Brewing success in the coffee industry

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Australian coffee shops can be individual one-off cafes or part of international chains, and success isn’t just about the business’ size, as Suzannah Rowley, senior IBISWorld analyst suggests. “Size is not necessarily a determinant of success in this industry given the nation’s obsession with high quality coffee flowing from a strong coffee culture that emerged in Australia with the arrival of European immigrants after World War II. As such, competition within the industry is intense with small local coffee shops competing fiercely and often outperforming international coffee shops. This is thanks, in part, to a better understanding and incorporation of the nation’s entrenched coffee culture into their business model.”

American coffee chain Starbucks’ 2008 closure of 61 of its 84 stores in Australia, is an example of the difficulty of an overseas brand getting a firm foothold in an established culture with specific tastes. Despite this, Starbucks remains one of the four major retail players in the Australian arena, alongside Gloria Jeans, McCafe and Hudsons Coffee, according to the latest IBISWorld report on the cafe industry.

Yet there is still plenty of room to play, says Rowley. “As such, barriers to entry remain low despite the presence of four significant coffee-house and cafe brands in this industry. Overall, the industry has a very low level of concentration which means that no one, or one group of companies, dominates the industry and new entrants can acquire market share without struggling to compete with dominant major players. This is supported by the high rate of entry and exit of establishments for this industry and also by the latest ABS 2006-2007 Survey on Cafes and Restaurants showing that 91.2 percent of operators in the industry are small businesses employing less than 20 people.”

 

The price of competition

The cafe market is described as a growth sector with profit margins currently low but improving. However, the cost of goods (COGs) are on the rise. “Rising coffee prices could have several effects on cafes and coffee shops but businesses may not necessarily suffer as a result of rising COGs,” says Rowley, who predicts a slight tightening of the market as less profitable operators who are unable to cope with the price-competition fade away. “On the other hand, it’s possible that many operators could justify a modest rise in the price of a cup of coffee so long as they maintain or improve the quality of other more intangible aspects that feed into the price of coffee such as excellent customer service, venue atmosphere, quality and efficiency. Other side factors to support this include the overall improvement in employment and rising household disposable income levels which means that consumers are more likely, or will be more able, to spend money on discretionary items such as coffee.”

 

Rowley believes the strength of Australia’s coffee culture and the extent to which it can maintain demand for this industry was largely demonstrated during the global economic downturn. “Normally, increased mortgage repayments, less excess cash coupled with falling consumer sentiment, generally dampens expenditure on discretionary products and services. Fortunately however, the effect on the industry has been much less severe compared to other hospitality industries; in fact revenue for the industry actually grew during this period. This suggests that coffee is considered an affordable luxury in Australia and an essential part of daily routine. As such, most people are more likely to sacrifice or cut spending on restaurant or catering consumption rather than forgo a cup of coffee. Similarly, it could also be concluded that consumers are likely to be more accepting of a modest increase for their daily cup of coffee than they would for other products.”

Figures in the IBISWorld report show a reduced average customer spend overall in cafes. But Rowley’s belief that consumers still value their cup of coffee is a view shared at mobile coffee business Cafe2U, which reports customers are not prepared to forsake the quality and service provided by franchisees serving up a good coffee. At Love Coffee and Crepes, customer feedback reveals that some customers are reducing the frequency of their food extras, such as sweet treats. However coffee sales remain strong, and the franchise is offering more meal deals.

Adding value to the customers’ offer makes sense in cost-conscious times but while franchise brands are addressing this in some way, there appears no obvious trend for value-seeking. At Aromas, Andrew Hely says “Although our menu and product offer is premium by design, our pricing structure is mid-market. As such, customer satisfaction relative to pricing remains, in broad terms, quite high. Our menu offer currently contains a number of value-for-money products. In general though, there has been no noticeable increase in demand for these products or for that matter any noted demand for an increase to this range.”

There’s also no particular trend showing among Love Coffee and Crepes’ customers. “Everyone is different,” says Carly Traber, national marketing manager. “Lots of people select the Meal Deal offers from the menu such as a coffee and crepe, or pancakes and juice. However there are still many people who are not bothered with price differences and their purchase will reflect that.”

Offering something for everyone is the answer at Gloria Jean’s Coffees, with an extensive product range with multiple price points designed to appeal to the widest possible range of guests, says Gareth Pike, general manager. This, coupled with strong operations and marketing, has seen sales growth from the same time last year.

 

Selling the brand

So how does a coffee business stand out? Encouraging repeat business through loyalty programs is one way that Love Coffee and Crepes is actively marketing at a local level. Add to this great customer service, improved product quality, and unique promotions as ways to stand out from the competition, says Traber.

 

“At Gloria Jean’s Coffees we strongly believe that value is not just about price, but also the quality of experience we offer our guests,” says Gareth Pike. “Is the environment and atmosphere in the coffee house right? Are the service levels the best that they could be? Our focus is guest expectation and how we can meet and exceed this.”

The vision at Aromas is to position the brand as the premier boutique cafe brand nationally, says Hely.

 

“As such we are really more focused on the delivery of a high-end product and service offer. We have no opportunity to influence what our competitors do but we certainly have the opportunity to influence the product and service interactions that our customers receive.

 

“We will continue to focus on the end delivery of these core services by providing unparalleled operational and policy support for our franchisees and partner organisations. If we get all of these things right our customer base will undoubtedly reward us with their loyalty,” he says.

Pike agrees that competition is certainly intense, but welcome. Rising to the challenge of competition is vital for businesses to survive and thrive, he says. The company is expecting 2011 to be a landmark year for Gloria Jean’s Coffees as a two year brand project will be unveiled soon. “The project will touch every element of our business, from teams and training to menus and coffee house look and feel. This will build on our foundation for our future growth,” says Pike.

 

Profitable plans

Franchisees in the fast growing franchise Xpresso Delight are in a very enviable position, says franchisor Stephen Spitz, because demand outweighs supply. “So we concentrate on providing quality coffee with service excellence and exceptional convenience day-to-day to our clientele. But at the same time we are always improving our systems to allow our franchisees to be even more productive and successful without increasing the amount of time they have to be in the business.”

 

Xpresso Delight’s Stephen Spitz and Paul Crabtree.

In the business-to-business Xpresso Delight network, profit margins have remained the same, reports Spitz. “We are competing with a cafe on a street corner [but] our prices are a third of what the average cost of coffee is today.”

Kenton Campbell is managing director of Zarraffas Coffee. He says profit margins are constantly changing with the costs of ingredients. “However we aim to meet a 65 percent average gross profit for drinks and 55 to 60 percent gross profit on food.”

Pike points out that profit is always a balance of managing costs whilst driving increases in sales. “Gloria Jean’s benefits from significant group buying power, along with our unique position in buying direct from Rainforest Alliance certified farms,” he says.

Keeping an eye on the costs of the main product is the way Cafe2U maintains margins. “Our focus is on providing great espresso coffee, which is less vulnerable to price competition, thereby insulating our franchise partners against margin erosion due to price competition, says managing director Derek Black.

The major profit concern at Love Coffee and Crepes is rent. “This means site selection and a good deal of time is spent on rent and lease agreements which is crucial for all our stores in our network,” reveals Carly Traber.

Proven systems, procedures and business support can go a long way to maintaining franchisees’ profit margins, suggests Aromas Andrew Hely, and that is one aspect of a franchise that appeals to new business owners.

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