Case Study Starbucks expansion to Rio

Table of Contents
Introducing the Starbucks Case The US success story of Starbucks Using the competitive advantages for international expansion The Starbucks brand. Environmental challenges of Starbucks Balance in cost reductions and local responsiveness Worldwide strategy Entry mode choice The systematic approach References Appendix A - Present value calculations 3 3 3 4 5 6 6 7 8 11 12 12

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Introducing the Starbucks Case

The successful coffee retailer Starbucks is planning to further expand abroad after its successes in Japan, Germany and many other countries. Many challenges have to be faced when entering a new market, and among them the difficulty of the opposition of local people. How should Starbucks deal with this in their expansion strategies, and more specific in the case of Rio the Janeiro?

The United States success story of Starbucks

With its incredible growth rate, Starbucks acquired international recognition. With a 20% growth of its revenue, Starbucks is ahead of many large well-known brands like Coca Cola and Wal-Mart. Starbucks CEO Schultz may state that There is no secret sauce here, anyone can do it!, still there must be specific ingredients in the Starbucks formula that settled the brand. From a resource-based perspective, Starbucks has several resources and capabilities that count for the companys sustainable competitive advantages. The resource-based view distinguishes three crucial elements: Physical tangible resources, intangible reputational and technological resources and human resources (Peng and Meyer, 2011, p.101), which will be used in analysing Starbucks competitive advantages. The physical tangible resources consist mainly out of the network of their carefully selected store locations. Instead of one store in a city, Starbucks builds multiple stories. Although the new store will reduce the nearby Starbucks revenue by about 30% at first, it wil reduce the delivery and management costs due to the more effective distribution chain and shorter customer per store. The intangible technological and reputation resources contain the firms goodwill, brand names and business relationships. The firms coffee is made from specially selected high-quality Arabica coffee beans, and hereby guaranteeing their costumers excellent coffee. Because of the high-density networks of the stores, this high quality and experience are associated with the Starbucks brand. Over time Starbucks gained this international reputation, and in this it established a strong and valuable trademark. Starbucks sees their employees as important human resources and Schultz believes that happy employees are a key factor in Starbucks competitiveness and growth. Starbucks encourages employees involvement in the company via a unique organization culture. Starbucks provides trainings for each employee and offers benefit packages to both full-time and part-time employees, which reduces the employee turnover rate significantly. Naturally this organizational culture became an important factor in the overall performance of the firm. This culture is valuable, rare, hard to imitate and organizational embedded and therefore it can be considered to be a competitive advantage to Starbucks (Peng and Meyer, 2011, p. 108-112). Now that the Starbucks participation in the US market is laid out the important question is how the key factors that turned Starbucks into a success in the US be used in their global expansion strategies.

Using the competitive advantages for international expansion

Nowadays most of the shops are opened in North-America, however Starbucks has turned its attention to foreign markets to continue growth. When venturing overseas Starbucks has its own way of doing business. The most important thing is they want local partners to run their foreign

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businesses. This implicates they test each country with a handful of stores in trendy districts, using experienced Starbucks managers. Then thirteen weeks of training follows and the stores can be taken over by their local partners. Because of countries unique food preferences, Starbucks adapts its food to the local tastes. This form of adaption strategy is especially successful when entering distant foreign countries (Peng and Meyer, 2011, p.428). This policy is also used in choosing a stores location and changing its appearance. The Starbucks approach to international expansion is to focus firstly at the partnership and secondly at the country. As mentioned earlier, they want to rely on their local connections so they have to find the right local partners to negotiate local regulation and other issues. To achieve the best result they are looking for local partners with similar values, culture and goals with respect to community development. A prospect partner needs to have experience with the local real estate and retail markets to ensure they are able to choose the store sites. Starbucks interest goes to partners who can guide them through the process of starting up in a foreign location. Entering a market through partnerships increases the knowledge about the local market and it ensures a higher market entry speed (Peng and Meyer, 2011, 370). The most valuable resource in expanding abroad is the well-known brand name. They can save on advertisement costs and expenditures can be concentrated investing in store buildings and creating the Starbucks experience. After a successful entry in a local market, a carefully designed strategy is rolled out with opening multiple stores in one area, taking full market share and thus keeping delivery and management costs low. In the following chapter the importance and value of the Starbucks brand name is addressed.

