Analyse trends in the UK branded coffee bar industry.
Contents
Overview page 2
Definition of Industry page 3
Intensity of rivalry amongst industry competitors page 4
Threat of Substitutes page 9
Threat of New Entrants page 11
Bargaining Power of Suppliers page 12
Bargaining Power of Consumers page 13
What does the future hold? page 15
Bibliography page 16
Overview
This report will be seeking to analyse trends in the UK branded coffee bar industry. It was estimated that the total coffee shop market numbered 7,603 outlets as at May 2003 and this growth is expected to continue at a compound rate of 5.1% between 2003 and December 2005. Much of this growth has been as a result of the development of the branded coffee bar which has seen phenomenal growth since the early 1990s and this seems to have continued unabated into 2003, despite accusations that the market is already saturated and in contrast to the views of many including Bobby Hashemi, of Coffee Republic, who is known to have said that 'the UK coffee market was sustainable to only 1500 outlets'.
Nonetheless the UK branded coffee bar market is still expanding after 7 consecutive years of growth. The market is forecast to grow by 9.5% per annum to reach 2,690 units by December 2005. Market turnover is forecast to exceed £1 billion in 2005 as the reach of 'coffee culture' grows. This growth is driven by consumer demand and lifestyle factors as leading branded operators such as Starbucks, Costa Coffee and Caffé Nero continue to expand across the UK with an increasing focus outside London.
This review of the industry will analyse trends in the branded coffee bar industry and look at the changes undergoing the sector. This should serve to illustrate whether growth of the industry is sustainable or whether there is overcapacity in the market with the consequent need for consolidation and restructuring of the coffee market.
Definition of Industry
Before we can proceed further it is essential that we define the exact nature of the industry we are looking at. It is very easy to get confused given the diverse range of facilities offering coffee for sale. It has been decided to utilise the economist's notion of an industry as the group of firms producing the same or similar products (i.e. products that are close substitutes for each other). (Johnson and Scholes, 1999).
Thus this report will be restricted to those establishments where coffee is the primary sales item and for the most part these are based on the European and US coffee shop models (Mintel, 2003) typified by the market leaders such as Costa Coffee which has been recently criticised as "too much of the Starbucks 'me-too' concept' (Starbucks being a leading US brand) whereas Café Nero has sought to transplant 'more of the Italian experience'. These establishments specialise in selling gourmet or espresso-based coffee, offering a diverse range and variety of coffee such as cappuccino, latte, mocha and so forth alongside other items such as pastries, tea and coffee beans which are usually on sale as add-ons to the main product line. It must however be noted that the food offer is generally very limited. The branded coffee shop includes venues such as individual stores, kiosks and concessions offered in a variety of locations including motorway service areas, bookshops and train stations. However an essential requirement to fall into our definition is that they be independent of the facility they are located in.
The report will disregard the multitude of other establishments that sell coffee, such as restaurants, in-store cafes, teashops or traditional cafes as well as sandwich shops such as Pret A Manger and Subway.
Framework for report
Now that a definition of the industry has been provided it is possible to proceed and carry out an in-depth examination into the branded coffee shop industry. Michael Porter's five forces framework will be adopted in order to help identify the sources of competition within the industry. The five forces framework seeks to explain the competitive forces by looking at five separate though not wholly independent facets of competition. These may be defined as threat of new entrants, intensity of rivalry among competitors, threat of substitutes, bargaining power of suppliers and bargaining power of customers.
Intensity of Rivalry among the Industry Competitors
The coffee shop market is characterised by a great deal of fragmentation, with the largest percentage of outlets being owned by individuals or small companies. This has the resulting effect that the total market value is difficult to calculate, although it was estimated to be in the region of £1.5 billion during 2002 (Mintel, 2003).
Figure 1: Segmentation of coffee shop market, January 20031
Number of outlets
% of total
Top five branded chains
940
6
Other branded coffee chains
250
4
Single-site/ independent coffee shops
4,810
80
Total
6,000
00
The phenomenal growth of the branded coffee shop has been driven by expansion with the present market leader, Starbucks, yet to show a profit (due to this expansion policy) despite its operation of 375 outlets throughout the UK.
