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.