Starbucks Corporation (NASDAQ: SBUX) and Dunkin’ Brands Group, Inc. (NASDAQ: DNKN) are the two largest eatery chains in the United States that specialize in coffee. While both companies maintain similar menus and overall strategies, there are key differences in their business models related to scale, store ownership and branding.
Despite being founded 20 years after Dunkin’ Donuts, Starbucks grew aggressively and is a substantially larger company. In 2016, Starbucks generated $16.8 billion in revenue while Dunkin’ Brands reported sales of $828.9 million. Starbucks has a larger footprint, with 22,519 stores to Dunkin’ Donuts’ 11,500 points of distribution. Starbucks has also expanded beyond the U.S. more extensively, with locations in 70 different countries. Dunkin’ Brands has a substantial international presence, though many of its international locations are Baskin Robbins ice cream stores rather than Dunkin’ Donuts stores.
In 2015, nearly 79% of Dunkin’s consolidated revenue was generated by Dunkin’ Donuts locations in the U.S., while international revenue contributed less than 4% to Dunkin’ Donuts’ branded stores revenue. Just under 20% of Starbucks’ consolidated revenues were attributed to markets outside of the Americas in 2015. Dunkin’ has announced aggressive international and domestic expansion plans with the hope to challenge its main competitor’s footprint, but the difference in scale stems from variations in expansion strategy.
Nearly all of Dunkin’ Brands’ locations are franchises while over 51% of Starbucks locations were company operated as of October, 2016. Licensed Starbucks stores are disproportionately located outside of the United States, and the company is not accepting applications for any new franchises as of March 2016. Over 75% of Dunkin Donuts’ revenue came from franchise fees, royalties and rental income in 2015, whereas only 10% of Starbucks revenues were derived from licensed locations.
Dunkin’ Donuts’ higher exposure to franchise and rental income leads to a fundamentally different business from Starbucks’ largely owner-operator model. This has major implications for revenue streams, cost structure and capital spending.
Company-operated stores have different operational and capital expense structures from franchised locations. Cost of goods sold (COGS) and store operating expenses are a much larger percentage of sales for Starbucks than Dunkin’ Donuts. Because COGS is so much more prominent in Starbucks’ expense structure, its profits are more severely impacted by changes in coffee bean prices. Starbucks also has a higher capital expense burden than Dunkin’ Donuts, which is not obligated to purchase kitchen equipment for franchise locations.
Focus and Branding
Dunkin’ Donuts markets itself primarily as a coffee seller that also offers donuts and foods, a fact made apparent by a coffee cup prominently featured on the company’s logo and executive management’s explicit assertion that Dunkin’ Donuts is a beverage company. Despite building an identity as a coffee seller, food is still an important element of Dunkin’ Donuts’ offering. In recent years, Dunkin’ Donuts has focused increasingly on nontraditional food options with the hopes of attracting customers outside of breakfast hours. The introduction of steak to its menu in 2014 was a step toward incorporating heartier food items alongside a growing number of sandwich options. Dunkin’ Donuts’ interiors are designed differently from Starbucks stores, with the former often resembling fast food stores in furnishings and decor.
Starbucks brands itself primarily as a beverage provider that offers a more typical coffee house dining experience. Starbucks locations are designed with the comfort of their customers in mind. Free Internet access and inviting decor offer a more enticing option for those looking for a place to read, relax or speak with friends. This also makes going to Starbucks a potential social activity, turning the stores into a destination rather than a simple distribution location. This appeals to customers seeking a premium experience. Typically, these customers have higher disposable incomes and are more willing to pay extra for higher quality materials. In economic downturns, people with lower disposable incomes are more likely to alter their consumption habits than people with larger financial cushions. While Starbucks is undeniably impacted by the macroeconomic environment, it is firmly established with a more resilient and less price-sensitive customer base, which helps to dampen the blows brought on by economic cycles. Like Dunkin’ Donuts, Starbucks has also shifted focus to include more products aimed at afternoon and evening customers. These include small plates and sandwiches as well as wine and beer.
Starbucks has built a more premium brand than Dunkin’ Donuts. Starbucks offers a more extensive menu and more product customization, which is reinforced by writing each customer’s name on the side of his cup. The company offers a comfortable and quiet environment with free wireless Internet access, encouraging customers to stay to socialize, work, study, browse media or listen to music while consuming their Starbucks product. Taken together, these factors form a more premium experience and command a higher price point. Dunkin’ Donuts has more competitive pricing, focusing on the middle class. In company filings and earnings conference calls, Dunkin’ Donuts’ management has described its intent to be the lowest cost provider in the market while maintaining quality above an acceptable minimum.
Because Starbucks operates its own stores, it has tighter margins than Dunkin’ Donuts. Profit after cost of sales, which includes product expenses and occupancy costs, was 83% for Dunkin’ Brands during the quarter ending June 2015. Starbucks only had 60% gross margin during this period. There is a similar divergence in operating margin with Starbucks posting 17.5% operating margin, which is more than 26 percentage points below that of Dunkin’ Brands.
As mentioned earlier, Dunkin’ Donuts has a lower capital expense burden than Starbucks. Dunkin’ Donuts’ $14.4 million in capital expense in the second quarter of 2015 was 31% of net cash flow from operations and 7% of revenue. Starbucks’ $944 million of capital expenses was 34% of net cash flow from operations and 19% of revenue. This discrepancy is a consequence of the different store ownership structures for the two companies, and it has material consequences for the fundamentals available to investors.
Investors should also note the difference in capital structure between the two companies. Dunkin’ Donuts carries $2.5 billion of long-term debt, which is 74% of total assets. Starbucks’ $2.4 billion of debt is only 18% of total assets.