The Starbucks brand.

The Starbucks brand is a valuable global brand. This is a strong resource of the company, especially since the brand markets itself given the companys low advertisement spending. The main branding occurs within the stores. Several features of the Starbucks model are important for and associated with the Starbucks brand. The Starbucks brand ensures excellent quality combined with the Starbucks experience (the atmosphere in the coffee stores). Therefore the company focuses on brand building when entering a new market. After a brand is established it can be extended and leveraged with for example partnerships as was done in U.S. Given al this, the brand name Starbucks is obviously an important resource. But what is the value of a brand name if people associate negatively with it, or is actively protested against? Will the Starbucks model work without its brand name relaying on its coffee purchasing strategy, the experience it creates in its stores and the corporate culture of the company. In general it can be said that U.S. brands are popular in developing cultures. A study conducted in 20 developing countries found that 70% of the consumers regarded an international brand qualitatively better than the local brand thus preferring the (established) international brand (Hein, 2007, p.4). This might be the general effect of the strength of a brand name on the perception of product quality. According to Hilgenkamp & Shanteau (2010, p. 561-563) brand name is the largest determinant of product quality across cultures and that consumers value products from strong brands as qualitatively better. This creates brand value, which is the added value of a brand product over a non-brand product, or the value of the brand for shareholders. The brand equity is the consumers behaviour towards, and perception and knowledge of the brand. With this it contains the

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association people have with the brand and it is a measure of the consumers value of the brand and is therefore useful in a brand review. (Tiwari, 2010, p.421-424). In a research about chain restaurant brands they conclude that the brand equity is the most important aspect of consumer equity, which in turn is an important aspect of the restaurant chains success and conversely the shareholders value (Hyun, 2009, p.529). Thus good brand equity is essential for successfully international expanding. Another recent study shows that the brands personality is influencing this brand equity more and more positive than the intensity of sales promotion (Florence et al, 2011, p.24). What could be concluded from this? Above all, brand names influence the consumers behaviour extensively and are important for businesses in general. The personality of a brand and its success add up to the brand equity. A strong brand like Starbucks is highly dependent on its name. Without it, it is just another coffee store, therefore it is not surprising that the chairman worries about the loss of reputation after some alterations in the concept that was made to support further expansion and drive down costs (Creamer, 2007, p.3). In the process of foreign entry, these identity values must be kept in mind. However, a brand does not stand by itself, other firm specific resources of Starbucks can be valuable as well. Already named is the lower management and delivery costs associated with a big network of stores in one area. Nevertheless, in order to build such a network, the initial stores must be successful and the Starbucks brand needs to settle in that area. In the personality of Starbucks, the brand name carries most of the valuable resource with respect to gaining market share and business success. However being a global player this part of the strategy includes some difficulties. The growing resistance against Multinational Enterprises (MNEs) and globalization in general these days is one of them.

Environmental challenges of Starbucks

Geographically speaking, Starbucks will enter a market and tries to dominate the market before further expanding to other countries are considered. Such an entry into new markets can give less desirable responses from local people, and this is something Starbucks has discovered before. There are some issues companies like Starbucks have to overcome when entering new markets. Antiglobalization movements can pose a big challenge for the firm. Payment of workers in developing countries is a topic that gets attention in local and worldwide media. Starbucks was being accused of paying less than a living wage to coffee plantation workers in developing countries. This can be harmful to the brand, especially when the sales and future expansion to other countries are considered. The company guidelines for payment to suppliers state that wages should be paid so that workers and their families can fulfil in their basic needs. Next to this, child labour is allowed only when its education is not affected. It is important the public will be informed about the way the firm is doing business in supplying countries. When this is not the case, the firms reputation might have to endure damage. Further issues dealing with anti-globalization are that local people with the agenda to block Starbucks from their community, with the argument of cultural imperialism. With this respect men can think of the example of the store in Primrose Hill. In this case there were British people who did not want to see this American company in their area, being afraid of losing their culture. Another example is in Beijing in 2000 when a store was opened in the Forbidden City. There was much controversy in the media about this, because the store was located in a part of the city that belongs to Chinese cultural heritage. Another reason that comes with globalization is the threat that local

