Despite all the talk about inflation cooling off, one area that hasn’t shown consumers any sign of relief is coffee. On the commodity level, for instance, nearby futures prices for America’s favorite beverage have increased a whopping 80% from a year ago. (By contrast, prices for everyday food commodities like corn, wheat and soybeans are significantly lower than they were last September.)
Meanwhile, on the retail level, coffee lovers have seen supermarket prices for even generic brands like Folgers jump by as much as 10% in just the last three months. And for fans of Starbucks (SBUX), a small cup of brewed coffee at a typical Starbucks store has risen by as much as 30% in the last year—and by almost 50% since 2020!
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The massive increase in beverage prices at Starbucks has sparked a flurry of commentary among consumers and investors alike as to whether the retail giant is pricing itself out of its original market (viz. middle-to-upper-middle-class customers).
Original Source: Wall Street Journal
Indeed, pricing pressures have had a tangible impact on storefront sales in recent years, with Starbucks reporting a 2% year-on-year decline in global sales in Q1. Even more worrying, Starbucks reported a 6% drop for orders in the critical U.S. market in the quarter ended June 30. This constitutes “the steepest fall in years outside of the pandemic and Great Recession,” according to The CFO magazine.
A more visceral picture of just how “fed up” many of Starbucks’ loyal customers are becoming with the brand was painted last month in a Wall Street Journal article entitled, “What’s Wrong with Starbucks?” After referencing the company’s 6% sales drop in Q2, WSJ observed:
“Restaurants boosted [prices] as wages, ingredients and other costs became more expensive, and now they’re paying for it. Nearly 40% of consumers said they are spending less on eating out, according to a recent survey by research firm Revenue Management Solutions.”
It’s no secret that the traditional panacea for falling retail sales is to lower prices. However, we’ve seen little evidence of that strategy in the broader retail sector since the pandemic years. And this begs a pertinent question for investors, namely: will rising prices potentially torpedo Starbucks’ nascent turnaround under new CEO Brian Niccol?
Not lowering prices is apparently part of Starbucks’ new strategy, which was articulated by Niccol. He made it clear the firm will focus on maintaining profits and, to that end, his company recently ended a deal that was begun in June for food-and-drink deals between $5 and $7. Instead, Niccol’s strategy for reviving flagging sales appears to be centered around new promotions, such as “buy one, get one free” deals, typically made via the Starbucks app.
During his previous tenure as the turnaround CEO for Chipotle Mexican Grill, Niccol revived the company’s flagging sales through a series of measures, which included increasing digital sales, improving the overall customer experience and adding new menu items. But at no time did he focus on lowering prices; in fact, menu item prices were raised on several occasions under his leadership.
There’s no reason to think Niccol’s successful track record as a turnaround CEO won’t continue at Starbucks, in my estimation. On that score, a phenomenon the investment world has witnessed in the last few years is for a nucleus of diehard fans of iconic brands—from Disney (DIS) to WWE (TKO)—to shrug off price increases and continue supporting the brand at almost any cost. And while many of the old-line original fans of those brands are no longer patrons due to higher prices, such companies continue to post impressive metrics despite diminishing customer bases.
While product price hikes typically come at the expense of losing a potentially large (and more price-conscious) segment of the customer base, the focus on short-term profitability over customer satisfaction has become so ingrained in recent years that it’s hard to see Starbucks resorting to traditional price cutting methods to stimulate sales. And since the diehards are typically deep-pocketed enough to keep overall sales buoyant, companies like Starbucks are willing to tolerate a shrinking customer base if they can continue boosting profit margins.
Another reason for believing Starbucks’ turnaround has legs despite the price hikes—at least in the intermediate term—is the sizable stake (nearly $2 billion) that well-known activist investor Elliott Management recently bought in the company. Elliott believes the new turnaround CEO acquisition has set Starbucks on a “transformational” path and, given the investment management firm’s track record of reviving struggling companies, a successful outcome for Starbucks is more than likely.
As for the long-time customers who lament Starbucks’ higher prices, there’s always Dunkin’ or Tim Hortons.
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