Excelsior Versus Starbucks - A Strategic Analysis Of The Japanese Coffee Market

Note on this Essay: It was published February 8, 2002, for a class on "Corporate Strategy" taken at Sophia University. The essay originally included several graphs and charts, but I have chosen not to include these in the online version of this document. If you find my essay useful, or if you have any comments, please visit my homepage for info on how to contact me.

The product life cycle concept (PLC) uses the age of a product category as a basis to assess three issues. First, PLC helps predict future sales growth, as well as customer and competitor behaviour. Second, PLC is used to prescribe appropriate marketing and other strategies. Finally, the product life cycle suggests how resources should be allocated among categories. Basically, the curve is derived from the fact that a product’s and industry’s sales volume follows a typical pattern that can be readily charted as a four-phase cycle known as embryonic, growth, maturity and ageing. Interestingly enough, the retail coffee market provides an example of an industry that experienced a shift of the product life cycle.

While Doutor Coffee was still expanding when Starbucks entered the market in 1996, nothing much had happened in the market since the first Doutor Coffee Shop opened in 1980. Starbucks, however, helped redefine the retail coffee industry and brought the situation back to the embryonic stage. Related to the product-lice cycle, the life-cycle portfolio matrix provides a pictorial presentation of all businesses of the firm in two dimensions. One dimension represents the impact of the external forces, which usually are not controllable by the firm. The second dimension, however, represents the strengths the firm has in the industry in which each of its businesses compete. Originally developed by Arthur D. Little Inc., the life-cycle portfolio matrix uses six categories of competitive positioning, namely dominant, favourable, tenable, weak, and nonviable.

The following chart displays the life-cycle position of the high-brand coffee market according to eight different descriptors, and the industry does as a whole appear to be in the growth stage. This means that the industry is still growing rapidly, but that customers, shares, and what there is of know-how is better known. Therefore, entry into the market is more difficult than in the embryonic state, in which the market is much less stable.

As earlier discussed, Starbucks increased the number of stores in Japan by almost 100% last year, but the company will unlikely be able to keep up this speed during this next few years. Good locations are becoming increasingly difficult to locate, but Starbucks still plans to double its current size by 2006. Excelsior is expanding at a similarly high speed, and is unlikely willing to let Starbucks remain the market leader. Tully’s, another American company, hopes to operate around 400 stores by 2006. This will be a major expansion from its current almost unnoticeable presence in Japan. Although perhaps a better description of supply than of demand, the speed at which the different chains expand is also a good indication of the current growth rate and the industry potential. Earlier figures concerning the consumption of coffee should support this optimistic forecast.

In terms of the product line, it consists of various types of coffee and snacks, and this is unlikely to change dramatically. Although Starbucks has introduced caffé latte and similar Italian drinks, it is not likely that anything dramatically new will be introduced in the foreseeable future. The number of competitors increased even last year, but it is currently possible to foresee what companies that will be the major players during the next few years. This evidently includes the foreign companies that were discussed earlier, but evidently also Doutor represented through Excelsior Coffee. Market share stability, however, is yet to be determined. Starbucks evidently has a head start on the other competitors, but the latter started entering the market in a serious manner only last year. In March 2001, Excelsior Coffee operated 30 stores, Tully’s had 23, Seattle’s Best had 15, while Italian chain Segafredo Zanetti operated 11. Compared to Starbucks, which at the time had 227 stores, these are minuscule numbers. Other companies have entered the market since then, and it thus remains to be seen who will end up as Starbucks’ main competitors.

With regards to purchasing patterns, this evidently is a difficult issue to address. As the high-brand coffee market is selling different experiences, the various chains evidently all hope to build up loyal customer bases. Still, as Starbucks is the only chain to have built up a somewhat stable presence in Japan, it is still difficult to say what impact the purchasing patterns of consumers will have on the industry. In terms of the ease of entry, the industry probably changed from embryonic to growth during 2001. Several strong American companies started a rapid expansion to catch up with Starbucks, for not to mention the effort made by Doutor through its chain of Excelsior stores. As much energy is put into finding the right locations for new stores, it has probably become much harder to enter the high-brand coffee market than what was the case only twelve months ago. The issue of branding is also difficult to determine, although Starbucks probably already has become relatively famous throughout Japan. Excelsior Coffee and similar brands are building up a presence in a very aggressive manner, and if it is not the case already, it is only a question of time before the competing brands become known.

