Starbucks' Problem: Massive Growth Begets a Need for More Massive Growth

Seeking Alpha
Mar 26th, 2007 with stocks: SBUX

Profit Margin Man submits: Starbucks' (SBUX) growth engine is the 'be all and end all'. The Founder has made a commitment to the market, so all staff is directed to pursue growth. While management says 'only good deals', folks get rewarded for deal numbers and there is no penalty for underperforming stores or bad growth forecasts. There is no penalty for underestimating how much a new unit might cannibalize another existing one; in fact, no one even tracks cannibalization in any serious manner. Why should they? Comparable store sales continue to increase, so how could there be a problem?

Well, consider this: Suppose a given market area has 300 existing Starbucks and 30 new stores open during the year so, at year's end, the area has 330 stores. Those stores came on line over the 12 month period. The typical store 'ramps up', hitting on all cylinders 5 to 9 months after opening. Looking at comparable store sales for the 2nd year often shows a 15 to 20 percent increase because the second 12 months are at the full-volume and the ramp up is gone. Consider what 30 stores comping at 20% due for the comparable growth of the whole 330. If the 300 don't grow at all, your financials will still show a 2% sales increase due to the 30 that 'grew' by 20%. Massive growth begets a need to continue massive growth up to a point.

In addition, the drive-through stores are doing significantly more volume than the regular ones. The hidden part of that equation is that wherever the drive-throughs are opened, the non-drive-through locations are cannibalized far more severely and it is the higher sales volumes that drive the profit margins to the expected returns. Dropping the sales on a $750,000 store by $150,000 due to impact may drop store profit by as much as 40%.

Either it is built for market share's sake, forget the margins, OR they are going to have to start closing the stores not delivering the expected profit margins, i.e, the older ones. With just 10 year leases, closing is really pretty easy. Oh, but they can't do that -- Mr. S promised 40,000 stores.

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Disclosure: Author has no position in SBUX