On Monday, Nestle announced that it will pay US$7.2 billion in cash for the rights to sell Starbucks coffee products in grocery stores and restaurants worldwide. The deal will allow Nestle to market, sell and distribute Starbucks brand. Many may ask why Nestle would spend so much on a segment which only generated US$2 billion in revenue about 9 percent of Starbucks total revenue. The deal is priced three times more than sales.
Nestle is the world’s leading coffee brand, however, in the U.S. it only accounts for 3 percent of the coffee industry. The company’s coffee brand, Nescafe, is viewed as boring by the younger generation and its other high end brand, Nespresso, has not garnered the appeal of many consumers.
The deal was made in an effort to recapture their appeal to trendsetters. Furthermore, Nestle is facing heavy competition from JAB Holding Company who has spent over US$30 billion to build its coffee empire. JAB Holding includes coffee brands such as Keurig Green Mountain and Peets. But the deal should help Nestle keep JAB at a distance.
Starbucks accounts for 15 percent of the coffee market in the U.S. According to market research firm Mintel, a jar of Nescafe and a bag of Starbucks coffee bean cost the same, but Nescafe makes more than three times the cups of coffee Starbucks beans make but despite this calculation, consumers prefer to use the more costly brand.
Starbucks plans to use the US$7.2 billion from the deal to fund stock buybacks and the deal would give them access to more markets. Currently Starbucks sells its products in 28 countries compared to Nestle which is operational in 190 countries. This expansion is something Starbucks would not be able to do on its own without spending a massive amount. The deal is said to prove profitable in the long term.
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