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competitors will be driven out of the market. CEO Schultz pointed out local competitors even benefitted from Starbucks entrance to the market, because a network of Starbucks attracts new customers into the coffee market, generating extra demand. For Starbucks there is another threat deserving some attention. Starbucks is very much linked to the US. Ethnocentrism might be a possible threat in expanding internationally. People from the US have the imago of being self-centred with a we lead the world mentality. This weak imago forms a possible threat when trying to expand into other cultures, because the local peoples perception of the US differs from culture to culture. This might lead to the creation of possible conflicts. The solution to such conflicts can be complex since the informal institutions will differ between the cultures. These differences between informal institutions can harm MNEs, as became painfully clear in the case of the Danish cartoons riots following the publication of the Muslim prophet Muhammed in Danish newspapers and where products of Danish MNEs were blocked from being imported into Muslim countries (Peng and Meyer, 2011, 66-67). Besides anti-globalization it is important to look to other challenges with respect to international expansion. Firstly, the firm needs to expand quickly into new countries, taking advantage of the existing opportunity, avoiding the threat of other firms using the brand and concept of Starbucks, getting away with those possible market shares. Another challenge for Starbucks is the fact the firm uses local partners outside North America and this means a lower share of profits. Because of the experiences that Starbucks had in the past with entering new markets, nowadays there is a discussion going on in the company about financial gains versus having a strong brand reputation. A systematic method to react to resistance within new markets has still to be developed.

Balance in cost reductions and local responsiveness

Dealing with constraints becomes more important when a firm enters an unfamiliar market (Mutinelli, Piscitello, 1998). These constraints include transactions cost, opportunity cost and costs related to gathering information about the new institutional environment. In recent FDI research, the most important decision faced by the firm who enters a foreign market is the choice between a joint venture and a completely owned company in the form of a Greenfield investment (Mutinelli, Piscitello, 1998). It seems joint ventures overcome these cost and uncertainty of foreign markets (Mutinelli, Piscitello, 1998), and when talking about uncertainties, there is limited risk in a joint venture investment due to a lower capital commitment. However, there is a high risk of coordination failure (Peng, Meyer, 2011). In general, joint ventures share costs, risks and profits. Besides they have access to the knowledge of the local partners about the environment. In this way, Starbucks can use the adaptation strategy (Peng, Meyer, 2011). The basic concept will remain the same; however the food can be adapted to the local taste as well as the interior dcor. This enables Starbucks to meet the needs and tastes of local people. Starbucks should find a trustable local partner, which shares the same values, culture and goals about community development. It is important that the local partners can support the process of starting up a Starbucks company in a foreign market.

Worldwide strategy
Starbucks goals are to expand overseas and to become a company with the most recognized brand name in the world. In each new country Starbucks opens a few stores and uses experienced Starbucks managers. Local employees will receive specific training to run the store successfully. The

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company wants to find the right partners to establish good partnerships in joint ventures. One of the reasons that Starbucks chooses to work with local partners is the risk involved with global expansion, as mentioned before. On the other side it reduces the companys profit, because of shared ownership. Views of the local communities on the establishment of new shops of Starbucks will be taken into account by the company. If Starbucks is not welcome in a community they will not locate a store in that area. Nowadays there exists a discussion within the company about when to enter new countries and when not to enter. Next to the expected returns in a particular country, also the protection of the brand name will be taken into account. When there is a high risk of resistance amongst local people towards the company, entry might not occur at all.

Entry mode choice

There are different modes of entry a firm can consider when they are going to operate abroad (Peng, Meyer, 2011). First it is important to determine whether to pursue equity or non-equity modes of entry. This is the main difference between multinational enterprises (equity) and non MNEs (nonequity). A non-equity mode relies more on exports and contractual agreements while with equity modes, FDI is the way of the MNE to enter a foreign market through joint ventures and wholly owned subsidiaries (Peng, Meyer, 2011). Firms who compete on the basis of technology, brand names or other intangible asset are likely to use equity modes rather than a contractual collaboration. However, even when a firm has decided to use an equity mode, there are still several factors that must be taken into account; commitment, risk, return, and control. The choice of the entry modes depends on two questions: how do we access complementary local resources? And, how much control will we attain? (Peng, Meyer, 2011). There are four different entry modes for firms who engage in FDI (Peng, Meyer, 2011): Greenfield (wholly owned) (Full) acquisitions Joint ventures (newly established) Partial acquisitions.

