Starbuck's Not So Stealth Plan to Expand Margins

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Nine blocks away from the original Starbucks location, in a renovated 1920s-era building, stands a 15,000 square foot statement of Starbucks' heritage of coffee innovation and its soaring ambitions for the future: the Seattle Reserve Roastery.

The Roastery offers visitors the experience of small lot coffee served in a variety of formats designed to appeal to coffee connoisseurs, including pour over, Chemex, Clover, siphon, French press, and other high-end brewing methods. The presentation occurs in a welcoming atmosphere, to make it nonthreatening for loyal customers to learn about the company's small lot coffees.

All Reserve coffee for Starbucks locations will be roasted in this location, which the company says will equal about 1.4 million pounds of small lot coffee in 2015. Reserve coffees are currently featured in 22 dedicated locations worldwide, and Starbucks will add 100 more in the next five years.

Starbucks has described the Roastery, in which a customer can follow the path of green unroasted beans through the building, as a "Willy Wonka" experience. This may be so, but the convergence of ubiquitous piping, small Probat roasters, tasting areas, and siphon brewing stations around the central pounded-copper silo seems to recall an era of bygone industrialism, with a hint of steampunk thrown in:

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Margins trump street credFor all this, among the coffee elite, Starbucks barely gets a nod when leading U.S. coffee roasters are discussed. Scroll through any lists of the highest regarded roasters, and you'll see that companies like Counter Culture, Intelligentsia, andStumptown-- each minuscule in comparison to Starbucks -- are the literal taste-setters among purists. These coffee innovators pioneered fair and direct trade practices, opened cupping rooms and training centers to spread coffee knowledge to both customers and baristas, and popularized alternative brewing methods.

But wait a moment, didn't Starbucks also engage in the above practices? And hasn't Starbucks poured a billion dollars into ensuring that its coffee will be 100% ethically sourced by 2015?The truth may be that the company will always be seen by independent roasters and coffee connoisseurs as a mass market purveyor.But that won't stop Howard Schultz and the Starbucks management team from exercising their vision, and taking pride in the position Starbucks holds in the coffee world today.

That position will only amplify in the years to come, especially when one considers the company's profitability. Selling higher margin coffees in limited batches at exclusive Reserve locations certainly won't hurt profits, but the long-term benefit derives from educating masses of coffee drinkers about higher end, more labor-intensive brewing methods, and creating a yen for more subtle coffee flavors.

Thus, exclusive Reserve locations are designed to kindle a desire in customers to enjoy a theoretically better-tasting cup of coffee at their home base, neighborhood cafes. The company has expanded the number of stores offering its proprietary Clover brewing system to nearly 1,000 in 2014, and global Reserve coffee availability will grow from 800 to 1,500 stores by the end of FY 2015. So while the Roastery and Reserve tasting stores may be a proud statement of Starbuck's artisanal credentials, they're also the tip of the company's spear in meticulously and patiently moving consumers up the coffee chain.

Consider that a Reserve coffee brewed via a nondrip process sells at a 100% premium or higher to the typical Starbucks brewed coffee. A tall (12 ounce) brewed cup of the company's standard Pike's Place or Blonde Roast sells for roughly $1.75 in my own city, whereas a similarly sized Reserve lot coffee brewed on a Clover sells for between $3.25 and $3.75.

When Starbucks began offering pour-over method coffee in its stores in 2010, some wondered if this would backfire, as the company had built its empire on funneling customers through the gauntlet of its early morning coffee lines. But management has utilized coffee premiumization to its advantage, promoting pour-overs, Clover-brewed coffee, and other slow production methods during off-peak hours.

It's a powerful formula: push higher margin products during dayparts in which the labor capacity is underutilized. Extrapolate this math as the global coffee drinking population yields to Starbucks' premium coffee evangelism, and one can see why the Roastery in Seattle is simultaneously a shrine to coffee engineering, and the crux of the roasters' future margin ambitions.

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Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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