Starbucks Coffee Distribution Preethi Kasireddy

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Network

Preethi Kasireddy Esmeralda Ayala Ari Eryorulmaz Billy Jung

[Company Address]

Table of Contents Abstract....2 Background and Problem Definition...2 Current Situation..2-5 Demand....2-3 Supply Side Concerns..3-4 Prices4-5 Distribution Network...5-7 Phase 1: From Suppliers to Distribution Centers.....5-6 Phase 2: From Distribution Centers to Regional Retailers...6-7 Recommendations7 Starbucks Use of 3PL.8 References..9-11 Appendix A12 Appendix B13 Appendix C14 Appendix D15 Appendix E16 Appendix F17 Appendix G18 Appendix H19 Appendix I.20 Appendix J.21 Appendix K22 Appendix L23 Appendix M...24 Appendix N25

Abstract Background and Problem Definition Starbucks, founded in 1971, is the worlds #1 specialty coffee retailer with more than 18,850 coffee shops in 40 countries. It operates approximately 8,800 of its shops, while licenses and franchises operate the remaining stores. The company also owns Seattles Best Coffee and Torrefazione Italia coffee brands. Starbucks offers a variety of food items, as well as roasted beans, coffee accessories, and teas and also markets its coffee through grocery stores and branded food and beverage products. Due to the immense global network that Starbucks has built over the past 40 years, this report will focus strictly on the coffee bean supply chain network for Starbucks U.S. In particular, the report will analyze international coffee bean suppliers, Starbucks US distribution network, shipping and transportation costs, and regional distribution network. Because of the tight supply and growing demand, evident from strong revenue growth, of coffee beans, all of the demand is not being met. Thus, the goal of this project is to find an alternative method for 100% of the demand to be distributed and supplied. The Current Situation Demand Starbucks coffee, which maintains 4.5% of the US market share for coffee, is expected to see an increase in per capital coffee consumption. For the fiscal year ending September 2010, Starbucks reported $10.71B Sales, with a 1-Year Sales Growth of 9.54% and a 13.26% operating margin growth. They reported $946.60M in net income, which a 1-Year Net Income growth of 141.97%. For fiscal first quarter of 2011, EPS of $0.45 were reported and increased profits of 44% from year-ago period. This growth was driven by in-store sales growth of 8% in the U.S. The

strength of Starbucks growth in comparison to the industry median growth of -0.35% for revenue and 10.04% growth in net income is a strong indicator of high demand for Starbucks from 20112016. Demand numbers were calculated based on 2009 imports. Risks that Starbucks faces include late delivery from supplier, slow replenishment lead time, damaged/unusable beans, random demand, unexpected increase in demand, and inaccurate demand forecasts. Therefore, to mitigate the risk of stock outs, a safety stock of 15% was applied. Coffee beans dont spoil or expire and so additional costs due to safety stock only come from storage costs (see Demand Analysis Tables in Appendix H). Despite higher commodity coffee costs Starbucks is expected to face in 2011 and 2012, the high prices are expected to reach normal levels starting 2013. Therefore, it follows the Starbucks will plan to meet 100% of the demand projected from 2011-2016. Supply Side Concerns Starbucks uses C.A.F.E Practices to ensure sustainable supply of high quality coffee beans. C.A.F.E Practices are a set of guidelines set to ensure high quality coffee beans, promote equitable relationships with farmers, workers, and communities, and protect the environment. All suppliers for Starbucks coffee beans must meet the minimum prerequisites of high quality Arabica coffee bean, economic transparency, performance, supply network of farms, and coffee growing and processing practices. Suppliers were chosen meticulously to smooth the forecasted supply fluctuations and long supply response times. Brazil, Vietnam, and Columbia make up the majority of the global supply for Arabica coffee beans for Starbucks, with market shares of 38%, 14.5%, 12.3%, and respectively.

Brazil, the largest supplier for 2010, is expected to have a decrease in harvest of 25% percent from 2010, while Brazils domestic consumption is expected to increase 5%, Mexico showed a decrease in exports of 17% in 2010. Columbia also poses a small risk due a major outbreak of fungus that affected supply in 2010, as well as Costa Rico due to adverse weather. Contingent upon these risks and the 2010 export growth/decline percentage, below is the proposed breakdown of import suppliers for 2011-2016. We recommended a decrease in Brazil imports to 40% of supply, rather than 60%. We also recommended an increase in supply from Honduras and Kenya due to strong coffee harvests in 2010 (see Appendix I). Prices Coffee bean prices in 2011 are on average 90% higher than 2010 due to the La Nina weather patterns plaguing Central America and South America, significant coffee plant damage in Columbia due to fungus on coffee crops, bad weather in Vietnam, and concentrated supply. Another contributing factor to the 2010 severe rice in coffee prices is the declining of the U.S dollar. This decline results in higher coffee commodity prices for Starbucks. In addition, low interest rates maintained by the Federal Reserve, due to the financial crisis of 2008 and 2009, has led to investors to increase investment in commodities, including coffee, which is another driver for higher coffee prices for Starbucks. The price per pound in January, February, and March 2011 were $2.35, $2.47, and $3.56, respectively. Derived from Treasury inflation protected securities and survey-based estimates, the Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.82 percent. Expected prices for 2011-2016 were calculated based on inflation rates, an existing contract Starbucks has with its suppliers for 2011, the assumption based on research

