Welcome to Business Breakdowns. Each week, we'll break down a real-world business that's in the news.
Today, we're talking about Starbucks - a company that's been in the news seemingly every week.
Listen in as Namaan and Jenny Rae cover the Starbucks business model and the key metrics they would manage to as advisors or operators at Starbucks.
Let us know which company to cover next!
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Starbucks Business Model Breakdown Transcription:
Today, we kick off with Starbucks. Welcome to today's episode of strategy simplified Namaan here, joined by my colleague Jenny Rae.
Almost every time we get together, we end up having a conversation about business and different businesses that we're reading about in the news. So today we thought that we would bring that conversation to you. Specifically, we're going to be talking about Starbucks. Starbucks has been in the news a lot lately. They just poached the former CEO of Chipotle, Brian Niccol, to come and turn the business around after the failed tenure of the old CEO, who was actually a former McKinsey consultant.
So today, what we're going to do is we're going to talk through some key stats of Starbucks's business just to lay a foundation of understanding for everybody. Then we're going to move into a conversation around Starbucks's business model, and then Jenny Rae and I will each share three metrics that we would be managing if we were in leadership at Starbucks today. Finally, we'll each end with a hot take and a prediction of what we think comes next for Starbucks.
So with that intro out of the way, let's start to dive into some of the key stats that we need to know about Starbucks today. Starbucks has over 36,000 stores, over 20,000 of which are international, not in the US, and around 16,000 of which are in the US. From those 36,000 stores in fiscal year 2023 Starbucks generated almost $36 billion in revenue and operating income from that $36 billion in revenue was almost $6 billion if you're doing the mental math, along with us at home, that means that each store at Starbucks generates just under a million dollars of revenue per year. With that context and background established, Jenny Rae, I'm going to turn it over to you to talk to us a little bit more about the business model of Starbucks.
One of the things that we teach in our seminars when we're trying to clarify business strategy is that the best business strategists are actually insanely simple. Instead of trying to think about a complicated dashboard of 7,000 metrics, we have one main metric that when you port it across any industry, any environment, any location you're going to find that you have a very similar set of ideas that will help you succeed in that type of either advisory role or internal operator role.
For Starbucks, the two options are binary. It's either a fixed cost business or a variable cost business. This doesn't mean that a variable cost business doesn't have fixed costs, or that a fixed cost business doesn't have variable costs. It means that one is the driver of the behavior and the driver of the metrics that you manage to and Starbucks is a variable cost business. What that means fundamentally is that every time Starbucks delivers something to their customers, it costs them a direct, incremental amount to do that. So there is a cup, there is milk, there is a syrup, there are the ingredients of the food items that you purchase at a Starbucks. Every single one of those goes directly into each one of those purchases. And when you're managing a variable cost business, you're going to really think about managing the price per unit, historically historically, Starbucks was revolutionary at doing because they brought the cost of a cup of coffee, which was a commoditized one to $2 item before that up by adding flavors and variations to the other thing that you can manage too is the variable cost of you. One of those units. So how much does it cost you to deliver the items that you are getting? And ultimately, you're managing the contribution margin per item that somebody is buying. How much are you able to get out of that customer net? So fundamentally, this is an important keynote for Starbucks. If you're looking at any business, you want to understand their strategy or understand where maybe they've gone wrong, they might have not fundamentally understood what kind of business they are.
Jenny Rae, that's really insightful. If I was at Starbucks right now, I would be looking at a whole host of metrics to try and figure out what would be my key drivers to initiate a turnaround. I identified three to four key ones that I'd be paying attention to the most if I was at Starbucks right now. And so I'm gonna walk through those really briefly, and we have not shared these ahead of time, so I'd love your reaction to them. Then I'm interested in hearing the metrics you'd be paying attention to as well.
The first metric that I'd be keeping an eye on is same store sales growth year over year. The second is visits per customer, and the third is the growth of my rewards program. And so I'm going to walk through these each in order and talk to you about why I'd be paying attention to these.
The first metric was same store sales growth. I would be looking at stores that are at least one year old to see how they are becoming established within the local market. Now, same store sales growth in fiscal year 2023 for Starbucks was down 2% in the quarter that ended on June 30, and this was driven not by a decrease in price or ticket value, but by actually a decrease in transaction volume. So in that quarter, transactions decreased by 6% while ticket values were actually up by 3% so as I was looking at the P&L, that told me that at least for that quarter, that P&L, that I was looking at price and the price, the contribution margin that Starbucks was able to generate from a transaction was not necessarily the key driver of the same store sales growth decline as much as visits volume and a decrease in transactions.
