The trouble with Starbucks
By Jenny Wiggins. Portrait by Charlie Bibby
Published: December 12 2008 11:43 | Last updated: December 12 2008 11:43
On a dark December morning three years ago, Howard Schultz bounded into a coffee shop in Dublin and started shaking hands with people in red T-shirts and green aprons before peppering them with questions. "Are you all new with Starbucks?" he asked the staff. "Who are the customers, and have they been to Starbucks before?"
The store was the second Starbucks to open in Ireland, and Schultz, a tall, lean, energetic man who had bought the Starbucks brand more than two decades earlier, was in town to find out what the locals thought of his empire. Watching his customers order espressos, lattes and cappuccinos as the morning sun slowly lit College Green Square, Schultz explained why the ubiquitous coffee brand had become so successful. "The story is kind of boring," he said. "We keep doing the same thing, year-in and year-out." And that thing wasn't really about coffee. Starbucks' rapid expansion, which saw it open more than 10,000 stores in three dozen countries, was sustainable, Schultz argued, because of the unique experience people had at the stores. "The one thing I think is really important," he said, "is the sense of community and human connection in every Starbucks store you go into."
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In 2005, Schultz had every reason to be confident about the future of the coffee chain that he had joined back in 1982 (when it comprised just four stores in Seattle). That December, Starbucks' stock was trading close to historic highs of about $30 a share. Its sales had risen by more than a billion dollars over the preceding year, as it opened stores in its home market twice as fast as it had in previous years. In its annual report, the company set itself a long-term target of owning 15,000 stores in the US, as well as "at least" another 15,000 internationally. Investors were told to expect earnings per share – a measure of profitability – to increase by 20-25 per cent annually over the next three to five years. Starbucks' objective, the report said, was to become the most recognised and respected brand in the world.
Was Schultz worried that the anti-globalisation activists who had attacked his stores in Seattle during the 1999 meeting of the World Trade Organisation might have done the brand permanent damage? Or the critics such as author Naomi Klein whose 2000 book No Logo accused the company of taking a generic product and "branding it so completely that it becomes a spiritual/designer object"? "Perhaps we have the opportunity to be a different type of global company…" he said simply. "One that makes a profit, but at the same time demonstrates a social conscience."
Starbucks was "the quintessential experiential brand", he claimed, which made it different from other big names such as McDonald's or Coca-Cola. The group didn't need to advertise on television because people found out about it by word of mouth. "The rules of engagement about building a consumer brand are very different from 10 years ago," he said. "That's why the power of the Starbucks brand is so solid, because it has been built on experience and not advertising and promotions." Anyway, Schultz has always been more interested in what he could do with coffee than in coffee itself. As a child in Brooklyn, he watched his parents drink instant – although they switched to percolated when they had guests. When Schultz describes his mother making the coffee, he talks about what it looked like rather than how it smelled or tasted: "I can remember with fondness the visual of the coffee perking and the little bulb on top."
He first discovered the taste of good coffee in 1981, when he was 28 and living in New York, managing the US operations of a Swedish company that sold kitchenware. He was puzzled as to why a small Seattle company, Starbucks Coffee, Tea and Spice, was ordering large quantities of an unusual kind of coffee filter – a plastic cone on top of a thermos – so he decided to pay it a visit. At the group's original store, in Seattle's historic Pike Place market, he was given a mug of coffee made with freshly ground beans from Sumatra. In his autobiography, Schultz says he was "hooked" by the third sip. "I realised the coffee I had been drinking was swill." As well as the coffee, he liked the people who owned Starbucks: Gerald Baldwin and Gordon Bowker, former college roommates from the University of San Francisco who had founded the company 10 years earlier and still only sold coffee beans, rather than coffee by the cup. On the plane back to New York, Schultz was already thinking about how he could become part of Starbucks. "Maybe," he thought, "I could help it grow."
