When Starbucks Coffee Company (NASDAQ: SBUX) filed its Form 10-K last week, it had this to say about its relationship with Kraft Foods Global, Inc., the division of Kraft Foods Inc. (NYSE: KFT) that distributes Starbucks coffees and teas to retailers: “In the first quarter of fiscal 2011, Starbucks notified Kraft that we are discontinuing our licensing relationships. We intend to work closely with Kraft to ensure an orderly transition.”

Kraft responded this morning, claiming that the agreement between Starbucks and Kraft, which began in 1998, “remains in effect indefinitely, subject to certain limitations and protections.” Kraft also said that it had started arbitration proceedings challenging Starbucks’ attempt to cancel the long-standing agreement.

On the other side, Starbucks has also issued a press release this morning disputing Kraft’s claims, especially Kraft’s contention that the agreement between the two companies is “perpetual in nature.” Starbucks also claims that Kraft did a lackluster job of promoting Starbucks’ products, and that this led to an “erosion” of Starbucks’ brand equity.

Kraft claims that the retail part of Starbucks’ business amounted to just $50 million when Kraft took over distribution in 1998. Kraft has grown that business to $500 million since then. If Starbucks wants out of the deal now, Kraft must be given enough time to effect an orderly transition, and — here’s the kicker — “Starbucks must compensate Kraft for the fair market value of the business plus, under most circumstances, a premium of up to 35 percent of that value.” That would be $500 million plus a premium of $175 million, just so Starbucks could regain control of its distribution.

Starbucks does not address the compensation issue in its press release, but it’s a sure bet that the company is terminating the deal with Kraft on some basis that would not require the payout Kraft refers to.

Given Starbucks’ history of fouling up its attempts to expand beyond the high-priced coffee-drink business, the company may want to be careful what it wishes for. Certainly Kraft makes money from the deal with Starbucks, but then Kraft knows how to distribute and promote goods in the retail market. There’s no evidence that Starbucks can do that.

Of course, Starbucks could offer to buy its way out of the deal with Kraft, but that is likely to cost it a bundle. One analyst thinks the distribution business could be valued as high as $1.5 billion.

That sum might be worth it, though, given the fairly limited options Starbucks has for growth. Basically it’s a choice between opening more stores, most likely internationally, or something else. Regaining control of its distribution business is probably the single thing the company could do to add substantially to its top and bottom line growth.

Paul Ausick

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