So I'd be looking at, if I was Starbucks, a way to increase the visits per customer that I can drive to my stores. If ticket value isn't the primary driver of slowing growth and it's a decrease in transactions, the implication is that a decrease in transactions is driven by fewer customer visits. And so how can I get people through the door more often in a given period of time? The way that I identified as the optimal way for Starbucks to do that is through growing its rewards program. Starbucks loyalty members spend three times more than non members and visit more often than non members as well, and 41% of Starbucks’ US sales are contributed by loyalty members. In summary, reward members are 5.6 times more likely to visit a Starbucks every single day.
So if I can grow my rewards program, I can increase my visits per customer, and I can also start to increase some of the contribution margin that I would be able to generate on each individual purchase.
That leads me to my bonus metric that I wanted to discuss as well, which is average transaction size. It didn't make my top three, but I would be keeping an eye on average transaction size to see that as I increased volume, am I staying within the transaction size range that I want per ticket, and because what I don't want to do is necessarily increase volume at the expense of pricing power inside of a variable cost business. So I would be keeping an eye on that as I was trying to increase foot traffic to my stores January. What do you think about that, and what are the metrics that you'd be looking at
Namaan, first of all, I think it's cheating to have a bonus metric, but that actually tees up really well to what I was thinking about here for Starbucks. I think that it's really insightful that you did some historical analysis and also, I think that's cheating a little bit, because not everybody knows where you're starting from, and sometimes people over rely on what happened to try to solve for the future. It's not necessarily at the root of it, because, for example, the visits per customer could be down, but also, like the new customer acquisition, or the customers per store, unique customers per store, could be down.
So there are other ways that that could be influenced. I just want to add that you did a great job. The bonus metric is actually my first one, so I looked up the average revenue per visit, per customer, and it's $5.56 and I'm sitting here as a mom, thinking, ‘is there a store in America that has the ability to charge less than $5.56 for a kid's meal?’ I don't think so.
When I was thinking about this, and I was thinking about what Starbucks doesn't do, one of the things that Starbucks doesn't do is it doesn't bundle. There isn't a you come in for a coffee and. You also get a food item and that's $9 and there isn't a kind of slimmed down menu that would be an expedited option that would also be a bigger ticket price. So anyhow, I think that this is one of the opportunities that I would look at. How could you increase the average revenue per customer? It can't possibly be through coffee upsells, even though I definitely also pay more than that at a lot of other places. So it's got to be through food, through accessories. I think there's probably some really needed innovation in their food offerings, because in the last few years, there have been very few great lunch options, right? There's very few fresh options. There are a lot of things that I think are lacking on the food and the pastry side that could be innovative, seasonal, etc.
The second one that I identified, and I thought of this one when I was kind of really thinking about the type of business that it is, is the percentage of customers that buy food right now, it's only 20% and when I was thinking about the way that I would manage a comparable store that sold something different, I was thinking about another store that I've been to recently, which is a Wendy's. I mean, you know, other fast food options would fit into this. Dunkin Donuts was actually one of the ones that I thought of, because Dunkin Donuts really has begun to revolutionize itself by thinking of itself as a more than donut store. So they're trying to get you when you go into Dunkin not to buy a donut or a six pack of donuts, but a donut and a coffee or a donut and a breakfast sandwich and having that kind of more than option, but only 20% of your customers opting into that.
Now, I think, means that something's wrong, either in your pricing, in the way that you're offering it, or in the product itself. So I would look at those fundamentally, and then the third option is the value of an average bundle externally. So you know, I don't only look at the current options, but I'd want to look at benchmarks, and you can look at that for all of them. But when I would think about what to price, the average price of a meal deal at a fast food service option, which, by the way, one of my bonus metrics would be the percentage of clients that use the drive through, or that order ahead. But especially the drive through, those are your kind of like they need an expedited list, potentially in an airport I don't own.
Naman, if you've ever stood in a what felt like an hour line to get a Starbucks, but like, Yeah, so like, you know, if you don't do that anymore, and you used to, like, there has to be some kind of expedited option where you don't get the full menu, but you can run through that expedited service option, or you can book it ahead you arrive at the airport, you book something, and it's there for you. When you get into the store right there, there has to be some kind of operation or queuing metric. The fact right now that the bundles at these other places are $10 and they're not even getting close, I think, is really fascinating. So, you know, you talked a lot about managing the volumes, which is great. I was just thinking like, Hey, I think that there are fundamental issues with valuation on the price that people are willing to spend per item. I know that for me, if I felt more value in an individual Starbucks visit, I would be willing both to pay on that visit, more for it, but also a higher likelihood to return. So we could probably go on for hours, but those are my three.
