coffee, making it the second most popular beverage after

water. Prior to 2009 the Coffee and Snack Shops industry saw significant grows in both

industry players and revenue. The economic downturn, and to some extent raised

awareness of health issue associates with fat and sugar intake, has stagnated the industry

over the last several years. The industry fell sharply in 2009 to 25.3 billion dollars in

revenue but has steadily increased at a rate of around 3% since. Industry revenue is

closely tied to consumer spending. In 2009, when consumer spending decreased 1.9%, the

Coffee and Snack Shop industry declined 6.6%. As consumer spending increased in the

following year by 2% and 2.3 % in 2011, the industry rose 3% and 3.1% respectively. This

is an indication that morning coffee is a luxury that is quickly abandoned during difficult

economical time. It is important to notice the rebound as well. As consumer spending

increase in the coming years, revenue within the industry will increase in tandem. This will

lighten the competitive atmosphere, in which the industry players fighting feverously for

marketshare from one and other, and shift focus to bringing home brewers and lapsed

drinkers back to their establishment. As the domestic economy rebounds this is a great

opportunity to purchase a large coffee retailer at a discount and reap the benefit during the

recovery.

Current State of the Industry (beyond Revenue): The Coffee and Snack Shop Industry is a mature one although it has the earmarks of a

slowly growing industry as it emerges from the steep economic downturn it faced late in

the last decade. It is estimated that the top four major players in the industry account for

over 40% of the available market share. As such, competition within the industry is high.

Franchises seem to do well representing only 10% of establishments but accounting for

nearly 65% of revenue.

The Competitive Forces: Porter’s Five-Forces Model for Analysis:

Force 1: Rivalry among sellers

As previously stated, the competition among coffee retail sellers is strong and intense. On

the national level, Starbucks, Dunkin Donuts, Krispy Cream, Seattle’s Best, and Peet’s Coffee

are among the leaders in quick service café. They also offer light food items, teas, coffee

accessories, and beans. In addition to rivalry between industry players, competition can

also be from other industries like convenience stores, gas stations, gourmet food shops, and

fast food. For instance, McDonald’s recently made a large push to pull market share from

specialty retailers like Starbuck with the McCafe line of coffees. McDonalds can sell a high

quality coffee at a reduced price in comparison to Starbucks and make up the margins with

the meal sales. Coffee is a high-margin business but it doesn’t compare to what retailers

will get for selling a full meal. This has caused increased competition in the industry and

Starbucks recently admitted that McDonalds has made inroads into the market. The

competition is not restricted on the choices of coffee and beverages or pricing; rather it is

on the overall customer experience. Each major coffee company has its own unique

business processes to differentiate itself from rivals. Starbucks’s coffee and beverages are

all handmade and they stress on this aspect as a live show of the barista. Coffee drinkers

can customize their drinks with their preferences. However, handmade coffee and

beverages tend to be labor intensive which add to the overall operational costs.

Force 2: The threat of new entrants

Barrier for entry into the industry is low.

The industry in fragmented and locations and equipment can be leased, lowering

capital cost.

The ability to purchase through franchise agreements decreases entry for new

establishments as well.

That being said, entry with the intent to compete with established franchised groups such

as Starbuck and Dunkin can be extremely high. Major coffee companies partner with well-

known businesses, like Starbucks with Barnes & Nobles and Safeway. In addition, major

players have sizable economies of scales in coffee production processes, logistics, and

marketing.

Force 3: Pressure from sellers of substitute products.

These substitute products are often not focused items in coffee estabilishement but are

readily available in nearby shops. Including:

Soft Drinks Juices Water Beer

Outside the retail space companies in the Coffee & Snack Shop industry compete with

instant coffee and other home brewing methods. This includes the popular Keurig

machine and individual K-cups offered by Dunkin Donuts, Starbucks, Green Mountain, and

Timothy's.

Force 4: Pressure from supplier bargaining power

The bargaining power of suppliers, the coffee bean farmers, is moderate to high depending

on the economies of the coffee company. Coffee beans are agricultural products and they

are subject to price volatility from weather, economic, political, export quota, embargoes,

and efforts on the International Coffee Organization, and the Association of Coffee

Producing Countries on coffee supplies. Starbucks started to enter into fixed price

agreement with coffee bean growers to guarantee adequate supply of coffee for their

17,000 + outlets. Coffee shops are also subject to commodity price fluctuation of dairy

products, sugars, paper products, and flour. Also, pastries and Danishes are outsourced to

private bakeries and they can raise the prices when their products become popular.

