Is Starbucks a Bank? A Bit on Strategies and Financial Accounting to Kick off the Semester

We’ve discussed Starbucks in class for many years. In fact, it serves as the background company for all of the MBA (and MSF) Financial Accounting classes at the McCombs School of Business . In addition to working through an understanding of their financial information, we’ve discussed aspects of their strategy and decision making and will echo some of that here:

This week the WSJ offered a video on Starbucks, How Starbucks Operates Like a Bank While Serving Coffee , which discusses some of the unique aspects of Starbucks. The video presents an interesting perspective and opens up the door for some fascinating questions. This post serves to offer some of those question, which we’ve includes in our past conversations. This should be useful for those considering how and why a business must change and even consider changing away from aspects that drove its past success. Then the post offers some tweaks to the video’s usage of financial information, which should be useful for those still trying to master accounting as the language of business and a great intro for students about to start a Financial Accounting class.

First, there certainly are some interesting things on Starbucks’ horizon

• Does the Insta-Consumer Even Want Baristas?

As noted in the video, Starbucks has long emphasized the experience inside its cafes and its drinks. Part of this experience is the barista making the drinks by hand (of course, with the assistance of machines). With technological changes, including at-home fully automatic espresso and coffee makers, this only-in-store performance art is a part of what Starbucks sells. However, with ever improving technology could Starbucks itself move toward more or even full automation? Moreover, if their consumers continue to demand instaface-worthy drinks made as fast as possible could this further push the workforce away from baristas? That is, could an autonomous drink operation be better linked to the insta-consumer ordering on an app via the drive thru… (perhaps from their autonomous car)? Would this change the discussion around rising wages and unionization?

• Have Our Cars Become the New Third Place?

If the in-store experience can change and in light of the trends noted in the video (80% ordered on the go before the pandemic) combined with the expansion of various food delivery options, will Starbucks need to reformat its stores? Could they break from their initial strategy of being the third place (a place for community in addition to home and work)? Starbucks' carefully curated front-of-the-house increases the size and overall cost of each store. Is it possible that even an dominant incumbent may need to consider the plan of new entrant Dutch Bro’s Coffee (or Domino’s) and focus drive thru/to go stores instead of stores with a third place to sit and drink coffee?

Combined, could Starbucks’ stores and its consumer interface represent a fundamentally different approach than we have seen in the past?

In the longer run, could a drive thru store with fully automated drinks offer the best deployment of capital and management of expenses in a manner that does not conflict with consumers' expectations?

Now for a bit on Accounting:

Some Financial Terms (an Introduction to Accounting as the Language of Business):

As this language of business, accounting offers outsiders the chance to examine a company’s performance, strategies and choices. However, accounting, like language, can be used or misused in ways that might not always convey the best message. As one example, it appears to be quite common to use the word literally to represent figuratively or not literal…

Revenue, Cash and Liabilities: An application with gift cards and pre-loaded mobile payments

The WSJ video opens with and builds off of a discussion of gift cards, with the narrator offering “it’s money that Starbucks gets to use upfront as revenue” and the reporter noting “eventually it is a liability if someone chooses to use it.” The video focuses on the question, “so how important are gift cards and the mobile app to Starbucks’ bottom line?”

Gift cards and pre-loaded mobile payments are a fascinating part of Starbucks' business, so it may help to line up some terms first before adding a bit on the specifics of they impact Starbucks' bottom line.

Is Collecting Customers’ Cash the Same as Earning Revenue?

Revenue is the amount of value that a company provides to its customer. Revenue is recognized when it is earned—when the company provides the value to the customer. If the customer’s payment and the company’s action happen at the same time, we record the cash collected as revenue. However, customers commonly pay either in advance of or after receiving goods or services, which leads to a difference in timing between the business event and the cash collection. When this occurs, we focus on the company’s actions to determine when to recognize revenue--when the value is provided to the customer, not just when the cash is collected.

Gift cards and pre-loaded mobile payments are cash collected from customers in advance of receiving goods or services. The cash collected from gift cards and mobile payments is not yet revenue as Starbucks has not yet provided the customer with a good or service (in Starbucks' case, a cup of coffee if a mix of both goods and services).

So if the cash collected is not yet revenue, what is it?

The cash collected represents a liability at the point of collection as once Starbucks has taken its customers’ cash Starbucks has an obligation to provide the customer with drinks in the future. This obligation is recorded on their balance sheet as a liability and this liability is specifically called Stored value card liability on Starbucks' Balance Sheet. When the customer uses the gift card, Starbucks recognizes the value of the coffee to the customer as revenue and settles its liability.

Pretending for a moment that something at Starbucks was only $5, a customer’s purchase of a $5 gift card is represented as follows:

When the customer buys the gift card for $5:

• Increase our cash account $5 (in bookkeeping this is a $5 debit to the cash account) and increase a liability account (in bookkeeping this is a $5 credit to the account Stored value card liability, which can also be called deferred revenue).

