Starbucks focuses on Europe after U.S. turnaround

Tue Mar 27, 2012 1:29pm EDT

* Eyeing European suburbs, more profitable drive-thrus

* Targeting EMEA operating margin of 15 pct over time

By Lisa Baertlein

SEATTLE, March 27 (Reuters) - Starbucks Corp hopes to brew up a European business renaissance after reviving its operations at home.

The world's biggest coffee shop chain dominates in the United States but has been just another player in Europe's famed cafe culture. It wants to change that.

The United States accounts for most of Starbucks' revenue and operating profit; the region that includes Europe, the Middle East and Asia (EMEA) kicks in about 10 percent of revenue and just 2 percent of operating profit.

And though EMEA brings in about twice as much revenue as Asia, it lags that region in operating profit because rent, labor and other costs are higher.

Starbucks recently said it had fallen short of its targets in Europe, where austerity measures aimed at reducing government debt are weighing on consumer demand in some countries. The company said it had taken steps to improve results in that market, which executives say has suffered from a lack of investment.

Starbucks is stealing a page from its successful U.S. "transformation agenda" as it works toward a long-term goal of delivering EMEA operating margin of 15 percent, versus 6.5 percent in the latest quarter.

Leading the charge is Michelle Gass, a veteran Starbucks executive who was a leader in the U.S. turnaround and is known for championing the company's blockbuster Frappuccino drinks.

"Our business in Europe today is quite reminiscent of what we went through in the U.S. back in 2008 -- a tough economy, record unemployment, fierce competition and our own self-induced mistakes," Gass, president of Starbucks Europe, Middle East and Africa, said at the company's shareholder meeting last week.

When Gass arrived in London about six months ago, she got an earful -- from everyone from cabbies to her dentist -- about weak coffee and too-milky lattes.

"Europe is espresso territory. To compete, we must absolutely deliver the best latte on the High Street," she said, referring to the European equivalent of Main Street.

Starbucks has retrained its European employees and is finding ways to squeeze out unnecessary costs like wasted milk, as it did in the United States.

It is also making market-by-market adjustments aimed at boosting results and paying for further improvements. A little over a week ago it changed the recipe of its small lattes in the UK to include two shots of espresso rather than one, which is the norm at Starbucks cafes elsewhere. Gass told Reuters that selling more lattes will more than offset the cost of adding the extra espresso shot.

Starbucks also has introduced a second espresso roast in France, another company first.

Food is a big part of the plan, and localized menu options include "bacon buttie" sandwiches in the UK and foie gras sandwiches in France.

"At Starbucks, when we take care of our own issues, the external environment doesn't matter," Gass told Reuters. "We've broken the cycle in the U.S. and I'm convinced we'll break the cycle as well" in Europe.

FROM VALUE TO DRIVE-THRUS

In the quarter ended Jan. 1, Starbucks' EMEA region reported a sales gain of 2 percent at coffee shops open at least 13 months -- respectable considering the fallout from Europe's debt crisis, but tepid compared with Starbucks' U.S. gain of 9 percent.

Gass declined to give a country-by-country breakdown but said sales at established shops in the UK -- Starbucks' largest market in Europe with 700 cafes -- were up during the latest quarter.

Starbucks opened its first UK cafe in 1998. Its top competitors there are Whitbread's Costa Coffee, Caffe Nero, and a host of independent operators, according to market research firm Mintel.

Consumers in Germany, Starbucks' second-biggest European market, are sensitive to economic jitters, but countries like Russia and Turkey are posting strong results, she said.

In the depths of the U.S. recession, Starbucks offered discounted coffee-and-food combos for the first time in its history. It also introduced Starbucks Rewards, a loyalty program that gives customers a free drink with every 15 purchased.

It rolled out Starbucks Rewards in the UK in January and plans to introduce the program in Germany this year.

The company, which is reporting record sales and earnings, has temporarily cut the price of small lattes in Germany and has permanently slashed the price of small cappuccinos in Greece by 1 euro to 2.5 euros.

The turnaround strategy worked in the United States and "it can work (in the EMEA region) as well," said Lazard Capital Markets analyst Matthew DiFrisco.

Starbucks closed nearly 1,000 cafes around the globe as part of its restructuring. Gass said there are no plans for more shutdowns.

Instead, the company's Europe strategy involves renovations and expanding beyond High Street and its expensive rents.

After giving its cafe at Berlin's Brandenburg Gate a makeover, Starbucks plans to spruce up 100 stores in the UK -- 70 of them high-profile cafes in London that will be ready in time for the summer Olympics.

The company is also eyeing Europe's busy suburbs, where rents are less pricey. Plans there include building American-style drive-thrus, which boast healthy profits.

Over the next five years, Starbucks plans to add 200 drive-thrus to the dozen or so it now has in the UK.

About 40 percent of Starbucks' U.S. cafes are drive-thrus.

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