Starbucks Chairman Says Trouble May Be Brewing

Brand Could Be Compromised,Schultz's Blunt Memo Warns;'Time to Get Back to the Core'By JANET ADAMY WSJ, February 24, 2007; Page A4

In our class discussions on Driving Organic Growth, we repeatedly talked about the importance of the emotive component of a value proposition. I actually used Starbucks as an example of building an empire by creating the “Starbucks experience”. The following is an excellent example of the challenges to maintain that emotive edge and its importance on maintaining competitive separation and pricing as the business expands.

We also emphasized that emotion is just not for the B to C world. My own experience of marketing and selling industrial nylon to the bias truck tire industry (talk about a commodity product) in the early 80”s is a case in point. My largest customer was 2X the next largest (about 4 customers in this range) and we had at least a 10% price premium at this customer! The reason is that my predecessors never shorted this customer over the previous 15 years when there were periods of major supply demand imbalances and I maintained that position (as we did with our smaller 100% customers who also had a 10% premium). This company knew or suspected they were paying more but the peace of mind of the purchasing agents knowing their preferred supply position kept them inbay. When you realize that were are talking about > 100 million pounds a year at this one customer, focusing on the emotive component of our value proposition yielded enormous financial rewards to my company.

If you e-mail formatting does not allow you to see my highlighting, go directly to the blog for easier reading

Starbucks Corp. built its broad appeal on what Chairman Howard Schultz labeled an "experience," including baristas who know customers' orders by heart and an atmosphere that entices patrons to linger for hours. That experience has enabled the coffee chain to charge the premium prices that fuel its robust earnings growth.

But now Mr. Schultz is questioning whether Starbucks' drive for growth and efficiency has diluted that experience. In a blunt Feb. 14 memo, he warned executives that the chain may be commoditizing its brand and making itself more vulnerable to competition from other coffee shops and fast-food chains. The nearly 800-word memo questioned whether Starbucks' automatic espresso machines, new store designs and elimination of some in-store coffee grinding may have compromised the "romance and theatre" of a visit.

The criticisms pinpoint Starbucks' biggest challenge. Mr. Schultz, the company's resident visionary, wants Starbucks to become one of the world's most recognized brands, with 40,000 locations around the globe, or more than triple its current count of about 13,000. But to do that, Starbucks must improve its efficiencies and make other changes that threaten to erode the virtues that made it so successful -- which in turn could jeopardize its ability to charge premium prices."

Over the past ten years, in order to achieve the growth, development, and scale necessary to go from less than 1,000 stores to 13,000 stores and beyond, we have had to make a series of decisions that, in retrospect, have lead [sic] to the watering down of the Starbucks experience, and, what some might call the commoditization of our brand," (A CLASSIC DILEMMA!!!!) Mr. Schultz wrote in the memo."Many of these decisions were probably right at the time, and on their own merit would not have created the dilution of the experience; but in this case, the sum is much greater and, unfortunately, much more damaging than the individual pieces."Starbucks spokeswoman Valerie O'Neil confirmed that Mr. Schultz wrote the memo. She said it reflects his "passion" and is "a reminder of how success is not an entitlement." She said the company hadn't yet implemented any changes as a result of Mr. Schultz's memo.

Nevertheless, even before Mr. Schultz sent the memo, Starbucks executives had conceded there was a risk that its expansion would move the company away from its roots. "If we just become about products, and not about the people side, I think the experience changes, and changes for the worse,"(THEY BEGAN TO FOCUS TOO MUCH ON THE PRODUCT AND COST REDUCTION EFFORTS AT THE EXPENSE OF THEIR UNDERLYING COMPETITIVE POSITION--THE EXPERIENCE) Jim Alling, president of Starbucks' U.S. business, said in an early February interview. "We never want to lose sight of where we came from."

The concern comes as Starbucks faces intensified competition from McDonald's Corp., which has upgraded its coffee, and Dunkin' Brands Inc.'s Dunkin' Donuts, which sells espresso drinks and is plotting a nationwide expansion. In recent years, as both those fast-food chains have added Starbucks-like touches, Starbucks has become more like a fast-food chain, adding drive-through windows, hot food and promotions for movies on its lattes. (THIS TYPE OF SHIFT OFTEN OCCURS WHEN THERE IS A CLEAR LEADER AND GROWING COMPETITORS) Mr. Schultz declined to comment for this article. He sent the memo in an email with the subject line, "The Commoditization of the Starbucks Experience." It then appeared on the Web site starbucksgossip.com.