Starbucks enters into fixed priced contracts with outsourced bakeries and obtains bulk

discounts. Smaller coffee shops with their relatively low volume consumption of these raw

materials, are subject to price volatility of these commodities.

Force 5: Pressure from buyer bargaining power

Buyer bargaining power is strong because the cost of switching to another brand of coffee

is low. The taste of coffee of each company is quite standardized and customers generally

have low brand loyalty and can get tired of the same taste. Small coffee shops have the

flexibility to make additions to their menu whereas large coffee companies often lack such

flexibility without the head office’s pre-approval. Furthermore, the shopping behavior of

customers tend to be affected by general health conditions, weather, and personal budget.

Industry Players:The major companies in the field include Dunkin’ Brands, Krispy Kreme Doughnuts and

Starbucks. Starbucks founded 1971 in Seattle Washington is the world’s #1 specialty coffee

retailer, with more than 17,000 coffee shops in 40 countries. Starbucks enjoyed rapid

expansion in the 1990s opening a new location every workday until 2008 when the global

economic downturn hurt the coffee and retail business. Today Starbucks controls 52

percent of the global specialty coffee market. Krispy Kreme Doughnuts founded 1937 in

Winston-Salem, NC also saw massive growth during the 1990s but slowed due to

accounting scandals, issues with the franchise owners and overall economic conditions.

Krispy Kreme is famous for its glazed donuts, not coffee, and some estimate that is one of

the major reasons the New England locations failed to connect with local consumers.

Dunkin Donuts, founded 1950 in Quincy, Massachusetts, is famous for its coffee, doughnuts

and other baked goods. Dunkin Donuts receives over half if its business today is in coffee

sales. Dunkin Donuts has more than 10,000 locations in 32 countries and can also be found

in many gas stations, supermarkets, malls and airport food courts. See Exhibit C :

Finaincial comparison of competition in the industry & Exhibit D : A Strategic Group

Map of Players in the Coffee & Snack Shop Industry

Future state of the industry (driving factors for change)

Although the Coffee & Snack Shop Industry is rather mature, certain changes will impact

competition over the coming years. We will see further movement towards competing on

price as “outside the industry” competition move into coffee sales. This will require a

focus on cost cutting to increase margins. Health trends will continue to shift customer

preference towards healthier low sugar and fat offerings. Maturity of the industry will

push retailers beyond the highly concentrate areas within the US market and

internationally as well. See Exhibit E: Coffee Consumption Comparison per country

Likely strategic moves of rivals Franchising is an important factor in the success of players in the industry and we

will likely see smaller coffee chains beginning to increase the number of retail outlet

in order to compete against larger chains such as Dunkin and Starbucks.

Established brands, such as Starbucks, will look to expand more internationally

moving into previously untapped markets through franchising overseas particularly

regions of Asia/China.

There is a growing concern regarding cannibalization of retail customers by K-Cup

offerings at home. We are likely to see brands that offer this at home method making

changes as well.

We are likely continue to see other coffee retailers expanding into more high price

point barista style coffee offerings and different roasts to entice customers from

home brewed simple coffees.

The raising health concerns will affect customer preference.

Menu items for more health conscience customers will be offered in order to capitalize

on this trend.

Concerns for high margin in this competitive landscape will create partnerships between

coffee retailers and other retailers. This will help coffee retailers lower costs and increase

margins. We have already begun to see this with Starbuck in Barnes and Noble and Dunkin

Donuts in Shoprite and this trend will increase.

Greatest competitive advantage - The Retail Coffee Experience:Ultimately, creating a great experience serves to differentiate many of these coffee retailers

from their competition and substitute product. For example, Starbucks does not compete

on price, but it makes business out of human connections, celebration of diversity and

culture, branding, new products, development of new channels of distribution, store

atmosphere and images. Their stores are specially selected to be in the best places in town

like high traffic and visible store and mall locations. And each store is designed with a

special theme. Dunkin' Donuts also offers specialty beverages, and they can do it faster

than at Starbucks due to their cappuccino machine that can brew a cup in under a minute

and at a lower price than their competitors.

