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Starbucks CEO Howard Schultz has big plans for the coffee chain. (Moe Doiron/Moe Doiron/The Globe and Mail)
Starbucks CEO Howard Schultz has big plans for the coffee chain. (Moe Doiron/Moe Doiron/The Globe and Mail)

Retail

Starbucks tries to build bridge from café to grocery store Add to ...

Howard Schultz once dismissed instant coffee as too lowbrow for his premium Starbucks Corp.

Now, the chief executive officer of Starbucks is selling $300-million (U.S.) a year of Via instant coffee and planning an aggressive expansion of his consumer product lineup that will take the Starbucks brand much deeper into grocery store aisles.

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As part of an effort to sell more products with higher profit margins than those of the core coffee business, Starbucks is developing more branded foods and beverages, which it will also distribute through food retailers. While Mr. Schultz declined to give details on what kinds of food and drinks the chain is planning to market, he said part of the offerings will focus on health and wellness; it will all start to be rolled out over the next year or two.

Mr. Schultz is a noted risk-taker, and famously returned to the helm of the company in 2008 to lead its revival after a doomed over-expansion. But his consumer product strategy now puts pressure on Starbucks to show that it can extend its brand beyond its core strength and into areas in which it has no track record.

"Over time it will rival the scale of our retail business," Mr. Schultz, 57, predicted in an interview about his blueprint for a full-fledged consumer products division in the business he built almost from scratch 40 years ago. "We're deeply committed to building a multibillion dollar [consumer products]business."

Mr. Schultz is staking out the grocery shelf at a time of limited growth opportunities in his U.S. retail base and slimmer profit margins in his still-expanding international division. In the United States, Starbucks is now adding roughly just one-tenth of the 1,000 cafes it built annually before 2008, when he put a stop to growth for growth's sake.

Packaged goods appeal to Mr. Schultz because they promise fatter margins than those in the retail coffee business. Starbucks estimates its consumer products segment can yield operating margins of 30 to 35 per cent, compared to U.S. retail margins that are expected to be close to 20 per cent this year. It makes the consumer products model look tempting, if he can get it right.

Already, as part of a move to play a bigger role in the distribution of Starbucks' existing consumer products, he's grabbed control from giant Kraft Foods Inc. for shipping Starbucks packaged coffee to supermarkets.

Last month, he struck a deal with a leading single-serve coffee maker Green Mountain Coffee Roasters to sell packs of Starbucks- and Tazo-branded coffee and tea for use in Green Mountain's Keurig single-cup brewers.

Under the deal, Starbucks will sell the single-serving coffee and tea packs at its own stores as well as at other retailers in the U.S. and Canada, starting this fall.

It paves the way for Starbucks to cash in on one of today's fastest growing java segments.

Coffee companies are racing to gulp up a piece of the single-serve pot: Tim Hortons, which is also ramping up its packaged coffee sales in grocery chains, is studying launching its own single-serve brew, chief executive officer Don Schroeder revealed at a conference last month.

Sales of coffee pods - which pop into the coffee machines - are relatively small in the North American coffee market overall but growing by leaps and bounds.

In Canada, pod sales soared by 8,634.6 per cent in the past five years to $34.2-million (U.S.) in 2010 and, in the U.S., by 866.7 per cent to $508.8-million, according to market researcher Euromonitor. Part of the appeal for companies is that, like the business of razors and razor blades, the big profits are made in repeat purchases of the pods - or razor blades - rather than the machines or razors themselves.

Mr. Schultz said that Via and Keurig and so-called K-cup single-serve systems are just the beginning of a big push at Starbucks into consumer products.

Just as he believes that Via reinvented the instant coffee sector, he thinks he can do the same in other packaged goods, tied in some way to coffee, he said. While he's not elaborating on the new products being developed, analysts suggest they could range from coffee-flavoured chocolate bars to more varieties of teas.

"We believe that we can create something that hasn't existed before," he said, adding that he's hired executives from packaged-goods titan Procter & Gamble Co., among other such companies.

To help cement the products' ties to the Starbucks coffee, its customers in the next while will be able to use its loyalty card in grocery outlets when they buy the chain's products, he said.

Still, some industry experts warn that Mr. Shultz may be biting off more than he can chew.

The Seattle-based chain has yet to distinguish itself as a destination for food while its instant coffee, although a more upscale version of supermarket counterparts, waters down its romancing-the-beans image, said Douglas Holt, president of consultancy Cultural Strategy Group in Fort Collins, Colo.

Starbucks also faces the challenge of getting its new merchandise on to supermarket shelves, Mr. Holt said. More than ever, grocers are culling their shelves of different versions of the same product, often in favour of their own lucrative private labels.

Mr. Schultz has shown his openness toward new concepts in the past, including the instant coffee idea. More than two decades ago, he turned up his nose at the idea of instant coffee at Starbucks. But after he tasted a powdered-based Starbucks-like coffee in the late 1980s, developed by a cell biologist, he liked it so much he eventually put a team on the project. Internally code-named JAWS ("just add water and stir") and later Stardust, the Via product was born. Today, he's turning his attention to a new breed of products.

"The rules of engagement for any company, small or large, that is trying to build a consumer-based business is changing so significantly that you just can't embrace the status quo as an operating principle," he said.

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Battle of the pods

Single-cup brewing systems have become the coffee industry's newest battleground.

The systems use a pre-packaged coffee "pod" with an attached filter. Hot water is forced through the pod to brew a cup of coffee. The pods are popular in offices and hotels and gaining ground in home use.

Despite accounting for only 10 per cent of the more than $8-billion (U.S.) coffee market in the United States, the niche market has attracted all the major players. And it's no surprise, with coffee pod sales expected to double by 2013, according to Euromonitor International.

Keurig K-Cup

Price: From $130

Owned by: Green Mountain Coffee Roasters Inc.

Brands: Starbucks, Timothy's, Dunkin' Donuts, Folgers, Tully's, Van Houtte.

Keurig, the market leader in the U.S., achieved success by combining its pod technology, called K-Cups, with popular regional brands. Three of the top five U.S. coffee brands sell products for the Keurig system. In all, more than 200 varieties of coffees, teas, ciders and iced teas are available. Customers can also purchase their own reusable filter, called My K-Cup, which can be used for coffee or tea.

Nespresso

Price: From $250

Owned by: Nestlé SA

Brands: Nespresso offers 16 pod types for home use, and eight for restaurants, hotels and offices

The biggest competitor to Green Mountain's Keurig, Nespresso posted sales of more than $3-billion in 2010. The company, which has a larger presence in Europe and sells its products in more than 50 countries, has sold 26.9 billion coffee capsules and 13 million brewing machines since 1986. Because it owns its own system and coffee pods, the company can control every stage of production.

Tassimo

Price: From $200

Owned by: Kraft Foods Inc.

Brands: Nabob, Maxwell House, Gevalia, Twinings

The Tassimo system works a little differently, in that it scans a barcode on every "T-Disc" pod for brewing instructions. The company says this guarantees every cup is brewed correctly. The system also uses dairy components to create blended coffee drinks. The company, which previously made Starbucks-branded pods, is expected to be a big loser in Starbuck's deal with Green Mountain.

Other brewing systems

Senseo by Sara Lee Corp., Dolce Gusto by Nestle, Flavia by Mars Inc., A Modo Mio by Lavazza, Cuisinart, AutoPOD and My Cafe by BUNN.

Amit Shilton

Follow on Twitter: @MarinaStrauss

 
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