As it has thus been determined that the high-brand coffee market has just entered the growth stage of the product life cycle, the earlier discussed market strength of Starbucks compared to its competitors should explain the above chart. At the end of 2001, Starbucks was at least twice as big as all its competitors combined. Excelsior, however, was struggling to catch up. The former company can thus be said to be dominating the market, while Excelsior on the other hand has a favourable position. The latter is due to the fact that the company has a similar level of stores to that of other late-entry competitors, but an expansion is probably also made easier due to the Doutor Coffee Group’s extensive know-how concerning the Japanese coffee market. According to the company’s investment guide for 2001, the average Doutor Coffee customer spends an average of 300 yen per store visit, while the average Excelsior customer spends around 470. With more experience, the company should be able to increase the latter figure, and could then perhaps consider transforming Doutor Coffee stores into the Excelsior brand. Obviously, this bears the risk of cannibalising sales, but it can be an option in cases where the total profit can be increased as a result. Related to this discussion is evidently the strategic positioning in terms of investment requirements.

Evidently, the position for Starbucks is dominant in this aspect as well. The company should thus invest to sustain growth rate and thereby pre-empt new competitors. Excelsior, however, should invest selectively to improve position. As resources are limited, the Doutor Coffee Group should be careful not to make investments that will not offer a positive return on capital. Diversification can be discussed, but caution is necessary in order to make wise investment decisions that can capture market share. Little is gained from opening a store for then to find it not to be viable and close it down. The Doutor Coffee Group should, however, have sufficient knowledge of the Japanese market to surpass the ability of its competitors to make decisions in this respect.

The strategic positioning in terms of profitability and cash flow is equal to the chart picturing investment requirements, and Starbucks Coffee Japan is already profitable. Still, the net cash flow is still likely to be negative for quite some time, this due to large investments in new stores. Taking the company public on October 11^th last year, Starbucks raised enough capital to finance stores expansions for the near future. After the IPO, Sazaby Inc. and Starbucks International each own 40% of Starbucks Coffee Japan. Regarding Excelsior Coffee, the situation is a bit more difficult to analyse due to the recent establishment of the coffee chain, but it is very unlikely that the company has become a net cash producer for the Doutor Coffee Group. Probably, large investments are still needed for expansion and various other costs, and with the number of stores numbering somewhere around fifty, scale has yet to be achieved.

In terms of the life-cycle portfolio, this is only of interest with regard to the Doutor Coffee Company, as Starbucks Coffee Japan only is represented through one product. The following chart depicts how the Doutor Coffee Group is represented in several different industries, but they are all related to food, coffee, or tea. Although the chain of Doutor Coffee shops is the company’s major asset, it originally started out with the Café Colorado. The latter first opened in 1972, and the current number of stores is 177. It is a franchise chain with an average per customer sales of 520 yen. Café Colorado is not self-service, however, and thus appears more similar to traditional mom-and-pop stores than to the other coffee chains mentioned in this paper. The rest of the Doutor Coffee Group’s portfolio is latter insignificant in terms of the number of stores, but includes two other coffee chains, one chain of Italian restaurants and also a self-service tea chain targeting women.

Although much could be said about this portfolio, it should be commented that the company has introduced two coffee chains into the market since Starbucks’ entry in 1996. One is Le Café Doutor, introduced in 1998, which represents an odd attempt at creating a premium-coffee chain based on the Doutor trademark. The fact that the latter is associated with rather cheap coffee obviously did not trouble the company’s marketing staff. Two years earlier, the company introduced Mauka Meadows to the market, a coffee shop specialising in the sale of Doutor’s self-produced Hawaiian coffee. While Le Café Doutor features a French atmosphere, Mauka Meadows is Hawaiian-style. Evidently, this shows that the Doutor Coffee Group tried different alternatives to counter Starbucks’ entry into the market, and perhaps the two earlier mentioned chains represented vague attempts at creating a new experience curve. However, the company did not succeed, and thus ended up creating Excelsior Coffee in the year 2000. Salon de thé Madeleine, a tea chain, may be an attempt to create an alternative to Starbucks, but it is too early to say if the company will succeed. The same can be said about the company’s other coffee chains, and though they are still embryonic, it can be doubted if they will ever experience rapid growth. As far as the Doutor Group’s Italian restaurants are concerned, they have been around since 1985 and make up around 34 stores. As Italian food is relatively well known in Japan, the market is either mature or ageing. Perhaps the management at the Doutor Coffee Group should study another useful business model to help them decide what businesses to keep, and which ones to abandon.

