Tying It Together
We began the chapter with the story of Starbucks—a coffee shop whose business strategy led it to become a multi-billion dollar chain. You’ve now learned the tools—the Five Forces framework—necessary to understand Starbucks’ strategy and how it led to its success. So let’s tie all this together by evaluating how Starbucks tackled each of the five forces to succeed.
Force one: Competition from existing competitors.
Starbucks controls nearly 40% of the U.S. coffee-shop market, while its next largest competitor, Dunkin’, controls about 20%. Starbucks also competes with chains like Tim Hortons, Peet’s, and McDonald’s, as well as countless independent coffee shops and restaurants. How does Starbucks maintain its dominant position in the face of so much competition?
In short, by differentiating and carefully positioning its products. When Starbucks started expanding in the late 1980s, your best bet for coffee was usually the local diner. Starbucks differentiated its coffee by making it fresher, stronger, and better. As Starbucks expanded, it further differentiated its product, offering a wider array of beverages from black coffee to the most sugar-laden Frappuccino. It’s not just selling coffee, it’s also selling ambience, and their comfortable couches are more inviting than the hard wooden chairs at Dunkin’. Starbucks is also a quick place to get a coffee: It’s located in busy, convenient areas, and its baristas are efficient. Starbucks has also worked hard to build a reputation for consistently good coffee. When you are on the road, just as you trust McDonald’s to serve a reliable cheeseburger, you can trust Starbucks to offer reliable coffee.
By differentiating all aspects of its product through effective non-price competition, Starbucks can charge high prices and still maintain a large, loyal customer base.
Force two: Threat of potential entrants.
Maybe you think you should start a superior coffee-shop chain that will overtake Starbucks. Well, Starbucks has made sure that it won’t be easy for you to compete by creating barriers to entry.
You go to Starbucks because everybody goes to Starbucks.
Starbucks employs demand-side strategies to try to lock in its customers. It has created switching costs through its rewards program. It has created network effects that make it easier to suggest that you meet a friend at Starbucks rather than somewhere they don’t know. And it has created brand loyalty so that many of its customers won’t easily be won over by a new rival.
Starbucks has also employed supply-side strategies in a quest to develop unique cost advantages. It has learned by doing, through decades of experience. It knows how to operate on a mass scale efficiently, making sure each coffee shop always has enough ingredients and that every employee knows how to brew each drink just the right way.
Entry deterrence is important to Starbucks, and its war chest of more than $1 billion in cash on hand gives it the means to win a bruising fight with any new rival. And it has proven throughout its history that it’s very capable of crushing market entrants.
Finally, Starbucks also has a sophisticated regulatory strategy, and its lobbyists are in constant dialogue with the government on a range of issues. As a result of all these barriers to entry, no new competitor has really been able to challenge Starbucks.
Force three: Threat of substitute products.
Starbucks also has to worry about substitute products. When you want to meet with someone, you don’t necessarily have to meet for coffee; you could also go to a restaurant or bar. If you really want coffee, you can buy it from a convenience store or restaurant. Or you could just make coffee at home. Perhaps your workplace has a coffee machine you can use. And if what you’re mainly looking for is a caffeine boost, you don’t need coffee; you can also drink tea or Red Bull.
In response, Starbucks has incorporated most of these substitutes into its own offerings. It sells tea, hot chocolate, strawberries-and-cream Frappuccinos, a Doubleshot energy drink, and food ranging from sandwiches to scones. Starbucks also sells bottled coffee drinks both at its coffee shops and at various retailers, as well as ingredients for making Starbucks coffee at home or in the office.
Force four: Bargaining power of suppliers.
Starbucks’ suppliers also have options. If you’re a coffee bean supplier, you don’t have to sell your beans to Starbucks; you can sell them to practically any coffee buyer. Equally, there are many coffee bean suppliers selling virtually identical products, and so when Starbucks negotiates with any individual supplier, its next best alternative is pretty good: Cutting a deal with other coffee growers instead. Starbucks uses this leverage to negotiate extremely competitive prices on its coffee beans. Starbucks is looking for their suppliers to invest in providing it with a specific premium coffee, and this requires their farmers to invest in the relevant farming technology. While this might create a hold-up problem for farmers, making them reluctant to invest, Starbucks solves it through long-term contracts and repeated interactions.
When it comes to its workforce, Starbucks has quite a lot of bargaining power, since there are millions of potential workers to choose from. As a result, the typical Starbucks barista makes only a few more dollars more than minimum wage. However, there are also many potential employers, so the stronger the labor market is, the higher Starbucks’ wages will need to be to attract good workers.
Starbucks faces a tougher situation when it comes to real estate. Many landlords would love to have Starbucks as a tenant. But in any given desirable area, there are only a few suitable storefronts, and many retailers compete for them. Because the number of total storefronts in an area is relatively fixed, landlords have a lot of bargaining power. They also know that Starbucks has a high willingness to pay, since a highly visible, convenient location is much more likely to be profitable than a nearby location that’s out of view. As a result, Starbucks pays a small fortune in rent.
Force five: Bargaining power of customers.
Customers also have bargaining power. If the price isn’t right, you can simply stop going to Starbucks and switch to a substitute, whether it’s coffee at a different coffee shop or iced tea. However, Starbucks still has a lot of leverage because of the choices it has made to differentiate its product. The locations convenient and you go there every day, so you know the coffee is delicious. Why would you walk two blocks over for coffee that’s slightly cheaper and of dubious quality? You could threaten not to keep buying Starbucks unless it offers you a lower price, but it’s not going to respond, because even if you go elsewhere you’ll hardly affect its bottom line.
As a result, Starbucks charges prices that are quite high, usually between $2 and $5—and it has enough market power that it can raise prices when it needs to. But Starbucks needs to maintain its reputation with you and many other regular customers. So Starbucks doesn’t raise its prices too often.
Starbucks also sells a product that is fundamentally habit forming. Nearly two-thirds of U.S. adults drink coffee every day, and they drink an average of three cups per day. A big reason for this is not just that caffeine can make you feel more alert. It’s also that caffeine has some nasty withdrawal symptoms, like fatigue, headaches, and disrupted sleep. So when the choice is between drinking coffee and feeling normal, or going without and feeling like a shell of yourself, you don’t have much bargaining power. Suddenly $4 for a coffee seems like a good deal, which is great news for Starbucks.
Let’s put the pieces together.
Our Five Forces analysis reveals that Starbucks’ success is no accident. Like other businesses, it has to worry about existing competitors, potential entrants, substitutes, and the bargaining power of suppliers and customers. But it has managed to deal with all five of these forces successfully, and so it continues to dominate the coffee-shop market.
These are the tools that you’ll need to master to succeed in any challenging managerial role. We analyzed many of these issues in previous chapters, and in this one, we’ve completed the job, adding a careful analysis of non-price competition, and of bargaining power. Now you can go out and use the Five Forces framework to identify opportunity, and then execute in a similarly strategic way to Starbucks.