Coffee competition

Tim Horton’s (TSX: THI) is finally getting into the latte race with Starbucks and McDonalds.

By coffee, we are differentiating between two separate products:
1. Drip-coffee: Served everywhere. Most corporate offices have a “coffee machine” that does this. Typically, a bag of pre-ground coffee is opened and put into a coffee filter and hot water is run through it to produce coffee. Add some cream and sugar for taste (which is usually required to diffuse the generally mediocre quality that is produced) and you have a product. Sold for about $1.20/cup at McDonalds and about $2/cup at Starbucks.

2. Espresso-coffee: Whole coffee beans are ground at the moment of preparation, compressed into discs, and hot water with pressure is run through these “espresso pucks” that deliver a few ounces of coffee-infused water. This is mixed typically with milk to produce lattes and cappuccinos. This has been Starbucks’ domain for a very long time, but McDonalds recently and today Tim Hortons have been getting into the game. Sold for about $4-4.50/cup at Starbucks and about a dollar less at McDonalds.

In terms of costing, the making of espresso has been transformed into a push-button system with the advent of automated espresso machines. You can buy one at Costco or any other place that sells appliances; a good quality automatic espresso maker will set you back over a thousand dollars (e.g. DeLonghi). Disclosure: I own one of these machines – once you get one, it is very difficult reverting back to regular drip coffee!

The preparation of espresso requires somewhat more product (beans in proportion to the liquid produced) and milk, but otherwise espresso products are very high margin which would explain the major players getting into that space.

I am not sure this is such a smart business decision on Tim Horton’s part, mainly because the target demographic for Tim Hortons is different than that of Starbucks. McDonalds also got into the market recently and I do not believe it was a good decision for them either – it muddles up their product offering. I should also disclose that I have not tried a latte at McDonalds or Tim Hortons, but eventually I should get down to doing some “product research” of my own to see how it compares to my own homemade product.

One other side note is that I generally stopped going into Tim Hortons when they reverted from fresh-made doughnuts to pre-frozen doughnuts. The product quality generally went downhill from that point forward as they tried to corporatize and make their operations into a more consistent manner – they likely determined that making fresh doughnuts caused too much variability between individual franchises.

My last note is that if Tim Hortons really wanted to compete in this market, they should price the product as the same or ever so slightly higher than their regular drip coffee.

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