The Cost of Breaking Ties

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To discuss its $2.7 billion arbitration settlement with Kraft (KRFT), Starbucks (SBUX) reassured investors that the cost of breaking ties with the distributor of its packaged coffee was the right move at the right time on a conference call earlier this month.

A day after an arbitrator issued the ruling in a dispute dating back to 2010, Starbucks Chief Executive Howard Schultz said on the call, “We are literally in very nascent stages of building a multibillion-dollar global consumer packaged business.”  The company had no choice except to move away from a distribution deal with Kraft, Schultz said. “Having gained full operating control, we now have the flexibility and the freedom to control our own destiny and, most importantly, preserve and enhance the Starbucks Global business and brand around the world.”

Brian Sozzi, chief executive of Belus Capital Advisors stated that the coffee chain hasn’t been shy about asserting greater control of the brand. Naked Juice (PEP) beverages and KIND (which Starbucks tried – although unsuccessfully to acquire) bars have been replaced since 2011 when Starbucks cafés began rolling out the company’s own Evolution brand of juices and snacks.

Let’s take a look at how sales have been affected by the split from Kraft:

  • 2013 – Sales of Starbuck’s consumer packaged goods (CPG) reached $1 billion which was double the sales of 2010.
  • Under its deal with Starbucks, Kraft states that the segment expanded considerably ($50 million to $500 million).
  • CPG is rapidly growing rapidly within the business.
  • CPG is in a “Channel Development” category within Starbucks that also includes airlines, restaurants and hotels and they hope to expand this part of the business in to a multi-billion dollar company.

The effect on its single-serve coffee business, the fastest-growing segment in at-home coffee sales is another advantage of the split according to Schultz.  While the Seattle-based company mogul is now free to push its own single-serve K-cups and Verismo, this wasn’t always the case; Starbucks was restricted to producing single-serve coffee exclusively for Kraft’s Tassimo system not too long ago.

The relationship between Kraft and Starbucks goes back to 1998 when Kraft distributed Seattle’s Best and Starbucks bagged coffee to local grocers.  The deal wasn’t working out for Starbucks and they offered Kraft $750 million to end the agreement citing that there was mismanagement involved by Kraft. Later rejected and upheld by a federal court, Kraft turned its nose up at the offer and sought an injunction to keep Starbucks from pulling out of the contract. Starbucks quickly walked away from the deal in March 2011 and just as quickly moved to incorporate the CPG distribution business in house. Seeking payment (plus interest and a premium—nearly $3 billion—and attorneys fees) for what they claimed the original deal with Starbucks stipulated, Kraft had launched an arbitration in November 2010 even before the legal proceedings played out.

This still doesn’t mean Starbucks does everything on its own even though they are asserting greater control over their destiny.  To manufacture and distribute ready-to-drink beverages, the company said it continues to work with PepsiCo (PEP), through the North American Coffee Partnership. “Our Pepsi partnership is a very strong partnership here in North America,” reassured John Culver, Starbucks’s group president for China and Asia Pacific, channel development, and emerging brands.

Source: www.businessweek.com

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