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Sunday, March 28, 2004 - Page updated at 12:00 A.M.
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Northwest stock contest 2004 | Consumer affairs

Starbucks steaming ahead with aggressive expansion plans

By Jake Batsell
Seattle Times business reporter

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The omnipresence of Starbucks has been punch-line fodder for years, perhaps most famously lampooned by a "Simpsons" cartoon featuring a mall filled entirely by Starbucks stores.

But if it seems like Starbucks is everywhere now, just wait.

"I believe that we will double the size of this company at least within the next five years, perhaps within the next three," Chief Executive Orin Smith told a crowd of Costa Rican coffee-farm owners and political officials in late January.

Starbucks, of course, already is one of the world's most ubiquitous retailers, with more than 7,600 retail stores in 34 countries. But as the company readies for Tuesday's annual shareholders meeting at McCaw Hall, it is pushing ahead with even more ambitious expansion plans.

Executives have told Wall Street to expect profit to swell by at least 25 percent this year as the company adds more rural locations, drive-through windows, wholesale accounts and foreign outlets. Chairman Howard Schultz has set an eventual goal of 25,000 worldwide stores, which would put Starbucks within shouting distance of McDonald's and its 30,000 locations.

And as it continues to sell coffee at a breakneck pace, Starbucks also is enticing U.S. customers to spend more time in its stores by offering wireless Internet access and a new digital-music service.

Analysts and observers have long warned of Starbucks hitting the saturation point. But with the company ticking off month after month of record sales results, that moment clearly hasn't arrived.

"This is a company that's opening three and a half stores a day," said Glenn Guard, senior analyst for Legg Mason in Baltimore. "There's plenty of evidence that would suggest there's still a lot of room left for this company to grow."

International growth

To hit the growth targets it has promised Wall Street, Starbucks needs copious amounts of coffee beans, and the company has taken steps to ensure a steady supply.
 
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Two months ago, Starbucks opened an agronomy office in San José, Costa Rica, designed to teach more farmers how to grow coffee beans that meet the company's picky standards. (Starbucks and other specialty chains use high-quality arabica beans, as opposed to the lower-grade robusta beans used for canned and instant coffees.)

The new office, billed as the first of its kind in the industry, aims to "improve the quality of coffee so that we can be assured of having a long-term supply that will enable us to continue to grow throughout the world," Smith said.

Over the past two years, Starbucks has doubled its international store count to more than 2,000. The chain shares its startup costs with its foreign partners, but the rapid growth still took a modest bite out of the bottom line: Excluding Canada, Starbucks' most mature market outside the U.S., the international division lost $18.5 million last year and $16.7 million in 2002.

Executives have vowed that the division will be profitable in 2004. In the first quarter, it made a $1.3 million profit outside of Canada, compared with a $7.8 million loss a year earlier.

While Starbucks runs most of its U.S. stores by itself, its strategy overseas has been to team up with local partners, splitting costs and profits and collaborating to come up with products that cater to each country's tastes.

The company has introduced versions of local noncoffee drinks such as strawberries and cream in the United Kingdom and green-tea Frappuccinos in Asia. In Taiwan, the birthplace of bubble tea, the company unveiled a drink last summer called the caramel coffee jelly Frappuccino, billed as "coffee and ice poured over chewy coffee jelly pieces, topped with an indulgent whirl of whipped cream."

Starbucks also has had to adjust its store design in foreign markets. Kathie Lindemann, a senior vice president for Starbucks' international division, said that about 85 percent of orders in foreign stores are consumed on the premises, which requires more seating and porcelain cups for those inclined to linger.

In the U.S., Lindemann said, it's almost exactly the opposite scenario: 86 percent of items are ordered to go, usually in paper cups.

When Starbucks entered Japan and Singapore in 1996, Lindemann explained, the company had the advantage of introducing the coffee-bar concept to tea-drinking societies with an affinity for Western brands. The company is making its foray into the trickier territory of Western Europe, which has a well-established cafe culture and is more resistant to American influences.

While executives say Starbucks' early results in cities such as Paris and Vienna beat internal projections, some analysts see long-term hurdles for the company in Europe.

"I'm concerned that western continental Europe will be more difficult than management currently believes," Guard said. "These are cultures that have had coffeehouses in their culture for a very long time. I think it's going to take quite a lot of time, if ever, to saturate that area with Starbucks."

Guard sees China as Starbucks' biggest overseas growth opportunity. Five years after opening its first store in China, the company has just 133 stores there, compared to more than 500 in much smaller Japan.

Starbucks continues to proliferate in the U.S. It now has stores in all 50 states, having arrived in West Virginia in December.

Aside from the perpetual mission to add more stores, the company is finding ways to keep customers inside once they walk through the door. More than 2,700 outlets now have wireless Internet access through T-Mobile, and earlier this month the company unveiled a digital-music partnership with Hewlett-Packard in which customers will be able to burn CDs at Starbucks stores.

More Starbucks bags of coffee are finding their way into supermarkets, where Starbucks saw sales rise 21 percent last year, and the company is landing more accounts in restaurants and universities.

To counter the perception that Starbucks is reaching saturation in the U.S., Smith and other executives often point out that the company is still growing in Washington state, its most concentrated U.S. market with 420 stores in a state of 6 million people. If Starbucks followed that ratio nationwide, it would have nearly 20,000 stores in the U.S. alone, though it's not likely that every region could support as many stores as the coffee-crazed Northwest.

A commanding lead

Starbucks has a whopping command over the U.S. coffeehouse market, with more than 5,500 stores. That's a store base well over 10 times larger than that of its closest specialty-coffee competitor, Diedrich Coffee of Irvine, Calif., which runs about 450 stores under the Diedrich, Gloria Jean's and Coffee People brands.

National doughnut-shop chains, such as Dunkin' Donuts and Krispy Kreme, may prove to be a more serious competitive threat. Dunkin' Donuts has been particularly aggressive of late, appealing to the blue-collar customer with a new line of espresso drinks priced about 20 percent lower than Starbucks.

Starbucks constantly faces the criticism that its shares are overvalued — its price-to-earnings ratio of 49.8 is well above the S&P 500 average of 22.1. Stocks with a high P/E ratio generally face high expectations for growth, and if earnings fall short of those goals, investors may sell their shares, causing the stock price to drop.

Still, many analysts are upbeat about the company's growth prospects, saying that none of its competitors is much of a threat.

"There's really no small specialty operators out there that are positioned to give Starbucks a run for their money in the next five years," Guard said. "But I do think Dunkin' Donuts will start to be thought of as a competitor to Starbucks, at least in some demographics."

Tully's Coffee Chairman Tom O'Keefe said he doesn't have any illusions about unseating Starbucks as the nation's specialty-coffee leader.

"I think the goal right now is who's going to be No. 2," O'Keefe said earlier this month. "Is it realistic to think that someone can evolve ... to be a clear No. 2? Absolutely."

O'Keefe, a Starbucks shareholder, often attends the company's annual meeting. With every market Starbucks enters, he says, more people become regular coffee drinkers — and potential Tully's customers.

"Every time I hear about Starbucks adding more stores or doubling their sales, all it does is make the umbrella bigger for us," O'Keefe said. "I'm tickled they're having great success."

Jake Batsell: 206-464-2718 or jbatsell@seattletimes.com

Copyright © 2004 The Seattle Times Company

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