- The Washington Times - Monday, July 14, 2008

When a Starbucks opened down the street from his Adams Morgan coffeehouse in 2004, Constantine Stavropoulos was a little worried. He had heard stories about the coffee giant’s ability to snap up customers and drive competitors out of business. Months later, his worries subsided. Customers were still lining up for Tryst’s lattes and espressos despite Starbucks’ presence. By the end of the year, Tryst’s sales had increased 10 percent.

“We were providing what Starbucks thought they were delivering: a community hub for people to meet and drink coffee together,” Mr. Stavropoulos said.

The store he once feared could now be at risk for closure. Earlier this month, Starbucks announced it will close 600 company-operated stores over the next year. Starbucks hasn’t disclosed which stores will be shuttered.

Starbucks reported that its U.S. operating profit fell more than 27 percent from the first quarter of last year. The company’s stock price has slumped 40 percent over the past 12 months. Starbucks executives say a sagging economy and the credit crunch have cut into profits and slowed foot traffic in stores. However, Starbucks also has been a victim of its own success.

The number of Starbucks stores that have popped up like mushrooms across the American landscape has long served as a punch line for late-night comedians - and that rapid growth is hurting business. Company executives said 25 percent to 30 percent of a Starbucks store’s revenue is cannibalized when a new store opens nearby. Starbucks had 7,087 U.S. stores as of February.

“There is no question that they’ve opened too many stores,” said John Owens, an equity analyst at the research firm Morningstar. “But the brand is also facing some issues.”

When the Seattle company began its expansion in the early 1990s, the coffeehouse concept was considered avant-garde. Very few shops were offering gourmet coffee at reduced prices. But times have changed. Businesses have taken a cue from Starbucks, copying its business model and trying to improve on it.

Shops such as Tryst are offering customers what Starbucks shops used to be - an intimate place to drink affordable coffee.

“A lot of us coffeehouse owners owe our existence to Starbucks,” Mr. Stavropoulos said. “We’ve just kept it small and more personal for our customers.”

In the beginning, Starbucks stores were neighborhood coffee shops. Chatting up a barista while he made an espresso to personal taste became part of a customer’s daily routine.

Over the years, however, the company’s stores have evolved from coffeehouses to fast-food restaurants, featuring drive-through windows, automated espresso machines and racks of CDs or iTunes gift cards for sale on the counter.

Independent and small-chain coffeehouses have gained ground on Starbucks and now command a 34 percent share of the market compared with Starbucks’ 29 percent, according to a 2007 study by the market research firm Mintel International Group. These small shops often provide high-quality coffee and are beginning to influence American tastes, said Mike Ferguson, a spokesman for the Specialty Coffee Association of America (SCAA).

Take Caffe Pronto in Annapolis, for example. Owner, Vincent Iatesta said Starbucks inspired him to open his own shop six years ago. But now he believes the one-time trendsetter represents the “corporatized approach to coffee.”

“The Starbucks brand has lost its luster in the coffee community,” he said. “They just stopped being creative.”

Mr. Iatesta travels the world in search of the best coffee. He sells it wholesale to other independent owners and by the cup in his cafe. He visits foreign farmers and evaluates their soil and coffee beans in order to provide his customers with “the best quality coffee.”

“The coffee industry as a whole is really defined by the specialty shops,” said the SCAA’s Mr. Ferguson. “Those places are offering the top-end products that cause people to re-evaluate the coffee they’re drinking.”

Mr. Ferguson said this change can be seen at convenience stores and large restaurant chains, which now offer iced mochas and flavored coffee. These products were practically unheard of about 10 years ago, but they are commonplace today.

Starbucks once was the driving force behind the coffee industry, but a new crop of shops is leading the way. There were 6,700 specialty coffeehouses across the country in 1996. By 2006, there were 23,900 of them, according to Mintel data.

The United States remains a nation of committed coffee drinkers - nearly 167 million of them, according to the National Coffee Association of U.S.A. Coffee surpassed soft drinks as the nation’s most popular drink last year, the New York-based trade group said.

To deal with the growing demand, more restaurants are stepping into Starbucks’ territory and providing gourmet and specialty coffee to their customers.

McDonald’s has aggressively pursued the gourmet coffee market. In April, McDonald’s began offering iced coffee in four varieties - regular, vanilla, hazelnut and caramel. It sells for less than $2, almost a dollar less than what the same drink costs at Starbucks.

“Customers’ tastes have changed toward coffee,” said Shannelle Armstrong, a spokeswoman for the Oak Brook, Ill., company. “We’re responding to the change.”

In 2005, McDonald’s introduced its Premium Roast coffee, a blend of Arabica beans from South and Central America. By next year, McDonald’s plans to add McCafe coffee bars to most of its U.S. stores. The McCafe menu, which already has been introduced in a small number of McDonald’s restaurants, features lattes, mochas, cappuccinos and espressos.

Likewise, Dunkin’ Donuts has added an array of specialty coffee beverages. The products are doing so well - amounting to 63 percent of sales - the Canton, Mass., company is expanding into regions where it didn’t have a presence before, said spokeswoman Margie Myers. Dunkin’ Donuts added 519 stores last year and has plans for more.

The growth of these companies presents a threat to Starbucks, said Mr. Owens of Morningstar, but the chain that started it all should survive the challenge. He expects that closing underperforming stores will boost the company’s productivity and get it back on track.

“I think they realize where they’ve fallen short,” Mr. Owens said. “Now they’ll strip out the loss-generating stores and begin moving on from there.”

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