Starbucks Franchise Cost

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					                                  Starbucks Wars
            How McDonald’s and Starbucks Defined their Industry
                                    By Rick Kowalski

       One can learn quite a bit about where the coffee house business is headed just by
studying how the quick serve restaurant (QSR) industry evolved.
       The coffee house business is moving through this evolution much quicker than the
QSR business, but the growing pains will be very similar. One fact resonates above all
others from QSR evolution: the QSR brands that clung to their original positioning grew
into strong competitors. The chains that lost their original positioning found themselves
in a steep sales decline that some were able to reverse and others were not.
       One very common way that chains lose their positioning is to add a vast new
array of products to their menus. Menu proliferation was a buzz-word in the 80s. QSR
chains were throwing every new product they could find at their customers without a
thought of how it would affect their market position. This almost ruined chains like Jack-
in-the-Box and Carl’s Jr., and even McDonald’s has fallen victim at times to this failed

Starbucks Captures Breakfast
       Recently Starbucks announced its intention to launch breakfast products. Could
this be a natural extension of their morning coffee business and add to the value of the
Starbucks enterprise? It definitely makes intuitive sense to leverage Starbuck’s morning
customer traffic and expand on it by offering food items appealing to that day part. Or, is
this the beginning of Starbucks menu proliferation initiative that will lead to an erosion of
its customer base?
       Will breakfast items, coffee makers, tea bags, plastic cups, mints and music all
begin to erode Starbucks position as the leader in specialty coffee?
       Will we be able to find everything from laxatives to frozen waffles in the
Starbucks of the future?
       And, is Starbucks in danger of aggressively trying to evolve into all things for all
people at the ultimate cost of its core business-specialty coffee?

QSR vs. Today’s Coffee House
       Other complicating factors in this interesting evolution of the coffee house
business are the differences between QSRs and coffee houses. The significant differences
between a traditional QSR (McDonald’s, Burger King, etc.) and a coffee house include
service, menu, marketing, and product. These differences are important, yet one
difference not yet discussed is the need for that “third place” between home and work.
Starbucks founder Howard Schultz had it right when he talked about Starbucks filling
this “small luxury” need.
       The coffee house is a warm comfortable place where people can go when they
want to escape work, and either can’t go home or don’t want to. QSRs haven’t done a
great job in filling this need. Their design/décor has been more inclined towards
durability and ease of cleaning, supported by colors, seating and hurried atmosphere that
turns tables quickly. Their products are targeted towards meal occasions, not spending
discretional time reading, socializing or working.
       Enter the Starbucks wars. Seeing the ease of entry, fierce loyalty of great coffee,
and the handsome profit margin, QSRs are rushing to develop specialty coffee programs
in an effort to capture more share with better coffee blends.