that prices will begin to decrease in 2012-2013 due to improving crops, and the assumption that prices will remain steady from 2014-2016 (see Appendices I - J for price chart and graphs). Distribution Network The teams alternative is to use the Facility Location model to see whether every supplier and every distribution center is necessary to meet 100% of demand for the years 2011 to 2016. If so, then each supplier will supply the appropriate number of pounds to each distribution center to minimize costs (Phase 2); and each distribution center will supply the appropriate number of pounds to each regional retailer to minimize costs (Phase 2). After finding the minimum costs for each year for both phases, the total annual costs per year will consist of annual Phase 1 and Phase 2 costs plus the buying cost of the coffee beans from the suppliers. Phase 1: From Suppliers to Distribution Centers For Phase 1 of the distribution network, we needed to find the appropriate allocation and costs to supply US distribution centers from outside countries. Four of the distributions centers in the US, which include Washington, Nevada, Pennsylvania, and South Carolina, are current Starbucks distribution center locations. When analyzing the IBIS US map (Appendix N) that highlights heavy areas of coffee demand, we observed that a reasonable amount comes from Texas. Assuming that distribution of coffee demand in the US as shown in figure only relates to Starbucks coffee, we found the absence of a distribution center in the south alarming and hence decided to add a distribution center in Texas to the existing Starbucks distribution network. Once the distribution locations were determined, supply, demand, and shipping costs needed to be found. We were not able to find specific exporting costs for each country so we assumed that Cameroons exporting coffee price of $1.70 per Kg ($0.77 per pound) was a good estimate for our

shipping rate. We assumed the available supply from each country was about 5% of their overall harvest considering that Starbucks is one out of their many customers. To calculate demand for each distribution center, we first needed to solve the Phase 2 network. Once we saw the distribution center to regional retailer allocation to meet each regional retailers demand, we added up the amount each state had distributed to each region, and that become our distribution center demand for the Phase 1 network. To then find the appropriate allocation and total cost we used solver. The average costs to distribute from the suppliers to the distribution centers for the next six years will be $352,041,433.00 The following are assumptions we made to calculate the minimum shipping costs from supplier to distribution centers: Shipping cost is $0.77 per pound Supply capacity from each country is 5% of overall countrys coffee harvest Demand of each distribution center comes from the demand being supplied to regional retailers (Phase 2) The total costs to distribute from the suppliers to the distribution centers for six years can be seen in the table below. Phase 2: From Distribution Centers to Regional Retailers In this phase, the same solving method in Phase 1 was used. The goal was to find the total minimum transportation cost per year from 2011 to 2016. Based on IBIS (Appendix N), the demand for Starbucks coffee was spread throughout the United States by eight regions. Each region has state demand percentages, so the state percentages were added up to calculate the regional demand percentages. Figure 1 in Appendix A illustrates the various regions and their respective demand percentages. For each year from 2011 to 2016, the regional percentages were

multiplied by the 2011 total demand to calculate the regional demands. The distribution center capacities were calculated by researching plant square footage for each location on Century 21s website. The team assumed that only 50% of the square footage of the buildings would be used for storage. The square footage was then multiplied by an assumed 30 feet building height to calculate the volume of the distribution centers. Assuming the dimensions of a 1-pound Starbucks coffee bag (0.25 x 0.25 x 1.00), the total distribution center volume was divided by the volume of the 1-pound bag. The following assumptions were made to calculate the total minimum transportation cost per year: Although the annual demand would change, the regional demand % would stay the same for each year Shipping by trucks ($0.88) costs a little more than shipping by sea ($0.77) The shipping cost of $0.88 per pound would remain the same for each year Square footage of plant Volume of plant Percentage of plant that would be used for coffee bean storage (50%)

Recommendations The teams recommendations to Starbucks would be to keep open all suppliers to meet distribution center demands and to keep open all distribution centers to meet regional retailer demands. Starbucks should allocate the appropriate number of pounds from suppliers to distribution centers, as shown in Appendices A C, and it should allocate the appropriate number of pounds from distribution centers to regional retailers, as shown in Appendices D F.