The market in 2002 had seen a two and half times increase in size on the 1997 levels, and turnover will have more than doubled at 1997 prices. The branded coffee shop market has seen average growth of around 20% a year over this period. Despite the difficult trading conditions faced in 2001, due to a fall in tourism caused by both the foot and mouth outbreak and the aftermath of 11 September, the market saw a rise of 16%, to almost £300 million.
Although the nation's economic future is difficult to predict, conditions are likely to be at least marginally better than those faced over the last two years especially given the conclusion of the Iraq conflict.
It is estimated that an increase of around 20% should be seen this year, largely as a result of continued outlet expansion. Many of the brands are also seeking to strengthen and consolidate their market position by such measures as improving their food offering, which will help to increase the spend per customer (a crucial indicator of success in the industry). In addition, there have been moves towards rationalisation and disposal of underperforming stores as the chains come under increasing pressure from competitors and the markets to demonstrate profitability. These measures should ultimately drive increases in turnover and improved profits.
As shown in figure 1 above, the market is dominated by single-site and owner-managed stores as well as 15 branded chains. Recent trends in the market, have seen brands such as Aroma disappear and the branded chains acquiring more of the independents.
Five branded chains currently account for 16% of the market, while the remaining other smaller branded chains have a 4% share. Nearly all of these companies are seeking to expand their estates over the coming years and it is likely that the number of single site and independent stores will fall as the branded stores increase in number. Allegra Strategies has forecasted the branded coffee bar market to number 2,690 units by December 2005 which would mean the branded chains would represent 36.56% of the overall coffee shop market.
The London market will serve as an early ...
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Five branded chains currently account for 16% of the market, while the remaining other smaller branded chains have a 4% share. Nearly all of these companies are seeking to expand their estates over the coming years and it is likely that the number of single site and independent stores will fall as the branded stores increase in number. Allegra Strategies has forecasted the branded coffee bar market to number 2,690 units by December 2005 which would mean the branded chains would represent 36.56% of the overall coffee shop market.
The London market will serve as an early signaller of national trends given that it has been the hub of activity for the branded chains. Competition has been intense in London with some of the smaller chains, such as Madisons, which do not have the backing of a large parent, being forced to pull out. Branded sites will often take-over existing sites and this may explain why although the number of branded coffee shops are expected to grow at a tremendous rate, the overall coffee shop numbers will increase much more slowly. This enthusiasm for acquiring sites which have previously operated as coffee shops arises from the fact that these sites already have the necessary planning licences and, often, a proven clientele. The practice of clustering where several branded stores open in one area, can also force local independents to close as they will not have the funds to sustain their activities during periods of underperformance.
It will be useful at this point to look at the top five brands in the UK in order to understand the competitive position a little better. The table below illustrates the growth in the number of outlets of the top five branded chains, between January 2001 and 2003.
No. of outlets
January 2001
No. of outlets
January 2003
% change
2001 - 2003
Starbucks
221
349
+58
Costa Coffee
250
310
+24
Caffe Nero
62
10
+77
Puccino's
6
95
+494
Coffee Republic
82
76
-7
Total
631
940
+49
Starbucks is a global brand operating 5,689 outlets in 28 countries and subsequent to entering the UK market in 1998, has emerged very quickly to become the market leader. All its outlets are company owned which helps to ensure the maintaining of a strong brand. In addition, the possession of a large infrastructure and excellent operational capabilities means that it has the resources in place to continue expansion at the current rate without allowing its brand or quality of coffee to become diluted. In addition to serving hot beverages and food, Starbucks also sells a range of other merchandise and operates a wholesale division.
Costa coffee which is part of Whitbread Plc was the dominant player until 2002. The company has plans for continued expansion and plans to expand to around 500 outlets by 2004/ 05. It is one of the few brands to turn a profit, reported to be £6.9 million in the year end to March 2002. Costa Coffee also operates a highly successful wholesale division supplying to a wide range of businesses, including caterers, restaurants, health clubs and offices. This ranges from the provision of coffee and machines to full Costa service. Costa is seeking to curtail its growth in London with a focus on the regions and large provincial towns (representing the general trend for the branded coffee shops).
Caffe Nero is the largest UK based, independent chain and operates across 40 towns and cities in the UK through its network of 110 stores. Its outlets are mainly high-street based although there are also some units in airports and railway stations. Like its rivals, it also has plans for aggressive expansion as highlighted by its take-over of the Aroma brand in March 2002. Given its national presence, it has needed to reorganise and centralise its supply structure and has sought to take advantage of economies of scale as it seeks to meet market expectations of unit and profit targets.