I think that's great, and I agree with you that when I think Starbucks, what I used to think was convenience, right? Like I want a cup of coffee quickly. I want a snack or a sandwich quickly. And the complexity of the menu, the time that it takes to service a transaction, has dramatically increased. Where Starbucks no longer feels like a convenience. It feels like a chore to go get my coffee, get my sandwich, and then move on with my day.
I think the danger with potentially expanding the menu or trying to be all things to all people is that you you add further complexity to your operations, and you somewhat water down the brand from being one of potentially quality coffee and food that goes with coffee right to pursuing like higher basket sizes and higher ticket sizes, and maybe moving away from the core business and what people actually come to Starbucks to experience. So that's a problem and a challenge for Brian Nichol to try and solve, but that's just one of the things that I was thinking about as you were talking through some of your bundling ideas and how we could increase the average transaction size at a Starbucks.
Well, if we move from there into hot takes, which, by the way, I agree with you, part of how I would bundle is I would pick out some of my highest contribution margin options. I'd look at those first and or my most frequently purchased items, right? I wouldn't necessarily try to change customer behavior, to try to drive the things that they're not already buying. I would just try to get them to think of me. As a place where they're willing to spend $10 or $15 per person, instead of a place where they're willing to spend five or six and there are, I think, big operational changes that we'll see at Starbucks that I'm really excited to see roll out as well.
But, but when I think about my hot take for Starbucks, I think that we're going to see the ability to order ahead, to queue faster, to do more of you know, I think that was part of why Brian was hired, right, which is that at Chipotle, your ability to actually not have to come into the store and create your burrito had reduced a point of friction to people, to the point where their mobile orders just increased so so much, and they were able to really deliver those rapidly.
Right now, the average length of stay for customers can be up to 37 minutes. That means that some people are staying for hours, but 70% of their sales come from the mobile app and the drive through and the drive, it's like equal terrible friction every time you do that. If I just want to get a coffee at Starbucks, there are, you know, I am imagining something in being pioneered, where you have a, like, two lane option, or you have, like, a drive up, pull up option, and then a different option outside of the lane.
It would be in the drive through where you have some people running and delivering really simple orders in a different location, even potentially through a second drive through window, like you would have at a Chick-Fil-A. So I'm looking forward to seeing how you can innovate that. But at airports, come on, that's a no brainer, right? You just want a coffee. You just want a coffee and a pastry. You want something that is like an under one minute order to prepare. There should be an expedited line for that kind of stuff.
I agree with you, and our hot takes are strangely similar. Actually, mine was that Starbucks was going to move more towards the model of a Dutch Bros or a similar coffee shop that actually doesn't have a retail footprint. So Howard Schultz, when he launched Starbucks decades ago, one of his primary goals in launching Starbucks was that it would become a third space in society, and that's just no longer I believe the optimal mission for Starbucks if they want to optimize their financial metrics.
So Starbucks's goal until 2030 is to open an average of eight new stores per day. That's incredible location growth, and I think we're going to end up seeing more and more of those locations move to being moved to having smaller footprints. So they're gonna be drive through only, they're gonna just have a pickup window with a drive through and not a lot of seating. So that's my hot take, that you're gonna end up seeing smaller and smaller Starbucks. One of the perks of being a rewards member and being an upper tier rewards member is that your order gets prioritized.
So if I have however many gold stars I have, and I'm at a certain tier in the Starbucks Rewards ecosystem, then the way to incentivize me to continue to spend more money, and the way to incentivize me to get to that tier is actually that my order is prioritized in the store. And so I think we'll start to see some of those innovations as well at Starbucks here that Starbucks here in the next 24 months, like a Marriott check in line, that's faster.
I love that. Naman. Can I just end by saying I think that part of the confusion when you look at a place like Starbucks is that it has a physical footprint. I naturally think of how expensive it is to have the infrastructure of a store set up and to have all of the overhead to manage a store, and you also have these laborers that are in the store that you're not paying by the unit. They're not commission oriented. You're paying them by the hour. So that feels to many people like a fixed cost business, but fundamentally, store openings are actually a sign of a variable cost organization, because every incremental store is in itself going to grow your bottom line, presuming that each of the stores are successful profitably.
I think that's just to harp on one point of confusion that you just mentioned at the end. I think that's why people mess this one up. And so we're really excited that you all joined us for this journey today. Thank you so much for digging into the strategy of Starbucks. If there's a metric that you would have put on your top three that we missed, please leave us a comment. Send us a message. We would absolutely love to hear from you. And if you also think we got it wrong, come on. Let's bring on the conversation. We're really excited to dig into more strategic conversations with you. Thanks for joining!