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Growing Competition from Both National Chains and Neighborhood Coffee Shops Threatens Starbucks’ Supremacy

While Starbucks still has an edge in the highly competitive U.S. coffee and breakfast market, other chains are expanding and picking up market share.

Amid slowing growth in an increasingly crowded market, coffee chain powerhouse Starbucks announced it will close 150 underperforming, company-operated U.S stores in 2019. Historically, the Seattle-based chain has closed about 50 stores per year. For now, the company, which pioneered the upscale coffee shop business, continues to dominate the U.S. market with 14,000 stores.

The upcoming store closings will take place primarily in urban markets that are “densely penetrated” with Starbucks locations. Most will be in major metropolitan areas.

“Certainly, there’s some cannibalization or saturation going on, particularly in some of those more highly penetrated markets where it sounds like most of the closures are going to be,” says Morningstar Inc. Analyst R.J. Hottovy. “When you cut out the bottom-performing stores, that can have a pretty meaningful impact on the company’s overall results. It’s not like they’re going to stop opening up stores. They just need to optimize the store base.”

According to Neil Stern, senior partner at Chicago-based consulting firm McMillan Doolittle, Starbucks remains a very successful concept. “But this is a case of opening too many stores too close together. The chain is fine, but the business model needs fine-tuning, particularly as customer habits change.”

They chain has also struggled a bit on the innovation front, Hottovy adds, noting that there haven’t been any new noteworthy products introduced over the past two years.

Starbucks’ sales are slowing down. The company announced it expects just 1.0 percent  growth in same-store sales in the third quarter—the worst performance in about nine years.

“Our recent performance does not reflect the potential of our exceptional brand and is not acceptable,” said Starbucks new CEO Kevin Johnson in a prepared release. “We must move faster to address the more rapidly changing preferences and needs of our customers.”

Johnson has been in charge of the company since Howard Schultz, executive chairman, stepped down in June. November will bring another high-profile departure as CFO Scott Maw retires.

Part of the reason for the chain’s recent dip in sales could be attributed to the fact that Starbucks closed more than 8,000 locations on May 29 for racial bias training following the arrest of two African-American men who were waiting for a friend at a Philadelphia Starbucks. The chain also delayed the launch of its spring/summer marketing campaign, which may have impacted sales.

Shift from urban to suburban

Starbucks plans to continue to expand, but will aim to target areas with fewer coffee shops. It’s shifting to “underpenetrated markets;” in other words, from cities to more suburban areas.

One reason is increasing competition from trendy, independent neighborhood coffee shops. It’s the small, artisan roast cafes that offer customers an experience, says Scott Holmes, senior vice president and national director of the national retail group with brokerage firm Marcus & Millichap. Even Starbucks acknowledges that the “collective group of independent coffee shops” poses competition, because they’re doing what Starbucks has done for years in terms of service and atmosphere, said Maw at the UBS Global Consumer and Retail Conference.

“That source of competition tends to be more in the urban areas,” notes Holmes. “So, where Starbucks still sees strength is in the suburbs where they can be the only real game in town.”

Meanwhile, Howard Schultz has also blamed hikes in minimum wages and other regulatory requirements in big cities for some stores being unprofitable.

Starbucks has a massive footprint of more than 28,200 locations worldwide. In 2017, it announced plans to open 3,400 new U.S. stores by 2021 and 12,000 new stores globally. It’s heavily focusing on Asian markets, including China.

“Where they think they will grow the most is in markets like China where their year-over-year growth is 9 or 10 percent vs. in the United States where same-store sales are down in the 2 to 4 percent range,” Holmes says. “They’re looking at how do we duplicate what we did in the Unites States in markets that haven’t matured yet.”

Other initiatives underway

To increase sales in the U.S., Starbucks plans to offer new beverages that will target consumers' growing preference for healthy nutrition. The chain is also planning to increase its digital initiatives and encourage more customers to use its app. The company added 5 million new digitally-registered customers since April 2018 and 2 million active Starbucks Rewards members year-over-year, representing 13 percent growth from the previous year.

However, the app has posed some challenges. Starbucks has experienced congestion issues at that front of its stores with mobile orders during peak hours.

“Starbucks built its brand by being a third place away from home and office for people to congregate and now by opening up for mobile order, effectively, you’re trying to serve two audiences at once, which is very difficult to do out of the traditional stores,” says Hottovy. “They have to figure out how to grow and how to configure the restaurants themselves. Things are changing in this industry so quickly, and this is a space that once upon a time, people didn’t think there was going to be a way for online and mobile order sales to really disrupt it. But it’s pretty clear that we’re seeing that disruption take place, and they just need to better optimize their store base for those trends.”

Hottovy says he can see a day in the future when Starbucks will have stores that are designed for more mobile orders or even mobile order-only, express stores. “Then you’ve got these Reserve high-end stores that are more experiential to satisfy different customers,” he adds. (Reserve Roastery is Starbucks’ upscale business).

Other Starbucks initiatives that are grabbing attention include its ban on plastic straws and a new “signing store” designed to serve the deaf.

Competition is brewing

Meanwhile, the coffee wars continue among the various market players. In addition to the more upscale, independent coffee shops, competition from lower-priced fast-food chains, including Dunkin' Donuts and McDonald's, is heating up.

Starbucks’ market share among leading U.S. coffee chains is 39 percent, according to Statista. Dunkin Brands Group is next at 22 percent. After that, the other 38 to 40 percent are smaller players.

“From a pure coffee point of view and as a chain, there’s really only Starbucks,” says Stern. “But a lot of other companies are also selling better coffee, from McDonald's to Dunkin’ Donuts​. The chain to watch is JAB Holding Co., which has lots of coffee assets: Caribou, Peet’s, Stumptown and Intelligentsia, in addition to Panera. Combined, they could become a potent competitor to Starbucks.”

Dunkin’ Donuts has about 9,200 U.S. locations and plans to add about 1,000 new U.S. stores by year-end 2020. The chain has a goal of eventually operating more than 18,000 U.S. locations. It’s also rolling out drive-thru lanes and has a new digital-catering platform it’s testing in several markets.

McDonalds, which operates 14,400 restaurants, rebranded its McCafe brand. “McDonald's is always a serious competitor, given their scale and breakfast business,” Stern says. “They’re a threat and have plans to upgrade their breakfast business.”

Canada-based Tim Hortons has 726 U.S. locations. It was acquired by Burger King in 2014 with major expansion plans. However, the jam-packed fast-food space and tensions with franchisees resulted in Tim Hortons pulling back in some of its largest U.S. markets, reports BNN Bloomberg.

Meanwhile, Coffee Bean and Tea Leaf announced it will triple the number of its U.S. locations by 2028. The chain plans to expand its number of U.S. cafes to 1,000 within the next five to 10 years, Reuters reports.

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