Profitability and Survival Rates for Coffee Shops

Would you like to be one of 3006 coffee shop businesses in Australia?   The sale of coffee compromises about 40% of their revenue.  (Cafes and Coffee Shops in Australia – Market Size, Industry Analysis, Trends and Forecasts (2024-2029)| IBISWorld)).

Definition of “Coffee Retailing Industry”

The coffee retailing industry includes cafes and coffee shops that serve food and beverages to customers on premises. It excludes operators mainly engaged in takeaway food services, restaurant and catering services and the operation of theatre restaurants and selling alcohol for consumption on and off premises

Outline (in 2023) of “Coffee Retailing Industry”

The coffee retailing industry may be described as a mature(saturated?) industry but unlike most mature industries, concentration rates are low and entry is easy  Specifically, in 2023 the main industry identifiers were (Cafes and Coffee Shops in Australia – Market Size, Industry Analysis, Trends and Forecasts (2024-2029)| IBISWorld

• A gross turnover of $10.3 Billion $A (+3/3%, 2019-2024)
• 157,000 total employees (approximately 109,000 FTE)
• Average profit margin of 7.9%
• Concentration – low
• Barriers to entry – low
• Competition – high
• Regulations – moderate
• Revenue volatility- high
• Innovation – low

Entry to “Coffee Retailing Industry” is Easy

Despite the presence of some larger chains, small businesses dominate the industry. As a mature industry growth is slow at around 1.7% increases in numbers per year, although 2023 saw a small drop of -0.5%. Low barriers to entry, including modest capital costs, the availability of incentives (mainly from shopping centre owners) and high churn about operators means that opportunities for entry are high.

Survival of “Coffee Retailing Industry”

The average life of  a coffee shop in contemporary Australia is 3-5 years (https://fluentincoffee.com/how-long-do-coffee-makers-last/) Only  50% of independent coffee shops manage to stay in business for more than five years, and only 33% make it past the ten-year mark (https://craftcoffeepotcom/coffee-shop-statistics). Currently only construction and building companies in Australia have a higher mortality rate than coffee shops (ABC News Australia – Coffee culture an early casualty of cost-of-living crisis)

The cause of the low survival rate

Surviving as a small business in any field in contemporary Australia is not easy. (https://www.smartcompany.com.au/startupsmart/advice/business-planning/research-reveals-trends-survival-rate-and-the-future-for-australian-small-businesses.) The data shows that of those companies with turnover below $200,000 per annum the survival rate is 61.9% and only 47.1% for those with turnover below $50,000

Being a coffee shop is worse. Low profit margins mean that that individual owners are highly susceptible to variations in consumer spending. While coffee consumption is often viewed as relatively price inelastic in the short run, it is also income elastic, which means in periods of high cost of living, as disposable incomes drop so too does the demand for coffee. In Australia at the moment, the income effect is outweighing the price inelasticity effect.(Inflation impact: Why coffee shops in Australia are losing steam (thenationalnews.com)

Cost structure of “Coffee Retailing Industry”

Table 1 – Cost Structure of coffee shop based on takeaway coffee

High percentage labour costs are a feature of most hospitality businesses in Australia, but coffee shops seem to be at the high end. Hospitality Australia estimates the average labour cost percentage is approximately 27% of total costs, this compares with 35% for Coffee shops (https://www.eposnow.com/au/resources/what-percentage-should-labour-cost-be-in-a-restaurant)

In addition to high labour costs rental charges, Coffee shops are facing increased rental costs  in shopping centres which are currently rising on average 4% per annum (Retail rents squeeze small stores out of shopping centres – ABC News). In an environment of zero or little growth in retail sales this can be highly problematic for coffee shop owners

Excess Product Differentiation

The days when coffee drinkers were content with a small section of coffee types is long gone    Coffee shop staff are now faced with a bewildering selection of coffee types made under a variety of techniques. A truncated list of  the varieties of coffee sold in coffee shops includes: Americano, Black Coffee, Cappuccino, Espresso, Latte, Macchiato, Mocha, Cold Coffee Variety, Affogato, Cold Brew, Frappuccino,  Frappe, Iced Coffee, Mazagran, Iced Latte and Nitro Cold Brew (The 15+ Types Of Coffee Explained: Ultimate Coffee Guide (thecozycoffee.com)

These often come with detailed customer specific instructions and ingredients This product mix and service requirements has two negative impacts on the profitability of the coffee shop. First it presents the attainment of the scale economies that would be available if a smaller number of coffee choices were available, Second, it adds to staff costs as staff need to spend more time on specialised requests and have a higher risk of mistakes, which leads to increase wastage.

New entrants try to overcome this trend by selling coffee alongside a range of gourmet pastries and other baked goods, which has improved the quality of the industry’s food offerings but has intensified competition among cafes and coffee shops.  The result is increased hospitality fatigue and business Insolvencies. These are not yet at UK levels but are fast approaching. An  estimated 33% of coffee shops in the UK are currently facing closure (A third of UK’s coffee shops facing closure due to soaring energy costs | UK | News | Express.co.uk)

The Sober Reality

In summary, if you want to open that coffee shop you will be faced with,

• Low profitability
• High staff costs and turnover
• Intense competition
• A requirement for considerable product differentiation
• Rental cost pressure
• Precarious cost structures
• Medium to low survival changes s

Swim against the tide and revert to price based/ specialisation of production along traditional economic lines.  For example:

• Cut back the offerings of coffee types to a maximum of three (for example, expresso, flat white and cappuccino and sell at between $2 and $3 along the lines of the & Eleven dispensing machines. This will allow, quick service, economies of scale to come in, staff costs and less wastage of over complicated orders that go wrong.
• Similarly keep food items to a minimum and sell as a package with the low cost no- frills coffee. Consider moving from traditional shop style accommodation to a coffee stall or moveable coffee wagon
• Place emphasis on quick, uncomplicated service

In adopting these strategies, location and client mix are important. In a period of constrained consumer spending, survival requires reduced staff costs and leveraging any available economies of scale by restricting coffee offerings to core coffee types.