IGU Advice to Starbucks Vice President Memorandum

Please respond in writing to the issues presented in this case by preparing two documents: a communication strategy memo and a professional business letter.

In preparing these documents, you may assume one of two roles: you may identify yourself as an NFL senior manager who has been asked to provide advice to Starbucks Vice President for Global Communications, Corey Dubrowa, regarding the issues he and the company are facing. Or, you may identify yourself as an external management consultant who has been asked by the league to provide advice to him.

Case 3.4: Starbucks Corporation
Tax Avoidance Controversies in the United Kingdom (A)
Starbucks’ coffee menu famously baffles some people. In Britain, it’s their accounts that are confusing.
Starbucks has been telling investors the business was profitable, even as it consistently reported losses.1
Introduction
On October 15, 2012, Reuters released a special report titled “How Starbucks avoids UK Taxes.” The
investigative reporters at Reuters compared legal filings in the English company register, Companies
House, with Starbucks’ own group reports and 46 transcripts of conference calls with investors and
analysts over a 12-year period. What they turned up were stark differences in how Starbucks viewed its
U.K. subsidiary internally and how it was portrayed to the U.K. government, specifically the tax
authority, Her Majesty’s Revenue and Customs.
Starbucks officials internally gushed praise on their U.K. business unit. On multiple occasions it was
referred to as “profitable” and a model for other regions to follow. In November 2007, the Chief
Operating Officer Martin Coles told analysts that the U.K. unit’s profits were funding Starbucks’
expansion in other overseas markets. However, the unit’s accounts showed a tenth consecutive annual
loss. The Reuters report went on to cite multiple instances when Starbucks provided positive news to
analysts yet showed operating losses to the U.K. government:
For 2008, Starbucks filed a 26 million pounds loss in the UK. Yet CEO Schultz told an analysts’ call that
the UK business had been so successful he planned to take the lessons he had learnt there and apply
them to the company’s largest market – the United States. He also promoted Cliff Burrows, former head
of the UK and Europe, to head the U.S. business.2
As soon as the newspaper hits newsstands and the Reuters website, there was an immediate public and
political outcry. UK Uncut, an activist organization, planned boycotts and sit-ins. Several Members of
Parliament (MPs) voiced outrage and quickly summoned Starbucks Chief Financial Officer Troy Alstead
to testify before committee.
Starbucks History and Image
Starbucks Corporation
In 1971, Starbucks was founded in Seattle as a coffee bean roaster and retailer. The location sold highquality coffee beans and equipment. The company started serving espresso coffee, the first drink that
Starbucks sold, in 1986. The next year, the original owners sold the fledgling chain to former employee
and current CEO Howard Schultz, who began an aggressive expansion campaign. Since 1986, the
company has opened, on average, two stores per day.
Starbucks issued its Initial Public Offering in June 1992. At the time the company owned or licensed 140
outlets and booked annual revenue of $75 million. In 2012, the total number of stores in operation
numbered more than 18,000 and were spread over 60 countries. For the fiscal year, Starbucks’
consolidated revenues reached a record $13.3 billion. Company-operated stores accounted for 79
percent of total net revenues during the 2012 fiscal year.3
Coffee is no longer the only item sold through Starbucks locations. This excerpt from the 2012 10-K filing
with the United States Securities and Exchange Commission summarizes the extent of their offerings:
Starbucks stores offer a choice of coffee and tea beverages, distinctively packaged roasted whole bean
and ground coffees, a variety of premium single serve products, juices and bottled water. Starbucks
stores also offer an assortment of fresh food offerings, including selections focusing on high-quality
ingredients, nutritional value and great flavor. A focused selection of beverage-making equipment and
accessories are also sold in our stores.4
Starbucks has also spun off a unique tea bar concept called Teavana Fine Teas and Tea Bar. They are also
expanding their juice line, Evolution Fresh, with an aggressive growth strategy with the goal of further
increasing their market share in the super-premium juice category. The company has also begun
exploring handcrafted carbonated beverages to offer for sale in its existing locations.
Howard Schultz
Howard Schultz is the Chairman, President and Chief Executive Officer of Starbucks. Before joining the
company he was the general manager for a Swedish drip coffee maker manufacturer called
Hammarplast.5 Starbucks was a client of Hammarplast and Schultz was impressed by the company’s
knowledge of coffee and the amount of business that they were conducting, even as a small outfit. A
couple of years after his first encounter with Starbucks, Schultz joined the company in 1983 as the
Director of Marketing.