When different entry modes are considered, the choice is often explained by three main theories: Transactions cost, Resource based view, Institutional theories (Datta et al, 2009 p.932). Several different modes of entry exist; however in recent years the most common trade-off is the choice between cross-border acquisitions and international joint ventures (Datta et al, 2009 p. 929). In general, firms must consider different modes of entry if they go abroad because every foreign country is different. Firms must choose an entry mode that fits best with their company strategy and they have to look at the environmental threats, the industrys competition, and the opportunities, the market demand, in the host country (Cui, Jiang, 2009 p.442). Joint ventures are commonly used when there is a short-term investment plan. The transaction cost and the risk is lower in a joint venture compare to an acquisition. The local partner has the knowledge of the foreign environment and can adapt more easily on the local demand. A joint venture is more likely to overcome the cultural barriers and offset regulative institutional barriers (Cui, Jiang, 2009 p.442). However; they have to share profits. An acquisition keeps its profits but has much higher transaction costs and risk and they cant adapt easily to the new environment and local demand (Datta et al, 2009 p.931). For Starbucks the same trade-off is applicable. When looking at Starbucks strategy and the importance of building their brand name it is important to settle quickly in the foreign country.

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Because Starbucks is taking the culture and local demand seriously, the joint venture is likely to be the most common used mode of entry.

Elements for market entry

When Starbucks is considering entering new markets certain elements should be taken into account. In the book of Peng and Meyer a model with building blocks of an entry strategy is described. Using this model for Starbucks, a systematic approach for entrance of new markets will be constructed (Peng and Meyer, 2011, p.362). First a location should be picked, by looking to a country, region and city. Therefore it is important to take expected revenues (growth potential) and also cultural aspects into account. Resistance of local communities against a new store of Starbucks should be taken into consideration. The brand name and reputation are important for the company, therefore this should not be risked. Entry to another country should increase the value of the brand. When this is doubtful beforehand entry should not take place. Second, a local partner with relevant experience has to be found in order to start-up a foreign location. This is also one of the criteria that have to be fulfilled before entry can take place. Timing of entry is another very important aspect for entry. Being a first-mover in the market gives opportunities to build relationships with customers and to create a strong brand name. Being a firstmover is an advantage for Starbucks, but not necessary condition for entry. Find an entry mode that enhances speed of entry is important in this respect (joint venture). When the company has a lot of knowledge about the local market and speed of entry is of less importance, an acquisition is preferred. Transaction costs might be higher with an acquisition; on the other hand the company has the benefits of full ownership. Furthermore HRM should be considered before entry. There need to be qualified people to work in the store(s). This is necessary to guarantee the Starbucks experience. Having people with the required experience and skills is an advantage, but not necessary. The company provides training for every employee. For logistics is it important to have acceptable transportation costs. Establishing more stores in one area is preferred, because this lowers logistic costs.

The systematic approach

To simplify the decision process about the development of Starbuck stores, we came up with the model in Figure 1. At first the decision to enter a certain country must be made. The question here is whether there is market potential and growth for high-end coffee ventures. If the country lacks such potential Starbucks should not enter this market. Then the scope of the operation must be determined. Is the focus on international, rich consumers or is the average inhabitant of the country a potential customer for the firm. Especially in developing countries this is an important consideration. If the common man in a country cannot afford a four-dollar of coffee the focus should be on different locations where international customers and rich natives come. Men can think about airports, shopping malls, and international business areas. In locations like this no resistance against the development of Starbucks ventures is expected. But if Starbucks decides to also open stores in neighbourhoods there can be resistance of the community. In that case the profitability of the planned stores must be recalculated taking this resistance into account. The potential damage to the brand name by for example media attention, as in the Primrose Hill case, must be considered as well since this is Starbucks most valuable asset. If the stores turn out unprofitable or the brand name

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damage can be substantial they should readdress their focus to the specific sites outside the community. If the resistance doesnt hurt the profit or the brand they should invest in coffee stores in this area. Figure 1: Decision model tree for entering a certain community or neighbourhood

Is there market potential in this country?

