Posted: June 26th, 2015

Topic: Group External Industry Analysis

 

Industry Overview

The coffee shop industry is part of the subsector, “Snack and Non-Alcoholic Beverage Bars,” which is part of the industry classification “Food Services and Drinking Places.” A coffee shop is a cafe-like foodservice establishment focused on serving coffee, teas, and light snacks. Beverages typically sold by coffee shops include brewed coffee and tea, espresso drinks, cappuccinos, café lattes, cold blended beverages, bottled water, soft drinks, and juices. Food includes pastries, bakery items, desserts, sandwiches, and candy. Many coffee shops sell whole or ground coffee beans for home consumption. Some coffee shops sell coffee or espresso-making equipment, grinders, mugs, and other accessories. Most coffee shops serve high-quality, premium coffee known as specialty coffee.

Coffee shops generally are designed to create a sociable environment for people to gather in small groups or relax individually. Coffee shops have a long history of offering environments in which people can easily socialize amongst their own groups and with strangers. This is reflected in language; when people say “meet for coffee,” they primarily mean meet to socialize or talk. Historically, coffee houses have been places where people gather, chat, work, write, read, and pass the time. The layouts of coffee shops often include smaller nooks and larger, more communal areas. In a more crowded coffee shop, it is common for strangers to sit at the same table, even if that table only seats two people. The design of most coffee shops is of one that encourages communication among strangers.

Given the broad scope of the coffee shop industry, our focus will be on the Seattle area. This market includes approximately 968 companies such as Starbucks, Tully’s, and Seattle’s Best. Seattle is considered a world center for coffee roasting and coffee supply chain management. Many Seattle-area people are coffee enthusiasts and they maintain a coffee culture in Seattle’s many coffeehouses.

Industry Key Economic Features

Market Size: 11.6 billion dollars nationwide

Scope of Competitive Rivalry: Local

Market Growth Rate: 2.7 percent average from 2009-2013 annually

Stage in Life Cycle: Mature

Number of Companies in Industry: 968 companies in Seattle, WA. Market share of main rival, Starbucks is 87%.

Customers: About 216,000. Average of 34% of the population buys coffee from a premium coffee shop.

Degree of Vertical Integration: Mixed. Some small business coffee shops roast their own beans, while most purchase product in its finished form. Starbucks and other large competitors work directly with farmers.

Ease of Entry/Exit: Low. Product itself is a low cost, the main expense for entering into the market is real estate and some minimal equipment cost.

Technology/innovation: The process for making coffee is standardized; however, the advent of techniques which make coffee taste better are being utilized more and more. These techniques often make the process of brewing a single cup of coffee slower (e.g., pour over, cold brewing, clover).

Product characteristics: Products are weakly differentiated; the ambiance of the space is the true differentiator.

Scale Economies: Large competitors such as Starbucks have a great advantage of scale. The small business coffee shop must purchase in small amounts.

Key Industry Cluster: Seattle is a cluster location for coffee shops, with Starbucks headquartered in Seattle as well as many other smaller rivals, more than anywhere else in the US.

Learning and experience effects: Moderate. Serving more customers by baristas working faster is a factor in some shops. However, many coffee shops aren’t focused on speed, but quality and ambiance.

Industry profitability: Growing. The coffee industry fluctuates with the economy. When the economy is good, consumers have more discretionary spending money.

 

 

 

 

Porter’s Five Forces of Competition

1. Rivalry among competing sellers

Rivalry among competing sellers in the coffee industry is high. In Seattle, there is a coffee shop on every corner, so the choices for the consumer are plentiful, and it is very easy for a consumer to switch brands by just walking across the street and ordering their standard beverage. Coffee shops open and close regularly as a result of the amount of choices consumers have; therefore, they offer deals to get consumers in the door, which in turn, increases competition. Starbucks, who is the industry leader, has been also acquiring other large local coffee companies such as Seattle’s Best Coffee, which makes them an even bigger rival than before.

2. Potential entry of new competitors

The coffee industry always has the potential entry of new competitors. Many of the small coffee shops cannot compete anywhere close to the same level as Starbucks when it comes to economies of scale. These individual shops often only store the amount of product they can hold on-site in a small storefront, which only allows for many small purchases. Starbucks also has a tried and true training program for new employees, which lowers the learning curve and makes their shops more efficient and consistent. Smaller shops most often have a non-standardized method of training, which results in several inefficiencies. The technology in the coffee industry has also been changing, and many of the smaller coffee shops are reverting to more primitive methods of brewing coffee slowly, which results in a better product. Starbucks stands out in this area as they are able to produce this same effect with large, expensive machines that take the same amount of time, but with less employee effort. Many consumers in the Seattle market are fiercely loyal to their preferred coffee shop; however, the portion of that market is small, and many consumers prefer Starbucks and their standardized approach.