When the card is used or redeemed by the customer for a drink that costs $5:

• Recognize revenue $5 (in bookkeeping this is a $5 credit to Revenue) and decrease our liability account (in bookkeeping this is a $5 debit to the account Stored value card liability, which can also be called deferred revenue).
• If there were no other transactions, our liability is fully settled and thus the balance of the liability would be $0 at this point.

So, how do gift cards and mobile payments affect the bottom line… wait, before we get into that what do we mean when we say the bottom line and while we are at it, what is the “top line” as in top line revenue growth? ?

The top line refers to Revenue, discussed above. Revenue is the top line on an Income Statement (Income Statements are also called the Statements of Profits and Loss or the P&L, more on that here: Income Statement Overview from former student Kevin Matthews at Business Insider). Revenue is not profit as every company incurs expenses to generate revenue. Expenses are the costs incurred to conduct the business in a period. Both revenue and expenses focus on the business conducted and thus are recorded even if we do not have a literal (old definition) transfer of cash. This is important part of accrual accounting as it allows financial statements to focus on a complete representation of the business as many transactions (employees working, buying inventory, manufacturing products) are not conducted by exchanging cash.

Revenues earned in a period minus all of the expenses incurred in a period give us Net Income, which is the profit for a period and also called the bottom line. In a literal sense Net Income is the bottom line on an Income Statement. More figuratively, the bottom line impact is final or total effect on a company’s profits from an event or transaction.

So how important are gift cards and the mobile app to Starbucks’ bottom line? And how is Starbucks even better than a bank? (By the way, using the ranking from the video, Apple would be one of the largest banks in the world.)

So does Starbucks generate income from gift cards?

Yes! First, the impact from gift card is worth exploring as a separate point from the fact that people buy gift cards and load the app to buy coffee. Starbucks certainly generates income from selling its coffee and other items as with large margins and price-insensitive customers, it is able to do generate income from coffee sales whether we pay with cash, gift cards or the app. That is, there are incremental ways that Starbucks generates income from its gift cards that are unique to Starbucks’ gift cards/mobile app and its large balance of deferred revenue.

First, the reporter in the video notes that ‘there are plenty of people who never use it” referring to gift cards and the money pre-loaded on the app. This is referred to as breakage revenue. In its 2021 annual report (p. 53), Starbucks notes that it had $181.1 Million of breakage revenue for fiscal year 2021. This revenue is from Starbucks’ customers effectively giving Starbucks money and then never wanting anything for it. That is, if a customer gives Starbucks $5 and never wants a drink, then they basically gave Starbucks $5 of income as Starbucks incurs no expenses (for simplification, I am completely excluding taxes). Think of the breakage revenue like a tip, but not a tip for the barista or machine who made the drink, it is a tip for Starbucks the corporation. In this way, Starbucks has access to income that a typical bank does not have (unless a 8-10% of depositors never seek to use the funds they have deposited).

Second, most Starbucks' customers that buy gift cards and load their app ultimately do use the funds to purchase coffee and other items. Even here Starbucks obtains a financial benefit and therefore operates like a bank. For example, as noted in the top graphic, an outstanding balance of $2.4 Billion implies that customers have deposited this amount of money to the (figurative) bank of Starbucks. While the customer will eventually withdraw the value of their deposits (in the form of drinks), the customer has given Starbucks an interest-free loan. Does this help Starbucks? Of course. If Starbucks has access to $2.4 Billion in an interest-free loan from customers then this is equivalent to money Starbucks does not itself have to borrow from a (literal) bank.

Using the outstanding balance from customers of $2.4 Billion noted above and assuming an interest rate on an actual loan of 4%, by "borrowing" from customers interest-free, Starbucks will effectively save $2.4 Billion x 4% = $96 Million in interest each year. This is what would have had to pay to have access to $2.4 Billion in cash each year (the savings increase with higher interest rates).

How else does the gift card and mobile app affect Starbucks' bottom line?

This is impossible for an outsider to quantify, but we can consider a few areas.

Data: As noted in the video, one benefit Starbucks gets from its mobile app/rewards program is the data it can collect on its customers? What do we buy? When do we buy it? Does our behavior change? How? How price sensitive are its customers, etc.? What products should they launch, discontinue, expand, etc.? Surely Starbucks' collection and use of customer data has been instrumental to its success over the past decades.

Commitment: Starbucks’ use of the mobile app and rewards programs surely influence its consumers to buy more, buy more often and, in many ways, move towards a monogamous relationship with Starbucks. (I believe this is related to the endowment effect , but will defer to experts in biases in consumer behavior).

Combined, these lead to a question that we’ve also discussed in class: Is it the consumer or the company who reaps the rewards from a rewards program?

We’ll be virtual for a few classes this Spring, but here’s to another great semester.

-PB

PS: For a fun wrap up to the Spring 2021, check out this graduation speech:?Class of 2021 Graduation Speech