Starbucks’ grocery gambit

December 5, 2013, 11:35 AM UTC
A Starbucks Signature Aisle at a Safeway store
Photo: John Keatley

Starbucks has made a business out of being everywhere — highway rest stops, cruise ships, and just about every block in Midtown Manhattan. The company even opened a full-service café on a Swiss train earlier this year. So it should come as no surprise that the ambitious retailer has its eyes set on taking over some real estate that has evaded it over the years: the grocery aisle.

Sure, Starbucks (SBUX) already sells items such as ground coffee and bottled Frappuccinos in supermarkets and corner stores, and indeed such items bring in about $1 billion in annual sales, some 7% of the coffee giant’s $14.9 billion in fiscal 2013 revenue. But Starbucks CEO Howard Schultz says he’s just getting started.

When executives started sketching out the company’s packaged-goods strategy, it was one of those “points in Starbucks history when a voice inside your head says, ‘This is a really big idea,’ ” Schultz recalls. He thinks sales from products sold outside Starbucks’ stores could someday rival the size of today’s core U.S. café business, a $10-billion-a-year enterprise — but with better margins.

Starbucks gave Fortune an exclusive look at how the company plans to make its products as ubiquitous in supermarkets as, say, Coca-Cola (KO) beverages or Mondelez (MDLZ) snacks. The simple answer is that Starbucks aims to amp up your bean-buying experience, leverage its popularity and loyalty programs to lure food shoppers, and peddle way more than coffee. Its recent flurry of acquisitions and partnerships — buying juice company Evolution Fresh and bakery La Boulange and forming an alliance with Danone for yogurt — could help the company broaden its grocery offerings for caffeine drinkers and non-coffee fans alike.

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The move isn’t a slam dunk. The supermarket aisle is a notoriously cutthroat arena littered with the carcasses of failed product launches. And despite Starbucks’ enormous sway with consumers, not all of its offerings have been winners — Starbucks Coffee Liqueur, anyone?

Nevertheless, Starbucks has tremendous consumer brand awareness created from its retail stores. And grocers are eager to burnish their own brands and attract shoppers by displaying the Starbucks logo in their stores. “Because of the impression we make every day in the cafés, we don’t have to work as hard when we launch new products,” says Michael Conway, a Starbucks executive vice president who joined the company in March to lead its business outside cafés.

A visit to a Safeway in suburban Seattle suggests how Starbucks will attack the supermarket. Here, and at some 170 other Safeway (SWY) grocery stores, Starbucks has established a so-called Signature Aisle. In reality it’s only a portion of the aisle, but it begins at the ever-important “end cap” — grocery store parlance for the outward-facing real estate at the front and end of the row. At this location Safeway features bags of coffee (a blend exclusive to grocers) under a sign with Starbucks’ distinctive mermaid logo.

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The setup aims to draw shoppers into the aisle, something supermarkets have struggled to do; consumers favor shopping the perimeter. Turn the corner and you’ll find neatly lined up packages of its instant coffee Via and boxes of single-serve K-Cups for Keurig machines, along with Starbucks’ packaged coffee, color-coded by strength of roast. It all sits on wooden fixtures reminiscent of Starbucks cafés. The company says it sees its sales lift — along with sales for all coffee products — after installing a Signature Aisle, which it has also done with Kroge (KR)r.

And that’s just coffee. In July, Starbucks and Danone announced a partnership to sell yogurt products under the Evolution Fresh name, first in cafés and later in grocers’ dairy sections. Starbucks’ carbonated beverages are now in test phase in Japan, Singapore, Atlanta, and Austin. Food items from La Boulange, which Starbucks bought in June 2012, are now behind the bakery cases in Starbucks locations. The company declined to discuss its ambitions for La Boulange besides upping food quality in its cafés, but before the Starbucks acquisition the brand’s products were already available in the frozen food section in a few high-end supermarkets.

Owning and controlling the items Starbucks puts in its stores is part of a larger company initiative, says Schultz. “Shouldn’t our shareholders benefit from our ability to build a brand inside Starbucks?” Schultz posits, “as opposed to selling a category or product that is something that we don’t own or have equity in?” It also helps when it decides to move them into the grocery aisle.

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Take the juice category. For years Starbucks sold Naked Juice, a PepsiCo (PEP) product, in its retail locations. But in 2011 it acquired 20-year-old juice brand Evolution Fresh, and today almost three-quarters of Starbucks cafés carry the beverage. The company also recently took Kind Healthy Snacks bars out of its stores and started making its own under the Evolution label.

Starbucks’ push into consumer packaged goods was a long time coming. In 1989, 18 years after it was founded, the company tiptoed into the business by selling private-label coffee in Costco (COST) (Schultz is close with the co-founders of the warehouse club). Almost 10 years later Starbucks partnered with Kraft (KRFT) when it decided to get into the packaged-coffee business en masse. In 2011, Starbucks dissolved the partnership three years early, a move that foreshadowed the company’s larger ambitions in the grocery aisle. Last month an arbitrator determined that the early end to the deal would cost Starbucks $2.76 billion — a hefty settlement that’s also a barometer of just how valuable the business is.

Ultimately, Starbucks hopes to integrate its café and grocery experiences, using its loyalty rewards program as a way to entice consumers to buy more Starbucks stuff (and track who is buying what). Ground coffee purchased in a grocery store, for example, comes with a code that loyalty program members can enter online, earning points toward free coffee in Starbucks cafés. And when a customer redeems that free coffee, in the future she may get a coupon for a discount on a bag of ground coffee at a local grocer. Since launching the program in May, 1.5 million people have entered codes from their bagged coffee. If Starbucks can keep customers engaged, it may be only a matter of time before its brands are as ubiquitous in stores as they are on Manhattan street corners.

This story is from the December 23, 2013 issue of Fortune.