A Full Business Breakdown

Business breakdown

We've covered a wide range of topics this year and it feels like a good time to work through a case study for added practice. To keep things simple, we'll break this into a multi-part series covering:

1. (Part I) Business model and unit economics
2. (Part II) Financial statement analysis
3. (Part III) Projections and planning

My goal is to show you how to assess your (or others') business from top to bottom.

As I enjoy my cup of coffee while writing this, I can think of no better case study than Starbucks Corp (ticker: SBUX).

You're probably familiar with Starbucks, but have you stopped to think about how the business actually works? There's a good mix of business models in here (manufacturing, retail, licensing/franchising) and the company recently had a high profile CEO change.

Today we'll cover 4 areas:

1. Business model
2. Profit model
3. Unit economics
4. Other valuable nuggets

1) Starting with the business model

Here's how Starbucks describes their business in their Form 10-K (an SEC filing of annual performance):

They operate roughly 21,000 company-owned stores and license another 19,000 stores to third-party operators. (Sounds like we'll find plenty of leases but also some high-margin licensing income, much like a franchisor.)

• How does this business work? They purchase coffee beans (raw material), roast and package those coffee beans (manufacture, warehouse, distribution), then lease and operate retail stores (retail)
• Who are the customers? Coffee and tea drinking consumers
• Competitors? Specialty coffee shops, fast food restaurants serving coffee, or other caffeinated beverages

Yes, this is an overly simplified view of Starbucks but we get a sense for what they do. And clearly it's more than just selling coffee.

2) Profit model

As a reminder, a profit model tells us how the business as a whole makes money. By now, we've gathered Starbucks is running stores (restaurants) and selling coffee, tea, and food.

Fortunately, we get a nice view of the various expenses as they relate to sales each year:

This is a remarkably consistent business... On the whole, for every $100 of sales, Starbucks is paying $32 for product (food, roasted coffee, etc.), $41 to run the stores (rent, labor, etc.), $8 for overhead like salaries and admin, and $5 for physical assets like roasting equipment, store fixtures, etc. That leaves $14 profit before taxes and interest for every $100 of sales.

Stepping back for a moment, this doesn't look like a broken profit model (i.e. a business that should be earning $15 per $100 sales but instead sits at $5). No, this is a good company looking to optimize their way from $14 to $16 profit per $100 while growing revenue.

3) Unit economics

How do unit economics differ from the profit model?

We've already seen several different products and business lines in here; so we want to know how they differ financially, which helps steer management attention and effort (strategy).

The percentages above are costs divided by all revenues. But the various products and channels likely carry different unit economics (margins) when we zoom in. Some examples:

• Food margins
• Beverage margins
• Licensing vs. company-operated margins
• Product margins (i.e. roasting & packaging for store sales)

Knowing these margin profiles would guide your strategy (we don't have enough detail to get this granular for Starbucks but you could with your own business).

Company-operated stores bring in $30bn per year across 21,000 locations while licensing revenues are $4.5bn on 19,000 locations — but those 2 divisions might contribute the same amount of operating income (i.e. if licensing revenue were 100% royalty income).

Here's how they describe licensed stores:

Digging deeper, Starbucks looks to be taking a 50/50 approach to company-owned vs. licensed stores and leaning heavier on partners internationally while self-operating domestically.

4) Other nuggets

• Gift cards — Customers can load reusable gift cards mainly through the Starbucks mobile app and while most of those dollars get spent within a year, they often hang around longer than that. In the meantime, Starbucks collects interest income on those outstanding balances which totaled $1.7bn. Not a bad way to collect some added income with minimal effort!
• Loyalty programs — Starbucks has a staggering 33.8m active rewards members. That's a huge base of recurring revenue!

Key takeaways — We're starting this series by piecing together a basic understanding of this business and how they make money. Next week, we'll dive into the financial details to gauge overall financial health and work toward forming some projections and strategy action plan.

Taking this to your own business — Look for the uncovered nooks and crannies of your business to understand what's driving results. Where are margins different? What makes your business unique? What problems are you solving for your customers? Focus on the narrative of your company.

Quick disclaimer: this is NOT intended to be financial advice, it's for educational and entertainment purposes only; be sure to do your own research if considering an investment in Starbucks!