Thomas Gilliam 9/05/2012 FIN 448 Professor Robinson Starbucks Case Industry and Strategy Analysis a.

Apply Porters five forces framework to the specialty coffee retail industry. 1. Rivalry among Existing Firms: Starbucks faces intense direct competition with coffee beverage retailers such as McDonalds McCafe shops, Krispy Kreme, Dunkin Donuts, and Tim Hortons. Although one of the largest coffee beverage retailers in the industry, Starbucks is faced with other competitors expanding their selection of premium coffee drinks. Starbucks leans on the idea that their particular company offers a unique service of quality coffee called the Starbucks Experience to render away from their competitors. Even with such brand loyalty, rivalry among existing firms is moderate/high. 2. Threat of New Entrants: Starbucks brand loyalty and number of locations nationally and internationally set high barriers of new entrants. To further expand these barriers, Starbucks entered into a licensing agreement to distribute Starbucks whole bean and ground coffee throughout the United States in approximately 39,000 grocery and warehouse club stores. However, potential threats do exist from growing chains of retail coffee shops including Panera Bread, Diedrich Coffee, and Caribou Coffee Company. These companies could expand the development of premium coffee drinks like those of Starbucks. With Starbucks global brand quality and the quality of the Starbucks Experience, threat of new entrants is fairly low. 3. Threat of Substitutes: A wide variety of substitutes appear in the coffee retail industry. Consumers who are on-the-go prefer a cheap and quick product rather than the Starbucks Experience. Convenience stores associated with many gas stations offer cheaper substitutes to a premium coffee. Many alternatives exist in the beverage industry such as energy drinks, soda, and even water. Even though none of these substitutes will offer the Starbucks Experience, the threat of substitutes is moderate/high. 4. Buyer Power: Starbucks does not sell just coffee, they sell the Starbucks Experience. The Starbucks Experience offers premium coffee drinks with higher quality and the experience of enjoying the coffee. This allows Starbucks to be less price sensitive because customers are willing to pay more for the experience and atmosphere. In the coffee retail industry, buyer power is relatively low because there are very few suppliers. 5. Supplier Power: Starbucks purchases higher-quality coffee beans from around the world that sell at a premium to commodity coffees. Starbucks purchases its coffee beans under fixed-price purchase contracts with various suppliers, with purchase prices reset annually. It sounds as if there are not many other alternative suppliers who offer such premium coffee beans. Since Starbucks purchases their coffee beans around the world, supplier power is relatively high considering the fixed price purchase contracts.

b. How would you characterize the strategy of Starbucks? How does Starbucks create value for its customers? What critical risk and success factors must Starbucks manage? Starbucks strategy of the Starbucks Experience provides a unique coffee selection of higher quality in a setting that cannot be matched by its competitors. Starbucks creates value for its customers by offering a luxurious setting which include Internet through the stores Wi-Fi network, specialty coffees, and importing the idea of the French and Italian caf into the busy North American lifestyle. Starbucks has managed to expand locations into several other countries. To further distinguish themselves from competitors, Starbucks entered into a licensing agreement to market and distribute Starbucks whole bean and ground coffee to approximately 39,000 grocery stores and warehouse club stores. Balance Sheet c. Describe how Cash differs from Cash Equivalents. Cash is considered the cash a company has on hand and is considered the most liquid asset. Cash Equivalents are considered a money market instrument and a maturity date so close that interest rates are unlikely to fluctuate. With interest rates unlikely to fluctuate, Cash Equivalents are in equal value to cash. d. Why do investments appear on the balance sheet under both current and noncurrent assets? Investment securities such as money market funds are considered a current asset because the firm will sell the asset within one year. Some investment securities such as long-term bonds appear on the balance sheet as noncurrent assets because the firm intends to hold on to the asset for more than a year. e. Accounts receivable are reported net of allowance for uncollectible account. Why? Identify the events or transactions that cause accounts receivable to increase and decrease. Also identify the events or transactions that cause the allowance account to increase and decrease. Accrual based companies use an allowance for uncollectible accounts because all transactions must be recognized as incurred even though cash has not been collected. A firm may reduce the allowance for uncollectible accounts if they expect to receive the cash in a timely manner. The allowance account may increase if the firm does not expect to collect the cash in the current period. f. How does the account Accumulated Depreciation on the balance sheet differ from Depreciation Expense on the income statement? Accumulated Depreciation accounts for the value of the asset from the time the asset was acquired. Depreciation Expense is the current expense of the asset for the current period. g. Deferred income taxes appear as a current asset on the balance sheet. Under what circumstances will deferred income taxes give rise to an asset? Firms recognize revenues and expenses during the period by tax reporting and financial reporting. If revenues are recognized in tax reporting earlier than expenses in financial reporting, this will result in deferred income taxes giving rise to an asset.