Starbucks Use of 3PL Starbucks has used Kraft to distribute its coffee in supermarkets and grocery stores for twelve years. Acosta Inc, the distributor for Starbucks VIA instant coffee has plans to take over Kraft, which will save money for Starbucks. According to a research study, Acosta will help Starbucks to develop sales and product display strategies starting March 1, 2011. This business plan actually came with the release of Starbucks VIA. Starbucks sold its VIA Product for the first time directly to retailers, bypassing third-party distributors. The team believes that leaving Kraft out of the game will generate a huge surplus of income for Starbucks. Another option is switching to another distributor instead of using Kraft Foods. Folgers Coffee, owned by Proctor & Gamble, has merged with JM Smucker in the last quarter of 2008. This was a 3.3 billion dollar deal that benefited Folgers to use the current distribution network that JM Smucker already has. On March 10, 2011, Starbucks signed a new agreement with Green Mountain Coffee Roasters, which own and distribute the K-Cup Keurig Coffee Brewing system. Green Mountain Coffee Roasters owns the biggest distribution network for the single-cup brew system in the North American market. Shares of Green Mountain went up 32%, and Starbucks shares went up 7.7% because of this beneficial agreement. While Kraft Foods had only 7.2% of the market share with its single serving products, Green Market dominates the market with more than 65% market share. Thus, the team recommends that Starbucks should further pursue this partnership with Green Mountain to expand into the single cup coffee market.

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<http://www.profi-forex.us/news/entry4000000902.html>. Real Estate Listings - Real Estate Agents | CENTURY 21. Web. 11 Mar. 2011. <http://www.century21.com/>. "STARBUCKS CORPORATION BUILDING A SUSTAINABLE SUPPLY CHAIN." Google Docs. GLOBAL SUPPLY CHAIN MANAGEMENT FORUM, May 2007. Web. 11 Mar. 2011.<http://docs.google.com/viewer?a=v&q=cache:5XFm3tNGQpwJ:www.gsb.stanfor d.edu/scforum/login/abstracts/documents/GS54.pdf starbucks coffee bean supply chain>. "Starbucks Opens Third U.S. Roasting Plant in Nevada. (Trade News). | North America United States from AllBusiness.com." Small Business Advice and Resources from AllBusiness.com. Tea & Coffee Trade Journal, 20 May 2003. Web. 11 Mar. 2011. <http://www.allbusiness.com/manufacturing/food-manufacturing-food-coffeetea/548196-1.html>. "USA QuickFacts from the US Census Bureau." State and County QuickFacts. Web. 11 Mar. 2011. <http://quickfacts.census.gov/qfd/states/00000.html>.

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Appendix A

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Appendix B

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Appendix C

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Appendix D

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Appendix E

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Appendix F

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Appendix G

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Appendix H

Demand Estimates
450 400 350 300 250 200 150 100 50 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Year Demand Growth % Safety Stock 2006 355 --2007 370 4.2% -2008 310 -16.2% -2009 322 3.8% -2010 334 3.6% -E2011 350.7 5.0 % 15% E2012 368.2 5.0% 15% E2013 386.6 5.0% 15% E2014 406.0 5.0% 15% E2015 426.3 5.0% 15% E2016 447.6 5.0% 15% * All values in millions of pounds

Expected Import -----403.3 423.43 444.6 466.9 490.25 514.7

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Appendix I

% change in Coffee Production 2010 Brazil -13% Vietnam -3.7% Columbia -15% Honduras +149% Kenya +52%

Country

% Supply for Starbucks 40%, 47.2 mil 20%, 18 mil bags 10% 10.5 mil bags 20% 3.8 mil bags 10% 3.7 mil bags

Average forecasted coffee harvest for 20112011 2016 6.23B lbs 2.38 B lbs 1.39B lbs 501.6M lbs 488.4M lbs

Supplier Imports

Brazil Vietnam Columbia Kenya Honduras

Year Price Inflation 2006 1.58 2.4% 2007 1.08 4.1% 2008 1.24 0.1% 2009 1.16 2.7% 2010 1.47 1.5% 2011 1.47 (w. contract) 1.6% E2012 2.50 1.86% E2013 2.30 1.86% E2014 1.90 1.86% E2015 1.93 1.86% E2016 1.97 1.86% Coffee Bean Price/lb ($) & Inflation

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Appendix J
4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Price Inflation

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Appendix K

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Appendix L

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Appendix M

Starbucks Revenue vs. Net Income

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Appendix N

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