In case you have not noticed, an interesting customer and supply chain distributor confrontation is underway, and it involves two highly visible players.  Kraft Foods signed a distribution agreement with Starbucks Coffee Company back in 1998, where Kraft provides global distribution of Starbucks coffee among retail outlets.  According to a company press release, Kraft notes that has grown this business from less than $50 million, to approximately $500 million in annual revenues, and Starbucks has recognized and acknowledged Kraft’s role in building this retail presence, leveraging its own supply chain capabilities.

Starbucks, however, now wants out of the deal.  According to today’s Wall Street Journal opinion commentary, Starbucks May Spill Kraft’s Coffee, (paid subscription may be required) this java experience provider has reached a challenge in growth.  While overseas expansion of outlets has gone well in some countries, other countries have presented more competitive challenges.  Starbucks is perhaps viewing the packaged-food business as a bigger growth opportunity for the future, and apparently wants more direct control.

The problem is that the deal with Kraft was designed as an indefinite arrangement, subject to certain conditions and limitations.  Starbucks has embarked on the inadequate performance route. It accused its partner of failure to properly market the brand, for example, not maintaining appropriate promotional displays inside grocery stores. According to the WSJ commentary, Starbucks sent a second letter on November 5th indicating that its partner had failed to remedy the contract breaches and that the deal would end in March of 2011.

Kraft’s public statement makes note that Starbucks could take over the retail distribution business, but needs to compensate Kraft for the fair market value of the business, plus allow sufficient time for an orderly transition. Kraft hints at interest in a premium of up to 35 percent of sales value.  The Journal commentary quotes a Wall Street analyst best guess that a Starbucks buyout could amount to $1.5 billion.  Starbucks would have to incrementally invest in its own global retail physical distribution, transportation and process capabilities or find another partner with more favorable terms.

Whenever lawyers get directly involved in supplier and customer deals, events can get ugly and relationships can, in-turn, be severely strained.  Rather than risk an acknowledged positive relationship among two well-known companies, it would seem that a more rational approach should be explored.  Arbitration, in our view, is an acknowledgement that neither side is willing to make movement.

Starbucks, for its part, has to recognize the value that Kraft has provided in leveraging its supply and distribution expertise, along with its supply chain process capabilities in sales and operations planning. It must internalize what it would reasonably take in time and money to re-create these capabilities internally. Competitor Dunkin Donuts has elected to have a third party maintain retail distribution, and many other service retailers opt more for leveraging someone else’s supply and distribution network, for instance Amazon or others, vs. investing in singular capability.  It really comes down to that key question, how strategic is supply chain physical or process capability to long-term growth needs.

Kraft, in-turn, should recognize the importance of key customer needs, including the desire of the customer to gain more financial benefit from an existing relationship.  Kraft is already under the looking glass regarding its recent acquisition of Cadbury, and consequent need to drive considerable incremental savings in overall supply chain costs among both companies.  One would speculate that a loss of Starbucks’ profitable retail business makes the challenge even more difficult, or the potential moving of Starbucks to another consumer goods competitor’s supply chain distribution network does not bode well for Kraft’s reputation either.

Perhaps it’s time to stop playing ‘my supply chain trumps yours’ and move toward a ‘win-win’ negotiation arrangement where the lawyers and the egos stand in the background.

Bob Ferrari

Disclosure: The author of the above commentary is an owner of the common stock of Kraft Foods.