h. Accumulated Other Comprehensive Income includes unrealized gains and losses from marketable securities and investments in securities as well as unrealized gains and losses from translating the financial statements of foreign subsidiaries into U.S. dollars. Why are these gains and losses not included in net income on the income statement? When, if ever, will these gains and losses appear in net income? Accumulated Other Comprehensive Income includes unrealized gains and losses from marketable securities and investments in securities because the current book value may fluctuate over time to the future market value. Not until the securities are bought or sold can the realized gains or losses appear in net income. This account also includes unrealized gains and losses from translating the financial statements of foreign subsidiaries into U.S. dollars because the exchange rate is also always fluctuating. Not until the asset is being exchanged into U.S. dollars will you be able to know the actual gain or loss to record in net income. Income Statement i. Starbucks reports three principal sources of revenues: company-operated stores, licensing, and foodservice and other consumer products. Using the narrative information provided in this case, describe the nature of each of these three sources of revenue. Revenues produced by company-operated stores is mainly from the sales of their premium coffee selection and the Starbucks Experience. Revenues from licensing companies could be a set percentage of revenues stated in the contract with the licensee. Revenues from foodservice and other consumer products could be the sale of whole bean and ground coffee to grocery stores and warehouse club stores. j. What types of expenses does Starbucks likely include in (1) Cost of Sales, (2) Occupancy Costs, and (3) Store Operating Expenses? (1) Cost of Sales: Supplies expense such as green coffee beans, dairy products, and paper and plastic products. (2) Occupancy Costs: Includes rent expense, insurance expense, and maintenance expense. (3) Store Operating Expenses: Internet for stores Wi-Fi network, wages expense, and advertising costs. k. Starbucks reports Income from Equity Investees in its income statement. Using the narrative information provided in this case, describe the nature of this type of income. Income from Equity Investees comes from investing in a company or companies with the firms stockholders equity. This can arrive from a partnership. Starbucks formed partnerships to produce and distribute bottled Frappuccino and Doubleshot drinks with PepsiCo and premium ice creams with Dreyers Grand Ice Cream, Inc. The source of Starbucks Income from Equity Investees could be the income derived from the earnings through this partnership.

