Starbucks: An analysis of supply chain

risk and mitigation strategies

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

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 (see Risk Matrix in Appendix 1). 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 (see summary
in Appendix 2).

Risks & Mitigation Strategies

a. 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.

As regards 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
(see Appendix 3). 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.
Recommendation
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.

b. Commodity Prices
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.

Recommendation

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.

c. Business Partners
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.

Recommendation
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.

Recommendation
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.