Starbucks Industry Case

These lower-end coffee vendors threaten Cataracts’ continual success by offering a less expensive product. Besides these major competitors, Cataracts also faces the threat of consumer substitution for Its products. Many coffee drinkers now use pods and home coffee makers for convenience reasons, which may hurt in-store purchase metrics. This poses a big issue because the company’s global growth relies heavily upon increasing in-store sales. Substitutes for Cataracts products also include teas, juices, and energy drinks, while bars and other local coffee shops may provide something similar to the “Cataracts Experience. On the other hand, It would e difficult for potential new competitors to enter the coffee Industry and compete on Cataracts’ level. The Cataracts brand is well-known and many barriers may preclude entrants from reaching similar worldwide success. Although few substantial ongoing costs would deter new entrants, entering the coffee industry and contending on a large scale with Cataracts would necessitate a large capital investment. The bargaining power of Cataracts’ customers is relatively high.

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There is an abundance of competitors In the coffee Industry to which customers could take their business If rises Increased substantially. And switching costs are virtually nonexistent. However. Because Cataracts follows a product differentiation strategy and evokes great brand image and loyalty, many Cataracts customers are not extremely price sensitive. The bargaining power of Cataracts’ suppliers is also relatively high. Since Cataracts is a global company with significant influence in the international coffee market, many suppliers may be hesitant to raise their prices or “force Cataracts’ hand,” so to speak.

However, coffee can only be produced In certain geographical areas of the world and even the Industry fair labor treatment Issues and Cataracts’ commitment to using only high-quality Arabica coffee beans, the company must selectively evaluate the suppliers with whom they engage. Competitive Strategy Analysis Cataracts’ primary strategy is to differentiate their main product, Cataracts’ brand coffee, as a high-quality product and to enhance the overall coffee buying experience by “providing each customer a unique Cataracts Experience” through superior customer service and quality control.

Cataracts Implements this plan with a high level of vertical integration and quality control in their supply chain. Cataracts monitors all phases of the production process from providing Farmer Support Centers for the producers of green coffee beans to controlling roasting, packaging, and distribution. This strategy has yielded Cataracts’ position as the largest coffeehouse company in the world. To sustain its prominence as an industry leader, Cataracts plans to continue “the disciplined expansion of [Its] global store base. Lines such as Cattle’s Best (a low-cost coffee), at-home Cataracts’ brand coffee options, and potential substitutes in the form of teas, Juices, and select food products. Cataracts intends to diversify its main product line further by introducing “new coffee products in a variety of forms, across new categories, and through diverse channels. ” Critical Risk and Success Factors Three factors heavily influence Cataracts’ ongoing risk and success. Commodity inputs function centrally within Cataracts’ business model; in particular, the Arabica coffee beans Cataracts procures command a price exceeding the “C” coffee price.

Price-to-be-fixed contracts place Cataracts at the mercy of regularly fluctuating prices despite efforts to lock rates, and supply deficiency may prevent Cataracts from inverting inputs into its specialty products and deriving associated revenue. Since Cataracts hinges upon product differentiation, brand quality maintenance is instrumental to risk and success management. Cataracts can somewhat rectify this internally with intellectual property supervision, solid customer service, and effective food safety examination, but it must carefully monitor its licensees to ensure their products coincide with corporate quality standards.

Growth markets comprise Cataracts’ third critical risk/success factor. Because the Americas provided 75% of 012 net revenues, Cataracts can diversify its fortunes with its ongoing expansion into Europe, the Middle East, Africa and Pacific regions. However, this requires careful evaluation of market-specific preferences, costs, regulations and distribution. Exercising prudence in such growth proves vital, as indiscriminate expansion led to store shuttering and income reduction during the late sass. Three elements to Cataracts’ success are its brand, loyalty, and distribution channels.