A year after pitching to Starbucks' founders his vision of it as a national coffee chain, Schultz was hired and put in charge of marketing. (Baldwin and Bowker were initially reluctant to take him on for fear his "energy" would destroy the company's mellow culture.) A year into the new job, Schultz had an epiphany which proved instrumental in forging the Starbucks we know today – the Starbucks in which "experience" is meant to trump all. On a business trip to Milan, he discovered what he calls "the romance of the Italian coffee bar". He started thinking about what Starbucks could become if it were to sell cups of coffee as well as beans. "It crystallised in my mind that coffee brought people together… and that as far as I could envision, at the time there did not exist in the US a place that brought people together with coffee as the conduit." But his vision caused the Starbucks founders to baulk – and Schultz had to leave the company to achieve it. He opened his own espresso bar, which he named Il Giornale, in 1986. Little more than a year later, he was back knocking on Starbucks' door – this time to buy the company. He merged their six stores with the three Il Giornale bars he'd established and dropped the Il Giornale name for the more recognisable Starbucks brand. From there, it grew and grew, and, 20 years later, in a cosy corner of Dublin, Schultz appeared to have achieved his dreams.
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Two months ago, Schultz was back in Europe, this time in London. Starbucks was holding a two-day conference for more than 1,000 British and Irish store managers in the city's Barbican centre, and Schultz was making a surprise appearance to boost morale.
Now 55, he was as slim as he had been three years earlier, and retained a neat, simple sense of style: white shirt tucked into grey trousers. But his face was paler than before, there were deeper lines on his brow and dark circles under his eyes. His hair, brushed back, was greying at the temples. He walked on stage at the Barbican Hall to cheers, applause and wolf-whistles. "Wow!" he said, and then, to friendly laughter: "Before I begin, is it possible to turn on the house lights so I can see you all?"
He stood very still, in the centre of the stage, hands clasped in front of his chest, as he assured the assembled employees that he had not come to give them a speech. Instead, he said, he had come "to talk from my heart". He began a story about a Starbucks customer he had met in a store in downtown Los Angeles a few weeks earlier: a plainclothes policeman with a gun in a holster on his waist. The man's name was Officer Kevin Coffey. "This is honest-to-God his name … C-O-F-F-E-Y."
Coffey's partner on the beat had been killed in a train accident three weeks earlier. The pair used to stop at Starbucks daily, and it had been her last stop-off before boarding the train. The man told Schultz that when his wife had asked him to consider giving up Starbucks in an effort to cut costs, he'd told her: "This store meant so much to us ... I can't give up Starbucks, because it's not only about the coffee."
The story was hackneyed – and one Schultz had told me half an hour earlier, in an interview – but it seemed to work. A sombre mood emerged in the auditorium as Schultz talked about the "humanity of Starbucks" and how it was more important than ever for store managers to create an experience that "values and respects" customers. Schultz needed to get his audience's attention. For the first time in the company's history, the number of people coming through its doors was falling rather than rising. It was losing money – this summer, it reported its first quarterly loss – as was Schultz, who had watched Starbucks's stock-price drop to $7 a share. Six hundred "underperforming" company-owned stores in the US (where more than 10,000 stores today contribute three-quarters of its sales) and most of its stores in Australia faced closure, and thousands of jobs were to be lost.
What had gone wrong? Like many retailers, Starbucks was hit by the economic crisis as people tried to stem their spending. This year's annual report, instead of boasting about predicted profits, warned of "an extremely challenging" 2009. But the credit crunch wasn't the only problem – or even the core problem: Starbucks' woes had begun long before the financial crisis emerged in late summer, as early as the late 1990s. As the company's stock price took off, management – who received large chunks of their compensation in stock options – succumbed to pressure from Wall Street analysts and investors to accelerate growth, sacrificing the brand's integrity in the process. When Starbucks held a meeting for the analysts who covered the company in October 2006 it was "like an adoration fest of Wall Street" said one analyst who attended.
