by Rosetta Taylor

Created on: January 21, 2012   Last Updated: January 24, 2012

Coffee may come second only to water as the most-consumed beverage in the United States, but Starbucks now has its eyes on the drinking habits of the 1.3 billion people who call China home. The cover of the 2010 annual report of Starbucks Corporation (NYSE: SBUX) carries these words among the corporate aims listed: 'Accelerate growth in China'. With more than 17,000 stores in over 50 countries already, it is following hot on the heels of Subway (privately-held) and  McDonalds (MCD) and may already have surpassed Yum Brand’s (YUM) KFC. China looks like being the ultimate battleground on which these fast food chains will fight for supremacy.

Unlike its weighty competitors, Starbucks does not offer direct franchises for stand-alone locations, filling this space in its business model through its wholly-owned and separately-branded subsidiary, Seattle’s Best Coffee. Licensed operations are generally limited to spaces within existing retail premises, such as large bookstores and department stores. Around 75% of store revenue comes from beverage sales and roughly 19% from food, with the balance being coffee-making supplies and equipment to take home. There are also a number of licensing agreements with other companies for the manufacture and distribution of Starbucks-branded coffee, tea and other food products.

Coffee is a global commodity subject to extreme price volatility, even in the market for the high-altitude Arabica coffee purchased by Starbucks. It is affected by weather, politics and economic conditions in producing countries. Starbucks buys using a combination of fixed and future price contracts, as well as engaging in commodity price hedging, so although the supply stream is substantially guaranteed the price is not. The other supply line challenge faced is in the competition with other retailers and food chains for the prime retail locations so necessary to the company’s business model. Starbucks is also particularly sensitive to contractions in discretionary spending which result from an economic downturn, although they have mitigated this to some extent by positioning the prepaid Starbucks Card as a seasonal gift item.

As well as competition from the fast food chains already mentioned, who now offer their own high-quality coffee-based beverages, Starbucks is also challenged by local and smaller chain specialty coffee shops like Peet’s (PEET), and by supermarket coffee brands such as those made by the Swiss giant Nestlé

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