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Howard Schultz says he’s just popping into Starbucks SBUX 0.38% for a cup of coffee this time. The man who ably guided the chain from 1987 to 2000, and then returned in 2008 for a nine-year encore, will become interim chief executive on April 4 as the company searches for a permanent successor to CEO Kevin Johnson.

He’s returning at a challenging time. Starbucks’ shares are down by 31% since peaking last summer as unionization pressure and inflation dog the company. The company says it will pay U.S. staff an average of $17 an hour by this summer.

Starbucks raised U.S. prices in October and January, and Mr. Johnson told investors last month that the company has “additional pricing actions planned through the balance of this year, which play an important role to mitigate cost pressures.” It is natural to wonder if that will leave an opening for competitors like Dunkin’ and McDonald’s —older chains that both made a midlife push into espresso drinks to capture some of the Starbucks magic. A “medium Dunkaccino” costs about $2.09 and a McDonald’s “Medium Frappé” $2.89, while the closest Starbucks equivalent, a “Grande Frappuccino,” is typically $3.95—or about 90% and 37% more, respectively, according to Fastfoodmenuprices.com.

Focusing on that price gap betrays a misunderstanding of Starbucks’ business model, though. Its beverages are as close as fast food gets to a Veblen good—one that becomes more desirable as its price increases. Distinguishing itself from the competition, with a literally addictive product to boot, creates a more loyal customer base. For example, in its most recent quarter, Starbucks reported an 18% increase in U.S. comparable-store sales but only a 12% increase in comparable transactions. The difference was ticket size.

But even though selling a cup of brown water and foam for more than a gallon of gas hasn’t yet caused customers to bat an eyelash, what happens when actual gallons of gas surge in price, as they have recently? Evidence from the 2007-09 recession is concerning. Comparable-store sales grew by an average of around 8% yearly chainwide between 2003 and 2006. They then fell by 3% in 2008 and 6% in 2009 as housing and stock prices slumped, unemployment rose and pump prices hit a record high. Today, with jobs plentiful and stocks relatively buoyant, signs of thrift remain scarce, but even affordable luxuries get the chop when household budgets are squeezed.

The chain’s potential pitfalls at home pale in comparison with those abroad, though. The last time Mr. Schultz strode back into the C-suite, China was its biggest emerging market but accounted for just 2% of the company’s stores. Starbucks wants to open its 6,000th outpost there this year, eclipsed only by the U.S., with 15,500 at last count. In contrast to its home turf, the chain has faced a social-media backlash in China for price increases. It also has taken heat for allegedly serving expired ingredients at one store, receiving an admonition from the Communist Party’s mouthpiece newspaper, People’s Daily: “Starbucks, please take back your arrogance.”

Moreover, its competitors there, both local and foreign, have similar brand cachet and aggressive growth plans of their own. Canada’s Tim Hortons more than doubled its store count in China last year, opening its 300th outlet in October. And Luckin Coffee, bouncing back from a financial scandal in which it fabricated transactions, had slightly more stores in China than Starbucks late in 2021 and was again growing quickly.

It is hard to tell how much price-sensitivity, Covid-19 lockdowns and competitive pressure are affecting the company in China, but the results aren’t pretty. Starbucks had a 14% decline in comparable-store sales in the nation for the quarter ended Jan. 2—a measure that was flattered by value-added tax exemptions in the year-earlier period. The current quarter has seen more widespread lockdowns.

Of greater concern than temporary hits to its business are geopolitical crosscurrents. Starbucks has only 130 stores in Russia, which it closed in response to the nation’s invasion of Ukraine. But China’s continuing friendliness to Russian President Vladimir Putin’s regime has raised the specter of U.S. sanctions against its much larger economy or a local backlash against American brands. Starbucks, especially with Mr. Schultz back at the helm, might be a relative safe harbor at least. Days before President Biden’s inauguration, Chinese leader Xi Jinping released an unusual open letter to Mr. Schultz, a frequent visitor to China and himself a one-time U.S. presidential candidate, asking him to help repair bilateral relations.

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How have your coffee-buying habits changed since inflation recently began to rise? Join the conversation below.

Reading diplomatic tea leaves or coffee grounds is hard. It’s easier to interpret cold, hard numbers: Even as Starbucks enacted price increases starting in October and announced more, analyst consensus revenue expectations barely changed for this fiscal year. But operating profit projections have been pared by 7.5% since then, according to FactSet. It can’t run fast enough to stay still. And Starbucks shares are as expensive today, as a multiple of prospective earnings, as they were on average during the decade leading up to the pandemic.

Shrinkflation is everywhere, but Mr. Schultz will have his work cut out for him selling investors a Grande priced like a Venti.

Starbucks trails only McDonald’s as the largest restaurant chain by market capitalization. WSJ’s Heather Haddon explains why mobile technology has become a business priority for Starbucks and garnered it a loyal customer base. Photo: Stanislav Kogiku/Zuma Press

Write to Spencer Jakab at [email protected]

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Source: WSJ

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