While visiting Milan on a buying trip, Schultz was struck by the presence of a coffee bar on virtually
every street corner. Not only were they serving countless espresso drinks, they also acted as meeting
places or public squares, providing a sense of community and belongingness. He took this newfound
knowledge back with him and tried to convince the owners to start offering hot brewed beverages in
addition to the coffee beans and leaf teas that they already offered. The owners resisted and, after a
brief stint trying to start his own coffee company, Schultz bought the retail unit of Starbucks for $3.8
million.6
Social Responsibility
Howard Schultz is considered the “soul” of the company. His passion and business savvy have made the
company into what it is today. He also brought to the company “a distinctive set of values that has and
continually shapes how the company engages their customers, their employees, and the communities
where they do business.”7 The company continually monitors its adherence to the norms of social
responsibility, noting in a CRS report:
We have been building a company with a conscience for more than four decades, intent on the fair and
humane treatment of our people as well as the communities where we do business, and the global
environment we all share.8
Starbucks provides full benefits for all of its employees, which it refers to as “partners.” They also
established a business practices goal: All of their coffee would be “ethically sourced” by 2015. The
cornerstone of this approach is their Coffee and Farmer Equity (C.A.F.E.) Practices, “a comprehensive
coffee buying program that ensures coffee quality while promoting social, economic and environmental
standards.” Through 2012, the company purchased 93 percent of their coffee in this manner.9
International Taxation
Typical International Tax Methods
Most governments tax individuals and/or corporations on income or profits, respectively. These taxes
are used to pay for everything from national defense and transportation infrastructure to food stamps
and farm subsidies. These taxation systems vary widely by government and there are few broad, general
rules. However, it is possible to understand the general corporate tax environment by understanding a
few choices that each government must make when it comes to their corporate tax policy.
Countries usually pick between two systems: territorial or residential. In a territorial system, only the
income from a source inside the country is taxed. For example, an American company with locations in
Canada would only have to pay Canadian taxes on the portion of sales that are within Canadian borders.
In a residential system, the residents of a country are taxed on their worldwide income, not just local
income. The residential system is geared more toward personal income tax and does not affect
corporations.
Corporate tax rates also vary widely by country. Every country has different funding needs based on
their size, the extent to which the government operates social welfare programs and numerous other
factors. Those looking to increase investment within their borders may offer lower tax rates and those
with large infrastructures to maintain may have higher tax rates. These varied tax rates provide an
unintended incentive for companies to attempt to transfer revenues and profits from countries with
higher tax rates to those with lower tax rates, thereby retaining more net income for shareholders and
managers.
Several tax avoidance strategies exist. Some companies charge subsidiaries for the use of “intellectual
property” such as the brand name and their business practices. These types of arrangements typically
charge 4 percent of revenue. Other companies that are vertically integrated upstream and downstream
charge units in high tax jurisdictions higher prices in order to move money to lower-taxed countries.
Transfer-pricing regulations allow this practice and companies can then allocate profits to high-charging
subsidiaries in low tax rate areas.
Starbucks Money Trail
Starbucks employs various legal methods in order to minimize their tax liability within the U.K. The
corporate tax rate in the U.K. in 2011 was 26 percent. Each step along the money trail is designed so
that in the end, the Starbucks subsidiary in the U.K. shows no profits on paper. This effectively reduces
their tax bill in that jurisdiction to zero even though that market may be very profitable for them.
The Starbucks subsidiary in the U.K. is heavily debt-financed. Even for a company with positive net cash
flows, the U.K. subsidiary still has large amounts of debt and large interest bills. All of these loans are
from the Starbucks headquarters in Seattle. The interest on these loans is higher than the interest rate
on the average Starbucks bond, at the LIBOR rate plus 4 percent versus the LIBOR rate plus 1.3 percent.
While this moves profits to the U.S. where there is a relatively high tax rate, the interest stays within the
company instead of being paid out to banks or investors who purchase their bonds.
Starbucks also charges the U.K. unit a royalty and licensing fee of 6 percent. This is higher than the 4
percent that a typical arrangement of this sort would charge. Starbucks claims that it has some
independent licensees who also pay 6 percent, so they are within their legal right to charge their own
subsidiary the higher rate, as well.10
The final method that Starbucks employs is how it pays for its main product and largest source of
revenue: coffee. A Starbucks entity is set up in Switzerland which is responsible for all coffee bean
purchases. The Switzerland location then has those beans sent to roasters throughout Europe, which
turn the raw beans into product suitable for making coffee products. The beans are then sold to the U.K.
Starbucks with a 20 percent markup. The beans never physically enter Switzerland. Switzerland has an
approximate 5 percent corporate tax rate on profits tied to international trade in commodities, a
category under which coffee falls.11
Coffee Shop Market
Starbucks’ growth plan and business model have been widely successful, allowing it to become the
second largest restaurant chain globally after McDonald’s with a market capitalization of $40 billion.12
Starbucks’ 2012 SEC annual filings reports revenues of $13.3 billion, with revenues in the EMEA region,
including the U.K., of $1.14 billion. The EMEA revenues represent a 9 percent growth over the previous
fiscal year. Within the U.K. specifically, the coffee shop market has remained strong despite a recession.