Although not Starbucks' founder, Mr. Schultz is responsible for building the company into the coffee empire it is today. He led the chain to blanket the U.S. with outlets starting in the 1990s and to expand overseas, and he also has steered it to growth through music and movie collaborations.

Starbucks' steady sales and earnings growth have made the company's shares soar since it went public in 1992. Starbucks said net income for the quarter ended Dec. 31 came to $205 million, or 26 cents a share, up 18% from $174.2 million, or 22 cents a share, a year earlier. Sales rose 22% to $2.36 billion from $1.93 billion. Shares of Starbucks have fallen about 9% in the past year. They fell 26 cents in Nasdaq trading yesterday to close at $32.75.

After growing up poor in a Brooklyn housing project, Mr. Schultz left his job as a salesman and moved to Seattle to join Starbucks in 1982. He envisioned expanding the niche brewer of strong coffee beyond the Pacific Northwest by bringing the romance of Italian coffee bars -- and their espresso -- to Starbucks so it would become an enticing gathering place.Mr. Schultz has sometimes bristled at changes that were part and parcel of the massive expansion he orchestrated. When an executive suggested Starbucks start offering nonfat milk for its espresso drinks, Mr. Schultz initially refused out of concern the drinks would taste thin. He went along after watching a customer in jogging gear walk out of a Starbucks because she couldn't get nonfat milk in her drink.

Last fall, Starbucks said it would add hot egg-and-cheese breakfast sandwiches, in part to attract customers who went to competitors to eat. Starbucks executives conceded there was a danger the sandwiches would make customers think of Starbucks as a fast-food restaurant. To prevent that, the company included more-sophisticated combinations, including eggs Florentine and tomato Parmesan.

When workers first tried cooking the sandwiches, cheese sometimes dripped off them and into the warming oven, sending a strong odor of burned cheese through the cafes. Mr. Schultz complained when he walked into a Starbucks near the company's Seattle headquarters and smelled a burning sandwich, according to a manager at the store. Starbucks switched ovens and told workers to clean them regularly.

More than one-quarter of Starbucks stores now have drive-through windows, and Starbucks says that over the next two years, that will grow to one-third of stores. At her Seattle store, shift supervisor Tanisha Jones says she concocts nicknames for drive-through customers based on their cars to make them feel the same warmth employees try to convey inside the stores. One customer who drives a Mini Cooper now orders the "Mini Cooper special," and Ms. Jones has instructed workers that that means a Quadruple Grande Americano with cream. "It's almost a hook to keep him from going to another coffee shop," she says.

Sacrificing 'Romance and Theatre'

In his memo, Mr. Schultz wrote that when in recent years the company switched to automatic espresso machines -- which have been used in some stores for at least five years and currently are in thousands of outlets -- "we solved a major problem in terms of speed of service and efficiency. At the same time, we overlooked the fact that we would remove much of the romance and theatre." Starbucks used to have all its baristas pull espresso shots by hand.

That move "became even more damaging" because the new automatic machines "blocked the visual sight line the customer previously had to watch the drink being made, and for the intimate experience with the barista," he wrote.Mr. Schultz wrote that Starbucks switched to "flavor locked packaging" for its coffees that eliminated the task of scooping fresh coffee from bins in stores and grinding it in front of customers. "We achieved fresh roasted bagged coffee, but at what cost?"

Mr. Schultz wrote. "The loss of aroma -- perhaps the most powerful non-verbal signal we had in our stores (VERY SUBTLE BUT POWERFUL!!!)."Mr. Schultz also wrote that streamlining the store-design process had created "stores that no longer have the soul of the past....Some people even call our stores sterile, cookie cutter," he wrote.

Some Starbucks stores no longer have coffee grinders or coffee filters. "In fact, I am not sure people today even know we are roasting coffee. You certainly can't get the message from being in our stores," the memo says."While the current state of affairs for the most part is self induced, that has lead [sic] to competitors of all kinds, small and large coffee companies, fast food operators, and mom and pops, to position themselves in a way that creates awareness...and loyalty of people who previously have been Starbucks customers. This must be eradicated," he wrote.

Some customers have noticed. Brad Luyster, a 41-year-old marketing manager from Canal Fulton, Ohio, says he used to seek out a Starbucks each morning to get a cup of coffee because he likes the atmosphere. But he was disappointed when he recently ordered a bacon-and-egg sandwich at a Starbucks in Chicago. The taste of the sandwich was fine, he says. It just didn't fit the experience.At the end of his memo, Mr. Schultz said he took full responsibility for the decisions Starbucks has made. "We desperately need to look into the mirror and realize it's time to get back to the core," he wrote. "I have said for 20 years that our success is not an entitlement and now it's proving to be a reality."