The growth-share matrix presents the firm in terms of a portfolio of businesses, each one offering a unique contribution with regard to growth and profitability. Instead of being considered a single monolithic entity, a given firm is rather viewed as many largely independent units whose strategic directions are to be distinctively addressed. Due to the complexity of such an approach with regards to Doutor’s rather diverse business portfolio, this model will be touched upon rather briefly. The growth-share matrix plots each business on a four-quadrant grid. While the horizontal axis corresponds to the relative market share enjoyed by a business, the vertical axis indicates market growth. The former does, in other words, characterise the strength of the firm in that business, while the latter represents the attractiveness of the market in which the business is positioned.

The following matrix presents the business portfolio of Starbucks Coffee Japan, and is of course very limited in nature. As earlier discussed in great length, the coffee chain is experiencing rapid growth and relatively high profit margins in Japan. The company’s position in the market is very strong, and the combined value of the company’s recent IPO and its current net profit is believed to constitute enough capital to finance the company’s expansion in the near future.

Doutor Coffee Group’s business portfolio is evidently much more complex, and includes the various chains that were presented in connection with the lifecycle portfolio matrix. The following chart is brief presentation of the company’s major businesses.

While some comments have been given in the matrix, more information is needed to make an appropriate placement of the Café Colorado chain. It is difficult to tell if the chain is profitable, and since its main competitors are primarily mom-and-pop stores, market share is difficult to determine. Very likely, however, the chain is a dog, but Doutor Coffee Group should anyway consider transforming some of the stores into the Excelsior brand. This could increase both market share and profitability, and would give the company a substantial boost in its quest to challenge Starbucks. Regarding the company’s other coffee chains and the recently opened tea store, it is too early to say anything certain about the future of these stores. Potentially, they could take focus away from the Excelsior Coffee chain, but if successful the Doutor Coffee Group might be able to pioneer a largely unexplored market. Additionally, a few comments should be made on the company’s various subsidiaries. These include Manga International, which specialises in the marketing of tableware and kitchen equipment, and Madeleine Confectionery, which produces and markets confectionery. As these are fully owned subsidiaries, it is unclear how the Doutor Coffee Group plans to create value for shareholders with these seemingly unrelated businesses. Additionally, the company runs coffee plantations on Hawaii and Jamaica, an issue that will later be discussed in some detail. The above chart, however, comments upon differences between Excelsior and Starbucks in terms of relative market share and market growth. Evidently, since the market is rapidly growing and few numbers are available, some subjective judgement was needed to make the chart. The relative market share is determined by dividing a company’s total business sales by that of its leading competitors, but Starbucks did not experience much serious competition before 2000/2001. Thus, while the chart evidently shows Starbucks’ leading position in the market, the reality is probably even more positive as far as Starbucks is concerned.

Originally developed by McKinsey, the matrix displays graphically, on a 3-by-3 matrix, the position of each business in a company’s portfolio. It rates the relative attractiveness of the industry in which the business operates, as well as the strength of the business versus that of its competitors. The two variables are assessed on a low-medium-high scale. The matrix is generally used to suggest the kind of investment strategy that should be followed for each business, as well as to develop the overall strategies. To determine the placement of a specific business, a weighted approach can be used to rate the external and internal factors influencing the business. The following chart presents the industry attractiveness for the industry as a whole, which is followed by the internal ratings for Excelsior and Starbucks.

In terms of the external factors, these are the same for both companies. The question of currency parity may become a factor if the yen should weaken substantially, yet the import cost of coffee constitutes only a minor cost in the high-brand coffee market. The market growth is, however, very positive. In terms of seasonability, it may be a problem for the companies to maintain the same sales ratio all year. Particularly the Japanese summer may prove a challenge, although Japanese customers are known for their liking of ice coffee.

The number of new entrants into the market is very high, and the competitive environment is thus likely get tougher. It is, on the other hand, difficult to predict what influence the recession will have on the purchasing patterns of consumers. As the average customer at Starbucks and Excelsior will spend somewhere in the proximity of 500 yen, one can argue that people still will be able to afford high-premium coffee once the recession deepens. Finally, the barriers to entry are still very low, as Starbucks is the only company to have solidified its presence in the market. This is likely to change soon, however, as many new entrants are aggressively opening new stores in a wide range of geographic locations. Overall, the industry is very lucrative, this mostly due to the high growth ratio. Still, a yet to be determined number of new entrants are likely to make the industry less stable, and the current situation is thus likely to change in the near future.

