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Starbucks buys Evolution to juice profits

Orange Wedged being dropped into water with white background. morgueFile user aaroncrawford

COMMENTARY Move over lattes, here comes some fancy juice. Starbucks (SBUX) announced that it would acquire juice company Evolution Fresh for $30 million. It's intended to be the beginning of a new brand of health and wellness stores that will incorporate juice bars and simple foods.

What makes the move particularly interesting is Starbucks' aim to "reinvent the $1.6 billion super-premium juice segment." The company is putting itself directly up against such brands as Odwalla and Naked Juice -- owned, respectively, by Coca-Cola (KO) and PepsiCo (PEP). It's a reflection of the lengths to which Starbucks must go to keep the company growing.

Cold coffee

Between its fiscal years 2007 and 2011 (the company fiscal year ends in October), Starbucks saw total revenue growth of 24.3 percent, as the graphs below show (graph on the left shows profit versus revenue, while the one on the right shows operating income and margin versus revenue):

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Compare that to the 45.8 percent revenue growth that Coke saw over its last five fiscal years or the 64.6 percent that Pepsi had over its last five full years of operation.

Although it has expanded into other product lines and moves a significant amount of products through other retailers, Starbucks has stumbled over recent years. A few years ago, chairman Howard Schultz publicly worried that the company was losing its soul. Lagging profits pushed management to close 600 stores that it considered under-performning in 2008 and an additional 300 the following year. It scaled back on opening stores in new locations.

Can't get there from here

As Harvard Business School marketing professor John Quelch wrote, there are limits to growth:

Starbucks is a mass brand attempting to command a premium price for an experience that is no longer special. Either you have to cut price (and that implies a commensurate cut in the cost structure) or you have to cut distribution to restore the exclusivity of the brand.
Quelch was prescient in 2008 when he said that the 600 store closings would be the first of a series of downsizing announcements. The trend has continued, although at a lower-profile pace. In the U.S. in fiscal year 2010, Starbucks had a net 57 fewer company-owned stores than it did the year before, although an additional 60 licensed stores made up the difference.

This last fiscal year, the net number of company-owned stores dropped by 2, but the number of licensed stores plummeted by 342. There was growth in both company-owned and licensed international stores, but it still suggests that when Starbucks is established in an area, there is a natural limit to its growth. And Dunkin' Donuts (DNKN) has taken advantage of the situation by attacking Starbucks and its core business. McDonald's (MCD) has done the same thing with its McCafé coffee bar line.

Squeeze out more money

That's what makes the Evolution acquisition particularly important. Starbucks has created an opportunity to expand through a new brand. If successful, the company could build the health and wellness equivalent of a café chain that didn't have a direct immediate competitor on the same scale.

The pros? Health and wellness is huge -- Starbucks quotes estimates of a $50 billion annual market. Although Starbucks doesn't have a direct presence per se, it does sell juices and bottled water at its stores and has cultivated a brand position of high quality products (whether you like the company's coffee or not). The move would allow Starbucks to expand without trying to push even more sales through the existing coffee line. And adding juice would also fit the company's current strategy to sell packaged product through other retailers.

The cons? Starbucks is trying to do something new -- even newer than when it opened its current chain back in the 1970s. Coffee shops and higher-end cafes had proven interest in premium coffee in the past. The question was how many people would pay more for a cup of coffee. Now Starbucks has to see whether people will get in line for a cup of juice with the same eagerness as they do for coffee. After all, Jamba Juice (JMBA) has been around for years and in 2010 saw $254.5 million in revenue. That's just a couple of percent of Starbuck's revenue and not enough to really get the company moving.