Starbucks accuses Kraft of hurting grocer sales

LOS ANGELES/NEW YORK Sun Nov 28, 2010 7:21pm EST

A mug bearing a Starbucks logo is pictured next to coffee beans during a news conference in Tokyo April 13, 2010. REUTERS/Yuriko Nakao

A mug bearing a Starbucks logo is pictured next to coffee beans during a news conference in Tokyo April 13, 2010.

Credit: Reuters/Yuriko Nakao

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LOS ANGELES/NEW YORK (Reuters) - Starbucks Corp has accused Kraft Foods Inc of mismanaging sales of its packaged coffee in grocery stores and wants to end their 12-year partnership due to Kraft's "material breaches" of their contract.

According to documents obtained by Reuters, Kraft has disputed Starbucks' claims, adding fuel to a fight that is sure to take center stage when Starbucks hosts its biennial investor conference in New York on Wednesday.

The Seattle-based coffee giant charged, among other things, that Kraft mismanaged store displays and marketing and failed to take "commercially reasonable measures to address the erosion of Starbucks market share," according to an October 5 letter from Starbucks' attorney Aaron Panner to Deanie Elsner, president of North American beverages at Kraft.

Unless Kraft fixed the breaches within 30 days, the letter said, their deal -- whereby Kraft sells Starbucks and Seattle's Best bagged coffees at grocery stores and other chains like Target Corp and Costco Wholesale Corp -- would end on March 1, 2011.

A second letter from Panner, dated November 5, said Kraft disputed Starbucks' claims and had "made no effort" to cure the breaches. So, it said, the deal would end, along with another one governing Starbucks' supply of coffee disks for Kraft's Tassimo one-cup coffee brewer.

Meanwhile Colleen Flaherty, Kraft's vice president of sales planning, said in an undated letter to retailers that its deal with Starbucks to sell Tazo tea would conclude at year end.

Kraft, which has overseen the growth of the bagged coffee business from $50 million to $500 million a year in sales, said in a statement that "the success of the business and its performance over the last 12 years are clear."

"If Starbucks wants to terminate in order to pursue an alternative arrangement, it needs to give Kraft sufficient time to execute an orderly transition and compensate Kraft for the fair market value of the business, plus a premium," Kraft said.

Under terms of the contract, that premium could be as much as 35 percent, according to a source familiar with the agreement, who declined to be identified because the source was not authorized to talk to the media.

Starbucks declined comment. Panner, at the Washington law firm Kellogg, Huber, Hansen, Todd, Evans & Figel, did not return calls seeking comment.

PUBLIC DIVORCE

Up until several weeks ago, Starbucks had never raised the issue of a breach, according to another source familiar, even though some of Starbucks' allegations date back years.

Starbucks has made no secret of its desire to have more control over its packaged goods business, which also includes bottled drinks sold by PepsiCo Inc. That is because it has few opportunities to open new coffee shops in the U.S. but still wants to increase sales and profits.

Shareholders of Starbucks and Kraft first learned of the battle brewing on November 4, when Starbucks Chief Executive Howard Schultz dropped the break-up bomb during a quarterly conference call.

Kraft's Chief Financial Officer Tim McLevish said then that it was too early to quantify any impact from losing the business, which it has had since 1998.

Over the years, Starbucks has cited its business with Kraft as letting it extend its reach beyond the walls of its stores.

At an investor meeting in April, Starbucks CFO Troy Alstead said the partnership let it "leverage the world-class capabilities they have in manufacturing, research and development and marketing distribution." In a September article in Advertising Age, another Starbucks executive said sales of its Natural Fusions bagged coffee met company standards.

Still, Starbucks' lawyer Panner charged that Kraft made a series of material breaches, from not devoting sufficient personnel and resources to not involving Starbucks in sales planning calls.

He said the breaches resulted in the loss of Starbucks' position as the undisputed leader in super-premium bagged coffee sold in licensed channels and damaged Starbucks "brand positioning" and "brand equity".

UBS analyst David Palmer said in a recent report that Starbucks' grocery coffee sales had suffered three straight years of sales declines in measured channels. The fall came at a time when the U.S. recession and continuing high unemployment boosted demand as people brewed more coffee at home and cut back on going out.

Starbucks cafe business also floundered during that period as customers reeled in spending. The chain's closely watched sales at established restaurants, a key gauge of performance, fell in fiscal 2008 and 2009 before rebounding in the 2010 fiscal year ended October 3.

(Reporting by Lisa Baertlein in Los Angeles and Martinne Geller in New York, editing by Matthew Lewis and Marguerita Choy)

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