Is the focus only on international/rich/jetset

Only use specific coffeestore locations outside communities (airports, shopping mall)

Do not enter this country

Is there (long term) resistance in target community

Does the resistance hurt the profitability or brandname enough to make the store unprofitable

Open stores in the Open stores in the community community

To reason whether Starbucks should open stores in Rio de Janeiro we use the model specified above. Since the decision to open stores in the particular community is already made, the main question is if the stores are profitable taking into account the resistance from the community (pick pockets and other criminal behaviour). To calculate the present value we used a discount rate of 13.75% (see the calculation in the appendix A) using the 2003 risk free interest rate of 4% (Damodaran, 2008, p. 26), the 2003 US market risk premium of 6.5% (Officer and Bishop, 2008, p.13) and Starbucks beta of 1.25 (Yahoo Finance 2011). The present value of the flag store under normal conditions assuming a 5% profit growth for years five to ten and a profit of $400.000 for the five years thereafter is $1.720.139 (see appendix for the calculation). With an initial investment of 1.4 million this investment is profitable. According to the case the damage of the community resistance can be between 5% and 20% of the revenues. Assuming that this will cut into the profit with the same magnitude the PV of the flagstore in the 5% scenario is $1.634.132 (still profitable) and the PV of the flagstore investment in the 20% scenario is $1.376.111. So in the worst case scenario the investment is not profitable. For the normal stores we used the same calculation (see appendix A) assuming a constant year profit of $300.000 after ten years and we came up with a normal condition PV of $1.321.825. With the

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upfront investment of $615.000 this is a highly profitable investment. Even in the worst case scenario the PV is $1.057.460 and thus still profitable. Only the flagstore is not profitable in the absolute worst-case scenario. But still, the resistance in that case must be long term and severe and since Starbucks can try to come to an agreement with the community, the long term worst case scenario is not likely to occur. Because the normal stores will be profitable even with high community resistance and the brand name will probably not be heavily damaged, assuming no ideological celebrities will attract extra media attention, this reports advise is to open the flagstore and four normal Starbucks stores in Rio de Janeiro.

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References
Creamer, M. (2007). Starbucks wakes up and smells the death of its brand experience. Advertising Age, Vol. 78, Issue 9, p. 3. Cui, L., Jiang, F. 2009. FDI entry mode choice of Chinese firms: A strategic behaviour perspective. Journal of World Business, Vol. 44, Issue 4, p. 434-444 Damodaran, A. (2008). What is the riskfree rate? A Search for the Basic Building Block, Stern School of Business, New York University, p. 1-33 Datta, D.K., Musteen, M., Herrmann, P. (2009). Board Characteristics, Managerial Incentives, and the Choice Between Foreign Acquisitions and International Joint Ventures. Journal of Management, Vol. 35, Issue 4, p. 928-953 Florence, V.F., Guizani, H. Merunka, D. (2011). The impact of brand personality and sales promotions on brand equity. Journal of Business Research, Vol. 64, p. 2428 Hein, K. (2007). Emerging Markets Still Like U.S. Brands. Brandweek, Vol. 48, Issue 16, p.4-4 Hilgenkamp, H. & J. Shanteau (2010). Functional Measurement Analysis of Brand Equity: Does Brand name affect Perceptions of Quality? Psicolgica Vol. 31, p. 561-575 Hyun, S. S. (2009). Creating a model of customer equity for chain restaurant brand formation. International Journal of Hospitality Management, Vol. 28, p. 529-539 Mutinelli, M., Piscitello, L. (1998). The entry mode choice of MNEs: an evolutionary approach. Elsevier, Research Policy, Vol. 27, 491506
Officer, B., Bishop, S., (2008). Market Risk Premium a Review Paper. Value Adviser Associates,

p. 1-42

Peng, M., Meyer, K. (2011). International Business. Cengage Learning EMEA. P. Tiwari, M. K. (2010). Separation of Brand Equity and Brand Value. Global Business Review, Vol. 11, Issue 3, p. 421-434 Yahoo (2011). Financial Indicators Starbucks. Retrieved at 29 September 2011 from http://finance.yahoo.com/q/ks?s=sbux

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Appendix
A - Present value calculations Discount factor used in calculations: ( ( ) )

PV of Flagstore PV flagstore at normal conditions:

= 1720139

PV with profit loss due to community resistance: 5% profit loss PV = 1634132 20% profit loss PV =1376111

PV of Coffee stores PV normal coffee stores at normal conditions:

=1321825

PV with profit loss due to community resistance: 5% profit loss PV = 1255734 20% profit loss PV =1057460

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