INTERESTINGLY, MC DONALDS CAME FROM THE OTHER DIRECTION. THEY EXCELLED AT PRODUCT QUALITY AND CONSISTENCY AND ARE NOW ADDING THEIR OWN EXPERIENCE. INTERESTINGLY, WHEN MY SON WAS JUST A KID, WE WENT TO MC DONALDS LESS BECUSE OF THE FOOD (AT LEAST FOR ME) BUT IT WAS THE MC DONALDS FAMILY EXPERINCE. THEY LOST THAT OVER THE PAST 10 YEARS OR SO BUT ARE GOING "BACK TO THE FUTURE".

IF ANY OF YOU HAVE A CASE WHERE THE EMOTIVE COMPONENT OF YOUR VALUE PROPOSITON IS CRITICAL, PLEASE SHARE IT WITH THE GROUP.

The American Way
By HAROLD EVANS WSJ February 17, 2007; Page A9

This is an unusual posting in that it is a fabulous editorial discussing innovation as the backbone of our American success. I thought our Kellogg community would enjoy the insights on innovation. If your e-mail formatting does not show where I highlighted, you might want to go direct to the blog site.

Enjoy…..

Why does the American economy keep confounding the Jeremiahs (and the Dow Jones Industrial Average keep soaring)? It is the appetite for innovation, the extraordinary capital to support risk, and the political framework of freedom for the individual. I recently asked Sergey Brin and Larry Page, through their search engine Google, what they could discover about American chief executives and innovation. They gave me 9,850,000 entries to read. By now it may be up to 10 million or more.

This cornucopia about innovation reflects a major but little remarked change that has taken place in American business thinking. Of course, Google is just one of the innovations which now make up the tissue of our everyday lives -- think of email, antibiotics, television, statewide banking, FM radio, personal computers, the uplift brassiere, helicopters, instant cameras, cell phones, synthetic fibers, radio tuners, MRI scanners, scheduled airmail, trans-Atlantic flights, fish fingers, microwave ovens, transistorized hearing aids, artificial insulin, lasers and jet planes, not to mention the container shipping that effectively initiated globalization.

The focus used to be on efficiency. As a crude guide to the developing change in emphasis, Google gives me today only half as many entries for CEOs and efficiency as it does for CEOs and innovation. Efficiency, once the be-all and end-all, is no longer considered enough for survival in the world economy. In a global marketplace, efficiency -- and the cost cutting associated with it -- is essential but may not be enough when competitors in China and India can discount you to death with demographics.
Our future depends on groundbreaking innovation. Yes, we must implement and develop the lead with efficiency, but in that management process never lose sight of the animating vision that created the innovation in the first place, or the lead will surely vanish. The mountain ranges of innovation are littered with the skeletons of the great corporations that lost sight of the summit they set out to conquer.

Flying across the vast landscape mapped by Google, however, a random descent to inspect what they are saying in the valleys reinforces the impression that while innovation is currently valued more than ever, this value is in danger of depreciating. There are any number of offerings in the Google search results and business literature that are described as innovations but are really techniques of managing an existing business or improving it at the margins. These are very useful no doubt, but have nothing to do fundamentally with innovation, change and especially systemic change.

We should reserve the terms "innovation" and "innovators" for real change and not confuse it with different functions. There is a fairly common acceptance of Joseph Schumpeter's definition of innovation as entrepreneurship, embraced also by Peter Drucker. It may be lèse-majesté to say so, but that acceptance is a pity. Entrepreneurship, the assumption of risk, may not be innovative at all. You assume risk if you open a new auto dealership, but this is not innovative unless you are the first.

An entrepreneur may be the enemy of innovation. David Sarnoff, the black-belt bureaucrat who headed RCA, was a classic entrepreneur, but he was the relentless and unscrupulous enemy of innovation in the introduction of FM radio. He was heavily invested in making AM radios and broadcasting AM through RCA's National Broadcasting Corporation. So he did his best to sabotage the astoundingly brilliant Edwin Howard Armstrong (1890-1954), inventor of FM, even though he had the right of first refusal of Armstrong's invention.

Armstrong, the inventor of so much in the technology of transmitting sound, was forced into being an innovator, starting his own company and broadcasting music flawlessly from WQXR in New York on July 18, 1939. (Interestingly, the 425-foot radio tower he built in Alpine, N.J. in 1937 to 1938 for the first FM radio station, was the salvation for NBC, among others, when the antenna on top of the World Trade Center collapsed in the 9/11 outrage.)