Dunkin’ Not in Third Place
       The anomaly to this discussion is of course, Dunkin’ Donuts. Dunkin’ is a strong
regional coffee competitor in the northeastern U.S. The typical Dunkin’ customer is also
a heavy QSR user, but they are also a heavy coffee drinker. Coffee sales at a typical
Dunkin’ in the Northeast will represent 65% or more of total sales. Donuts are something
that Dunkin’ franchisees wish they didn’t have to mess around with. They have found
that pouring coffee is a much easier and more profitable business.
       Dunkin’ is clearly a QSR, but is also positioned in coffee. Yet, they don’t really
fit into that “third place” definition. Dunkin’ users are much more inclined to grab and go
rather than sit and chat. The typical Dunkin’ Donuts store design is not necessarily
inviting or warm and welcoming. Both posters hyping new products and washable
surfaces are the rule. How will the Dunkin’ brand play in markets where a “third place”
defines the coffee house?
       Dunkin’ management has publicly stated they want to expand towards the west
coast. The challenge this Dunkin’ brand will face is whether customers west of the
Mississippi will recognize the chain as a great place for donuts (and maybe other fast
options) or a coffee place. This is important because the Dunkin’ business model turns on
its ability to sell significant amounts of coffee. Supporting the expansion of the Dunkin’
brand solely on donuts and breakfast sandwiches will be difficult, especially because they
use franchising as their method of expansion.
       Will Dunkin’ management fundamentally change the way the store looks and acts
in order to put the brand in the “third place” arena, and if they do, will customers buy it?
       Dunkin’ may also be answering the siren’s song of more menu appeal (a.k.a.
menu proliferation) by adding Supreme Omelet sandwiches and lunch items that help
bolster their weaker day part. With the hiring of a top-notch executive chef to develop
new menu items, as well as a team of culinary experts and a multi-million dollar test
kitchen, the research and development effort at Dunkin’ is a well-oiled machine.
       Dunkin’s product development efforts appear to be targeted towards the
McDonald’s customer rather than the more upscale Starbucks customer.
       Starbucks is also adding more SKUs with retail merchandise, so while Dunkin
beats a path to the McDonald’s customer, Starbucks is apparently looking to take share
from big box retailers, QSR and the Internet! Starbucks aspirations are very big, indeed.
       While Dunkin’ and Starbucks slug it out for more market share, traditional coffee
house brands continue their gains with more distribution and friendlier, more comfortable
environments. It’s A Grind and Diedrich’s, for example, provide a very inviting and
coffee-focused atmosphere, perfect for socializing and relaxing. These brands that
cultivate an inviting atmosphere and continue to focus on coffee as a complex beverage
with a variety of flavors appeal to the customer who isn’t interested in a QSR
environment or the products they serve.

Three Categories Emerge
       As the big players and other brands continue their evolution, the following three
primary market segments appear to be emerging in the coffee house industry:
               1. The Starbucks segment. This segment is defined by the largesse of the
       Starbucks brand and all that goes with it. Its direction is flowing towards more
       products that continue to drive same store sales growth. The relative price/value
       position vs. coffee house competitors is high.
               2. Dunkin’ takes charge of the second segment with a more “everyman”
       approach to coffee. This segment walks and talks much more like QSR than does
       the Starbucks segment. Its relative price/value position vs. competitors is in the
       lower-middle area. However, there is no real credible competition in the donut
       segment. Products and prices are below Starbucks, and this concept is positioned
       fairly well if economic times become difficult. Merchandise is not part of the
       product mix at Dunkin partly because of its market position, and partly because its
       franchise business model would not tolerate it.
               3. Experiential marketing chains and independents. This segment is being
       defined by quality and customer service, driving higher end coffee house players
       such as It’s A Grind, Caribou Coffee, Diedrich’s Coffee and a handful of other
       chains, as well as many independents, from coast to coast. Products and
       atmosphere are clearly a cut above Starbucks, and several levels above Dunkin’.
       Customers tend to be upper income professionals or someone looking for more
       than a hot cup of drip coffee to grab and go. This segment treats coffee as a rare
       commodity with mysterious origins and political ramifications. The atmosphere of
       the coffee house is closer to a club hangout for movie stars like the Pure or Rain
       in Las Vegas, or the SkyBar in Hollywood. The relative price/value position vs.
       competitors is only slightly higher than Starbucks.
       Other segments may emerge as this industry continues its evolution and the
current leaders may inadvertently re-position their brands in a way that enhances value or
erodes it. One thing is for sure, however, the coffee house industry is evolving in a
similar way as the QSR industry, but at a much faster rate.
       Being a student of past QSR successes and failures could help coffee house
brands avoid serious pitfalls.



Rick Kowalski is Vice President, Operations for It’s A Grind (IAG Coffee Franchisee
LLC), based in Long Beach, California. He has an extensive foodservice background,
including notable brands such as KFC, Hilton Hotels and Dunkin brands. An
accomplished strategist, marketer and operations professional, Kowalski also holds a
Masters of Business Administration from Pepperdine University. He and his wife
Valerie, along with their two children live in Coto de Caza, California.

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