Starbucks Hits McDonald's with Seattle's Best

With McDonald's experiencing a fair amount of success with its McCafé coffee brand — one analyst estimates that the company sold about $1.5 billion in coffee last year — Starbucks could no longer sit on the sidelines. Last week it announced that it would sell one of the premium brands it owns — Seattle's Best Coffee — in Burger King and Subway restaurants, at AMC movie theaters and at supermarkets and coffeehouses across the country, with 30,000 locations in all. The company won't admit that McCafé played a part in its decision to expand Seattle's Best, a former rival that Starbucks purchased in 2003, which has sat quietly in 500 Borders bookstore locations over the past few years. "Our endgame is to bring our great coffee everywhere," says Michelle Gass, a veteran Starbucks marketer who is now president of Seattle's Best. "Howard [Schultz, the Starbucks CEO] discovered, Wow, he's got this diamond in the rough of a brand that is part of the corporation, and we had not put the resources and the backing into it." (See the top 10 bad beverage ideas.)

No matter the ultimate motivation, Starbucks has thrown another salvo in what has been one of the more heated business competitions in the country: the fight for share in the $13.7 billion specialty-coffee category. Analysts are applauding Starbucks' move. "Seattle's Best offers Starbucks enormous growth potential," says John Glass, who covers restaurants for Morgan Stanley. "And it makes sense to partner with Burger King and Subway against a common enemy: McDonald's." With Starbucks seemingly saturated on every street corner across the country, the company needs to deliver its blend to other channels in order to expand. The Seattle's Best brand will sell for lower prices at fast-food joints than what Starbucks sells in its own stores. (See the 10 worst fast-food meals.)

The strategy presents a fair amount of cannibalization risk. If I get used to buying Seattle's Best at Burger King, why should I fork over an extra few bucks, and higher profits, to Starbucks? The company argues that since Seattle's Best offers a different taste profile — a more mellow, accessible flavor — each brand will develop its own fans. And the truth is, there's probably room for more players, since, even in the face of the recession, there seemed to be demand for higher-quality coffee. McCafé rolled out last summer during the downturn. Despite McDonald's success with the brand, as Glass points out in a research report, Starbucks' same-store sales have risen in the last two quarters, including a 7% jump in the first quarter of this year. "McDonald's' heavy advertising for McCafé may have increased awareness for the entire coffee category and helped improve sales figures overall," says Greg Schroeder, an equity analyst with Wisco Research.

This summer, McDonald's will launch its Frappe, a Frappuccino-like beverage, plus fruit smoothies to provide Starbucks with even more competition. Frozen coffee is less crafted and more commoditized than hot lattes; McDonald's will sell its Frappe in the $2.29-$3.29 price range, while Starbucks' Frappuccinos are retailing between $3 and $5, according to Glass. So McDonald's' foray into frozen coffee may have a greater negative impact on Starbucks' sales. But as Glass points out in his report, only 37% of U.S. Starbucks locations have a McDonald's store within a half-mile. This relative lack of geographic overlap may lessen the McDonald's threat. (See the best business deals of 2009.)

Starbucks is betting that Seattle's Best will further slow the McDonald's coffee momentum. "What we, Seattle's Best, distinctly have is a real coffee company," says Gass. "We ourselves have 40 years of history, and we're part of Starbucks." Is she saying that McDonald's is not a "real" coffee company? Gass simply laughs. Your move, Mickey D's.

See an interview with Starbucks CEO Howard Schultz.

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