CNBC Stock Blog

Coffee Wars: How Starbucks and McDonald's Blew It

Jason Notte|Staff Reporter

Remember when Starbucks drinkers were elitists, Dunkin' Donuts adherents feared non-English languages and McDonald's coffee became coff-"ay"? Thankfully, the coffee wars are over, but who won?


It wasn't the baristas or their caffeine-addled denizens, but the one-cup commuter. Last year, Starbucks had just finished closing 600 underperforming locations when it opted to close 300 more last January and eliminate 7,000 positions.

Smelling blood in the water, competitors such as McDonalds and Dunkin' Donuts intensified advertising and shifted strategy, with McDonalds launching its McCafe gourmet coffees and refurbishing stores to include coffee counters, televisions and, in some cases, fireplaces.

By the end of Starbucks' fiscal year last September, revenues were down nearly 6% and same-store sales had dropped 9%. McDonald's, however, didn't fare much better — revenues were down 7% in the U.S. and globally. Even while crediting its frappes for a 12% jump in second-quarter profits and 4% increase in same-store sales, McDonald's has somewhat softened its focus on in-store coffee — briefly annoying Jamba Juice with a foray into smoothies earlier this summer.

Where did all of that revenue go? Ask Green Mountain Coffee Roasters , which was more than happy to let the restaurant chains lease space, spend on ads and knock themselves out — with $1 coffee under the golden arches or low-priced, low-grade Pike Place brew for Starbucks customers who still can't figure out the difference between American drip coffee and espresso.

Riding the success of its Keurig K-Cup single-serving coffee machines in homes and offices across the country, Waterbury, Vt.-based Green Mountain exploited partnerships with Newman's Own, Tully's and Caribou Coffee en route to 56% sales growth each year for the past three years.

A homemade cup of coffeehouse-quality brew was the caffeine addict's drink of choice, as the National Coffee Association trade group's 2010 National Coffee Drinking Trends Study showed a jittery 86% of Americans preparing their coffee at home — percolating 4% from last year. Of the 56% of Americans who drink coffee, the study found that 16% changed their drinking habits as a result of the economy. With 40% of all coffee consumed considered to be "gourmet," that meant a shift from the counter to the coffee aisle.

In the case of Minneapolis-based Caribou Coffee, while sales at coffeehouses increased 3.4% last year and comparable store sales dove 2.3%, commercial sales including K-cups jumped 42.4% in the same period. Commercial sales also leapt 4% as a percentage of total sales, a trend that continues as Caribou's commercial sales growth (51%) far outpaced that of its coffeehouses (4.4%) last quarter.

The same holds true for San Francisco-based Peet's Coffee , which lost to Green Mountain in a bidding war over single-cup coffee company Diedrich. The company has only 192 retail locations — only eight east of the Mississippi River — and gets nearly 35% of its net revenue from grocery and delivery sales. While the company's coffeehouse sales grew 7% last year, grocery and delivery sales of Peets Coffee by the pound nearly doubled that growth rate. Growth was even more disparate last quarter, when a 4% retail gain was minimized by a 22% hike in grocery and foodservice revenue.

Nearly a year after its brief stumble, Starbucks has received the message. The launch of its VIA single-serving instant product in stores and supermarkets helped Starbucks push third-quarter revenues up 6%, to $2.6 billion, increase same-store sales in the U.S. by 9% and improve its operating margin to 15.6% from 10.8%. Revenues have improved 7% year-to-date, while comparable store sales growth spun 180 degrees, from down 7% last year to up 7% this year.

For now, Green Mountain and its home-brew ilk have seized the spotlight, though their reign may be short-lived. Coffee prices hit a 13-year high last week, trading at nearly $1.99 a pound, forcing J.M. Smucker to boost prices 9% on its Folgers, Millstone and Dunkin' Donuts coffees. Green Mountain followed suit, announcing plans to raise prices on its K-Cup offerings 10% to 15% next month. With Starbucks saying it will absorb the cost increase for the time being, it's possible the company may end up winning the same coffee war its instability started.


Disclosure information was not available for Notte or his company.