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Can Starbucks Survive Consumer Cutback?


Coffee giant gambles on free java, discounts to keep customers entrenched.


According to Bloomberg, in a move to halt declining sales, Starbucks may push loyalty cards. The website explains:

Starbucks (SBUX) Corp. Chief Executive Officer Howard Schultz may introduce a plan for a loyalty program to stanch declining U.S. sales at a shareholders meeting tomorrow.

Schultz will probably offer free coffees or discounts to customers using prepaid Starbucks Cards to entice the chain's most frequent customers to visit more and avoid competitors led by McDonald's Corp., said Joseph Buckley, an analyst at Bear Stearns & Co. who recommends holding the stock.

The company may also say it will lower prices on food and drink combinations to win back customers hurt by the slowing economy. Starbucks has already begun using the prepaid card to offer deals to customers, saying last month that it will give out two hours of free AT&T Inc. wireless Internet access a day to Starbucks Card holders.

It doesn't matter what the price of coffee beans or cream is doing. Consumers are tired of paying $4 or more for a cup of coffee. They are looking instead for "recession specials" if they are willing to spend at all.

How can Starbucks compete with McDonald's (MCD), one of its biggest competitors in this area?

  • Lower prices.
  • Give free refills.
  • Provide free Internet service.
  • Offer loyalty discount cards.

Cost cutting like the above has just begun and consumer attitudes towards frivolous spending is why. "Frugality is in, extravagance is out," says David Rosenberg, a North American economist at Merrill Lynch.

Indeed, it's important to notice how consumer attitudes toward spending are putting downward pressure on all non-essential spending, even though the U.S. dollar has been falling like a rock.

Such attitudes are certainly not indicative of the inflation fears expressed by two dissenting Federal Reserve governors on Tuesday. See Broker Dealers Fly, Gold Falls as Fed Cuts 75 Basis Points for more on dissenting opinions and reasons for Tuesday's rally.

For a look at the Consumer Price Index (CPI) as a lagging indicator and more comments from David Rosenberg and others on the new wave of frugality, please see Attitudes Lead, The CPI Lags.

As frugality sets in, look for the CPI to peak.

For more on Starbucks' difficulties, check out Hoofy & Boo's always-astute report.

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No positions in stocks mentioned.
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