Sourcing Coffee Beans for Starbucks
Starbucks Corporation is an American global coffee company and coffeehouse chain based in
Seattle, WA. Starbucks was founded in 1971 by Jerry Baldwin, Zev Siegl, and Gordon Bowker,
who met while studying at the University of San Francisco. In 1984, they purchased rival Seattle
coffeehouse chain Peet’s and started selling espresso in addition to more traditional roasted
coffee beans. In 1987, former employee Howard Schulz bought the Starbucks chain and quickly
began expanding outside Seattle. Today, Starbucks has over 23,000 locations in over 65
countries, employs 230,000 people, and its annual revenue exceeds $19 billion.
Procurement: Pre-season Contracts and Open Market
This mini-case focuses on one of Starbuck’s products: roasted Arabica beans. In short, Starbucks
purchases green Arabica beans from independent coffee growers around the globe, roasts the
beans, and sells them to retailers. There are two main procurement channels for Starbucks:
•
Pre-season contracts. Under a pre-season contract, the company agrees to buy the crop
of a grower at a fixed price per pound. The volume of beans purchased in pre-season
contracts is always a key business decision, and typically ranges between 40% and 70%
of the total requirements. The pre-season contract specifies a base price, and generally
includes incentives depending upon the quality of the beans. The average base price for
a pre-season contract in 2016 has been $1.5/lb.
•
Open market. Alternatively, the company can purchase coffee beans on the market. In
recent years, the open market price for coffee beans has been quite volatile, ranging
anywhere from $0.5/lb to $3/lb.
Processing of Green Beans
The green beans must be roasted before selling. The fixed costs associated with processing,
distributing and marketing the end product are about $100 million per year. In addition, there
are variable costs for labor, power, etc. Starbucks has the capacity of roasting 200 million
pounds of beans annually in-house, at a cost of $4.3/lb. By outsourcing to smaller, independent
facilities, it is possible to roast even more than 200 million pounds, albeit at the higher variable
cost of $5.3/lb.
Market for Roast Beans
After extensive market research and careful analysis of historical data, Starbucks is confident
that the demand for its processed Arabica coffee beans is given by the following expression:
Expected demand (lbs) = 600M – [35M * Price]
For example, if the price is 10$, the company is expecting a demand of 250 million pounds.
Questions
1. Build a spreadsheet model in Excel that predicts the profits for the coffee roasting division
of Starbucks, when it procures 60% of its raw materials using pre-season contracts, charges
$11/lb for its roasted beans, and the open market price for green coffee beans is $1.75/lb.
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Sourcing Coffee Beans for Starbucks
2. Suppose that Starbucks procures 60% of its raw materials using pre-season contracts, and
charges $11/lb for its processed beans. How is profitability affected by the uncertainty in
the open market price for green coffee beans? [Hint: use Data Table, and do a scatter plot
of the profit as a function of the open market price.]
3. Suppose that Starbucks procures 60% of its raw materials using pre-season contracts, and
the open market price is $1.75/lb. How much should Starbucks charge for its processed
beans to maximize its profits?
4. Suppose that Starbucks charges $11/lb for its roasted beans. What fraction of raw materials
should it procure using pre-season contracts, and how do the resulting profits depend on
the open market price of green beans? [Hint: use a two-dimensional Data Table]
EXTRA QUESTIONS. For each of the next questions, you should assume the conditions of part
1 of the case apply.
5. The head of procurement negotiated a new sourcing contract, whereby the pre-season price
(per pound) depends on the quantity sourced. This dependency is given in Table 1 below.
Min (lbs)
Max (lbs)
0.00
50,000,000.00
50,000,000.00 75,000,000.00
75,000,000.00 100,000,000.00
100,000,000.00 125,000,000.00
125,000,000.00 150,000,000.00
150,000,000.00
Infinity
Price ($/lbs)
2.25
2.00
1.75
1.50
1.40
1.25
Table 1 - New pre-season contract pricing
For instance, if the total quantity in the contract is 60,000,000 pounds, the total sourcing
cost to Starbucks would be: 50,000,000 * $2.25 + 10,000,000 * $2.00.
What is the price that Starbucks should charge for its roasted beans under this contract to
maximize its profit? [ Hint: avoid overly complex (e.g., nested) IF statements! ]
6. Starbucks is considering expanding its operations into one new market. It is currently
evaluating four possibilities, described in Table 2 below.
Market #
1
2
3
4
Demand intercept (lbs)
280,000,000 290,000,000 310,000,000 275,000,000
Demand slope (lbs/$)
-22,000,000
-23,500,000
-24,400,000
-21,000,000
Expansion cost ($)
20,000,000
30,000,000
35,000,000
26,000,000
Table 2 - Potential Markets for Expansion
When expanding, Starbucks would incur fixed costs related to opening new facilities, hiring
new staff, etc., but would gain access to a new market, where it could sell at a different
price than the home market. Which market should Starbucks expand to, and what price
should it charge in this new market? [ Hint: AVOID constructing 4 different models here!
Think about how to change your original model into a flexible one, so that the expansion
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Sourcing Coffee Beans for Starbucks
market could be a decision. Also, try to structure your new model so that you can drag
formulas across, and you do not have to input very similar formulas for each market. ]
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