Starbucks' rivals brew up a coffee war

By The Associated Press

As Starbucks investors met in Seattle for the chain's highly anticipated annual shareholders meeting last week, coffee drinkers around the country lined up for a cup of joe from one of the coffee giant's competitors.

In a promotion the company said was timed to celebrate the first day of spring, Dunkin' Donuts gave away 16-ounce cups of iced coffee all day, a coincidence that seemed to highlight Starbucks' (SBUX, news, msgs) latest woes.

The Seattle chain, which virtually pioneered the now-exploding specialty-coffee market, has been faced with concerns from investors and its own management that if it continues to grow at its rapid pace, the brand will be diluted enough to allow competitors to gain a stronger foothold.

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At the same time, competitors such as Dunkin' Donuts and McDonald's (MCD, news, msgs) have expanded their offerings to compete.

"There's no question in my mind that the competitive juices in the coffee area have grown exponentially," Dunkin' Donuts President Robert Rodriguez said

The free coffee day, which followed a hot-coffee giveaway at Starbucks the previous week, is one way Rodriguez is trying to focus more attention on Dunkin' beverages.

For years, consumers associated the name Dunkin' Donuts with its doughnut counters rather than its coffee. To change that, Dunkin' has been aggressively promoting its new line of espresso drinks and menu offerings by TV chef Rachael Ray and has launched an advertising campaign with the tag line "America Runs on Dunkin'."

Earthy walls and coffee beans

Soon, the privately held chain will undergo a makeover at its stores reminiscent of a certain competitor, complete with earthy walls, waiting areas for espresso drinks and coffee beans on display.

Rodriguez said the new look is designed to make the stores "warmer to customers" while highlighting beverages.

"Consumers want to see a much deeper lineup of beverages," he said.

Dunkin' first introduced a line of espresso drinks in 2003, directly competing with a Starbucks staple. The line now makes up more than 5% of sales. In total, the chain had worldwide sales of $4.7 billion in 2006.

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In comparison, Starbucks' company-owned stores had $6.58 billion in revenue during its fiscal 2006. More than 75% of those sales -- around $5 billion -- were drinks. The rest of store sales came from food, whole coffee beans, coffee-making equipment and other merchandise, according to the company's most recent annual report.

But from its smaller base, Dunkin' recently unseated its rival as No. 1 in a 2007 customer-loyalty index produced by Brand Keys, a market research firm.

Taste and value

They're not the only ones winning awards that seemed like a shoo-in for Starbucks. McDonald's introduced a line of premium coffee that earned first place in this month's Consumer Reports issue for best in coffee. The brand beat out Starbucks, Dunkin' Donuts and Burger King (BKC, news, msgs) for both taste and value.

Now McDonald's is branching out into espresso drinks. The fast-food chain, based in Oak Brook, Ill., has begun introducing McCafe concept restaurants in select locations in the United States with comfy couches, cappuccinos and pastries that look more like the neighborhood Starbucks than your typical Mickey D's.

To those naysayers who question whether a burger joint can serve a good cup of coffee, spokesman Bill Whitman said that "for those who haven't been in a McDonald's lately, it's time to come back and take another look."

With more premium-coffee options brewing, the battle for the hearts of coffee lovers will come down to a fight for location, said Darren Tristano, an executive at Technomic, a restaurant and retail consulting firm.

Dunkin' Donuts, for example, has had great success on the East Coast challenging Starbucks, but it's still trying to become more of a presence nationally, he said. There are now about 5,300 Dunkin' Donuts stores in the United States. Starbucks, on the other hand, has 6,010 stores in the country and plans to open 1,700 more in its next fiscal year.

A watered-down experience

JMP Securities analyst Kristine M. Koerber said the chains can have the most impact by differentiating their products.

"That's something Starbucks has always had an edge on," Koerber said.

But how long will that edge last? In a memo leaked to the media in February, Chairman and Starbucks visionary Howard Schultz said the company's rapid expansion has watered down the Starbucks experience. Since the memo was released, Starbucks shares have fallen 6%.

But Tristano said it may be some time before the Starbucks brand is severely diluted and the competition has a real shot at being pronounced the winner in the coffee wars.

"Starbucks is like Google (GOOG, news, msgs)," he said. "It's still one of the most recognizable brands in the world."

But Dunkin' Donuts chief Rodriguez, who characterized the coffee competition as "formidable," said the expanding marketplace may be a boon to all of its players.

"Anytime any of our major competitors bring attention to a category, the category grows," he said. Besides, he added, "we feel confident we have the best product in the marketplace."

This article was reported and written by Lauren Shepherd for The Associated Press.