3. Competitive pressure from substitute products

Caffeinated beverage product substitutions are becoming more and more popular. Soda and energy drinks such as Red Bull have been around for quite some time. Recently, coffee shops have needed to compete with a new addition to the market, “energy shots,” such as 5-Hour Energy, which are concentrated caffeinated drinks. Other contenders for customers include home espresso makers, and the Keurig, which is a convenient, single-serve coffee concept that consumers can make in the comfort of their own home at a fraction of the cost. The portability and ease in which to find these substitute products is a competitive edge, however many consumers do not equate these products to one another as their taste and the time of day you generally consume them is very different.

4. Competitive pressures stemming from supplier bargaining power and supplier-seller collaboration

As coffee and dairy are commodities available on the open market from many different sellers, they do not have much bargaining power with their customers. Most coffee suppliers are small farms in poor areas. However, many coffee shop companies have established relationships with their suppliers and seek to improve their business and community through training, technical assistance and monetary help. This gives both the farmer and the coffee shop a competitive advantage and also leaves the farmers with little in terms of leverage in the future.

5. Competitive pressures stemming from buyer bargaining power and seller-buyer collaboration

Consumers have all the power in their choice of coffee shop, and their cost to switch is low. Coffee shops depend on a high frequency of customer purchases. The customers of coffee shops also know very well what a cup of coffee should cost and are unwilling to pay more than what they expect, unless they are highly compensated with other perks like quiet places to work with free Wi-Fi. Buyers also have a choice of where and when they purchase coffee. Many consumers choose to brew their own coffee at home or drink the drip coffee from work as opposed to going out to a coffee shop. If their discretionary spending money decreases, it is likely that coffee will be one of the first things to go.

The rivalry among sellers and the power of choice consumers have in the coffee shop industry is quite staggering. In order to thrive in this industry, one must wrestle with the larger firms’ familiarity, while competing with many other small businesses that are in the same competitive position. The key, as always, is to differentiate themselves in some way, such as with quality, customer service, and atmosphere.

Changes Caused by Driving Forces

Coffee shops make up a mature industry, in which there is a low threshold to gain entry into the market. Although there are no dynamic forces changing the industry rapidly, there are drivers that are changing the market itself.

Larger coffee retailers such as Starbucks have looked to expand globally because of saturation in the domestic market. Starbucks has been able to use a strategy that also caters to local tastes to adapt to the market they are entering. They have green tea smoothies in Asia. They have also respected cultural leanings. For example, in the Middle East, they have men-only and family areas (Pastier, 2005). For smaller companies that are not expanding to foreign markets, globalization means possible new suppliers and easier access for rare types of beans.

Growth rate has also been a factor in terms of market saturation and demand by consumers as the economy is slowly recovering from recession. In January 2009, Starbucks closed 300 stores and had closed 660 the year before (Clark, 2009). For independent coffee shops, the recession drove down sales for shops that were not differentiated or established well in the community. For independent shops that had a distinct business, this actually became an opportunity to expand as leases and construction became cheap (Allison, 2009).

On the innovative front, some independent shops are trying to make a premium end market to become a sort of “craft beer” but only for coffee.   Intelligentsia Coffee actually spends time at the source where beans are grown to oversee the entire process and works directly with the supplier (History, n.d.).

Technological forces are playing a part for home brewing. With the recession, some customers tried to see if they could save money by making their own coffee using special brewers like the Keurig. Starbucks and Tully’s actually make K-Cups for these machines instead of trying to compete with the makers directly.

Environmental Scanning

Social concerns will continue to have an impact with the coffee market. Starbucks has commitments for recycling and reducing waste. They are also trying to build greener stores and help farmers mitigate the effects of climate change. Even McDonald’s has gotten rid of their foam coffee cups, buys from sustainable farms and are involved with a program to train farmers (McDonald’s to Replace Foam Coffee Cups, 2013) (McDonald’s and Coffee Sustainability, n.d.).