As far as the internal factors are concerned, Starbucks does not surprisingly rate higher than Excelsior. This is first of all due to the former company’s high market share, which again is translated into high brand awareness. Second, the company does in addition have high managerial competency in terms of marketing and operating high-brand coffee stores, and can also draw on knowledge from the various locations in which Starbucks operates. Excelsior Coffee, however, has yet to build up a substantial presence and still has a rather minuscule market share in the high-brand coffee market. In terms of financing, Starbucks improved its position dramatically through the initial public offering of last year, while Excelsior Coffee can draw on capital from the Doutor Coffee Shops. Other foreign entrants as for example Tully’s, rely primarily on franchising to enter the Japanese market, and the company’s investment requirements will therefore be relatively minor compared to Excelsior and Starbucks. On the other hand, Tully’s entry into Japan will thereby also have a smaller profit potential, but it is still too early to predict what approach will be the most lucrative in terms of entering the Japanese high-brand coffee market. In conclusion, it can thus be said that both Starbucks and Excelsior operate in a very attractive market, but that Starbucks has an advantage due to stronger internal factors.

The above chart depicts a strategy technique developed by Michael E. Porter to analyse the five basic competitive forces that determine the ultimate profit potential in an industry. In the middle box are the current industry competitors, and thus describes the rivalry that exists among rival firms. The market and its main players have been commented upon earlier, and will therefore not be touched upon here in further detail. In terms of suppliers, it is here interesting to note that the Doutor Coffee Group owns two large plantations in Hawaii. Totalling 660,000 m², the Mauka Meadows plantations are the largest on the island, and do according to the company produce the world’s highest quality coffee. Using the latest technology available, the coffee is then roasted at a company-owned plant in Funabashi, for then to be sold through wholesale and retail. Symbolising the Japanese tradition of improving on already known foreign, Doutor Coffee Company President Toriba comments on the company’s backward integration:

“Most of the coffee industry processes beans by roasting, a method that can be adapted to mass production. Doutor’s direct-heating method of roasting coffee beans means that we sometimes suffer slightly in terms of productivity. However, the trade-off is more than acceptable, considering the difference in taste. This kind of large-capacity, direct-heating equipment was not used anywhere in the world, so we had to invent the method on our own”.

Evidently, the Doutor Coffee Group can only benefit from this presumed superiority in taste if customers actually acknowledge a difference, otherwise the reduced efficiency due to the backward integration is an unnecessary cost. Starbucks does, on the other hand, buy its coffee beans on the world markets. The company has, as a consequence, been much criticised by human rights organisations, which pressure has forced Starbucks to make at least subtle changes to its purchasing system. There are thus evidently both benefits and disadvantages to both supply approaches, but a throughout financial analysis is likely necessary to make a formal conclusion.

As far as the threat of new entrants is concerned, McDonalds has already made attempts to incorporate seemingly high-brand coffee into its menu. It is not clear, however, that this will represent a potential threat to Starbucks and Excelsior. As the indoor environment, profile, and customer segment of McDonalds differ greatly from that of the high-brand coffee shops, it is unlikely that McDonalds will pose a viable threat. The likes of Mr. Donut could, on the other hand, revitalise its operations to become an alternative to Starbucks and Excelsior. This could evidently also be done through an independent venture, but donut stores and high-brand coffee stores are seemingly alike in many ways. An upgrade of Mr. Donut’s image along with the introduction of high-brand coffee could help this transformation process; perhaps even a joint venture with for instance Seattle’s Best could be an option. Mr Donut could thereby combine the attributes of a donut store and a high-brand coffee store, and as a result increase sales and target new customer segments. Other potential Japanese and foreign entrants are evidently too numerous to mention, but entry has already been made more difficult due to the intensifying competition in the market.

Potential substitute products may initially not appear great in quantity, and beer, wine, and tea constitute perhaps the main alternatives. Still, as it has been commented upon earlier, Starbucks and Excelsior are selling experiences, and thus not simply coffee. Any establishment that can offer the same kind of service and atmosphere may therefore become a potential competitor, particularly when considering that the product sold does not appear to influence customers in a noticeable manner. Still, while Doutor Coffee Group has made attempts at creating successful chains through its Hawaiian and French high-brand coffee stores, they have at least not been able to succeed yet. The same can be said about the company’s attempt to create a chain of high-brand tea stores, so finding the right strategy to satisfy customer demands and aspirations is not an easy task. With regards to the earlier discussed experience curve, however, it is evident that a new entrant should attempt a different strategy rather than to attack Starbucks and the numerous other high-brand coffee chains head-on.