Puccino's is a flexible chain based predominantly in the South East with outlets comprising kiosks in transport hubs and larger stores on high streets. Flexibility of brand allows it to fit various locations, however this has the disadvantage that the different store formats may lead to a fractured brand identity. This may explain the lower brand awareness identified in an Allegra survey. Unlike its competitors, Puccino's faces the problem of maintaining tight operational control over a loose network of franchises. Operating as a franchise may further reduce opportunities for attracting outside financing but this may not be such a problem as it has group backing with Segafredo Zanetti holding a 20% stake.
The most dismal performer in recent times has been Coffee Republic which has failed to perform to expectations. Its outlets are to be found mainly in the high street, with half its sites located in London. It has undergone a programme of divestments which have seen the closure of most bookshop concessions. It has also sought to arrange new supply deals potentially saving the company around £1 million.
Observers are commenting that it may be turning the corner as a result of its restructuring program. Given its strong brand it may be able to build back its position once its financial health improves.
There appears to be very little differentiation between most of the brands with the majority of coffee shops being based on the European model. Even Starbucks, widely regarded in the UK as characterising the American coffee shop model, is originally based on the European coffee shop culture, with servers referred to as 'baristas' and sizes given Italian names. In all of the branded chains, the food offering is also usually Italian in flavour, with panninis and ciabatta popular choices. Cakes and pasties are also popular and of a similar type. This has resulted in very little differentiation within the industry although the brands themselves are trying to provide this through the promotion of customer service, new product development as well as in-store atmosphere and ambience (Mintel, 2003).
In addition to a similar product offering, the pricing structure also appears to be almost identical. Thus these branded chains do not seem to be differentiating on the basis of price.
Figure 4: Pricing structure of 'Big 5' brands, 2003
Brand
Type
Small
Medium
Large
Starbucks
Cappucino
.79
2.15
2.39
Latte
.79
2.15
2.39
Croissant
£1.00
Costa Coffee
Cappucino
.79
2.15
2.39
Latte
.79
2.15
2.39
Croissant
£1.05
Caffe Nero
Cappucino
.30
.60
.90
Latte
.30
.60
.90
Croissant
£0.80
Puccino's
Cappucino
.25
.70
2.05
Latte
.25
.70
2.05
Croissant
N/A
Coffee Republic
Cappucino
.45
.75
2.10
Latte
.45
.75
2.10
Croissant
£1.00
The locations being used by the chains are all very similar with clustering in key locations. As well as the high street, branded stores are a common feature at railway stations, motorway service areas and shopping centres. There has been a recent trend to moving towards new areas, particularly by Costa Coffee, which now has outlets in banks, hospitals as well as tourist attractions (usually achieved through partnership with corporate franchisees). This is likely to continue into the near future as brands look for new and innovative locations to continue expansion. However, the experience of Coffee Republic with regards to bookshop concessions (which it is having to divulge from its portfolio) shows that the branded chains need to be wary of taking on all locations.
Given this lack of differentiation it is surprising that only 6% of respondents in a Mintel survey were found to use the nearest shop to them. This implies that coffee shops have indeed been able to distinguish and set themselves apart from their rivals. Another way in which the chains (Starbucks and Costa Coffee) are seeking to differentiate themselves is through the offering of in-store Internet access in partnership with high-speed internet providers.
Although there is intense competition within the branded coffee shop industry, it is still a growing market and it appears that the big players are all ready to accommodate each other. There is very little price competition with brands instead seeking to capitalise on their in-store atmosphere and service provision.
Although the big four players are driving through aggressive expansion plans the market has not yet seen the cut throat competition that characterises more mature industries. Rivalry is in seeking to grow market share which all the major brands (with the exception of Coffee Republic) have been able to do fairly successfully.
Threat of Substitutes
The branded coffee chains are in competition with a wide range of other venues and that serve beverages and snacks, particularly those that similarly rely on high visibility and the custom of passing trade.
The traditional cafe
Much of this sector has been stimulated by the growth of the branded coffee shop market, which has raised the bar of competition for the traditional coffee store. These have the advantage of not following a 'one size fits all' model but catering to local needs and tastes. They are also generally preferred by the elder proportion of the population offering amore traditional mix of food and beverages.
