Small Business Lessons from the Coffee Wars


SEATTLE (TheStreet) -- Americans might have cut back on frothy cappuccino drinks, but coffee consumption has remained remarkably stable in the past year. That's good news for the companies fighting for their share of the caffeine-addicted public.

Even though consumer spending is down, McDonald's (Stock Quote: MCD) and Peet's Coffee & Tea (Stock Quote: PEET) have actually seen revenue rise, thanks to smart product launches. Even Starbucks (Stock Quote: SBUX), which saw a significant slump in sales, has managed to rebound.

In any competitive industry, a business must find its niche and defend it. If you can define and maintain your territory as well as Starbucks and McDonald's do, you'll stay ahead of the competition.

Anyone in the coffee business has one built-in advantage: a broad base of potential customers. About half of American adults drink coffee every day.

"Consumers still see coffee as an integral part of their everyday lives," says Robert F. Nelson, chief executive officer of the National Coffee Association. "Even if economic conditions cause some to alter their coffee choices, they are nonetheless continuing to enjoy coffee at levels very much on par with recent years."

Coffee has been a morning mainstay for decades, but the quality and cost has improved in recent years. Starbucks popularized upscale coffee creations, such as frappuccinos.

McDonald's even entered the business this year with its McCafe, and so far it looks like a winner. Sales at McDonald's restaurants in the U.S. were up 3.5% in the second quarter and 2.6% in July. Increased coffee sales contributed to the gains.

McDonald's CEO Jim Skinner said in a statement that customers want "menu variety, value and convenience."

Consider those three factors. McDonald's is about as convenient as it gets, with more locations than any other restaurant in the country. And the company relies on low prices to attract budget-conscious consumers. That leaves menu variety as the main area where the company can innovate to bring in new revenue.

McDonald's is a marketing powerhouse that understands its customer base, so it knew how to zero in on McCafe's potential consumers. Rather than trying to ape Starbucks' confusing array of specialty drinks, McDonald's offers three choices: cappuccinos, mochas and lattes.

The goal wasn't to convince coffeehouse habitués to become McDonald's regulars, though there are probably some budget-conscious folks who have exchanged their morning Starbucks for McDonald's. The real advantage has come from converting existing customers. McDonald's dominates the fast-food breakfast category; convincing some of those regulars to pay a little more for their coffee has already paid off.

Another coffee player, Peet's Coffee & Tea, has also seen sales rise in response to the economy. The National Coffee Association says at-home coffee preparation is up 5% this year from 2008. That has helped brands with strong grocery-store presence, like Peet's, which is sold in about 8,400 stores throughout the country.

Peet's saw net revenue increase 5% in the second quarter, and grocery-store sales went up 9%. At the same time, the company is burnishing its gourmet credentials by partnering with privately owned Godiva to sell a new Godiva-branded brew.

While Starbucks has a reputation for quality, it's also known for its higher prices, a bad trait if you're trying to attract customers during a recession. The company's same-store sales slid 5% during 2008, and then fell 9% and 8% in the first and second quarters, respectively.

Starbucks slowed expansion plans, closed stores and began hawking a more affordable brew, along with customer-loyalty cards. Those moves helped the company slow its sales decline to 5% in the third quarter. Cost cuts have boosted the company's profit margins.

Peet's, McDonald's and Starbucks offer three different customer experiences. Each company would probably love to steal market share from one another. But the coffee business has proved there's room for three strong players, as long as you have enough customers craving your product.

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