An impairment in these areas could significantly hinder future earnings, but positive changes could alp this company grow its global market. Because of these areas importance to Cataracts, an examination of how the company accountants for these risk and success factors will help determine if the 10-K properly represents the financial health of Cataracts. Distribution Channels Due to a disagreement with one of Cataracts major distributors, the Company chose to alter its previous method for distribution by cutting out the middleman and distributing directly to third-party sellers.

This change impacts the potential earnings of the company in two major ways. First, it exposes the company to a attention legal liability from the breach of its prior distribution agreements. Second, the change from use a larger more established distributor to direct distribution could decrease the growth of these areas or increase potential cost. In addition to those new concerns, Cataracts’ business model of opening many company-operated stores has led to rapid growth, but this model can also have the effect of distorting expenses and assets on its financial statements by misstating the true nature of the investments in these new locations.

Cataracts’ flexibility in recognizing possible legal liabilities as legal accruals lows for discretion and an ability to hide potential losses in the footnotes rather than on the balance sheet as a liability. The Company requires legal reserves to be can be reasonably estimated,” but importantly, the decision of when these thresholds has been met falls to the Judgment of management.

When such a large possible liability area is left to management discretion, there will be the chance that a manager will fail to act in the most appropriate way in order to presently increase earnings by failing to disclose the Company’s projected loss from the legal proceeding. However, the disclosure of this potential liability in the footnotes still signals that management does view this as a possibility, and its reasoning for failing to disclose more could be due to legal strategy.

For Cataracts, discretion in the area of legal accruals has allowed it to not recognize a contingent liability for its potential loss in a lawsuit with Kraft over the breach of a distribution agreement in its 2012 10- K even though the Company believes that a negative outcome is “reasonably possible. ” The amount of this potential loss could be up to $2. 9 billion according to Kraft, but since the Company’s management does not feel it can provide a reliable number itself, they have the discretion to not list any liability at all for the lawsuit.

As the Company’s total revenue for the year was $13. 3 billion with operating income of $2 billion, even a negative outcome that requires the Company to only pay half the requested amount will substantially affect the earnings of the Company. Although Cataracts does not reasonably estimate the possible settlement amount with Kraft, the pending lawsuit certainly leaves a lasting impression on the financial statements ND the company’s distribution operations. Because of the termination of the agreement with Kraft, Cataracts took full control of its packaged coffee business as of March 1, 2011.

This resulted in the development of the direct distribution model, which gave Cataracts the benefit of recognizing full revenue from packaged coffee and tea sales. This model helped the total Channel Development net revenues for fiscal 2011 increase 22%, or $153 million. While this new distribution model did increase revenue for the company, it also caused other operating expenses as a percentage of total net revenue to increase. This occurred as a result of the increased expenditures that were needed to support the new direct distribution operations.

Cataracts also revised the presentation of revenues in 2011 to demonstrate the effects of the newly implemented distribution model. Although there is a change in the presentation of the statements, there is no impact to consolidated or segment total net revenues from this change. Cataracts’ fallout with Kraft and the subsequent implementation of the direct distribution model may have resulted in increased revenues in the short term, but the potential losses from the ending lawsuit could eventually overshadow these temporary increases in revenue.

While Cataracts’ accounting methods do fall within the boundaries of GAP, the financial statements may not accurately depict the full ramifications of this change. While this major modification to the company’s distribution operations could bring in more revenue in the future, it also results in significant uncertainty regarding the burden of distributing all of the company’s products internally. The increased future expenses associated with the internal distribution model and the new responsibility f distributing its own product unquestionably makes it more difficult for Cataracts to accurately forecast future earnings.

To further Cataracts’ impressive distribution footprint, the firm is currently embarking upon prudent expansion strategies. Cataracts’ 10-K, the firm currently records these outlays as expenses. Because costs are fairly concrete and little estimation is involved, potential for earnings management under this framework is relatively slim; indeed, close competitor Pander Bread similarly expenses these costs. Conversely, these outflows are essential for and inextricably linked to these new locations and will generate future economic benefit.

