OMBA606: Section 9023

Week 11- The Assessment of Business Risks in Japan for Starbucks

Jenny Glenn & Nona Keith-Henson

 

Executive Summary

The potential for coffee sales in Japan is significant. The Japanese economy is the second only to the United States with a gross domestic product (GDP) of 481 trillion yen (U.S. $3.67 trillion) in 1998. Starbucks Coffee Japan, Ltd. is a major operator in the Japanese food service industry and has a current market capitalization of U.S. $71.14 million (Starbucks, 2003). Starbucks Coffee Japan faces business risks and challenges as the company comes to the ten-year milestone of operations. Business expansion continues with new store openings, but earnings per share are declining (Nation’s restaurant news, 2002) and concern persists about the stagnant Japanese economy. This report evaluates six key risk areas from an economic and a political perspective to determine the most favorable business strategy for the next five to ten years of operations. The results of the analysis concluded that an aging population was the greatest threat to continued profitability, because a declining population has fewer customers, and an older population may not desire expensive beverages full of caffeine. The two next significant risks were workforce culture and hostile government policies towards immigrant labor to make up for a reduced labor pool. Our recommendation is that Starbucks Coffee Japan should continue to use the joint venture\licensing business strategy to mitigate the possible effects of these risks. This structure has been very effective for Starbucks so far, and does not create business vulnerabilities if workforce culture, an aging population, and government anti-immigration policies cause store-staffing problems.

 

Introduction

Starbucks Corporation is noted for delivering aggressive market growth along with its trademark coffee drinking experience. The company has made the transition from 17 coffee shops in downtown Seattle, Washington 15 years ago to a globally recognized brand with more than 5,689 outlets (stores, kiosk, etc.) in 28 countries by September 2002, with sales climbing an average of 20% annually since the company went public 10 years ago, to $2.6 billion in 2001 with $52 million in foreign joint ventures alone (Business Week, 2002).Starbucks International began Starbucks Coffee Japan in 1995 to embark on the global expansion of its vision to delivering shareholder value through premium customer service operations. The company has grown from zero stores in 1995 to 379 stores in April 2003, and projects to reach 500 stores in the near future (Starbucks, 2003). On the surface, Starbucks Coffee Japan seems to be steaming along to success. Does the economic reality match appearances? This subgroup report investigates the business risks behind the Starbucks’ decision to move into the Japanese market.
Over the course of the semester, “The Global Strategists” team in OMBA 606 Section 9023 intensively investigated six broad businesses issues that act to increase or reduce the risk of unprofitable operations for Starbucks. The six issues are: product and service standards, anti-competitive practices, economic infrastructure, financial markets, social infrastructure, and business and workforce culture. Each area of risk is comparatively rated against the other five categories of risk. With the risk factors ranked, a set of alternative ways of entering the Japanese coffee shop market is evaluated for the potential to mitigate business risk. The business vehicles considered include exporting; licensing; franchising; joint venture with a company already established in Japan; or operating as a wholly owned subsidiary.The paper concludes with a recommendation of the business vehicle(s) that would be most likely to reduce business risk and increase the odds of success.

Risk Analysis for Starbucks

The six risk factors we chose to evaluate are not an exhaustive list of all of the potential areas of risk that a business may be exposed to. Risk factors not evaluated in this report include tariff barriers, non-tariff barriers, intellectual property laws and practices, monetary policy, fiscal policy, dispute resolution, or corporate governance. These areas of risk were not considered because they were not as likely to affect Starbucks business operations as the six risk factors that were selected. Coffee shops are localized operations are require smaller amounts of startup capital and turn a profit faster than capital-intensive, long lead time operations like beverage manufacturers or steel mills. Monetary and fiscal policies imposed by the government do not have an immediate cause and effect impact on consumer spending habits. Coffee brewing does not involve trade secrets, scientific formulas, or artistic works so there is no intellectual property to defend. Japan imports a great deal of the food it requires, so the country does not erect significant tariff and non-tariff barriers to coffee importing. In 2000, for example, Japan imported $1.762 billion worth of coffee and cocoa (Agro-Trade, 2001). Business dispute resolution and corporate governance are modeled after the laws Starbucks is familiar with in the United States (U.S. State Department, 2002).
Coffee shops are a customer service oriented, labor and advertising intensive businesses that have relatively low barriers to new competitors. We organized our assessment of the selected risk factors by grouping the topics into the two primary categories of economic risk and political risk. Economic risk evaluates all of the factors that increase or decrease social cooperation, which in turn create increases or decreases in the economic well being and prosperity of the Japanese people (Heyne, Boettke, and Pryrchitko, 2002). Political risk encompasses all of the business consequences that may occur due to government decisions on policies.