A 2009 study from Allegra Strategies shows that the coffee shop market in the U.K. has seen 15
consecutive years of either flat sales or growth, with the market reaching £2 billion in consumer
spending in 2012.13
Within the U.K., Starbucks faces a fierce competitor in Costa Coffee. Founded in London in 1971, Costa
Coffee has grown from a wholesale roasted coffee supplier to become the U.K.’s largest coffee chain,
supplanting Starbucks in 2010.14 In 2012, Costa saw an increase in profits of nearly 30 percent, reaching
£90.1 million. In contrast to Starbucks, Costa paid a tax bill of £15 million during the 2011–2012
reporting period. While the U.K. coffee shop market appears strong and close competitor Costa Coffee
reports growing profits, Starbucks claims that it is not generating profits within the U.K. Global CFO Troy
Alstead reports that Starbucks has recorded profits in only three years since they entered the U.K. in
1998 and that 25 percent of their U.K. stores run at a loss.15
High rents and space costs within U.K. cities were proposed as reasons for Starbucks’ failure to generate
profits; however, Costa Coffee has been able to achieve an operating margin of 14.3 percent with a
similar retail footprint and comparable labor costs.16 Chief executive of Costa Coffee, Andy Harrison,
appeared to enjoy Starbucks’ tax avoidance controversy, commenting “Costa has been the UK’s
favourite coffee shop for quite some time and we remain the taxman’s favourite coffee shop, too.”17
HMRC, Parliament and Public Opinion
The taxman within the U.K. is Her Majesty’s Revenue and Customs (HMRC), which is responsible for the
collection of both personal and corporate income taxes, among other duties. Formed in 2005 as a
merger of two previous tax entities, the HMRC outlined its purpose and vision by stating “We make sure
that the money is available to fund the UK’s public services” and “We will close the tax gap, our
customers will feel that the tax system is simple for them and even-handed, and we will be seen as a
highly professional organisation.”18 In the HMRC charter, it is further laid out that the public can expect
the HMRC to “tackle people who deliberately break the rules and challenge those who bend the
rules.”19
The HMRC received help in their mission from Reuters in publishing their special report on Starbucks, as
well as from several other media investigations in 2012. A Guardian report on Amazon showed the
online retail giant paid no corporation tax on more than £3 billion in sales within the U.K.,20 while The
Telegraph reported that Google paid just £6 million in tax on £395 million of U.K. turnover.21 Following
these reports, representatives from all of the firms were summoned to Parliament to speak to the
Publics Account Committee. Corporate tax avoidance had become a hot button issue for both the media
and government, with Michael Meacher, an MP for the Labour Party, stating specifically that Starbucks’
tax behavior “is certainly profoundly against the interests of the countries where they operate and is
extremely unfair. they are trying to play the taxman, game him. It is disgraceful.”22
While several corporations were the subject of media tax avoidance investigations and summoned to
Parliament, Starbucks faced the brunt of the public uproar. According to the YouGov BrandIndex, which
measures the strength of a company’s brand perception, Starbucks dropped to a record low score of –
28.6 following the release of the Reuters special report. In the month leading up to the Parliament
summons, Starbucks’ score remained around –16.7, which is in sharp contrast to its score from 2011 of
+3.1.23 In contrast, the BrandIndex scores for Google and Amazon barely dropped due to their media
reports and Parliament summons. The U.K. director for BrandIndex, Sarah Murphy, commented:
A brand’s buzz score typically recovers following a spate of bad press, but we aren’t seeing that with
Starbucks, which is quite unusual. Its scores started to level out around the end of last month, but
whatever modest recovery Starbucks has made could well be in jeopardy if this story flares up again in
the media.24
UK Uncut
The continued negative public backlash against Starbucks could have something to do with the actions
of the organization UK Uncut. While it started as a simple hashtag, UK Uncut grew during the recession
into an organized movement with protests and boycotts in over 50 U.K. cities.25
UK Uncut campaigned against the government’s austerity plans to cut public services and reduce the
deficit, claiming the deficit could be reduced and welfare services maintained if the government
collected all the tax revenue it was due. A UK Uncut FAQ says, “It is estimated that £25bn a year is lost
through tax avoidance – money that could fund the refuges, rape crisis centres, sure start centres and
child benefit payments that are currently being axed by the government.”26
One of the first UK Uncut targets, Vodafone, was forced to close nearly 30 stores around the country
due to protests and sit-ins.27 Since 2010, banks such as Barclays, RBS and HSBC, and retailers like Boots
and Tesco have come under fire from UK Uncut.
Following the release of the Reuters report in October 2012, UK Uncut began to target Starbucks with
protests and boycotts. On November 11, 2012, the date that Starbucks CFO Troy Alstead was scheduled
to meet with Parliament, UK Uncut announced a new campaign against Starbucks, titled “Refuge from
the Cuts.” The intent of the campaign was to turn dozens of Starbucks’ locations on a Saturday in
December 2012 into services that were being cut by the government, such as refuges, homeless shelters
and crèches.28 A UK Uncut activist was quoted as saying “Starbucks is a really great target because it is
on every high street across the country and that’s what UK Uncut finds really important: people can take
action in their local areas.”