For those of you that have not been living under a rock for the last couple of years, you may have patronized a Starbucks and seen a customer scan their phone at the checkout and then somehow magically get coffee without ever paying. What is this wizardry that is going on? I mean, you’ve seen people pay with pretty looking cards that have a Starbucks logo, but that’s clearly a gift card, not some magical electronic thingie. This magical pay-by-phone is not only a convenience for regular customers, but it’s Starbucks’s way to push mobile payments forward while device manufacturers do their best Benny Hill trying to implement mobile payments.

Starbucks Coffee

Starbucks Coffee

Enter the Starbucks app (and Passbook integration). Sure, techies love it because you can PAY WITH YOUR FLIPPING PHONE (MAGIC)! People with smartphones love it because they don’t have to carry around their Starbucks card anymore (lighten the wallet!). But what about Starbucks? Do they love it? Is this just some pilot that is draining millions of dollars from Starbucks and will ultimately be scrapped?

Before I continue, I am not involved with Starbucks so everything that follows is from a complete outsider’s view, but everyone should be paying attention to what they are doing over there at this recognizable Seattle coffee chain.

Starbucks LOVES this idea. Let’s take a look at how the process works:

  • Gift card holders register their gift cards (or sign up) for free.
  • Balances are now available on the phone or the card, and users are encouraged to “auto-recharge” their cards when balances get low.
  • Starbucks essentially becomes a bank flush with cash as people work off these balances (in Q4(FY) 2012 alone, Starbucks reported almost $700 MILLION in activations and reloads)
  • The average transaction size now goes from $5 to $23.

Let’s take a look at those last two items. Now as far as my limited accounting experience can tell me, there is no public reporting of the current liability balances associated with their gift cards. It’s in there somewhere. The takeaways here are:

  1. Starbucks is now getting cash to (optionally) finance parts of their business.
  2. Their cost per transaction is lower with reloads and the number of payments goes down dramatically.
Starbucks : Birmingham : England : UK : Enjoy!, by uggboy

Starbucks : Birmingham : England : UK : Enjoy!, by uggboy

Here’s the illustration. If I only used my credit card to buy coffee, they would charge $4-5/visit and the payment system would take its cut (usually both a transaction fee plus a % of the transaction). Now, the payment system is insanely complex. Some of the best assets that retailers have is their ability to negotiate a good deal with their processors (and exploit every last penny from it). Some perks include discounts for the number of transactions, or tiered discounts depending on transaction size. Let’s use some assumptions. Let’s say that Starbucks pays $0.15/transaction plus 1.49% for each one that goes through. If I visit Starbucks 5 times per week (M-Th, plus Sunday AM) and spend $5 each time, Starbucks earns $1,300/year for my patronage and pays $58.37 in fees if I use my credit card.

Now, let’s say that I install the app on my phone, and set it to recharge $50 every time my balance gets low. I have now reduced their transaction volume with me to 10% of the original (26 times to recharge vs 260 transactions). This changes the fees to $23.27, or a 60% reduction in my cost burden to the company with the added benefit that they get to use my cash for anything they want while I work it off over a period of time.

Now let’s talk about how this works on a macro scale. According to the report I linked to above, Starbucks had around 148 million transactions redeemed on gift cards. Let’s run those numbers through my assumptions. Instead of $22 million in per-transaction fees they would have spent around $2 million (a savings of $20 million can’t be overlooked no matter who you are) in that quarter alone.

WOW! Think about how that would work on a global scale! If I were Starbucks, I would offer incentives to up that recharge amount so that I have even fewer transactions and more cash to play with. If you look at it from a PCI DSS perspective, it’s not unreasonable that games like this could even lower their merchant level from a Level 1 to a Level 2.

Does this work in every business? No. If the average ticket size isn’t somewhere in the $5-$10 range, things might break down. But think of the number of businesses that operate in a B2C market that could benefit from this! If this describes your business, you would be a fool to not look very closely at what those coffee roasters from Seattle are doing and figure out how to do something similar in your own business.

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