Economic risk factors

Four types of economic risk factors may affect Starbucks Coffee Japan. Economic infrastructure is the underlying support for all business operations. This includes transportation systems, the availability of electrical power, ease of importing food, and similar issues. Financial markets determine the ease or difficulty of raising the money for business operations and to purchase goods and services. The business and workforce culture of Japan controls whether or not the company can employ a sufficient number of motivated workers to deliver the coffee shop ambiance that customers are looking for, which Starbucks intends to be an attractive buffer zone between home and work (Theodore, 2002). Product and service standards are closely tied to business and workforce culture. A chain store depends on presenting a customer with the same experience of food quality, food price, store cleanliness, and customer attentiveness across all stores. If people have inconsistent experiences between stores, the value of the business brand will decline. 

Economic infrastructure is the basis for carrying out economic activities in a country. If Starbucks misreads the current and projected future state of Japan’s economic infrastructure, the company may over invest or under expand. In the case of over investment, Starbucks will not recover the return on investment if the company had used to money in one of the other twenty-five countries where it does business. If Starbucks makes too many over investment decisions, the company’s investors will put their money in other investment vehicles and Starbucks’ growth momentum will stall. Starbucks cannot avoid the risk of over investment by restricting expansion, however. The business world has seen that selling coffee beverages returns good profits. Competitors will move into the Japanese market and open stores in favorable locations in Starbucks leaves an opening. 

Our team’s individual report analysis judges Japan presently has a powerful, robust economic infrastructure. Power generation and distribution, transportation systems, trademark protection, and contract law are all equal to or more business-friendly that the same area in the United States. Over the next ten years, there are some potential problems that may increase business risk. These factors include fluctuating fuel oil prices, which directly transfer into transportation and electrical power expenses; and transportation gridlock from increasing population and finite land areas. Overall, Japan’s economic infrastructure is favorable for Starbucks business operations and does not present an area of high risk. 

Financial markets provide funds for investment. The performance of the markets has been very uneven in Japan in the last fifteen years. The country suffered through an investment bubble much like the United States’ Internet craze that burst in 1990. The Japanese government employed an increasingly aggressive series of steps to restart economic growth, culminating in the Foreign Exchange Control Law of 1998 to liberalize financial transactions between Japanese and foreign countries. The financial markets also benefited from laws that enabled Japanese citizens to participate more fully in stock certificate and investment trust ownership (Hill, 2003). Japan’s financial markets have reformed in ways that are more favorable to Starbucks’ future business operations.

Business and workforce culture present a mixed set of risks to Starbucks’ future operations. Business culture in Japan is intensely loyal and committed to one’s company and trading partners. This focus acts as a risk reducer for Starbucks. Employees are dedicated to the company and have a service orientation that surpasses the average American worker’s attitude. Workforce culture can also be a risk to Starbucks, due to the twin forces of population decline and population aging. Older customers may not be interested in a turbo-jolt of java once or twice a day. With a smaller population, there will be competition for employees. Starbucks may have to offer better pay and benefits to attract the workers it needs to continue opening new stores.

Product and service standards are an area of low risk at this time. Our analysis in the week 4 individual report showed that Japanese consumer preference and employee emotional investment in providing superior service combine to make product and service standards an area of minimal risk.

Political risk factors

Three types of economic risk factors may affect Starbucks Coffee Japan. Political risk comes from the unpredictable shifts in government policy that can drastically change business conditions. Political risks include sudden changes in social infrastructure, which may cause consumers to boycott products perceived as American because of an unpopular war. Political risks may also arise from long-standing government policy, as is the case with Japan’s resistance to immigration. This was not a problem when Japan had only a few stores. As the company expands to hundreds of locations and thousands of employees, workforce shortages become a serious issue. Finally, anti-competitive forces that restrict trade or support economic inefficiency put Starbucks at a disadvantage.