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In January this year, Schultz unexpectedly returned to the helm of the company, resuming the chief executive role he'd left in 2000. If he was going to put Starbucks back on its feet, he'd have to rethink what it stood for. Part of that process would be a look within: Starbucks has been Schultz's life work. He is fond of telling the story – a boy from the Brooklyn projects sees his father, a blue-collar worker, struggle to feed the family and determines to build a better life. "I grew up literally on the other side of the tracks … I had a healthy respect for how I grew up but I wanted to improve on that. I didn't want to wind up in public housing." Asked what drives him today, he still says "insecurity".
How to brew the perfect cup
1 Start with quality, freshly roasted coffee beans.
2 Since coffee is 97 per cent water, use the purest you can find: preferably bottled or filtered (but avoid distilled).
3 Get your ratios right. The coffee-to-water ratio determines strength and flavour. The ideal is generally considered to be two tablespoons for every 180ml of water. Adjust to taste.
4 Use a fine grind for a quick extraction (20–25 seconds) and a coarse grind for longer extractions (3–4 minutes). Overly lengthy extraction leads to harsh flavours; brevity to undeveloped ones.
5 Ideally brew between 195˚F and 205˚F, just below boiling point. Higher heats will scorch the coffee, making it harsh and bitter.
As a boy, Schultz wasn't interested in business: he wanted to be a professional athlete, and went to Northern Michigan University on a football scholarship. He graduated with a degree in communications and worked in a ski lodge for a year before getting a place as a sales trainee at Xerox. "I walked out with a healthy sense of self-esteem," he says in his book. He spent several years in sales, doing a lot of "cold calling" before joining the Swedish kitchen goods company, Hammarplast, in 1979.
Although Schultz's initial idea was to build a chain of espresso bars where people could drink coffee standing up – like they did in Italy – he soon realised that customers, who could increasingly afford to drink $2.50 lattes as the economy boomed, liked sitting down and lingering. A tweaked vision emerged: Starbucks could become the American equivalent of the English pub, the German beer garden and the French café. The company began building bigger stores, with more seating. And as laptop computers became commonplace accessories, the shops became a destination for people who wanted to work as well as socialise.
By 1990, Starbucks was profitable, and a year later it was offering stock options to all its employees (which is when it started calling them "partners") – in addition to full healthcare, even for part-time staff. In 1992, it listed on the New York Stock Exchange and by the mid-1990s, the coffee-shop experience was so common to Americans that it played a central role in the decade's hit television series, Friends. Starbucks had spotted what people wanted before they knew they wanted it.
But as Starbucks pursued growth, the company got lazy, and, some say, greedy. To make lattes and cappuccinos more quickly, it replaced its labour-intensive La Marzocco espresso machines, which required baristas to grind and press coffee for every cup. In their place, it installed Verismo automatic machines, where the barista's role was reduced to pressing a button and watching the coffee flow out. (Starbucks's baristas complained of being "de-skilled"). And it wasn't just the taste of the coffee – Schultz's coffee-house experience was also suffering. To help maintain sales momentum (the company was very proud of its record of increasing comparable store sales by at least five per cent, year-on-year) it diversified away from coffee and started selling hot food, CDs, books and DVDs. Meanwhile, the company opened so many stores, so quickly, with the same design (often getting rid of plump armchairs and couches and replacing them with hard wooden chairs), that by 2007 even Schultz was describing them as sterile.
At the same time, competitors were emerging, some of them from unexpected places such as the world of fast food: McDonald's and Dunkin' Donuts both realised they could draw in more customers by selling good coffee – customers primed by drinking Starbucks' brew. Dunkin' Donuts runs a website, DunkinbeatStarbucks.com, which encourages people to e-mail virtual postcards bearing messages such as: "Friends don't let friends drink at Starbucks." McDonald's encourages similar "interventions": "Click here to help a friend kick their snobbish habit," reads one window at its website, Unsnobbycoffee.com. Enough people clicked, and soon Starbucks was feeling the business equivalent of caffeine withdrawal symptoms.
