NORTHFIELD, ILL. — Kraft Foods Inc. on Nov. 29 said it is initiating an arbitration proceeding against Seattle-based Starbucks Corp. after the latter’s move to end its agreement with Kraft to distribute and promote Starbucks packaged coffee in stores. The agreement dates back to 1998.

Howard Schultz, chairman, president and chief executive officer of Starbucks, first disclosed Starbucks’ plans to end its agreement with Kraft during a Nov. 4 conference call discussing fourth-quarter financials.

“For the last 10 years or so, Starbucks packaged coffee has been distributed to grocery stores and other outlets by Kraft Foods,” Mr. Schultz said. “A month ago, we informed Kraft of our intention to discontinue the distribution arrangement. The details and timing around any transition will be subject to further private dialogue. We intend to work closely with Kraft to ensure an orderly transition, putting an emphasis on ensuring that our mutual customers are well served. We intend to keep our discussions with Kraft private and we are not in a position to provide further commentary at this time.”

But on Nov. 29, tension between the two companies escalated, as first Kraft, and then Starbucks, issued statements on Starbucks’ move to end the agreement.

For its part, Kraft pointed to its instrumental role in helping grow Starbucks retail grocery coffee business from less than $50 million in annual sales in 1998 to more than $500 million in 2009.

“Starbucks unilaterally and unjustifiably declared in public statements the agreement’s termination, needlessly risking confusion among customers about the agreement’s status,” said Marc Firestone, executive vice-president, corporate and legal affairs and general counsel, Kraft Foods.

Following Kraft’s response, Starbucks issued its own statement in which it said the agreement between the companies is not perpetual in nature and is set to expire in 2014, unless sooner terminated per the agreement.
Starbucks also said Kraft did not meet its responsibilities to work closely with Starbucks on marketing decisions and customer contacts.

“Kraft’s failure to meet its responsibilities resulted in the erosion of brand equity and experience at grocery that Starbucks customers have come to expect through their experience in Starbucks stores,” Starbucks said.

Starbucks said it now plans to take back the business on March 1, 2011.

Kraft said if Starbucks takes over the business, it needs to give Kraft time for a transition and must compensate Kraft for the fair market value of the business plus a premium of up to 35%.

“In effect, Starbucks is trying to walk away from a 12-year strategic partnership, from which it has greatly benefited, without abiding by contractual conditions,” Mr. Firestone said. “Kraft reasonably expected Starbucks to honor the contract. We are confident in our position and look forward to presenting the facts before the arbitrator.”

Starbucks is expected to give more details during a meeting with analysts on Dec. 1.