Monday, December 21, 2009

Costa Coffee's Acquisition of Coffee Heaven

Just few days ago, Costa Ltd, the wholly-owned subsidiary of Whitbread had made a significant breakthrough into the Central and Eastern European (CEEC) market via the acquisition of Coffee Heaven. Costa sealed the deal with an attractive amount of £36 million, which is small compared to Whitbread’s annual capital spending of more than £ 300 million. But there are more to be gained by Costa:

(1) Greater supernormal profits. The acquisition of Coffee Heaven (CH) allows Costa to enlarge the scale of its operation into other parts of Europe. As in this case, CH owns chains of coffee shops in Poland, Czech Republic, Bulgaria, Hungary and Latvia. There are 90 outlets in total. No doubt CH is making losses in recent years. But if the management team of Costa were to be able to turn the fortune around, the economic benefits would be great. A larger supernormal profit is expected in near future.

(2) Faster way to grow. Basically a firm can choose to expand via both internal and external. Internal growth is normally slow. This is because a company may need years or even decades to build a reputation for the good or service it is selling. Once it successfully develops a brand loyalty, through spread of words and marketing campaign it will then enlarge its market pie. However, by acquisition of another brand, the company is almost certain to increase its market share in no time

(3) Easy to penetrate a market. To some extent, the coffee market in CEEC could have low contestability. This means certain high barriers are there. For instance, Costa may need to advertise aggressively to break the customers’ loyalty and also to promote itself since it is not a household brand there. Also Costa needs to consider the pricing policy of its rivals. They might use limit pricing to deter Costa from entering the market. This is a policy of reducing the price of a cup of coffee to a level where new firms may find it unprofitable to enter into the market. Through the acquisition of CH, Costa can immediately win the trust of consumers. Also it can leverage on the expertise of CH when it comes to exquisite taste of Polish people

(4) Saturated market in UK. Costa has more than 1000 stores in UK alone and this could be a sign that coffee market in UK has entered into a saturation stage. It is difficult for them to further grow their market share, unless there is a significant turn in tide for instance, collapse of rival firms, new brand of coffee drinks that take the market by storm or lowering down of business tax

(5) Rising income. At the moment of writing, there are tentative signs that CEEC economies are heading for the better. For instance, Poland showed a surprising economic growth in the second quarter of 2009 and wage growth is picking up again. Meanwhile Czech Republic’s real GDP is bouncing back in 3rd quarter, lifted by the performance of export. Most important of all, the number of middle income earners is rising substantially over the years. As such this will fuel the demand for high street coffee shops (better classified as luxury good with YED greater than 1). In other word, there is still plenty of room to expand

(6) Economies of scale.
It is associated with the fall in long run average costs due to rise number coffee drinks sold. Costa will be purchasing more coffee beans, sugar and related equipments in a bigger scale. This will place them in a better position to negotiate for discounts. Also it is now much easier for them to borrow larger sum of money to expand their operations (if they want to). Banks will normally charge lower interest rates due to solid financial position and better ability to repay. Coffee house with no significant reputation will find it difficult to raise cash. Banks will demand higher rates for the risk they assume

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