The largest ecological factor that affects this industry is the crop of coffee beans. Prices for coffee beans can fluctuate not just because of demand concerns but the health of the overall crop. Brazil recently has had a drought and prices for coffee are set to rise. Global warming will also play a part in the future of the supply of coffee beans. Technology will probably aid in this respect with generating plants that can grow in drier conditions or less hospitable environments (Wexler, Lewis, & Josephs, 2014).

Technological issues will also be a concern as the expensive espresso machines become easier for home brew systems to replicate the quality at home. There are expensive home espresso machines such as the flagship model for Nespresso. As the cost for these machines comes down, there is a potential for a loss at coffee shops.

Company Positions

Starbucks and other larger companies such as Tully’s are in a strong position as they are able to harness economies of scale that independent coffee shops cannot compete with.

Independent coffee shops are in the weakest positions. With easy entrance into the market by competitors, an independent shop either has to have a great location away from other competitors or they will have to carve out a niche such as the high end “craft” coffees. As with most small businesses, they will have to be especially agile to changes in consumer taste and trends.

Below is a strategic group map of competitors in the retail coffee shop industry.

Future Strategy

On a national level, there are few huge players in the retail coffee industry. The two largest competitors are Starbucks and Dunkin Brands Group (owner of Dunkin’ Donuts), who collectively own 60% of the market share in the Coffee and Snack Shop industry (Coffee & Snack Shops in the US : Market Research Report, 2014). In spite of being one of the two top competitors, Dunkin’ Donuts owns approximately 10% of the retail coffee market share that Starbucks does (Friedman, 2014). The rest of the retail coffee market is made up of smaller chains and independent coffee shops.

While many of these smaller competitors are sure to devise strategies that will grow their business and increase their market share, this analysis will focus on Starbucks as the industry leader and will group the smaller competitors in with Dunkin’ Donuts, the second place contender. For comparison, Starbucks owns over 13,000 stores in the US and reports annual sales of approximately $15.3 billion (InsideView: Starbucks Corporation, 2014). Dunkin’ Donuts franchises over 7,000 stores in the US and reports annual sales of approximately $6.2 billion (Dunkin Brands Group, Inc., 2013).

Both Starbucks and Dunkin’ Donuts have seen growth in recent years. Although both companies tout their marketing strategies and innovation as the source of that growth, it is likely that a large factor has been the improvement in the US economy and the continued rise of disposable income of consumers (Friedman, 2014). In upcoming years, both the leader and its followers must devise strategies that will ensure continued growth, expanding sales to existing customers and reaching out to new customers and markets.

The chart below depicts possible strategy moves in the near future by Starbucks and Dunkin’ Donuts, as leader and main competitor.

 

Starbucks

Competitive Scope	Strategic Intent	Market Share Objective	Competitive Position/ Situation	Strategic Posture	Competitive Strategy
National	Maintain position as dominant leader	Hold on to present share and grow at industry average. Growth by: – Open more stores – Expand product offerings; healthier options, juices; teas	Well- entrenched; able to maintain present position; loyal customer base	Mostly offensive; expands offerings in anticipation of customer preferences instead of in response to competitor actions; opens new stores where market exists	Focusing on a market niche: – Higher end – Coffee lovers   Pursuing differentiation based on: – Image and reputation – Premium atmosphere of stores – Premium quality and consistency

 

Dunkin’ Donuts

Competitive Scope	Strategic Intent	Market Share Objective	Competitive Position/ Situation	Strategic Posture	Competitive Strategy
National	Increase market share	Expansion via internal growth – Open more stores in new geographical regions – Expand product offerings	Getting stronger; on the move	Mostly offensive; expanding into new markets; tests and introduces new products regularly to entice new customers	Pursuing differentiation based on: – Value – Convenience

 

Starbucks is the industry leader by quite a large margin. A possible goal for Starbucks is to maintain current position while expanding at a rate that is not necessarily explosive. Management of the company has stated a goal of opening 1,500 new stores in the US over the next five years (Chen, Even with ~20,000 stores worldwide, Starbucks has room to grow, 2014). In addition to opening new stores, Starbucks is expanding its offerings. Not just a coffee shop, Starbucks continues to offer more food options to customers and is seeing an increase in their food sales. As time goes by, the expectation is that, as food sales increase, those food sales will also support beverage sales (Chen, Why food will become more important to Starbucks’ future growth, 2014). Who doesn’t need a drink to go along with their food?

