Starbucks: An analysis of supply chain risk and mitigation strategies
Khan, S., Johnson, A., Gill, G., Chittuluri, H., Agrawal, S.
Date of Publication: 2015-04-28
- Farmer Relationships and Sustainable Sourcing
- Commodity Prices
- Business Partners
- Geopolitical and Macroeconomic Issues
With 27,000 stores operating in more than 64 countries, Starbucks Coffee has become a global leader in the delivery of the coffee experience to consumers worldwide.
Just one cup of the ubiquitous Starbucks coffee can depend on inputs from up to 19 different countries. The company walks a delicate balance between its trademark vertical integration, while also engaging over 9,000 suppliers, from its coffee farmers across the world to its custom roasters, to distribution logistics providers and retail.
Given its global footprint, Starbucks also faces a range of risks that affect both the company’s short-term profitability, such as the speed at which its distribution systems deliver product to its retail outlets, as well as long-term sustainability, such as environmental resilience and coffee farmer’s capacity.
Furthermore, Starbucks is growing rapidly, both globally and in its product lines. It is expanding its offerings to include wine and tea bars that create customer experience-centered retail outlets similarly, and when the company acquired La Boulange to centralize its US bakery operations, it doubled the number of refrigerators in America.
Growth at this scale, coupled with a diverse product range, vast global footprint, and highly complex supply chain, requires careful management of known and unknown risks. In this report, we outline four key supply chain risks that Starbucks faces, detailing how those risks affect business operations, Starbucks’ efforts to mitigate them, and recommendations to further develop the company’s response.
Farmer Relationships and Sustainable Sourcing
Starbucks is heavily reliant on commodities sourced from the developing world, such as coffee, tea, and cocoa. In delivering these products across its supply chain, the company links consumers in some of the wealthiest regions of the world with suppliers in some of the poorest.
Risks & Effect on Business Operations
To fulfill growing demand, Starbucks must be able to depend on the quality and stability of suppliers who may face limited resources, regulation restraints, and capacity controls. Currently, Starbucks pays its suppliers an average of 23% above market prices to procure the high-quality Arabica coffee its brand relies upon. Given the limited supply of beans that meet its standards as well as price volatility discussed in the commodity prices section below, the company faces potential shortages, and skyrocketing prices of its core product should its criteria not be met in a given harvest.
Additionally, Starbucks’ relationships with suppliers – especially those in the developing world – have long been a target issue for activists of human rights, environmental and labor issues. Activists began pressuring the company to offer fair trade coffee in 2000, and the company faced a major reputational blow in 2006 after campaigns by Oxfam against Starbucks dealings with the Ethiopian government as well as the documentary Black Gold. In an industry with active competition on sustainability issues, the health of the Starbucks brand is reliant on the company’s ability to source ethically traded inputs.
Current Mitigation Strategy
Given these risks, Starbucks leadership have asserted that it is in company’s interest to support the development of high-quality, sustainable production of coffee, tea, and cocoa, and sees this as a leadership opportunity. As Dub Hay, Senior Vice President of Coffee stated in 2004, “Starbucks buys only about two percent of the world’s coffee beans, but as an industry leader and specialty coffee retailer with thousands of locations worldwide, we have an opportunity to lead change.”
Starbucks has chosen to invest in its farmer suppliers, and now exerts considerable influence over its suppliers regarding quality and sustainability. Its initiatives focus on three areas: People (including grower) wages and quality of life, Planet, including environmentally sustainable farming practices, and Products, including tracking of coffee certification and quality.
People and planet-focused initiatives include the setup of Farmer Support Centers in China, Colombia, Costa Rica, Ethiopia, Guatemala, Rwanda, and Tanzania staffed by agronomists and sustainability experts, which advise farmers on responsible growing practices to improve the volume and quality of their harvests. The company also provides farmer loans and incentives for grower performance, as well as community support.
In regards to product certification, the company began sourcing Fair Trade coffee in 2000 and developed its Coffee and Farmer Equity (C.A.F.E) standards in partnership with Conservation International in 2001. By 2006, the company became the largest purchaser of Fairtrade coffee in North America, and it became difficult to find sufficient supply of beans that were compliant with these systems, prompting further investments in the aforementioned farmer support initiatives.
