Monday, May 21, 2007

Starbucks' (SBUX) Ethiopia Fiasco: Firings Ahead?

After the work I have done on Starbucks (SBUX), I ended up in correspondence with people intimate with the recent Ethiopian negotiations (on the Ethiopian side). In response to a question I asked I got the following response....

"At this moment, SBUX and Ethiopia are working out the terms of a licensing agreement acknowledging Ethiopia's ownership of three coffee marks. An Ethiopian official told me today that he hopes an agreement will be concluded in the coming week or two. SBUX was offered exactly this deal 18 months ago or so, but it rejected the offer dismissively and without seeking to discuss it. This led to the Oxfam campaign that has tarnished the SBUX image. SBUX's arrogant rigidity is a mystery. Prices were not mentioned in that agreement, and are not mentioned in the present -- probably very similar -- version, as far as I know."

In any matter, it is now clear that Starbucks will be paying more for it coffee from Ethiopia. Do not be surprised to see other coffee producing nations look to do the same thing in an effort to enhance profits.

"Coffee prices are rising as demand for premium coffees has been rising (in part because of SBUX's own growth) faster than supply, though supply of ordinary coffee is plentiful. The two executives within SBUX who are held most responsible internally for their mishandling of this are Dub Hay and Sandra Taylor. Both could be gone some months from now, but it is likely that Schultz will wait long enough to weaken the cause-effect link to the Ethiopia embarrassment since SBUX hasn't openly acknowledged how badly they handled it. It has been a PR disaster for SBUX but has given Ethiopia invaluable publicity for its coffees. Millions who were ignorant of the facts now know that Ethiopia is a coffee producer, that it is the original home of coffee, and that its coffees are among the world's finest."

The Ethiopian fiasco has badly tarnished the "Good Citizen" image Starbucks once had. In a Wal-Mart (WMT)inspired move Starbucks seems to have put profits ahead of the lives of Ethiopian coffee farmers in order to protect the bottom line. This uncharacteristic move to me is extremely telling. It is a sign that management recognizes costs are rising at a rate faster than they can offset them with revenue increases either by passing them off to customers or selling those customers more non coffee products. Their 1% transaction traffic growth the last quarter illustrates they will not be able to do it selling more people more items. This realization is causing them to do almost anything to control any cost they feel they may be able to, hence the initial hard line in Ethiopia. It smacks of a bit of desperation from a company who is seemingly in denial about it's future.

After all the negative publicity from this and doubt about future profits recently due to competition from the likes of McDonalds (MCD) and Dunkin Donuts, a profit warning would put shares into a free fall.

Perhaps Schultz and company are hoping for cost relief to bail them out or have a "Hail Mary" planned. Either way, the rest of 2007 could very unkind to shareholders.

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