Dunkin’ Donuts intends to branch out into new geographic areas, while still continuing to expand product offerings. By 2015, the franchise will open its first standalone location in California (Dunkin Brands Group, Inc., 2013). While Starbucks is everywhere, Dunkin’ Donuts has had few stores on the Western side of the US. This leads to an interesting possibility. Dunkin’ Donuts sells a very popular coffee. As a matter of fact, consultants Brand Keys, in their annual Customer Loyalty Engagement survey, rated Dunkin’ Donuts at the top of their list for customer loyalty in the coffee category (Passikoff, 2014). Take that popular coffee and expand its distribution base (new geographic markets), and Starbucks may have a closer competitor vying for their customers!

In addition to expanding into new locations, Dunkin’ Donuts continues to expand its product offerings. In 2012, it introduced 30 new products and tested many others (Dunkin Brands Group, Inc., 2013). Like Starbucks, it is not just a coffee (or doughnut) shop. Dunkin’ Donuts’ focus on value and convenience is expected to ensure its continued growth.

Key Success Factors

Location, Location, Location

A key to success for coffee shops is to be in the right place. Shops must choose locations that are where the customers are and that are easily accessible. Research must be undertaken to discover where the target market is concentrated and where they will shop (Berman). Also, although coffee drinkers aren’t limited to making morning purchases, that segment of the day is still the busiest for coffee shops. Busy morning rushes demand that shops are easily accessible. This means not only easy to get to, but easy to get in and out of, or just to drive through.

Atmosphere

As mentioned in the Industry Overview, the atmosphere of the coffee shop is what makes it an experience for customers. This is the component that makes the difference between having a cup of coffee at home or going out for coffee. Comfortable seating, pleasant color combinations, and friendly, competent baristas all come together to create a relaxed, mellow atmosphere that a Keurig just can’t provide.

Product Quality

Location and atmosphere are key factors for success. However, without product quality, they might well be in vain. Consumers do not all appreciate the same coffee bean or roasting method or concoction, but they can all agree that if the quality is poor, they will not be a repeat customer. Providing customers with good quality ingredients should be a primary goal of retail coffee shops (Berman).

Industry Analysis

The coffee shop industry has approximately 20,000 stores in the US and realizes about $20 billion dollars in annual sales. Not just coffee purveyors, these shops also sell a variety of teas, juices and other beverages, as well as food items. Successful coffee shops market their premium product to a premium market, typically ages 25 to 45. Key success factors in this industry are atmosphere and service. Equally important to the shops are the price they pay for coffee beans (Weber).

While a decline in disposable income and healthier eating trends hurt many coffee and snack shops during the recession, demand is set to continue increasing in the five years to 2013. Indeed, according to a recent industry analysis, “More young people are drinking coffee than ever, as 40 percent of adults age 18-24 say they drink coffee daily” (Weber). As the economy continues to recover, consumers will start to spend more money on luxuries, such as eating out, which will help raise the industry’s revenue. Furthermore, operators will look to international expansion in Asia and the Middle East to boost growth as the industry nears domestic saturation (Coffee & Snack Shops in the US : Market Research Report, 2014).

The Coffee and Snack Shops industry has taken advantage of the rising economic rise over the past five years, posting growth in each year since 2009 (Coffee & Snack Shops in the US : Market Research Report, 2014). As one of the most nimble industries within the broader food service sector, coffee and snack shops have been able to adjust to changing consumer preferences as spending has picked up and consumers opt for more convenient, affordable menu items. Stores that once specialized in catering to the unhealthy whims of consumers have strategically changed to provide healthier, gourmet menu items. Because gourmet food normally comes with higher price tags, the industry has experienced a surge in profit. Over the five years to 2014, industry revenue is expected to increase at an annualized rate of 2.7% to $30.2 billion (Coffee & Snack Shops in the US : Market Research Report, 2014).

The competition of growing gourmet coffee shops is increasing exponentially. Several heavy hitters have already established their ranking in the coffee shop hierarchy and are depending on new ideas and concepts to keep them competing advantageously in the saturated market, by offering more food options, loyalty programs, and new drink recipes to keep their patrons coming back (Passikoff, U.S. Consumers Drinking A Latte More Coffee, 2013). As the leading chains in the industry, Starbucks and Dunkin’ Donuts, continue to dominate markets around the world, independent coffee shops and smaller, regional chains are finding ways to break into new markets as well. These smaller coffee shops and cafes are using alternative strategies that extend beyond the brand association. Examples of competitive factors include:

• Quality over quantity;
• Creating a niche reputation, such as bikini baristas;
• Strong customer recognition and relations; and
• Expanded offerings beyond the coffee shop, such as distribution of products at retail stores for home use.