Summary:It is clear that the industry will grow in the coming years. With new technology making the

coffee experience faster, and better able to meet the unique taste of each customer, the

potential for growth certainly exists. We would not recommend opening an independent

coffee establishment but the takeover of an established franchisor such as Starbuck,

Dunkin, or Peet’s could be a profitable endeavor given the upswing in consumer spending

and the opportunity for international expansion. It is important if you are to enter this

industry that you keep in mind the current trends and how it will affect your competitive

rivals position. Also retailers must keep their customers' needs in the forefront, while

supporting the farmers, and continue to think of new ways to be creative in their offerings,

ensuring that customers return to their stores.

Resources:Symonds, William. A Java Jolt for Dunkin' Donuts. Business Week, December 20, 2004

Josephs, Leslie. Coffee Roasters Keep Eye on Supplies. Wall Street Journal, March 18, 2012

Pohl, David. The End of Coffee as we Know it. The Huffington Post, October 5, 2010

Karen L. Wagner. Coffee on Every Corner. . Specialty Coffee Retailer January 14, 2011

Nima Samadi IBISWorld Industry Report Coffee & Snack Shops in the US March 2012

Tim Hortons, Annual Report 2011. Tim Hortons Inc. Dec 2011.

Thompson, Strickland. Case study of Starbucks Corporation, Strategic management 11th ed., McGraw-Hill, 1997.

Starbucks. Annual Report 2011. Starbucks Corporation. Dec 2011.

Appendixes:

Exhibit A: Ten year history of revenue and establishment increase with five year future estimates

Year Revenue Number of EstablishmentsRevenue Opportunity

2003 17,760.80 37,323 0.4758674282004 19,413.00 40,650 0.4775645762005 22,853.40 42,909 0.5326015522006 24,718.40 45,360 0.5449382722007 26,259.30 47,568 0.5520370842008 27,139.80 49,023 0.553613612009 25,348.50 45,468 0.5575019792010 26,107.70 47,562 0.5489193052011 26,927.80 48,857 0.5511554132012 27,843.80 50,123 0.5555094472013 28,842.60 51,436 0.5607473362014 30,235.70 52,684 0.5739066892015 31,122.80 53,987 0.5764869322016 32,457.10 55,246 0.5875013582017 33,898.60 56,102 0.604231578

Light grey represents estimations.

Exhibit B: Ten year history of revenue and establishment increase with five year future estimates

Graphically representation of previous exhibit. Green line average sales per establishment. Slight upward slant of the green line indicates that proposed revenue is slightly outpacing estimated increase in establishments.

Exhibit C : Finaincial comparison of competition in the industry

Market Cap (in millions) OutletsRevenue (in millions)

Starbucks Corp 4327 17003 11700Dunkin Brands 2148 16800 628Krispy Kreme Doughnuts 507 646 363Peets Coffee 636 192 371Noah Restaurant Group 245 733 436Jamba Juice 124 743 263

Exhibit D : A Strategic Group Map of Players in the Coffee & Snack Shop Industry

=

Peets Market Cap: 636M

Reve

nue

in M

illio

ns

Number of Retail Outlets

Starbucks

Market Cap: 4.3B

Dunkin Brands

Market Cap: 2.1B

Krispy Kreme Market Cap: 506M

Noah Market Cap: 245M

Jamba Juice Market Cap: 123M

…………………………

Derived from previous exhibit this exhibit maps the competition in the industry. The size of the circle represents market capitalization. The X Axis features revenue and the Y Axis the number of retail outlets. The small cluster of dots in the lower right represent independent coffee shops. These players constitute a large portion of the industry.

Exhibit E: Coffee Consumption Comparison per country

Source: NationMaster.com

Analysis shows that the U.S. coffee drinker consumes little compared with most European coffee drinkers by volume measured in kgs. There is a marketing opportunity for the growth of coffee consumption in the U.S.

Exhibit F: Coffee Consumption Comparison with Household Income

Source: Experian.com

The analysis of Exhibit C shows that as household incomes increase the rate or consumption increase. The lower income households consume less coffee than higher income households.