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Before Schultz stepped off the stage at the Barbican, he told his employees that Starbucks had created many of its own problems. "The question is," he said, "are we going to be able to right the ship?"
To do so, Schultz is doing more than telling stories. He is also making serious changes to the product, trying to claw back some of the ground lost in the past decade, when perceptions of Starbucks coffee went from being the best on the block to the high-street equivalent of instant. To start, he is spending tens of millions of dollars on new coffee machines. One, called the Clover, makes brewed coffee – for which Starbucks will charge a premium because the Clover requires both more beans and more labour (the beans are "scooped, weighed, ground and brewed to order"). Another machine, called the Mastrena, makes espressos. Although baristas are still only required to push a button, it grinds coffee fresh for each cup, and is smaller and prettier than the Verismo machines now in use, allowing customers to see the baristas making their drinks.
That detail hints at what Schultz knows as well as anyone – that just making better coffee is not the answer: it's the experience, stupid. But Schultz is more radical: "It's not enough to reaffirm our coffee position and embrace the heritage and tradition of the company… it has to be linked with innovation so we stay ahead." He refers to Steve Jobs, Apple's co-founder (whom Schultz knows and for whom he says he has "a healthy respect"), and asks: "Who would have thought, five to 10 years ago, that Apple would reinvent itself?"
He also knows that Starbucks cannot be as complacent as it once was – in a harsh economic climate, it needs to give people a good reason to make Starbucks part of their day. It has to advertise on television. It has to offer "value" by running promotions and loyalty schemes, such as a "Gold Card" that will give customers a 10 per cent discount on store purchases for a $25 annual membership fee. "These were things that were never part of our DNA in the past, that need to be now," he reasons.
But he rejects the idea that it is time for Starbucks to give up its aspirations to be more than a mass-market consumer brand. "I think it's really important for the leader of an organisation of any size to create a vision and a picture for people to aspire to be part of. The question isn't whether or not it's realistic, the question is: do people want to be part of that?"
And there's the crux of the comeback – and where Schultz is taking a gamble. Can he create an experience as inviting as the Starbucks of the 1990s, but suited to a world in recession? It's a cliché of credit-crunch analysis to point out that unemployed bankers will soon lose their taste for $2.50 cups of coffee, no matter how comfy the in-store sofas. Is it one Schultz can prove is unfounded? Brand consultants say cups of giant, milky, overpriced coffee were something of a fad that coincided with the bull market. Now that consumers are more fussy about how they spend their money, they are questioning why they went to Starbucks in the first place. "Starbucks needs to seriously and rapidly re-evaluate what the brand stands for, what it sells, and what the consumer experience should be," says Don Williams, chief executive at London-based brand consultancy Pi Global. "Far from exuding an air of everyday indulgence, the often slightly dog-eared assembly line that is your average Starbucks store is suffering the double whammy of being both too familiar and overpriced."
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Starbucks is not the only big consumer brand to have run into trouble. McDonald's successfully turned itself around after both its sales and stockprice dropped sharply in the early 2000s. It redesigned its restaurants and came up with healthier menus. But McDonald's does not pretend to be more than what it is: a restaurant chain that sells cheap food fast. Although it has made minor additions to its menu such as salads and organic milk, it knows its core business is selling hamburgers.
Some of Schultz's turnaround measures are purely pragmatic. He wants to reduce the company's dependence on the US: "2009 will be the first year in our history where we will have opened more stores internationally than in North America and I suspect that trend could continue for a couple of years," he says. Focusing on other markets will allow Starbucks to keep meeting Wall Street's demands for continued growth even as sales fall on home soil. Still, it will be no mean feat – sales are dropping in Canada and the UK, too. And as its experience in Australia showed, where a mature and sophisticated coffee-consuming market, educated by the country's Italian immigrant community, rejected the brand, Starbucks cannot assume that people will embrace its coffee culture.