Additionally, coffee shops are being guided by the needs of the consumers, who are demanding better coffee at restaurants and even at home.  Their new product offerings include single serve cups of their more famous roasts at each of their locations and at grocery stores. These strategies, while designed to strengthen their brand, could also end up being the downfall in an otherwise very saturated, but strong industry.

 

References

Allison, M. (2009, March 1). Owners of small coffee shops take plunge during recession. Retrieved from The Seattle Times: http://seattletimes.com/html/businesstechnology/2008795071_coffeeshops01.html

Berman, C. (n.d.). Key Success Factors for the Coffee Business. Retrieved from Chron: http://smallbusiness.chron.com/key-success-factors-coffee-business-68398.html

Chen, X. Y. (2014, February 11). Even with ~20,000 stores worldwide, Starbucks has room to grow. Retrieved from Yahoo! Finance: http://finance.yahoo.com/news/even-20-000-stores-worldwide-130010277.html

Chen, X. Y. (2014, February 10). Why food will become more important to Starbucks’ future growth. Retrieved from Market Realist: http://marketrealist.com/2014/02/food-to-become-more-important-part-of-starbucks-future-growth/?utm_source=yahoo&utm_medium=feed&utm_content=toc-3&utm_campaign=even-with-20000-stores-worldwide-starbucks-has-room-to-grow

Clark, A. (2009, January 28). Starbucks shuts 300 more stores. Retrieved from The Guardian: http://www.theguardian.com/business/2009/jan/28/starbucks-shuts-stores-recession-us

Coffee & Snack Shops in the US : Market Research Report. (2014, February). Retrieved from IBISWorld: http://www.ibisworld.com/industry/default.aspx?indid=1973

Dunkin Brands Group, Inc. (2013, February 22). Dunkin’ Brands 2012 Annual Report. Retrieved from Shareholder.com: http://files.shareholder.com/downloads/ABEA-68SCR9/3007125577x0x650114/408603D0-6E62-422F-AB40-3A7C89686005/DNKN_2012_Annual_Report_Final_.pdf

Friedman, N. (2014, February 11). Is Dunkin’ Brands Group Still a Slam Dunk? Retrieved from DailyFinance: http://www.dailyfinance.com/2014/02/11/is-dunkin-brands-group-still-a-slam-dunk/

History. (n.d.). Retrieved from Intelligentsia Coffee: http://www.intelligentsiacoffee.com/content/history

InsideView: Starbucks Corporation. (2014, February). Retrieved from InsideView: http://www.insideview.com/directory/starbucks-corporation

Lewis, J. (n.d.). The Effects of Globalization on Coffee Companies. Retrieved from Chron: http://smallbusiness.chron.com/effects-globalization-coffee-companies-37460.html

McDonald’s to Replace Foam Coffee Cups. (2013, September 26). Retrieved from Environmental Leader: http://www.environmentalleader.com/2013/09/26/mcdonalds-to-replace-foam-coffee-cups/

McDonald’s and Coffee Sustainability. (n.d.). Retrieved from McDonald’s: http://www.aboutmcdonalds.com/mcd/sustainability/signature_programs/coffee_story.html

Passikoff, R. (2013, September 16). U.S. Consumers Drinking A Latte More Coffee. Retrieved from Forbes: http://www.forbes.com/sites/robertpassikoff/2013/09/16/u-s-consumers-drinking-a-latte-more-coffee/

Passikoff, R. (2014, February 4). Apple, Dunkin’, Facebook And NFL Meet Growing Expectations In 18th Annual Customer Loyalty Engagement Index. Retrieved from Forbes: http://www.forbes.com/sites/robertpassikoff/2014/02/04/apple-dunkin-facebook-and-nfl-rise-to-growing-expectations-in-18th-annual-customer-loyalty-engagement-index/

Pastier, J. (2005, November 30). Starbucks: Selling the American Bean. Retrieved from BloombergBusinessweek: http://www.businessweek.com/stories/2005-11-30/starbucks-selling-the-american-bean

Weber, A. (n.d.). Retail Industry Analysis 2014 – Cost & Trends. Retrieved from Franchise Help: https://www.franchisehelp.com/industry-reports/retail-industry-report/

Wexler, A., Lewis, J. T., & Josephs, L. (2014, March 4). Brazil Drought Jolts Commodities’ Prices. Retrieved from The Wall Street Journal: http://online.wsj.com/news/articles/SB10001424052702304585004579419473654460330