Howard Schultz’s return to the coffee chain brings a bold pivot to boost profitability while risking what makes Starbucks a premium brand

“New Starbucks Opens In Restroom Of Existing Starbucks" was a brilliant satirical headline back in 1998 when the coffee chain already seemed ubiquitous. As of a month ago, the day that Howard Schultz returned for his third stint as chief executive officer, it had nearly 10 times as many shops in North America.

When Mr. Schultz revealed that store count along with the chain’s unspectacular fiscal-second-quarter results, the chain’s shares were down by more than 40% from their all-time high last summer. Cost and wage pressures along with a bitterly contested unionization drive at home, and a recent sales collapse in China, the chain’s second-largest market, all weighed on sentiment. But this past Wednesday, the first trading session following the release, the shares surged by nearly 10% in their best day since a sharp rebound in March 2020 following the Covid-19 market panic. That came despite the fact that the company suspended financial guidance for this year.

The jump was a vote of confidence in Mr. Schultz’s plans. His strategic shift also has plenty of pitfalls, though. One bold move was to halt the company’s multibillion-dollar share buyback program at a time when the stock was in the doldrums. Since recently departed Chief Executive Kevin Johnson took over in 2017, the chain has repurchased about a quarter of its shares outstanding. That move was responsible for most of its earnings-per-share growth over that time, including projections for 2022. Mr. Schultz said on the company’s call that, while buybacks deliver a good return, the company could do better reinvesting the cash.

He spelled out some sensible-sounding efficiency investments that also risk damaging the chain’s brand cachet. They include installing drive-throughs in 90% of new locations and machinery that will allow baristas to handle increasingly complex customer orders more quickly. Starbucks is less and less the “third place" between the office and home for customers to socialize, relax or mooch off free Wi-Fi while nursing a Caramel Macchiato.

If customers are just picking up a paper cup of foamy brown water possibly made by a machine, why pay what analyst Lauren Silberman of Credit Suisse says is a 43.5% premium on average compared with similar beverages at quick-service restaurant peers like McDonald’s? The environment at a Starbucks is more inviting and upscale, but only 30% of customers now consume their purchases on premises. In a sign of its fading brand value and ubiquity, a similar beverage at Starbucks is about 11%-12% cheaper than at other specialty coffee shops.

What isn’t cheaper is running a Starbucks these days. In the most recent quarter the chain said that product and distribution costs rose by 23.8% and store operating expenses by 17.4% year-over-year, even as net revenues rose by just 14.5%. There are more price increases on tap. In the U.S., more than half of Starbucks’ sales gain was a function of higher ticket sizes—largely a result of price increases—as opposed to more foot traffic.

If costs are the problem, drive-throughs are almost certainly cheaper to operate, though Starbucks didn’t respond to questions as to how much cheaper. Investors should consider what Starbucks management reportedly feared when it first invested in drive-throughs—that it was a bad look for the chain. After all, part of its appeal is being a more refined place with prices to match, compared with, say, Dunkin’.

It will be a delicate balance—especially if high inflation pinches consumer pocketbooks to the point that people think twice about affordable luxuries like expensive takeout coffee. Automation and more-efficient store formats could help keep Starbucks cheap enough to retain its loyal customers. Or they could cheapen the experience, sending some to competitors.

This story has been published from a wire agency feed without modifications to the text

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