Finally, the premium coffee stores appeal to a very wide customer base, but perhaps not to segments below high school age, who might prefer less expensive options. Evidently, there are alternatives available for non-coffee drinkers, and the high-brand coffee stores do therefore not exclude customers who might prefer tea or juice. As far as the powers of the different competitive forces are concerned, it is at least clear that the power of suppliers is very weak. The world’s many coffee plantations are in deep competition, and in years of regular harvest there tends to be an oversupply of coffee. Evidently, Excelsior is in a different situation due to the backward integration of the Doutor Coffee Group, but at least Starbucks should not have problems using a wide range of suppliers. Similarly weak is the power of customers, particularly as the demand for high-brand coffee until now has seemed to be higher than the available supply. Customers visiting Starbucks often face a long line, and finding a seat is a game of luck. As long as this situation continues, customers will hold relatively little power, but this may soon change as supply increases and competition between the rival companies intensifies. The threat of potential entrants was until recently very high, but most American and foreign companies that considered the Japanese market have already made up their minds in terms of entering or not. Still, there may be the potential of other companies entering the market of high-brand coffee, but as discussed with concern to the product lifecycle, there is now a better awareness of who these competitors are. In terms of substitute products, Doutor’s launch of a tea-room was probably an attempt at challenging Starbucks with something new, but it has yet so far not appeared to be a success. Beer and wine have long been alternatives to coffee in Europe, but it is questionable if a similar pub or wine culture could develop in Japan. It should be remembered, however, that few analysts believed Starbucks would become successful in Japan. Still, the company has beaten even the most optimistic forecasts, and a new fresh approach to the market is probably necessary if Starbucks is to be surprised in the same manner as the latter once caught Doutor off-guard.

Conclusion

While a thorough presentation has been given of the Japanese coffee market, and also of the coffee chains run under the brand names Starbucks and Excelsior, some additional comments need to be made about the future strategy of the chains. The following chart uses the logic of the product lifecycle to suggest a future strategy for both Starbucks and Excelsior. According to the product life cycle, there are four families that cover the entire spectrum of business positioning within the portfolio matrix. These are natural development, selective development, prove viability, and withdrawal. As the chart shows, both Excelsior and Starbucks are part of the natural development family, which implies that the competitive strength of the business demands strong support to secure further growth. This is evidently true for Starbucks due to the company’s strong position in the market, but also to Excelsior due to the potential of the chain becoming one of Starbucks’ major challengers.

Although the two chains belong to the same family in terms of strategy, Starbucks should attempt to defend its position while Excelsior should focus on gaining position gradually. Starbucks evidently possesses a dominant position in the market, hence the company’s main aspiration should be to maintain this position. Excelsior, on the other hand, enjoys a favourable position in a growing industry, and should therefore attempt to solidify its position in the market. Furthermore, while some comments have been made on this earlier in the paper, a major challenge for all the companies in the high-brand coffee market is to find the right locations for new stores. As the Porter model showed, there is no shortage of either suppliers or customers. As a result, the main challenge is securing the proper locations to secure further growth. Evidently, the ultimate locations should be busy with people, but evidently also relatively trendy unless a company wants to avoid cheapening its brand. This might be particularly important to Starbucks, which certainly should not lower the value of its brand image or compete on pricing. Its premium pricing explains much of the reason for the company’s success, and Starbucks should thus not be worried if other late entrants begin exploring the market between high- and low-end coffee.

The challenge for Excelsior is obviously to copy Starbucks, but also to become better than the original in the eyes of customers. If the Doutor Coffee Company should prove itself successful at just this task, it will not be the first time a Japanese company has made improvements to Western product. Starbucks, for instance, has a non-smoking policy, which perhaps loses the company some sales due to the relatively lax Japanese regulation of tobacco. In contrast, Excelsior Coffee divides its stores into smoking- and non-smoking sections, thereby attracting customers who prefer to smoke while drinking coffee. Additionally, Excelsior Coffee certainly has more freedom that Starbucks in terms of making changes to its menu. The chain sells both beer and wine, and since the company is fully Japanese owned it might prove better able to meet the country’s domestic needs.

The real battle, however, is not likely to take place before the industry matures and an inevitable shakeout begins. Boston Consulting Group founder Bruce Henderson argued there would only be room for three significant competitors in a stable competitive market, and the challenge for both Excelsior and Starbucks is to be among the market leaders once growth starts slowing. Only then will the market reach a potential equilibrium, and only then can the winners be declared.