Social infrastructure creates risk when there are shifts in the composition and expectations of the Japanese people. Japan has a culture of conformity and group identity, which Starbucks has recognized and adapted to. The advantage of a highly educated, wealthy, conforming population is that change does not come rapidly in this type of country. Japan does not have religious diversity or minority populations creating social change. If Japanese society embraces the Starbucks brand and integrates coffee drinking into daily life, the company can be successful for a long period of time. Risk enters into the business situation when the native Japanese population becomes increasingly older and leaves the workforce.

Government policies control immigration laws and economic reform. Both of these areas are very important for continued success of Starbucks Coffee Japan. Japanese policy is hostile to immigration in general, and makes very few accommodations for unskilled labor. Starbucks may have to resort to developing automated substitutes for the employees behind the counter. This may be acceptable to Japanese consumers, since Japan is the world’s leading inventor and manufacturer of robots. The cost of creating this alternative is an unknown expense, and finding adequate numbers of employees is an increasing concern. Government policies also affect the direction of Japan’s continued recovery from stagnant economic growth. 

As the government adjusts banking regulations and interest rates, new business loans may become more expensive and make the cost of opening new store locations unattractive. 

Anti-competitive practices and foreign relations may affect Starbucks if the company moves into a segment of the food service industry that is more highly regulated or politically sensitive that coffee shops. At this time, the business risk in this area is minimal. The indigenous Japanese coffee companies have not been able to create the type of cartel relationships that characterize the manufacturing industries (most notably the automobile manufacturers and their suppliers). Starbucks has also done a good job of partnering with Japanese businesses to remove any potential “American” stigma from the brand. 

The rankings for the eight risk areas for Starbucks’ operations in Japan evaluated in this paper are summarized in Table 1.

Table 1

Starbucks’ Business Risk in Japan Ratings Table

 
Risk Area

Risk Ranking
Very Favorable

Favorable

Cautious

Dangerous
Economic infrastructure
X
Financial markets
X
Business and work force culture

 
X
Product/Service standards
X
Social Infrastructure -stability
X
Social Infrastructure -Aging population
X
Current administration – government policies
X
Anti-competitive Practices/Foreign policies
X

Key:Four categories of risk were developed, with “Very favorable” being the lowest risk and “Dangerous” being the highest risk category.

VEHICLES FOR STARBUCK’S ENTRY INTO JAPAN 

In 1995, Starbucks Chief Global Strategist, Shultz along with Behr, began exploring foreign investment opportunities, targeting the Japanese market first. 
To build the Starbucks ‘brand’ in Japan, several strategic avenues had to be considered such as licensing, franchising, joint ventures, exporting, etc. Prior to 1995, Starbucks had spent very little money on advertising, preferring instead to build the brand cup-by-cup with customers and depend on word-of-mouth and the appeal of its storefronts and kiosk in the United States. The company was, however, engaged in a growing effort to extend the Starbucks brand and penetrate new foreign markets. In addition to expanding internationally, venturing into ice cream with Dreyer's and development of a new cold beverage (Frappuccino) with Pepsi, discussing the potential development of fruit-drinks and brand name candy, partnering with licensees, and developing specialty and mail-order sales, Starbucks had begun selling its coffees in U.S. supermarkets in the spring of 1998, with the intent to market the products in Japan immediately based on the instant sales growth. 

a. Wholly-Owned Subsidiaries 

Starbucks Coffee Company established an international arm to conduct foreign direct investments by forming an umbrella of foreign subsidiaries.In markets outside the continental United States (including Hawaii), Starbucks' strategy is to license a reputable and capable local company with retailing know-how in the target host country to develop and operate new Starbucks stores. In some cases, Starbucks is a joint venture partner in the stores outside the continental Untied States. Starbucks created a new subsidiary, Starbucks Coffee International (SCI), to orchestrate overseas expansion and begin to build the Starbucks brand name globally via licensees.In October 1995, SCI established a licensing agreement turned joint venture resulting in the opening of Starbucks Coffee Japan, Ltd. by October 1996. The wise investment choice to maintain wholly-owned subsidiaries allows Starbucks Coffee International the ability to exercise total control over their foreign market growth strategy while gaining the benefits of a local operating partner, which was apparent after licensing to ESCO Korea Ltd., in 1999 (Ordonez, 2000).

