Excerpted from Entrepreneurship: A Real-World Approach, 2nd Ednow available

Challenge: To improve cash flow, reducing the unpredictability of sales for a nonessential purchase

Solution: Find ways that encourage customers to prepay for goods long before they purchase them, and invest those funds safely

There’s a pretty good chance the last time you ordered a Starbucks latte, you’d already paid for it. Perhaps you used the Starbucks mobile app on your smartphone, or you may have used a Starbucks prepaid card, but you’d already given Starbucks your money. How do we know this? In early 2016, a whopping 41 percent of all Starbucks transactions in the US and Canada were completed via a Starbucks prepaid card or the company’s app. (1)

That represents a mountain of cash filling up Starbucks’ coffers before they ever grind a coffee bean. When the company created its Starbucks Rewards program, it wasn’t setting out to pile up cash. The primary purpose of the Starbucks Rewards program is to build customer loyalty and to make it easier for customers to make purchases and give gifts.

For every purchase, customers earn stars—the currency in the coffee giant’s point system. When they accumulate enough stars, they get rewards: free drinks, food, or merchandise. Loyalty programs such as these—whether a coffee shop, supermarket, bookstore, whatever—help ensure that the best customers, and thus the most profitable, keep returning and spending.

Gift cards, of course, are extremely popular. Americans love the convenience and flexibility of giving and receiving little plastic cards loaded with cash credits they can use at their favorite retailer, restaurant, movie theater, whatever.

Starbucks’ loyalty and gift card programs have been a huge success by any measure. In early 2016, its loyalty program boasted 12.1 million active users in the US, and over 20 million worldwide. (2)  And Starbucks estimated that a whopping one in seven Americans received a Starbucks gift card as a present during the 2014 Christmas holiday season. (3)

The success of these programs has had the very beneficial—and somewhat unexpected—side effect of bringing the company a lot of cash and improving Starbucks’ cash flow.

The holy grail—the most desirable but elusive form—of any company’s cash flow is consistent, predictable payment from customers. Every business dreams of having steady, continuous, and predictable cash coming in.

That’s one reason the subscription business model has become so popular with companies. With subscriptions, customers sign up for goods or services to be received on a regular basis—often paying in advance at regular intervals (typically monthly). You likely have subscriptions for Internet and cable service, certain online services, many smartphone applications, and some food delivery programs, as well as magazines.

The Starbucks prepaid program, although not a subscription model, works in a similar fashion. The company can count on its best customers to load up their prepaid cards—on plastic or on their smartphones—on a regular basis. Essentially, when those 12 million-plus Starbucks customers load up their accounts, they lend the company money interest-free. And they’ve been “lending” Starbucks a whole lot of money. In the first quarter of 2016 alone, customers had loaded their Starbucks cards to the tune of $1.2 billion—more money than some smaller regional US banks have on deposit. (4)

How has Starbucks chosen to manage all that cash? Remember, it still has to provide lattes and frappuccinos to those who have cards or credit, so Starbucks has to have access to the cash necessary to purchase the coffee, milk, and cups it’ll need and to pay its rent and employees.

So, like a bank, Starbucks primarily puts its money away. It invests in relatively risk-free financial instruments, such as high-grade corporate bonds, Treasury notes, and certificates of deposit. All of these also yield interest. Unlike a bank, Starbucks doesn’t have to pay its depositors interest. So it makes money on the money it invests.

In 2013, Starbucks earned $146 million in interest by investing the money customers had loaded onto prepaid cards. That alone is equivalent to 8 percent of its total profits for that year. (5)  In addition to interest income, the company also earns cash from unredeemed cards—cards customers paid for but didn’t use. In 2015, those unused cards amounted to $39.3 million, equivalent to the profit generated in an entire year by 320 company-owned Starbucks stores. (6)

Clearly, the prepaid card and loyalty programs have been a huge financial benefit for Starbucks. Realizing this, Starbucks has looked for ways to expand these programs.

In 2016, Starbucks announced it was partnering with JP Morgan Chase & Co. to issue a company-branded, prepaid Visa debit card, which will offer Starbucks rewards on purchases customers use at any store that accepts Visa. The rewards may be lower than those received making purchases at Starbucks itself, but since few (if any) debit cards offer rewards, there’s an incentive for customers to use these. And in choosing a prepaid debit card over a typical affinity credit card, Starbucks may appeal to younger, debt-averse millennial customers.

The ability to use the prepaid card for everyday purchases could result in customers loading up large amounts of cash onto their cards—in effect, “lending” even greater amounts of money to Starbucks. When it comes to cash flow, Starbucks is “big bucks.”

Questions

1. Why do you think Starbucks customers are willing to prepay for products they might not receive for days or even weeks or months?

2. In addition to subscriptions and prepaid cards, are there other ways businesses can encourage customers to pay in advance, before receiving goods or services?

3. Getting customers to prepay is obviously a win for any business. What other types of businesses might be able to use this method?

4. What types of businesses might be able to provide their goods or services on a subscription basis to improve their own cash flow?

5. What dangers, if any, are there for a company in having customers prepay for goods or services?


1. “Starbucks has more customer money on cards than many banks have on deposit,” by Tonya Garcia, MarketWatch, June 11, 2016.
2. https://news.starbucks.com/news/starbucks-2016-annual-meeting-of-shareholders.
3. https://news.starbucks.com/news/record-card-purchases-expected-christmas-eve.
4. “Starbucks has more customer money on cards than many banks have on deposit,” by Tonya Garcia, MarketWatch, June 11, 2016.
5. “Starbucks just sold $1.4 billion in gift cards. What did it do with that cash?” by Kyle Stock, Bloomberg, Jan. 24, 2014.
6. “20 million reasons why Starbucks’ rewards program is so powerful,” by Jeremy Bowman, The Motley Fool, June 11, 2016.