Illy confronts Starbucks with a low-cost indy strategy

IllyCaffè SpA may not have a company-owned store near you, but it's a good bet you know the company's coffee. Illy's espresso machines and coffee beans are available to purchase online at the company's website, on Amazon.com, and a wide variety of retail outlets. Its art-inspired cups are a favorite of Italiaphiles (a good friend whose husband is Milanese was my introduction to the designer series of tiny espresso cups and saucers). And, after three years of success in Italy, the company has expanded its Artisti del Gusto (Artist of Taste) certification to the U.S., with 28 shops around the country serving Illy coffee, and about 100 more planned by 2012.

In Tuesday's Wall Street Journal, Illy is said to be using this strategy to compete with Starbucks (SBUX) through the "backdoor." It's a bit of a reach -- after all, 128 coffee shops is about 1.1 percent as far-reaching as Starbucks, and far less of a threat to market share than Dunkin' Donuts or McDonald's (MCD), both of which have challenged Starbucks with their low-priced, high-volume and ubiquitous coffee.
Accustomed as I am to coffee shops here in Portland which pledge allegiance to one small craft roaster or another, sporting the bird-themed Stumptown sign or the architectural Bridgetown Roasters (or a half-dozen others), I have to say this isn't at all a new concept. But that's not to say it isn't a good one.

Illy's Artisti del Gusto certification works this way: independent coffee shops with "relevance in their market" are selected to use only Illy coffee beans and agree to do so for a three-year period. Baristas are trained to pull an Illy-quality espresso and given recipes for other drinks common to Artisti del Gusto shops. Illy provides art work, coffee machines, glassware and other branded touches, such as the red Illy umbrellas. Certified coffee shops are periodically monitored for consistency, and the certification can be pulled if the lattes aren't up to snuff.

This is almost exactly the way the Stumptown Coffee program works here in Portland, and has done so for many years. More than providing a way for the excellent coffee company to sell its beans in more places, it greatly expands the company's reach without significant investment, allowing it to focus on a few company-owned shops and commit the rest of its capital to finding and roasting really great beans.

Not only is this is a proven way to expand with minimal investment, it's also a way to increase the reach of a brand, and indoctrinates a much wider audience to the superiority of your coffee beans. In other words, it's a great way to market your product in grocery stores and online outlets, without a national advertising campaign. A coffee shop on your corner is far better than a billboard, since it's a place you already trust and whose coffee you are conditioned to love by association. Starbucks sells the majority of its packaged coffee through grocery stores; a whopping two-thirds of its ground and whole bean sales take place outside of its coffee shops.

Will this challenge Starbucks' coffee shop market? Probably not, though a small minority of shops may find the new competition fearsome. It could challenge the coffee giant's comfortable leadership in the grocery market, however. And it's interesting to see that Starbucks has recently taken a similar sort of strategy to Illy's -- expand its reach through independent coffee shops. The difference is that in Starbucks' case, the shops are very expensively capitalized by the company, from leases to furniture to a long and intensive research & development project, and most importantly, the shops are removed from most Starbucks branding. The 15th Avenue Coffee & Tea store in Seattle is a pilot project that, if initial messaging is correct, will be copied in other cities -- but with yet other branding.

Illy is competing with Starbucks, but not quite in the way The Wall Street Journal suggests. And Starbucks is, oddly and expensively, competing with itself (and then its other self, and the other one . . . ). Starbucks may win here, but they won't do so without much capital expense.

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