Postwar, Sarnoff became a genuine promoter of innovation in pioneering a system of color TV compatible with black and white, defeating the non-compatible electromechanical system pushed by Bill Paley of CBS. But Sarnoff, entrepreneur, also did to Philo T. Farnsworth (1906-1971), the inventor and innovator of electronic television, what he had done to Armstrong. In the end he had to pay Farnsworth for his groundbreaking patent but then had the gall to claim the credit he did not deserve as "the father" of television. He was certainly an innovator in the creation of a number of myths about himself: Time magazine's 100 Most Important People of the Century issue (in 2000) still credited him as the innovator of both radio and television.
When an innovator is overlooked or an innovation misrepresented it is not simply a question of equity; it distorts our perception of the essence of innovation and the essential qualities of an innovator. It clouds our perception of what it takes to survive in global competition.

The individual dominates the story of American innovation and is insufficiently honored in our histories -- to say nothing of the abysmal history courses in schools and colleges. Only recently did Columbia University honor Armstrong with a plaque in his laboratory, and Rutgers University is still short of funds to catalog properly the immeasurable riches of Thomas Edison's papers -- all five million pages of them.

The research departments of major corporations have not been unproductive -- one thinks of the Bell Labs for the transistor and today Monsanto in biotechnology -- but can anyone have had more impact on our world than the 23-year-old trucker who got frustrated at the day he spent on the noisy pier in Hoboken, N.J., waiting to have his cotton bales unloaded from his truck, loaded onto the cargo ship, and then unloaded and loaded again at the other end?

For nearly 20 years, Malcom McLean did nothing about his inspiration that it would have saved everyone a lot of time and trouble if he had just been able to drive his truck on to the ship. Why didn't anybody facilitate that before he organized the sailing of the Ideal X from Port Newark, N.J., on April 26, 1956? Might as well ask why it took us so long to put wheels on luggage.
Mr. Evans is the author of "They Made America: From the Steam Engine to the Search Engine: Two Centuries of Innovators" (Little, Brown, 2004).

For innovation success, do not follow the money

By: By Michael Schrage, FT.com sitePublished: Nov 07, 2005

The excerpt builds off the Open Innovation discussion in an earlier posting. I believe Open Innovation approaches can dramatically enhance R&D productivity as defined below. Open Innovation is NOT about reducing cost; it IS about enhancing our innovation effectiveness.

...............Any policymaker, chief executive or innovation champion who relies on R&D intensity and R&D budgets as a meaningful or usable metric to assess global competitiveness virtually guarantees shoddy analysis and distorted decisions. Few things reveal less about a company's ability to innovate cost-effectively than its R&D budget. Just ask General Motors. No company in the world has spent more on R&D over the past 25 years. Yet, somehow, GM's market share has declined.

"There is no correlation between the percentage of net revenue spent on R&D and the innovative capabilities of an organization – none," Bart Becht, chief executive of Reckitt Benckiser, the Anglo-Dutch consumer cleaning products leader, said recently. The $8bn-per-year revenue company reports an R&D intensity of 1 per cent. Nevertheless, Mr Becht's company enjoys a reputation both for innovation and for relatively high margins of its global products. Similarly, Illinois Tool Works – a diversified $11bn industrial products company – spends but 1 per cent of its revenues on R&D across its 665 business units. Yet the 93-year-old company is likewise regarded as a premier industry innovator that consistently ranks in the top 100 of US corporate patent recipients. Even Apple Computer defies the high-tech, high R&D intensity stereotype associated with successful innovation icons. Apple's 2004 R&D intensity of 5.9 per cent lagged behind the computer industry average of 7.6 per cent. More significantly, its $489m annual R&D spending was a fraction of larger competitors such as Sony or Microsoft. Yet the iPod, iTunes and iBook enjoy breakthrough status as profitable innovations that have extended the company's global reach.

This anecdotal evidence is not atypical. Last month, Booz Allen, the consulting giant, published a report confirming the fears of executives who see innovation as a holy grail to market share and profitability. The survey of the world's top 1,000 corporate R&D spenders found there was "no discernible statistical relationship between R&D spending levels and nearly all measures of business success including sales growth, gross profit, operating profit, enterprise profit, market capitalization or total shareholder return". In other words, more is not better. ..............

R&D productivity – not R&D investment – is the real challenge for global innovation. Innovation is not what innovators innovate, it is what customers actually adopt. Productivity here is not measured in patents granted but in new customers won and existing customers profitably retained..............

What is not fine – what is deceptive and destructive – is perpetuating a myth that the economic health of a country or of a global enterprise can be measured by how much it allegedly spends on R&D as a bid to invent the future.