Statement of Cash Flows l. Why does net income differ from the amount of cash flow from operating activities? Cash flow from operating activities represents only one source of net income (loss) on the statement of cash flows. Others include cash flow from financing activities and investing activities. Net income is the result of revenues after the cost of sales and operating activities. m. Why does Starbucks add the amount of depreciation and amortization expense to net income when computing cash flow from operating activities? The amount of depreciation and amortization expense reduces net income. The expense is computed from operating activities because the depreciation expense is accounting for an operating asset. If an asset was being purchased in the current period, rather than an expense, the capital expenditure would be considered an investing activity. n. Why does Starbucks show an increase in inventory as a subtraction when computing cash flow from operations? Starbucks increase in inventory is shown as a subtraction because their particular company does not produce as much revenue from inventory. For example, the sale of premium coffee drinks produce revenue rather than the coffee machines. This causes Starbucks Inventory account to be an expense. o. Why does Starbucks show a decrease in accounts payable as a subtraction when computing cash flow from operations? The decrease in account payable when computing cash flow from operations can be explained by Starbucks not having any operating assets with a maturity of over a year. p. Starbucks includes short-term investments in current assets on the balance sheet, yet it reports purchases and sales of investment securities as investing activities on the statement of cash flows. Explain why changes in investment securities are investing activities while changes in most other current assets are operating activities. Purchases and sales of investment securities are classified as investing activities. Changes in most other current assets such as accounts receivable and inventories are due to the sale of goods or services while marketable securities are not. q. Starbucks includes changes in Short-Term Borrowings as a financing activity on the statement of cash flows. Explain why changes in Short-Term Borrowings are a financing activity when most other changes in current liabilities are operating activities. Short-Term Borrowings is a loan or borrowing of cash which is classified as a financing activity. Changes in other current liabilities such as accounts payable are considered operating activities due to the purchase of goods or services while loans are not.

Relations between Financial Statements r. Retained Earnings, 2007 Net Income, 2008 Treasury Stock Retained Earnings 2008 $2,189.4 315.5 (102.5) $2,402.4

The $102.5 million difference could be a result of Starbucks buying back stock of their own company. Another explanation could be the company satisfying their shareholders by disbursing dividends. s. Property, Plant, & Equipment, gross 2007 Net additions to Property, Plant, & Equip. 2008 Property, Plant, & Equipment, sold 2008 Property, Plant, & Equipment, gross 2008 Accumulated Depreciation, 2007 Depreciation Expense 2008 Property taxes Accumulated Depreciation, 2008 $5,306.6 984.5 (573.8) $5,717.3 $2,416.1 549.3 (204.5) $2,760.9

Depreciation Expense would be added to total accumulated depreciation. The difference could be the property taxes taken out of the depreciable asset. Interpreting Financial Statement Relations t. The dollar amount shown for property and equipment net of accumulated depreciation increased between the end of fiscal 2007 and the end of fiscal 2008, yet the percentage of total assets comprising these assets declined. Explain. The balance sheet may be deceiving at times like these. Although the balance sheet does in fact state Property, Plant, and Equipment net of accumulated depreciation has risen, the percentages of other long-term assets can explain these inverse numbers. From 2007 to 2008, all percentages of long-term assets have increased including long-term investments, equity and other investments, other assets, and other intangibles. All of these percentage increases can fluctuate the percentage amount of Property, Plant, and Equipment net of accumulated depreciation use from the amount relative to total long-term assets. This is also a good example why it is useful to look at percentages rather than numbers which can be misleading. u. From 2005 through 2008, the proportion of total liabilities increased while the proportion of shareholders equity declined. What are the likely explanations for these changes? The years 2005 to 2008 were a range of explosive expansion for Starbucks. The proportion of total liabilities increased due to the short-term borrowings and accounts payable accounts having substantial increases in this time of expansion. Creating new channels, expanding to new countries, and loans caused the proportion of total liabilities to overpower the proportion of stockholders equity.

v. How has the revenue mix of Starbucks changed from 2005 to 2008? Relate these changes to Starbucks business strategy. A major component of Starbucks revenue mix is the licensing agreement. By the end of fiscal 2008, Starbucks whole bean and ground coffees were available throughout the United States in approximately 39,000 grocery and warehouse club stores. Another major component is the major business location expansion during fiscal year 2008. Revenues were being produced by 681 net new company-owned stores and 988 new licensed stores. Another change of incoming revenue was Starbucks business strategy of global penetration. By the end of fiscal 2008, Starbucks owned and operated stored in Canada, United Kingdom, and in China. w. Net income as a percentage of total revenues increased from 7.8 percent in fiscal 2005 to 3.0 percent in fiscal 2008. Identify the most important reasons for this change. This change could be a result from the increasing change of total assets. Plant and equipment along with accumulated depreciation increased which could have changed the percentage of net income as total revenues to decrease.