b. Licensing 

Despite that fact that Starbucks resisted franchising in North America, an initial decision to license its format in Japan was considered until the company realized that a pure licensing agreement would not give Starbucks the control needed to ensure that the Japanese Licensees closely followed their successful formula.However, establishment of a 50-50 split joint venture with local retailer Sazaby, Inc. would provide operational control while giving the growth responsibility to the licensee.To ensure that the new licensee joint venture would prove successful, Starbucks transferred some employees to Japan to conduct training classes for all Japanese store managers and employees. The licensing agreement also required adherence to the store design parameters established in the U.S. (Hill, 2003).

In recent years, Starbucks had begun entering into a limited number of licensing agreements for store locations in areas where it did not have ability to locate a store outlet, such as in airport and hotels (through Marriott and Hyatt), on airplanes (United Airlines), university and college campuses. Starbucks received a license fee and a royalty on sales at these locations and supplied the coffee for resale in the licensed locations.All licensed stores were required to follow Starbucks' detailed operating procedures, and once again all Japanese managers and employees who worked in these stores received the same specific training as their North American counterparts. 

Starbucks also had a specialty sales group that provided its coffee products to restaurants, airlines, hotels, universities, hospitals, business offices, country clubs, and select retailers. Despite much internal debate at Starbucks about whether such a move made sense for Starbucks and the possible damage to the integrity of the Starbucks brand if the quality of the coffee served did not measure up. After seven months of negotiation and discussion over coffee-making procedures, United Airlines and Starbucks came up with a way to handle quality control on some 500-plus planes with varying equipment, and Starbucks became the coffee supplier to the 20 million passengers flying United both national and international (refer to their Japanese website) each year. 

In addition, Starbucks made arrangements to supply an exclusive coffee blend to Nordstrom’s for sale only in Nordstrom stores, to operate coffee bars in Barnes and Noble bookstores.A 1997 licensing agreement with U.S. Office Products gave Starbucks the opportunity to provide its coffee to workers in 1.5 million business offices across the world whereas, the specialty sales division generated sales of $117.6 million, equal to 12.2 percent of total revenues in 1997. (NOTE: I’m checking on whether this company has offices in Japan)

c. Joint Venture 

In keeping with the initial licensing concept to Sazaby, Inc. turned joint venture as discussed above, after months of meetings and experimentation, PepsiCo and Starbucks entered into a joint venture arrangement to create new coffee-related products for mass distribution through Pepsi channels, including cold coffee drinks in a bottle or can.Howard Schultz saw this as a major paradigm shift with the potential to cause Starbucks business to evolve in heretofore unimaginable directions; he thought it was time to look for ways to move Starbucks out into more mainstream markets. Cold coffee products had generally met with very poor market reception, except in Japan, where there was an $8 billion market for ready-to-drink coffee-based beverages. 

In October 1995 Starbucks partnered with Dreyer’s Grand Ice Cream to supply coffee extract for a new line of coffee ice cream made and distributed by Dreyer's under the Starbucks brand. A joint venture that bottled its Frappuccino specialty beverage (a mix of cold coffee, ice, sweetener and milk) in 1996 for retail sale resulted $10 million in revenues that year (Starbucks.com).A similar deal has made the Starbucks the top supermarket brand for ‘coffee’ ice cream, and another venture has given the company a 35% share of specialty whole-bean and ground coffee in grocery aisles throughout the U.S. and Japan.

d. Franchising

From 1971 through today, the parent company, Starbucks Coffee, and it’s international wholly-owned subsidiary, Starbucks Coffee International has managed to maintain complete strategic control of it’s foreign operations and have not had to, nor do they have future plans to franchise despite increasing competition from global coffee manufacturers. Franchising competition in the Japanese market stems from Kraft General Foods (the parent of Maxwell House), Procter & Gamble (owner of the Folger's brand), and Nestle, which also distributes their coffees through supermarkets. There were also a number of specialty coffee companies that sold whole-bean coffees in Japanese supermarkets, but because many consumers were accustomed to purchasing their coffee supplies at supermarkets, it was easy for them to substitute these products for Starbucks. Japanese observers expected many of the local and regional chains to merge in efforts to get bigger and better position themselves as an alternative to Starbucks. However, numerous local restaurants throughout Japan have picked-up on the growing popularity of specialty coffees and had installed machines to serve espresso, cappuccino, lattè, and other coffee drinks to their customers.

