Is Starbucks’ stardust losing its sparkle?

Three years ago, Starbucks proudly reported trading results for a “momentous year” in which it made its first profits after 17 years of operating in the UK. Profits after tax for the year ending September 2015 came in at £25.8m after a loss of £9.8m the previous year.

Fast forward to earlier this month, and the results for FY 2018 show a reversal, with a loss of £21.3m after a modest £1.3m profit for FY 2017. This decline has occurred despite an increase in Starbucks’ UK store estate of the best part of 150 to reach 980 by September 2018 (it now has over 1,000 outlets).

This drop merits closer consideration of what has been behind this reduced profitability and what might be expected going forwards.

Starbuck’s growth was helped by a combination of factors. Revenue was buoyed by a 3.8% rise in like-for-like sales, which in turn came on the back of 5.9% previously. On costs, it renegotiated leases and closed unprofitable stores, benefited from better buying and improved coffee prices, and the business transitioned more sites away from company-owned towards licensed and franchise stores, which helped reduce administrative and staff costs.

Franchising to the fore

From a position of closer to 50:50 in 2015, Starbucks has continued to transition its store estate, and by September 2018 the balance was 37:63 in favour of licensed and franchised over company-operated.

This transfer very much remains part of its core strategy, with the business paying the price of some over-expansion and ill-considered property deals in its earlier years. Indeed, the smaller print details in the latest accounts include a one-off provision of £20.7m relating to onerous leases on some of its retail sites. This cost represents a significant chunk of the overall reported loss.

That said, the business has also struggled with higher costs and much softer topline growth. Costs increased from further investment in higher quality products, with several new food and drink options introduced, including expanded salads and hot lunches, new porridge lines and new cold coffees, such as Nitro Cold Brew. The moves to reduced company store ownership have also had an impact on reported turnover, which declined from £405.6m in 2015 to £387.6m in 2018. This decline has also been impacted by a significant slowdown in reported like-for-like sales growth, which came in at just 0.8% in FY 2018.

Some encouragement from comparative insights – for now

Without doubt, trading conditions in the market during 2018 were challenging and were not helped by a deterioration in high street footfall. However, a crucial question for Starbucks is the extent that its performance has been poorer or stronger than key rivals, and there is some good news of sorts for Starbucks via the negative like-for-likes that Whitbread reported for Costa, ahead of its sale to the Coca-Cola Company.

We can also use the MCA Eating Out Panel to review company performance. Interestingly, running April-June data for the last three years, it is evident that all three of leading players have lost visit share at lunch (particularly Costa). But at breakfast, Starbucks and Caffè Nero, have enjoyed some share growth. Other coffee shop channel winners include the growing array of smaller artisanal chains and independent operators.

Product quality considerations emerge as a key need for coffee shop customers, and this clearly plays to the strengths of many craft-led operators. We are also seeing signs of corporate fatigue, with bigger national chains losing some consumer appeal. While it might still rank as a relatively low need, we are seeing more consumers, currently one in 20, regard not being part of national chain as an important venue consideration for them.

Bolder play required?

What we are seeing here is a triple-whammy of the Big Three having to deal with softening consumer demand, intensifying competition and rising cost pressures. Costa’s response includes a stronger focus on multiple coffee products and formats, as opposed to coffee shops directly. By contrast, Caffè Nero is preparing for a more mature domestic marketplace via a consolidation and multi-brand strategy that has seen it acquire Harris + Hoole and majority own the Coffee#1 businesses. Starbucks has thus far been trying to better manage its cost base and focus on upgrading its product offer. Essential as this is in the short-term, I can’t help thinking this is not enough, and that the business risks being out-flanked over the medium-longer term without a bigger play.