Preaching From the Ballmer Pulpit


By STEVE LOHR
NY Times, Published: January 28, 2007

There was a fabulous article on one of the most successful companies of our generation, Microsoft, in this past Sunday’s New York Times. It was an extensive interview of their CEO, Steve Ballmer. I excerpted the article to point out how a very successful company struggles when faced with a major market discontinuity. The important thing is that they have recognized it and are driving change.

“You’ve got to be very realistic about where you are, but very optimistic about where you can be…..

THE DISCONTINUITY IN THE MARKET

More homes and offices are getting wired with high-speed Internet connections, a market-altering shift that is buttressed by a stream of advances in data storage, computer-processing and software. This second generation of Internet technology animates advertising-supported Web services like search, and opens the door to the delivery of online alternatives to Microsoft’s popular desktop programs like e-mail, word processors and spreadsheets…..

THEIR INITIAL REACTION
Mr. Ballmer and other Microsoft executives often scorned online alternatives to its desktop software as second-class options with no market. Internet-based software, they say, lacks the features and functions of Microsoft’s “rich client” programs. Also, what happens when computer users are not connected to the Internet, say, on an airplane?
That’s wishful thinking on Microsoft’s part, according to the Internet insurgents from Google and elsewhere. They say Microsoft’s critiques attack older, browser-only programs instead of newer software services that place some applications on PCs while also linking the machines over the Web to supercomputing data centers. New features and services, they say, can flow to users every time they tap in, instead of waiting three years for the next version of Office………

THE CALL TO ARMS
An internal memo written 15 months ago by Ray Ozzie, who has taken over for Mr. Gates as Microsoft’s chief software architect, had a different tone. It was titled “The Internet Services Disruption,” and it was a call to action. “It’s clear that if we fail to do so, our business as we know it is at risk. We must respond quickly and decisively.”

THE DILEMMA AND THE CHALLENGES IT BRINGS -- A HUGE PROBLEM FOR MOST OF US
“The dilemma for Microsoft is that it is a prisoner of its business model, and the fact that it is a gilt-lined prison makes it brutally hard to change.”
One of the evolutionary laws of business is that success breeds failure; the tactics and habits of earlier triumphs so often leave companies — even the biggest, most profitable and most admired companies — unable to adapt……..

BALLMER’S’ PERSONAL STRUGGLE
“One of the biggest mistakes I’ve made over time,” he acknowledges, “is not wanting to nurture innovations where I either didn’t get the business model or we didn’t have it.” ……
Pushing Microsoft outside its traditional comfort zone, Mr. Ballmer acknowledges, has not always been his first instinct

THE BEGINNING OF THE CHANGE
At one point, he says, “All software will become software with a service.” Mr. Ballmer emphasizes the word “with.” The clear message is that Microsoft is embracing the move toward software written by using open Web standards and delivered over the Internet, but that these software services will be added to Microsoft products instead of replacing them. We will move to the new world, he suggests, but will not cannibalize our flagship products.

THE IMPORTANCE OF RUNNING EXPERIMENTS
One subject the two have discussed repeatedly is the necessity for big companies to constantly keep evolving and trying new things, some of which will succeed and some of which will fail.

UNDERSTANDING HOW TO MANAGE ACROSS THE THREE HORIZONS IS CRITICAL (OPTIONS (HORIZON 3) , LAUNCHES (HORIZON 2), AND EXTENSIONS HORIZON 1)
“Focus is an essential thing, but you sort of want to focus short-term and be expansive long-term,” he explains. “If you really want to be a technology company that’s relevant and important and driving value for the long run, you’ve got to have big eyes.”


CHANGING THE BUSINESS MODEL AND IT IS HARD
A handful of executives attended, including Mr. Gates, Mr. Ballmer and Mr. Bach, who now leads the Xbox and Zune units....
“The real discussion came down to some very hard choices about Microsoft deciding to do something that was really not our normal model,” Mr. Bach recalls. A video game console is tailored for playing games, unlike a personal computer, which is a general-purpose system. The Xbox would run its own software. “It’s not Windows,” Mr. Bach says, “and we don’t pretend it’s Windows” — a notion that was heretical inside Microsoft when Xbox was first concocted…….
Still, despite investing billions, Microsoft has yet to show any profit from its video game venture. “Look, the jury is still out,” Mr. Ballmer acknowledges. “But I feel very confident that we’ve built a good market position with Xbox. I feel very confident that we’re on track to make money.”


THEIR CRITICAL QUESTION
Where will it find new growth as the Windows and Office businesses continue to mature? Can Microsoft navigate its way to a future that is as bright as its past?