Starbucks on Tuesday said it plans to speed the pace of its development of new coffee shops.
It’s a curious development, given the chain’s core problem at the moment: Falling transactions. Yet there is a method to the Seattle-based chain’s madness. The company’s focus will be on smaller cities, where it is traditionally underpenetrated.
“Store development efforts are focused on Tier 2 and Tier 3 cities where we see population growth and forecast both underserved demand and high incrementality,” CEO Laxman Narasimhan told analysts on Tuesday.
It’s a strategy being adopted by a growing number of major chains, which increasingly view smaller cities as ripe for development at a time when expansion is expensive and good locations are harder to find.
Chipotle Mexican Grill, for instance, has increased its projections for U.S. development, largely because it has rethought the types of cities where it can expand.
McAlister’s Deli, the largest brand in the GoTo Foods portfolio, grew to become a $1 billion concept largely by focusing its development on smaller cities and towns.
Starbucks is the nation’s second-largest restaurant chain by sales, behind only McDonald’s. It is also the second-largest chain by unit count, with nearly 17,000 coffee shops, and is on pace to overtake Subway to become No. 1 within a few years.
Both McDonald’s and Subway, the other two most prevalent U.S. chains, operate numerous stores in such cities. Starbucks’ future growth, therefore, depends on its ability to open in these communities.
Yet pure expansion at a time when traffic and sales are falling is risky. Same-store transaction count declined 6% last quarter. More restaurants would seemingly exacerbate that issue.
Starbucks, however, says that expanding into these cities gives it access to customers who otherwise would not visit one of the chain’s coffee shops.
“Even with 16,700 stores across the U.S. and another 7,300 in China, we have abundant white space ahead,” CFO Rachel Ruggeri told analysts. “Particularly as populations continue to move to more suburban and rural areas.”
Consider Joplin, a town of 52,000 in Southwest Missouri that is home to trucking companies but is not generally known as a typical Starbucks city. But it has a growing population, up more than 13% over the past 20 years. And it is the hub of a metro area with more than 200,000 people.
Starbucks opened a drive-thru-only unit there last August, the city’s fourth location. The company said unit volumes in that area are approaching $2 million and Ruggeri expects that unit to be paid off in less than two years, with cash margins nearly 30%.
New store revenue is “highly incremental,” Ruggeri said.
Executives said they are using the company’s artificial intelligence system, called Deep Brew, to identify sites in Tier 2 and Tier 3 cities with population growth.
“We’re really underpenetrated in those markets,” Narasimhan said. “If you look at the pipeline of real estate investments in the U.S., they’re really targeted at the Tier 2, Tier 3 cities mostly.”
The work being done with Deep Brew, he added, will ensure that the returns on new units remain strong.
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