Inside Starbucks’ Risky Bet on Selling Food

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Starbucks is betting that consumers and investors alike will have an appetite for its products beyond coffee. With the recent acquisitions of Teavana, Evolution Fresh and La Boulange Café and Bakery, the Seattle-based coffee giant is aiming to expand its offerings and capture the midday and afternoon traffic that has been elusive so far.

It’s not the first time the coffee chain has tried the risky concept.“The first time they tried to expand into food, there were some missteps because of the way they incorporated food into the logistics of the restaurant,” says Darren Tristano, executive vice president of Technomic, Inc. With last year’s purchase of La Boulange for $100 million, what Starbucks has done is “found a way to incorporate sandwiches and baked goods into that concept to create a broader meal offering.”

On the company’s most recent conference call in July, chairman and CEO Howard Schultz told analysts that was on track to be in 2,500 of the company’s U.S. coffee shops by September, including stores in New York, Chicago, Boston and Los Angeles. “We’re seeing both an enthusiastic customer response and substantial lift in incrementally,” he said at the time. On the conference call, Schultz credited Starbucks’ 9% sales growth in the U.S. to “continued beverage innovation and increased food attachment resulting from the success of our transformed and reinvented food program.”

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Analysts say adding La Boulange positions Starbucks to compete better with Panera Bread, to an extent, and rival coffee purveyor Dunkin’ Donuts.

And the changes go beyond croissants. In addition to baked goods, Starbucks is hoping to do for tea and juice what it did for coffee, turning them from commodities into high-end, high-margin products. The first Teavana store is scheduled to open this month in New York City, and the company has visions for a standalone chain of Evolution Fresh juice bars.

“You’ll see juice bars with customization, you’ll see tea bars from Teavana,” says R.J. Hottovy, senior restaurant analyst at Morningstar. “Starbucks is a very good retail operator in finding locations and getting a lot of customer transactions at high velocity. I think you can replicate a lot of those things with tea and juice as well.”

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Tristano says owning these companies rather than relying on outside suppliers for non-coffee menu items has two advantages: It lets Starbucks better control the quality and make changes, and it will shave a couple of percentage points off the company’s food costs. “Now, the downside is if they start to get into managing their own food supply. It does create more of a distraction from what they do best, which is serving a great cup of coffee.”

Analysts agree that demand is there, but say executing on new products correctly will be a challenge. The coffee shops don’t have full restaurant-style kitchens; many didn’t even have freezers, which had to be added to accommodate the new baked goods, according to the New York Times. (The new baked goods arrive at Starbucks stores frozen.) Consultant and former Starbucks executive John Moore told the Times, “The stores are set up as places to brew and serve coffee, and they don’t have a back of the house suitable for the prep work and other work that goes into serving high-end pastries like these well.”

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But analysts see another benefit to this burgeoning growth, anticipating that an expanded product line-up will let Starbucks sell more items in more places. ”I also like the idea that they have new products to take to grocery stores and warehouse clubs,” Hottovy says. Starbucks has had success bringing its Tazo tea brand, Starbucks bagged coffee and K-cups into stores, he points out.

With baked goods and juices added to the mix, a lot more retail shelf real estate is up for grabs, which is likely to boost Starbucks’ profit margin. “This is the next evolution,” he says.