Starbucks has mastered Globalization successfully and therefore has no need to franchise which could compromise the integrity and brand image that they’ve worked to achieve. Global expansion in and of itself is the company’s development of marketing strategies that treat the entire world, specifically its major regions, as a single entity to include the standardizations of products, brand ‘image’ advertising, promotional campaigns, coffee prices and its distribution channels.

e. Exporting

Although Starbucks does not have a need to export coffee from Japan, most coffee was purchased in the commodity market—coffee was the world's second largest traded commodity—coffee of the quality sought by Starbucks was usually purchased on a negotiated basis at a substantial premium above commodity coffees, depending on supply and demand at the time of purchase. Coffee prices were subject to considerable volatility due to weather, economic, and political conditions in the growing countries, as well as agreements establishing export quotas or efforts on the part of the International Coffee Organization and the Association of Coffee Producing Countries to restrict coffee supplies.Therefore, Starbucks entered into fixed-price purchase commitments in order to secure an adequate supply of quality green coffee beans and to limit its exposure to fluctuating coffee prices in upcoming periods. When satisfactory fixed-price commitments were not available, the company purchased coffee futures contracts to provide price protection. Nonetheless, there had been occasions in years past when unexpected jumps in coffee prices had put a squeeze on the company's margins and necessitated an increase in the prices of its beverages and beans sold at retail.

In another aspect Starbucks could be seen as exporting by the utilization of their internet services and mail order catalogs to generate business outside of the local targeted market.Starbucks published a mail-order catalog that was distributed six times a year and that offered coffee, candies and pastries, and select coffee-making equipment and accessories. A special business gift-giving catalog was mailed to business accounts during the 1997 Christmas holiday season. The company also had an electronic store on the Internet. In 1997, sales of this division were about $21.2 million, roughly 2 percent of total revenues; almost 50,000 mail-order customers were signed up to receive monthly deliveries of Starbucks coffee as of late 1997. Starbucks management believed that its direct-response marketing effort helped pave the way for retail expansion into new markets and reinforced brand recognition in existing markets.

Table 2 - Business Structure Ranking Table

Business type

Risk Ranking
Economic advantages

Economic disadvantages

Political

advantages

Political disadvantages
Exporting
0
0
+1
0
Licensing
+1
-1
+2
0
Franchising
0
0
+2
0
Joint Venture
+2
-2
+1
-1
Wholly-owned Subsidiary
+5
-1
0
-5

Key:Risk Scores range from highest (-5) negative indicating the degree to comparative disadvantage, to lowest (+5) positively indicating the degree of comparative advantage, with zero (0) being a category that presents not applicable and/or no significant country difference with regards to Starbucks business expansion.