In-store catering
The in-store catering market has been revitalised in recent years as new concepts have been introduced to attract customers and venues such as Marks and Spencer's Café Revive which are now in direct competition with the branded coffee shop. Research carried out by Mintel on consumer behaviour indicates that a third of the population visited an in-store coffee shop in 2002, compared to a quarter in 2000. Even the grocery multiples have sought to introduce café-style operations in direct competition with the branded coffee shop. Asda has introduced its Food to Go concept into supermarkets, offering a similar menu to the branded coffee shop but at significantly lower prices.
Debenhams also offers Café Venue, in the branded coffee shop format, in a third of its stores whilst Marks and Spencer's Café Revive was available in most of its store. As well as developing its own brand of blended coffee for use in its cafes, Marks and Spencer packages the blend for sale to its customers. This is a concept used by a number of the branded coffee shops, including Caffe Nero.
Pubs
Pubs are also in competition with coffee shops, in that they are both places where drinks can be purchased without the need to buy food as well. Many pubs now also offer hot beverages alongside more traditional drinks, with cappuccino and latte being widely available. There has also been a convergence of style between some pubs and the branded coffee shops, with both featuring relaxed, comfortable seating and providing newspapers and magazines for customer use (Mintel, 2003).
Although many pubs are not a direct threat to the branded coffee shop, some chains such as All Bar One are in direct competition for the same type of young and affluent clientele. For example, a Mintel survey found that 13% of those in the pre-/ no family lifestage group thought the coffee shop to be a good alternative to the pub. One pub chain, JD Wetherspoon is aiming to compete with coffee shops for the lucrative morning market as it opens its outlets at 10 am to offer coffee and breakfast.
Other competing outlets
There are a number of food outlets that the branded coffee shop market is in direct competition with, particularly with regards to the lunchtime food market (an area the branded coffee shops are targeting to increase their food sales) and estimated to be worth in excess of £6 billion (Mintel. Lunch Foods, Market Intelligence - UK report, January 2002). Many of the sandwich shops such as Pret A Manger and Benjy's, have high quality coffee products and similar food offers. Currently only 6% of users use branded chains at lunch time, a figure which needs to increase if they are to increase their spend per customer by selling more food.
The majority of sandwich sales are take-away and are dominated by big names, such as Boot sand Marks & Spencer. Eat-in sales accounted for £205 million in 2002 and the market has increased in value by almost a third since 1997. Sandwich chains have continued to increase the number of outlets over this period with Pret A Manger doubling in size to 130 outlets and Subway showing a seven fold increase to 56 outlets.
There are also a number of new, emerging markets which although small in number, may have the advantage over branded coffee shops in terms of providing a new and fashionable experience for their customers. As well as competing for clientele, these new concepts will also be in direct competition for the same prime sites.
Figure 5: Size and estimate value of emerging catering markets, 2002
No. of outlets
Market value
(£ million)
Bagel bars
52
5.2
Juice bars
32
5.7
Soup bars
35
1.3
Sushi bars
64
20.0
Many of these new markets reflect a trend towards healthy eating and drinking that is becoming more prevalent in the UK and is one that is not obviously addressed by the coffee shop. These new concepts may highlight trends in eating and drinking that could be easily adopted by the coffee shops.
There is another new threat in the form of Coffee Nation, providers of espresso-based drinks via a vending machine, who have fewer overheads and are able to operate in much smaller locations.
Coffee shops have also had to combat the perception of coffee as a cold or wet weather drink. New products such as Starbucks' Frappuccino and ice-cream based drinks have helped to maintain seasonal consistency in sales.
Threat of New Entrants
'Given the intensely competitive nature of the marketplace the entire branded coffee bar sector is struggling to make money in the face of saturated markets and intense competition' (BBC news online). This does not bode well for new entrants and thus only the most dedicated and committed businesses will seek to try to break into this market.
The above view is typical of that reflected in certain sections of the media, but the public's perception is that there are not too many coffee shops at all. Only 6% of respondents to the Mintel survey felt that this was true and although this figure more than doubled for those living in London, this still accounts for only 14%.