Like other chief executives trying to slim bloated organisations, Schultz has been getting rid of layers of senior management, and phasing out "non-core" products – such as smelly hot sandwiches in the US (to be replaced by sandwiches that don't interfere with the coffee aroma), and some of the books and CDs it sells. Stock analysts say Starbucks can push changes through quickly because Schultz's opinions are respected. "If it had been anyone other than Howard, there may have been more resistance," says Sharon Zackfia, an analyst who tracks the company at US investment group William Blair & Co. "He invites opinions but at the end, what he says goes."
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Some Starbucks-watchers think the real key to the company's future lies in its ability to meet less prosaic needs. Nancy Koehn, a professor at Harvard Business School who published a case study on Starbucks earlier this year, believes that when the financial turbulence under way in many parts of the world eases, a new set of consumer values could emerge. She predicts that after the "shock and awe" of the recession dissipates, Starbucks has a good chance of re-engaging with consumers who want to buy products from companies with a social conscience. "This brand," she argues, "has much more room in it to absorb these new values than McDonald's or Dunkin' Donuts."
Schultz, who seems more humble than he was three years ago, takes personal responsibility for pushing Starbucks too far too fast ("I've said to people, if you want to blame anyone, blame me"). He says he still thinks it is possible to create a different kind of company while pursuing growth: "It is vitally important that we maintain our commitment to the basic fundamental value of what Starbucks stands for, whether it was Fair Trade yesterday or the Red campaign we're launching in the US [Starbucks is donating money from some of its Christmas drinks sales to African Aids programmes as part of the Product Red campaign]… I take great personal pride in the fact we are now the largest buyer of Fair Trade coffee in the world – we couldn't do that when we were small."
Maybe. Schultz seems to believe it, and he has little reason to fool himself: "I'm the largest individual shareholder, so I've lost a tremendous amount of equity myself, more than any other individual," he says. "I've lost almost a billion dollars. So I'm personally very motivated." And there's a bigger motivation than just money. "It's the respect," he says. "The legacy."
There are signs that Schultz is close to figuring out what that legacy could be. A few days after the US election, he wrote an article for The Huffington Post, a liberal news website, telling business leaders not to leave the problems of fixing the US economy to the president-elect. "Now is a time to invest, truly and authentically, in our people, in our corporate responsibility and in our communities. The argument – and opportunity – for companies to do this has never been more compelling," he wrote.
The piece struck a chord, and Schultz was swamped with interview requests. "I wasn't prepared for what was going to happen," he says earnestly. "I wasn't looking for a platform. I wrote it as much for our people as I did for the general audience; the responsibility of business is not to turn inward during this time, that's what responsible capitalism means." Some responses were critical: "Corporate social responsibility," wrote one, "is somewhat of an oxymoron, especially coming from Starbucks, [which] put the little guys, the neighborhood coffee-houses and shops out of business, took the individual feel away and replaced it with a cold, green, retail coffee shop with weak and bitter coffee." But he also received support: "Great ideals and I hope they are not just empty words," read another post. "Large companies evading their social responsibility is at the root of the current problem."
Schultz has been here before. Starbucks was attacked for being a faceless corporate entity more than a decade ago, and ever since Schultz has struggled to persuade people that's not the case. But he is a remarkably zealous man; the kind who is so focused on thinking about what to do next that he doesn't see the problems in front of him. He describes himself as being "ultra-curious": "I've always felt like I have the inherent ability to see things that were either under the rock or around the corner."
Schultz never wanted Starbucks to become a "soulless big chain". But he allowed it to happen, perhaps because he was so driven (he sleeps only five hours a night) that he didn't know when to stop. Now that he has been forced to slow down, the question is what he will do with the time he has been given. He has come close to realising his goal of making Starbucks the most recognised brand in the world. Does he still have a chance to make it the most respected, or even the best loved?
Jenny Wiggins is the FT's consumer industries correspondent
Copyright The Financial Times Limited 2008