CONCLUSION

After thoughtful study, this report concludes the comparative business risks advantages and disadvantages associated with Starbucks expansion into the Japanese market.With the globalization of markets, greater foreign competition, and the reduction of entry barriers, it becomes all the more important to benchmark a company's risk indicators against other firms on a worldwide basis.Industry analysts in 1998 saw Starbucks as being well on its way to becoming the Nike or Coca-Cola of the specialty coffee segment.It was the only company with anything close to national market coverage. The company's most immediate objective was to have 2,000 stores in operation by the year 2000.In the overseas market, in 1999 there were 281 actual stores, as of September 2002, there were 1,200 abroad and still growing (Business Week, 2002).Its longer-range objective was to become the most recognized and respected brand of coffee in the world. The company's efforts to greatly increase its sphere of strategic interest via its joint ventures with Pepsi and Dreyer's, its move to sell coffee in supermarkets, and the possibility of marketing fruit-juice drinks and candy under the Starbucks label represented an ongoing drive on Schultz's part to continually reinvent the way Starbucks did business.Shultz admits that while its practice of blanketing an area with stores helps achieve market dominance, it can cut sales at existing outlets, “we probably self-cannibalize our stores at a rate of 30% a year.”The company may possibly be at a defining growth point, as it has reached a level that makes it harder and harder to grow just due to the law of large numbers (Business Week, 2002).However to duplicate its enormous returns of its first decade, Starbucks had no choice but to export its concept aggressively on the global market, planning to increase its foreign base by 35%, but not without risks. The company makes less money on each overseas store because most of them are operated with local partners. While that makes it easier to start-up on foreign turf, it reduces the company’s share of the profits to as little as 20 to 50%. 
In order to sustain the company's growth and make Starbucks a strong global brand, Schultz believed that the company had to challenge the status quo, be innovative, take risks, and alter its vision of who it was, what it did, and where it was headed. Under his guidance, management was posing a number of fundamental strategic questions: What could Starbucks do to make its stores an even more elegant "third place" that welcomed, rewarded, and surprised customers? What new products and new experiences could the company provide that would uniquely belong to or be associated with Starbucks? What could coffee be—besides being hot or liquid? How could Starbucks reach people who were not coffee drinkers? What strategic paths should Starbucks pursue to achieve its objective of becoming the most recognized and respected brand of coffee in the world? 

Starbucks Coffee Company and its wholly-owned international subsidiaries have mastered the art of global Customization, which called for strategic adjustments to their marketing mix according to the cultural, regional, and national differences that they encountered in Japan.Schultz has put strong emphasis on achieving both good strategic and good financial performance. In the late 1980s he put strategic objectives (rapid expansion into new geographic markets and building the requisite organizational infrastructure) ahead of profitability, arguing that profits would soon follow (which it did). During the 1992-1997 periods, the company's strategic and financial performance was solid and the company achieved its objectives of 2,000 stores by the year 2000 and aggressive expansion into foreign markets. 

Although the coffee conglomerate is still in the early stages of a plan to colonize the globe, there are plenty of minefields ahead, and now Starbucks is waking up to the ‘grande’ challenge faced by corporations bent on becoming global powerhouses, hence the phrase, “Think globally, Act locally,” which basically describes the successful presence Starbucks enjoys today in every major emerging global market, such as Japan.

REFERENCES

Agro-trade handbook 2001. Retrieved from the World Wide Web on March 21, 2003. http://www.jetro.go.jp/ag/e/report/agrotrade2001.pdf

Business Week Online. (September 9, 2002). Planet Starbucks - to keep up the growth, it must go global quickly. New York: McGraw-Hill. Retrieved March 12, 2003, from http://www.businessweek.com/print/magazine/content.02_36

Heyne, P., Boettke, P., & Prychitko, D. (2003). The economic way of thinking (10th ed.). Upper Saddle River, NJ:Prentice-Hall, Inc.

Hill, C. (2003). International business with Global Resource CD, PowerWeb and World Map (4th ed.). New York: McGraw Hill p. 202-205. 

Hoover’s Online–The Business Information Authority. Starbucks Corporation

Ordonez, J. (October 27, 2000). Starbucks to start major expansion in overseas market. Wall Street Journal. Retrieved March 14, 2003, from http://info.umuc.edu/mba/public/mba-library.html 

Starbucks Coffee Company. International development.Retrieved May 9, 2003, from http://www.starbucks.com/aboutus/internationaldev.asp

Starbucks Coffee Japan Ltd. company website. Retrieved March 12, 2003, from http://www.starbucks.co.jp/ja/home.htm 

Starbucks Japan stung by earnings, sales slump. (2002, November 18). Nation’s restaurant news (36) 46. Retrieved from the World Wide Web from on May 1, 2003 from MdUSA database Business Source Premier.
 
Theodore, S. (2002, October). Expanding the coffee experience: Starbucks keeps sales brewing with new products, innovation and global expansion. Beverage industry (93)10. Retrieved from the World Wide Web from on April 27, 2003 from MdUSA database Business and company resource center.
U.S. Department of State, Bureau of East Asian and Pacific Affairs. (June, 2002). Background Note: Japan. Retrieved From the World Wide Web from http://www.state.gov/r/pa/ei/bgn/4142.htm#govon April 9, 2003.