These traits suggest that Cataracts should consider capitalizing these costs as assets to best represent the economic impact these outflows truly yield. With global expansion and increased vertical integration characterizing the recent success of Cataracts, many important decisions must be made internally regarding capital procurement. Rather than owning their facilities outright or franchising their business, the Company has chosen an alternative approach. “We [Cataracts] lease detail stores, roasting, distribution and warehouse facilities, and office space under operating leases. While there are many advantages to leasing, this discretionary move by management is, at least to some degree, an accounting strategy. Unlike those under capital lease, assets contracted through operating leases do not appear on the balance sheet as assets, increasing Cataracts ROAR. Furthermore, because the Company is not purchasing their facilities to own, Cataracts avoids incurring a significant amount of debt, which in turn also improves their Debt-to-Equity ratio. While these ratios are not entirely representative in reality, the accounting creates a situation where investors could potentially be misled.

Cataracts’ goodwill functions centrally in maintaining the firm’s brand equity, thus ascertaining the importance of practices pertaining to goodwill accounting. Cataracts recently effected preliminary goodwill accounting measures entailing a “qualitative assessment” wherein it determines whether goodwill’s fair value “more likely than not” exceeds its book value. Assuming it does, Cataracts then proceeds to an empirical fair value approximation to evaluate whether impairment is necessary.

To calculate an appropriate fair value for comparison to current book value, Cataracts makes its own approximations of future revenue trends and operating expenses and discounts this anticipated income using an appropriate interest rate. In its 10-K, Cataracts acknowledges the arbitrary nature of goodwill impairment. While this method properly represents goodwill’s fair value at a given point, the inherent and pervasive estimation grants Cataracts executives carte balance to manage earnings in order to meet desired earnings goals.

The “Recent Accounting Pronouncements” section of Note 1 in Cataracts’ 2012 10-K adequately conveys that the new qualitative analysis corresponds to a September 2011 FAST pronouncement regarding the goodwill line item. Moreover, Cataracts plainly articulates their fair value calculation method and references the estimation innately involved. However, the actual forecasted revenues, expenses and interest rates are excluded from the 10-K, precluding analysts from evaluating whether Cataracts’ goodwill calculations are valid or if the firm exercised considerable earnings management.

One means for analyzing whether earnings management overrode any necessary impairment is to obtain the aforementioned forecasts and compare them to historical trends in Cataracts’ revenue and expense growth in conjunction with anticipated effects of the goodwill does not factor into losses incurred due to store shuttering because upon shuttering a location, “the remaining assets… Do not constitute an integrated set of assets that are capable of being conducted and managed for the purpose of providing a return to investors. ” Yet because goodwill serves such a pivotal role in

Cataracts’ success, the firm’s current accounting proves insufficient and may deceive investors into believing more goodwill assets are greater than the actual cumulative amounts. Cataracts should restate its financial statements to display impairment for goodwill abdicated during past store shutdowns; because of the relatively significant restructuring process in recent years, this may materially impact the goodwill line item. Cataracts has a strong focus on customer loyalty and the revenues they see from this aspect of their business. One way they recognize revenue with respect to this is their stored value cards”.

To ensure a high accounting quality, Cataracts books a deferred revenue upon the sale of one of their gift cards. They realize this revenue once the stored value card is redeemed. However, at a certain point the likelihood of redemption becomes remote. This is where management discretion becomes a major factor. Although not explicitly stated in the footnotes, once a certain period of inactivity is reached the outstanding balances are analyzed and an amount of revenue is recognized. Although a relatively small portion of their overall revenues (65. Lion in 2012), earnings management becomes an option. This is partly due to the fact that their stored value cards do not have an expiration date and Cataracts maintains a policy that no service charges will be applied to the cards which could diminish their value over time. That being said, this recognition does lend too higher accounting quality. Even though they are recognizing revenue on a still outstanding liability, the likelihood of redemption is so remote at a certain point that not doing this would fail to represent Cataracts’ economic reality accurately.