Turning Starbucks (SBUX) Into A Bar

Starbucks (SBUX) posted bad earnings for last quarter.  Over the last 2 years Starbucks expanded extensively, refusing to recognize that there was a limit to the number of people who would pay $3 for a cup of coffee. In a recession, that number drops.

In order to improve margins Starbucks will fire another 6,700 people. Starbucks had revenue of $2.6 billion for the last calendar quarter of 2008, a decrease of 6%. The firm’s fiscal year ends in September, so its most recent report was for its Q1. Starbucks reported net income of $64.3 million compared with net income of $208.1 million for the same period a year ago

Starbucks has learned in a year what it takes some companies a decade to discover. Its business prospects are limited because Starbucks appeals to a modest number of customers who are prepared to pay a premium for a commodity. It always was a demonstration of how much ambiance counts in pricing.

A little over two years ago, Starbucks was talking about doubling the number of stores it had worldwide to 40,000. That was never going to happen and now it is possible that the firm may have to continue to cut outlets. Along with the company’s earnings release, Starbucks said it will close 300 stores immediately.

Starbucks’ problems are simple but nearly impossible to solve. It cannot drop pricing by any meaningful amount to bring in new customers. It has a high cost of goods and expensive store locations. Unlike McDonald’s (MCD) and other fast food chains, Starbucks does not have a broad enough menu to keep stores open 24-hours a day. It has to pay rent on real estate that it only uses for part of each day.

Starbucks has two choices now. The longer it waits to pick one, the more it will cost the company’s shareholders who have watched Starbucks stock drop from almost $35 two years ago to below $10.

The company can set up its stores so that they are in a business to attract traffic and revenue at night to improve yield-per-location or it can continue to cut outlets and people until it gets its margins back to where they were in 2007. The stock is not going back up until that kind of profitability returns.

Starbucks could get liquor licenses and sell alcohol from 6 PM until midnight or it could admit that people can still brew Maxwell House in their own kitchens for about $.10 a cup. Starbucks is not a 40,000 store business. It was never a 10,000 store business even on its best day.

As almost any regular customer would say, this is a great company.  Wall Street is beginning to understand that it is just the wrong size. 

Douglas A. McIntyre