Although the public's perception may be that there are not too many coffee shops, the financial positions of the various brands does not paint a positive picture. New entrants are typically attracted by the opportunity to earn abnormal profits however given the dire financial status of some market incumbents such as Coffee Republic, this does not look very promising.
The leading five brands have been able to consolidate their positions developing brand awareness which appears to be critical to success in the industry. This potential hurdle faced by new entrants will significantly hamper their chances of success. The current incumbents have achieved their relative positions with very little promotion and advertising instead relying on word of mouth and personal recommendation. However in order to challenge the market leaders, any new entrant will have to spend heavily on advertising as well as have the funds to go through periods of underperformance especially if it seeks to open in cluster sites where other branded chains exist.
In addition, the large estates of the leading five branded chains puts them in a good position with regards to suppliers and with the ability to dictate terms (particularly in the case of Costa Coffee and Starbucks). Any new entrant will not have this advantage and will have to set up distribution channels and supplier networks which will be relatively more expensive due to reduced economies of scale.
Thus the chances of any new entrant emerging as a successful player in the market are significantly limited particularly given the plight of Coffee Republic which is seen by many as ripe for take-over by one of the other brands. For a new entrant to have any hope of survival it will need to be supported by a strong parent which can finance rapid growth even through periods of underperformance with each outlet acquisition costing an estimated £200,000.
But even the support of a powerful parent does not guarantee success as was illustrated by the closure of 6 Jacqmotte stores in central London, due to their poor performance. The Jacqmotte brand is owned by Douwe Egberts Coffee and Tea International and operates a network of stores in Belgium.
Bargaining power of suppliers
Given the prominence of the five leading branded coffee chains and their dominance of a coffee shop market consisting of small, owner-managed sites, these brands will have undue prominence and will often be able to dictate terms to suppliers. A range of suppliers are used in providing the variety of products, but quality is critical to the supply decision. The quality of their products is identified by most of the chains as a unique selling point of their brand. A large amount of the food provision will be supplied as the finished product and thus in order to ensure consistency of brand (essential to success in the sector), the branded chains will need to ensure long term maintenance of the supplier relationship. This will involve a partnership with both parties relying on each other, the supplier for the large quantity of business being put its way (and the associated investment this may involve) and the branded chain for high quality, continuos supply.
Many of the food partners such as Maison Blanc (supplier to Coffee Republic) operate their own outlets, but also provide wholesale supply services.
As they move from operating at local or regional to national level, the supplier will need to have the capacity to service their growing needs. This requirement will usually mean that the branded chains will work with a selective few larger suppliers who have the capacity to meet their demand in what is otherwise a very fragmented market consisting of many local suppliers. This will also allow the branded chains to take advantage of economies of scale in their purchases.
These chains are major purchasers of coffee, with Starbucks accounting for 1% of the coffee beans sold worldwide. The market for green coffee is at an all time low due to over-production. The coffee commodity market is in crisis with prices at an all time low of $0.45 for a pound of beans compared to a high of $3.15 in May 1997. Production consists of about 25 million smallholding farmers across the developing world. This fragmentation gives the purchasers tremendous buying power, however in recent times farmers have formed fair trade collectives which ensure that they get a fair price for their produce. Consumer awareness of their plight has subsequently led to the branded chains offering fair trade coffee for sale.
Starbucks purchases directly from the farmers allowing it to get the exactly quality of the green coffee which it subsequently roasts. Some of the smaller branded chains purchase their coffee from wholesalers, but in general the branded chains can exercise a great deal of power in the supplier relationship. The fall in value of the coffee commodity market has allowed the branded chains to earn greater margins on their coffee products as most of these savings have not been passed into the consumer.
Bargaining power of consumers
Consumers are in a very strong position vis-à-vis the branded coffee chains. The branded coffee shop is merely one in a range of venues where consumers may choose to eat out or drink coffee. It is the customers of the branded coffee chains who hold high buying power. Given that only 6% of people go to the branded chain nearest to them, there is clearly differentiation in the market. However, respondents in the same survey challenged the prevailing image of the branded coffee shop as a good place to meet friends, with only 10% of respondents agreeing with this statement (Mintel, 2003).
Given that the rise of the branded coffee chain has been due to the corresponding growth of 'coffee culture', fashionability of the brands is important and may be a driving force for attracting customers. The demise of the traditional coffee shop has partly been due to its decline as a fashion accessory. Starbuck's success may very much rest on its upmarket, trendy image. Thus there may be some degree of social conformity forcing individuals to their choice of brands.