In 2013, Starbucks sourced 95% of its beans from sources certified by C.A.F.E., Fairtrade or other externally audited systems, and it has pledged to raise this to 100% by the end of 2015. The company also participates in the Global Social Compliance Program; a business-driven initiative focused on improving environmental and working conditions in global supply chains.
As climate change, economic development and competition continue to shift the coffee supply landscape, Starbucks will continue to face challenges in sourcing fully certified coffee for its retail operations worldwide. One option to better incentivize growers to meet Starbucks standards may be to develop an incremental grading system and reward high-performing suppliers with preferred supplier status.
As the world’s largest coffee retail chain, Starbucks’ success is highly dependent on its ability to provide coffee to their customers at a consistent and affordable price. Three of Starbucks’ most essential inputs are coffee, dairy products, and diesel fuel. As commodities, these products are susceptible to price fluctuations.
Risk & Effect on Business Operations
Coffee is the most substantial input for Starbucks’ business. The price of coffee is subject to high price volatility based on the supply and demand at the time of purchase. The supply of coffee at any one time can be adversely affected by many things including but not limited to – weather, natural disasters, crop disease and the macroeconomic state of the region or country from which Starbucks purchases its coffee.
In addition to supply and demand issues, Starbucks does business in over 60 countries and is therefore susceptible to exchange rate fluctuations. The appreciation or depreciation of foreign currency can result in the erosion of Starbucks’ cash flows from its international operations.
Current Mitigation Strategy
The high altitude Arabica coffee that Starbucks purchases does not trade in the commodity market. To maintain price stability of this input, Starbucks uses fixed-price and price-to-be-fixed contracts. With a fixed-price contract, Starbucks agrees to purchase coffee from a specific supplier at a set price. With a price-to-be-fixed contract, Starbucks agrees to buy a certain amount of coffee from a particular supplier at a particular time without agreeing on a price. It is possible that Starbucks believes their size and relationships with suppliers makes their price-to-be-fixed contracts a relatively safe choice, despite not negotiating a price in advance.
Concerning the price volatility of commodities such as coffee, diesel, and foreign exchange rates, Starbucks uses many methods to control costs. For commodities traded on the open market such as most coffee and diesel, Starbucks uses price hedging or futures hedging. For other significant inputs such as dairy and Starbucks relies on their relationships with suppliers to guarantee access to a stable price and supply. To protect from cash flow loss to due exchange rate volatility, Starbucks uses derivatives and futures hedging.
While Starbucks’ relationships and experience with commodity trading equip them to tackle the risks associated with commodity pricing and the volatile nature of the coffee and diesel markets, their annual reports admit that they are still susceptible to geopolitical and macroeconomic forces. By sourcing product from more regions and sourcing more inputs from within the international markets where they receive the most substantial proportions of their non-US revenue – such as their growing sales and coffee sourcing in China – they can more effectively protect themselves from forces that they can control or influence.
While Starbucks has become associated with vertical integration, the company engages in a wide range of partnerships across its supply chain, including with its growers, custom roasters, producers of the manufactured items it procures, logistics providers and retail licensees.
Risk & Effect on Business Operations
Starbucks’ reputation relies on the ability of its partners to deliver products and services in a timely, efficient, high-quality manner. Third party vendor quality and service may be disrupted due to shipping problems, trade restrictions, natural disasters, or failure to meet standards, as well as a range of other factors beyond their or Starbucks’ direct control. Disruption can result in the loss of product, litigation, revenues, and profits, as well as damaged reputation.
In particular, the company’s immense growth can make it increasingly difficult to ensure consistent supply and maintain adequate internal controls. Starbucks’ brand value centers on customer experience, and – in early years, the company directly owned all of its retail outlets. As the company sought rapid international growth, joint ventures with local retail and restaurants became Starbucks’ core market entry strategy due to its need for local expertise. The company typically entered into licensee relationships, gradually increasing Starbucks’ ownership stakes to at least 50%. However, licensee-managed retail outlets are at risk of failing to deliver on Starbucks’ exacting customer experience requirements. They are also authorized to use Starbucks logos, which may lead to erosion of brand reputation if licensee quality and service lag.
