How Starbucks Makes Money (SBUX)

In the late 20th century coffee was a beverage, not a lifestyle brand. Then Starbucks (SBUX) came along, first spreading across the United States and then the world. Whether you’re a loyal Starbucks customer or not, you’re probably familiar with the broad strokes of the company’s history. Starbucks was founded in Seattle in 1971, expanded to a few dozen stores (in Seattle, Vancouver, and Chicago) by the late 1980s, then metastasized seemingly overnight into a 29,000-store colossus.

The Starbucks concept is about as low-tech as modern business gets, and the corresponding margins are delicious. Even an unadorned black coffee at Starbucks sells for quadruple its underlying costs. So what’s the company’s secret, and how did a glorified neighborhood espresso bar invade 70 countries and turn the consumption of coffee into an activity unto itself and a $82 billion business?

Starbucks released Q4 2018 earnings on Nov. 1, 2018. The coffee retailer reported that revenues of $6.3 billion this quarter, an 11% increase from the same time last year.

The company divides its operations primarily geographically, into the following divisions:

• The Americas
• Europe, the Middle East, and Africa (EMEA)
• China/Asia-Pacific
• Channel Development (corporate-speak for “everything other than retail stores,” including the packaged ground coffee you get at the supermarket and the single-serving Frappucino bottles at the convenience store)

Starbuck-owned stores accounted for 79% of its total FY17 revenues of $22.4 billion. Starbucks company stores encourage loitering, which might seem counterintuitive. But company store customers end up buying a lot of coffee on their extended visits – more than the people who line up at the licensed stores with the intention of drinking a quick coffee and getting out. Licensed stores’ operating margins are higher than those of conventional stores.

Also, the relative numbers have something to do with the licensed stores being located in North America, where the sedentary act of buying coffee and then settling in for a long and relaxed linger is well-established. Coffee drinkers in the rest of the world, at least outside of Vienna, have yet to adopt that behavior en masse.

The company also owns other brands that the uninitiated might think compete with Starbucks – such as Seattle’s Best and Teavana. At the retail level, the dominant majority of Starbucks’ revenue comes from drink sales. Beverages account for 73% of the sales mix. Pastries, sandwiches, and other food account for a historically consistent 20% of sales, with the remaining 7% split almost evenly between packaged coffee/tea and “other” (e.g., espresso machines and mugs).

On Nov. 14, 2012, Starbucks acquired the specialty tea store, Teavana, for $620 million. Five years later on Jul. 28, 2017, however, Starbucks announced that it would close all 379 Teavana locations due to poor sales and low chance of improvement.

With 29,324 stores, it’s a given that Starbucks has to franchise, right? Wrong. Starbucks has a very, very limited number of franchisees in the United Kingdom and South Africa, and it doesn’t accept franchise submissions in North America. But that doesn’t mean that every one of those stores is company-owned in the strictest sense. Notably, 79% percent of its revenues comes from company-operated stores, meaning that thousands of stores operate under licensing agreements. The airport kiosk, the bookless corner of your neighborhood Barnes & Noble (BKS), the stand-up service counter at the entrance to Safeway – all of those locations help Starbucks pervade the minds of its customers, and make it inescapable. 

The licensed stores are familiar on Starbucks’ home continent, if not dominant. These comprise 42% of the company’s total of 15,607 North American stores. But in the rest of the world, licensed stores are in the majority – including 55% of the company’s 6,443 stores in China/Asia Pacific and 80% of stores elsewhere. Add it all up, and company-owned stores predominate by only the slimmest of margins, 50.6% to 49.4%. 

Starbucks’ revenue continues to rise, faster than you’d expect for a company that appears to have permanently saturated most parts of North America. But it’s a big planet, and double-digit growth is standard for Starbucks overseas. Its total revenues have been increasing in China/Asia-Pacific for the past few years, but North American revenues still make up most of the company's total annual stake.

Starbucks cites premium single-serve products as its catalyst for growth, and why not? Modern single-serve coffee machines retail for more than machines that can brew 12 cups at a time – a circumstance that would seem to stand classical economics on its head. People enjoy paying for cachet, even when it makes no sense to do so. By and large, those are your Starbucks customers. 

Wholesale coffee prices are falling, thereby broadening the company's margins. Depending on where you live and how early you wake up, packed drive-thrus are a common sight at Starbucks throughout the world. The people in the cars are devoted to Starbucks’ particular varieties of high-margin whole-bean coffee. The company has expanded seemingly overnight and has continued to grow during the past year.