The most common time to visit a coffee shop is while travelling or shopping and around a fifth to a quarter of respondents use them at this time. The power of the consumer is illustrated by the fact that the location of coffee shops are selected on the basis of their ability to service the needs of potential customers, thus being located in high street centres and travel locations such as railway stations and airports.
Figure 6: Population trends, by age, 2001 -'05
2001
'000
2003 (F)
2005 (Proj)
% change
% change
5-19
3,673
3,835
3,916
+4.4
+2.1
20-24
3,555
3,662
3,737
+3.0
+2.0
25-34
8,332
7,930
7,706
-4.8
-2.9
35-44
8,804
9,002
9,079
+2.2
+0.8
45-54
7,758
7,604
7,699
-2.0
+1.2
55-64
6,266
6,748
7,030
+7.9
+4.2
65+
9,358
9,480
9,596
+1.3
+1.2
Total
47,746
48,261
48,763
+1.1
+1.0
The demographic composition of the UK is constantly changing and is one of the underlying factors likely to have an effect on the branded coffee shop market, given its core consumer base of the young and the affluent. According to the Mintel research, the branded coffee shop is most popular amongst those in the 20-34 age range. The popularity of dedicated coffee shops tend to fall with those aged above 54, apart for the in-store coffee shop sector.
In the period 2003-2005, there will be a contraction of 3.7% in the total aged between 20-34, a negative trend for the coffee shop industry. The largest growth will be seen in the 55-64 age range only a quarter of which had visited a branded coffee shop in the previous 12 months (Mintel, 2003). In order to continue with positive growth, the branded chains may need to appeal increasingly to these older age ranges, without alienating younger customers.
The branded chains are used primarily by those in the AB and C1 socio-economic categories and these are also the groups most likely to have a positive attitude towards coffee shops. Three times as many ABs than C2s like the branded coffee shop environment and twice as many like the choice and variety of flavours of coffee. By 2005, the ABC1s are expected to account for 54% of the adult population, largely due to an increase in the number of graduates and a move towards more managerial roles. The coffee shop sector is likely to benefit from the increase in ABC1s.
Given that the branded coffee bar industry is primarily a customer driven industry, the branded chains will need to take into account these socio-economic changes, reflecting the changing needs of the population. If they fail to do so, there are many other venues waiting to capitalise on their lack of momentum.
The power of the consumer is further demonstrated by the growth of 'fair trade coffee' which all the branded chains offer on demand. Although Starbucks had earlier rejected demands to add this to its product offerings, it was forced to relent in the face of unswerving pressure from the public.
What does the future hold?
There is likely to be further consolidation and Coffee Republic continues to be the target of speculation. It is not yet clear as to which chains will eventually emerge as the UK's top brands. Starbucks and Costa Coffee are two likely candidates, backed as they are by two wealthy parent companies. The branded chains will need to adopt a more 'managed' approach to their expansion plans following several years of too rapid expansion otherwise they may be victim to unwieldy support infrastructures.
As discussed earlier, the recent movement away from London and the South East will stimulate trade, although the branded coffee shops may need to extend their client base in order to achieve further growth. Older members of the public may be well placed to provide the coffee shops with customers at times when they are needed the most, such as in the afternoons when coffee shops are at their quietest.
Demographics and response to new fads in eating will be essential in maintaining competitiveness given the branded coffee shop's reliance on the trendy and fashionable professional groups. Brand loyalty should continue to be developed given that the results of an Allegra consumer research survey revealed that 67% chose to visit their favourite coffee shop despite the ever growing numbers of outlets.
They will further need to develop their food offerings given the need to increase their share of the lunch time market. The various companies may need to look at some of the areas where the public hold negative views of the branded coffee shops. The Mintel survey revealed that the most commonly held view of the branded coffee shop was that they are too expensive and the companies may need to address these issues if they are to strengthen their brands.
Bibliography
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Allegra Strategies, 2003, Project café - UK Coffee Bar Market,
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Lukoff, D J, 2001, The Coffee Shop Days, Xlibris Corporation
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>
> UK Coffee Bar Culture, http://www.globalchange.com/ppt/coffee/sld030.htm
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Source: Mintel report on UK coffee shops