Current Mitigation Strategy
The Starbucks brand has become known for its longstanding focus on vertical integration, in contrast to trends toward outsourcing and decentralization that have become common among its peers. Starbucks has long relied on this centralized control over its supply chain as its risk mitigation method of choice. Starbucks’ acquisition of La Boulange for $100M in 2012 furthered the company’s vertical integration, but may place it at risk of supply disruption should the La Boulange system fail to deliver as expected. In other areas of its operations, however, Starbucks asserts that it does source from a wide variety of partners as part of its risk mitigation strategy. The company also provides training, support, and monitoring of operations to some business partners.
Notably, Starbucks has adopted a gamification approach to predicting supplier procurement needs of some products. The CIO of a company which supplied paper cups and other supplies responded to growing frustration with challenges in supplying appropriate quantities of red holiday cups to Starbucks outlets by creating a supply chain-based data game. This process assisted in improving staff collaboration, communication, and timely responses to changes in demand while cutting excess inventory by 60% and $400,000 within the first 90 days of use. It has since been used to roll-out other new product lines.
The gamification example above illustrates the value of investing in data-based systems, as well as supplier relationships and capacity development. In addition, the use of strong incentives to mitigate lapses in quality may assist in motivating supplier vigilance regarding efficiency and quality. While Starbucks is unlikely to shift far from its vertical integration legacy, continued re-evaluation of its operations, as well as those of its suppliers, can ensure its operations maintain a balance between efficiency and control.
Geopolitical and Macroeconomic Issues
China/Asia Pacific (CAP) and Europe, Middle East and Africa (EMEA) represent the regions that Starbucks is dependent on for growth. The fact that Starbucks sources the majority of its coffee from Latin America makes it vulnerable to geopolitical and macroeconomic shocks that are limited to this region. In addition to supplying Starbucks with most of its coffee, Latin America is a growing market and home to 740 Starbucks coffee houses.
Risk & Effect on Business Operations
Starbucks is increasingly reliant on CAP and EMEA countries for the company’s overall growth. Entering these new markets comes at a higher cost and also requires Starbucks to do business in varying regulatory environments and political regimes. In the case of Europe, these risks might be mitigated due to the single currency and regulatory structure, but expanding into the Middle East, Asia and Africa come at a higher cost per store.
In Latin America, natural disasters, inclement weather, and geopolitical issues can pose a risk to Starbucks supply of coffee. Severe weather and natural disasters can damage crops or interrupt maritime traffic and disrupt shipments of coffee and other inputs. Economic shocks are a risk in every country in which Starbucks operates given that the company relies on customers’ disposable income. If consumers of Starbucks lose their livelihoods, they may be forced to purchase a less costly alternative, resulting in the loss of Starbucks’ revenue and ability to invest in expansion.
Current Mitigation Strategy
As was noted earlier, Starbucks sources the majority of its coffee from Latin America, but it has been diversifying by increasing coffee purchases from China. They are also diversifying their coffee sourcing in rest of the world as well as the products they offer consumers. Concerning the potential geopolitical issues, Starbucks recognizes them, but its responses are more reactive without a specific mitigation strategy in place.
Starbucks should source more of their inputs from the countries where they do business. Doing so would provide some protection from economic shocks in other countries and regions. Also, coffee beans from China only represent a small portion of the Starbucks business. By relying on China for more coffee, they can build stronger relationships with farmers there and protect themselves from potential shocks due to weather, natural disasters, politics in Latin America.
Starbucks continues to be a leader in the coffee industry, and the growth of its product lines and geographical footprint attest to the company’s ability to manage risk in increasingly complex supply chains. Whether the company can continue to do so in its new markets, and fully integrate ERM approaches will test the company’s core systems and provide an example to other businesses operating in the food and beverage space.