Starbucks looks to Seattle's Best chain for growth

Starbucks Corp. is hoping its Seattle's Best Coffee chain will be its growth engine during the recession.

Even as Starbucks shutters hundreds of namesake locations, cuts jobs and shaves other costs, it is seeking franchisees to open new cafes and kiosks of Seattle's Best Coffee nationwide.

Since Starbucks took over the chain in 2003, most new Seattle's Best Coffee cafes have opened inside Borders bookstores and kept a relatively low profile. Many consumers don't know there's a connection: Seattle's Best Coffee's logo is red, Starbucks' is green, and there is no mention of Starbucks inside Seattle's Best Coffee stores.

Not only could opening more franchised cafes help Starbucks - which reports its second-quarter earnings Wednesday - expand without increasing its operating costs. Promoting Seattle's Best Coffee also could help Starbucks pursue two distinct streams of the coffee market simultaneously.

Seattle's Best Coffee's food, including ice cream and hot sandwiches, targets a broader market than the pastries and sandwiches and high-end juices and protein drinks at most Starbucks. And its much milder beans have been available since January in more than 2,800 Subway restaurants.

"It gives them an opportunity to reach out to a different audience," analyst Darren Tristano of Technomic Inc., a food industry consulting firm, said of the plan to open more Seattle's Best Coffees.

Starbucks says the slightly lower prices and milder taste of Seattle's Best Coffee make it an especially viable vehicle for growth now, though the company declined to say how many new stores it hopes to open or where.

"We believe that the Seattle's Best Coffee brand can play a unique role in helping capture a larger share of the coffee segment by providing options and a variety to a broader spectrum of customers," Starbucks Chief Executive Howard Schultz said in January when he announced the plan.

Sales at Starbucks overall have declined the past year, including a 9 percent drop in same-store sales - that is, revenue at stores open at least a year - worldwide in its first quarter. Analysts expect another big drop in the period that ended March 29 compared with a year earlier.

The company does not break out sales or profit for Seattle's Best Coffee and declined to give any numbers for the brand. But there are roughly 550 Seattle's Best Coffee locations nationwide, including 12 stand-alone cafes, compared with 9,000 company-operated Starbucks stores and some 7,000 licensed stores in locations like hotels and airports.

Most Seattle's Best Coffee revenue is counted in the 16 percent of Starbucks Corp. sales from "specialty operations," which also includes revenue from distributing Tazo Tea beverages in the U.S. and Canada and sales from a bottled coffee drinks joint venture with PepsiCo Inc.

So analysts said it's unlikely that adding Seattle's Best Coffee cafes will make much difference in Starbucks overall revenue. But it certainly could be helpful and might even create a candidate for a spin-off that could increase the company's cash reserves in the future.

"It gives them a secondary strength," Tristano said.

Starbucks has been quietly building the Seattle's Best Coffee brand since it bought the Seattle Coffee Co. - its parent company - almost six years ago for $70 million in cash from AFC Enterprises Inc., which also owns the Popeyes fried chicken chain.

Morningstar analyst R.J. Hottovy said building it further by adding more franchisees - something Starbucks has resisted for its namesake brand - could boost the company's overall profit because franchisees typically pay their own operating expenses and they aren't booked by the corporate parent.

Starbucks officials said in January that they would consider turning some shuttered Starbucks stores into Seattle's Best cafes and the company has since converted a Hawaii Starbucks into a Seattle's Best Coffee. A Texas-based franchisee has committed to opening 10 Seattle's Best Coffee locations. And other franchisees, the company said, are close to signing up.

The biggest challenge to expanding Seattle's Best Coffee may be crowding in the premium coffee market.

Growing numbers of local cafes and local chains in the Washington, D.C. area, San Francisco, Portland, Ore., and other cities see themselves as countering the mass-marketing and dilution of espresso by Starbucks.

At the other end of the spectrum, virtually every fast-food operator has been trying to get into the specialty coffee business. The biggest new player is McDonald's Corp., which is about halfway through introducing espresso-based drinks in all its 14,000 U.S. restaurants.

"It seems like a risky strategy to me," Zacks Investment Research Inc. analyst Ann Northrup said of expanding Seattle's Best Coffee. "The premier coffee market is becoming oversaturated."