Starbucks is smarter than you think.
Over the years, the company has invested heavily in its mobile app. Customers have grown to love the user-friendly experience. They love the customization features. And most of all, they love the rewards.
But I recently discovered a very unique strategy Starbucks is using to pull even more value from its mobile customers:
By using those customers as a very generous lending partner.
Starbucks's ingenious mobile strategy
Here's how the Starbucks plan works.
Until recently, if you wanted to use the Starbucks app to pay in-store, you had to load money onto the app first. Starbucks refers to this as your digital Starbucks card--think of it as a gift card for yourself. Whenever you pay with your preloaded digital Starbucks card, you earn two stars for every dollar spent. These stars can then be used later for rewards, like free drinks.
Under the company's new loyalty program, customers are now allowed to link a credit card, debit card, or mobile wallet to their account and pay directly for purchases--but there's a catch. When paying directly with a credit card or other linked payment method, you earn only one star for every dollar spent--as opposed to the two stars when using your digital Starbucks card.
Of course, Starbucks also offers physical gift cards, giving you the option to pay with these. And yes, you guessed it, physical Starbucks gift cards also earn you two stars for every dollar spent.
In a recent piece for The Motley Fool, investor Neil Patel highlighted that as of March 29, Starbucks customer prepaid balances (unused account balances sitting on either digital or physical gift cards) amounted to just over $1.4 billion.
So, what's the big deal?
Think about that for a second. Consumers love Starbucks so much that they're willing to make a deposit to redeem coffee at an unknown future date and time. Starbucks is essentially gaining access to an interest-free line of credit, one that equates to roughly 4% of the company's total liabilities. Whereas a traditional bank is severely restricted on the actions it can take using customer deposits, Starbucks has more leeway; it can reinvest directly back into the business on expansion opportunities. The company's free cash flow is also enhanced, as this phenomenon decreases working capital needs.
And if that weren't enough, continues Patel, "a significant portion of these 'coffee deposits' end up going unused." Since Starbucks digital and physical gift cards have no expiration date, Starbucks uses historical data to estimate how much the company expects will never be redeemed. The company describes this as "breakage," and, according to Patel, Starbucks generated $141 million in revenue from it in 2019.
That's a $141 million donation to Starbucks.
"Based on the current liability balance," writes Patel, "Starbucks actually earns interest at a rate of approximately 10%."
But before you blame Starbucks for what may seem like a diabolical plan, consider this:
The Starbucks app is one of the most popular mobile apps in the world, with over 3.5 million ratings in the Apple app store alone, and an average rating of 4.8 out of 5 stars. Those are astonishing numbers.
As a Starbucks customer myself, I've used the app countless times, and I've also bought physical gift cards numerous times for friends. Is there a chance that some of my friends never cashed in on those cards? Sure. But have I gained back multifold through rewards I've gained through the app? Definitely.
In the end, Starbucks' strategy is genius because it gives the company access to cash flow and produces extra revenue. It also generously rewards customer loyalty, so customers don't get offended if they leave a little unspent cash on a gift card somewhere.
And those are lessons every business can learn from.