Case 1 I Starbucks in 2004: Driving for Global Dominance
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exhibit
1
Number of Starbucks Store Locations, 1987-2003
licensed Locations of Starbucks Stores Outside the Continental United States, 2003 --
Source: Company records and reports.
encouragedto learn how to grind the beansand make their own freshly brewed coffee at home. Baldwin, Siegel, and Bowker were well acquainted with Peet's
'~' "-"", ., ~~
whole-bean coffees,while anotherhad shelvesof coffee products.The store did not offer fresh-brewedcoffee so\d by the cup, but tasting samples were sometimesavailable. Initially, Siegelwas the only paid -employee. wore a grocer's apron,scoopedout beans He
for customers,extolled the virtues of fine, dark-roasted coffees, and functioned as the partnership's retail expert. The other two partners kept their day jobs but came by at lunch or after work to help out. During the start-upperiod, Baldwin kept the books and developed a growing knowledge of coffee; Bowker served as the "magic, mystery,and romance man.,,2 The store was an immediate success,with salesexceeding expectations, partly becauseof interest stirred by a favorable article in the Seattle Times. For most of the first year,
2HowardSchultz and Dori JonesYang, Pour YourHeart Into It (New York: Hyperion, 1997),p. 33.
~
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Part 2 I Casesin Crafting and Executing Strategy
Starbucksorderedits coffee beansfrom Peet's,but then the partners purchaseda used roaster from Holland, set up roasting operationsin a nearbyramshacklebuilding, and came up with their own blends and flavors. By the early 1980s,the company had four Starbucks stores in the Seattleareaand had beenprofitable every year since opening its doors. But then Zev Siegel experienced burnout and left the company to pursue other interests. Jerry Baldwin took over day-to-day managementof the company and functioned as chief executive officer; Gordon Bowker remained involved as an owner but devoted most of his time to his advertising and design firm, a weekly newspaperhe had founded, and a microbrewery that he was launching known as the RedhookAle Brewery.
Howard Picture
Schultz Enters the
In 1981, Howard Schultz, vice president and general manager of U.S. operations for a Swedish maker of company depended mainly on word of mouth to get stylish kitchen equipment and coffeemakers,decided more people into its stores,then built customerloyalty to pay Starbucks a visit-he was curious about why cup by cup as buyers gained a senseof discoveryand Starbuckswas selling so many of his company'sprodexcitement about the taste of fine coffee. ucts. The morning after his arrival in Seattle,he was esOn his trip backto New York the next day,Howard corted to the Pikes Place store by Linda Grossman,the Schultz could not stop thinking about Starbucksand retail merchandising managerfor Starbucks.A solo viwhat it would be like to be a part of the Starbucksenolinist was playing Mozart at the door, his violin case terprise. Schultzrecalled,"There was somethingmagic open for donations. Schultz was immediately taken by about it, a passionand authenticity I had never experithe powerful and pleasing aroma of the coff~es, the enced in business."4 The appealof living in the Seattle wall displaying coffee beans, and the rows of cofarea was anotherstrong plus. By the time he landedat feemakers on the shelves.As he talked with the clerk Kennedy Airport, he knew in his heart he wantedto go behind the counter,the clerk scooped out some Sumato work for Starbucks.At the first opportunity, Schultz tran coffee beans,ground them, put the grounds in a asked Baldwin whetherthere was any way he could fit cone filter, poured hot water over the cone,and shortly into Starbucks. Although the two had establishedan handed Schultz a porcelain mug filled with freshly easy,comfortable personal rapport, it still took a year, brewedcoffee. After taking only three sips of the brew, numerous meetings at which Schultz presentedhis Schultz was hooked. He began asking the clerk and ideas,and a lot of convincing to get Baldwin, Bowker, Grossmanquestionsabout the company,about coffees and their silent partner from San Franciscoto agreeto from different parts of the world, and about the differhire him. Schultz pursued a job at Starbucks far more ent ways of roasting coffee. vigorously than Starbucks pursued hiring Schultz. A bit later, he was introduced to Jerry Baldwin There was some nervousnessabout bringing in an outand Gordon Bowker, whose offices overlooked the sider, especially a high-powered New Yorker who company's coffee-roasting operation. Schultz was had not grown up with the values of the company. struck by their knowledge about coffee, their commitment to providing customers withcquality coffees,and their passion for educating custom.ers about the merits 3Ibid.,p. 34 of dark~roastedcoffees. Baldwin ,told Schultz, "We
4Ibid., p. 36
don't managethe businessto maximize anythingother than the quality of the coffee."3 The company purchased only the finest arabica coffees and put them through a meticulous dark-roastingprocessto bring out their full flavors. Baldwin explained that the cheaprobustacoffees used in supermarketblendsburned when subjectedto dark roasting. He also noted that the makers of supermarketblends preferred lighter roastsbecause it allowed higher yields (the longer a coffee was roasted,the more weight it lost). Schultz was also struck by the businessphilosophy of the two partners. It was clear that Starbucks stood not just for good coffee but also for the darkroasted flavor profiles that the founders were passionate about. Top quality, fresh-roasted, whole-beancoffee was the company's differentiating feature and a bedrock value. It was also clear to Schultz that Starbucks was strongly committed to educating its customers to appreciate the qualities of fine coffees.The
Case I I Starbucksin 2004: Driving for Global Dominance
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Nonetheless, Schultzcontinued to presshis ideas about the tremendous potential of expanding the Starbucks enterpriseoutside Seattleand exposing people allover America to Starbuckscoffee. Schultz ar~ed that there hadto be more than just the few thousandcoffee lovers in Seattlewho would enjoy the company'sproducts. At a meeting with the three owners in San Francisco in Spring 1982, Schultz once againpresentedhis ideas and vision for opening Starbucks stores across the United Statesand Canada.He thought the meeting went well and flew backto New York thinking ajoboffer was in the bag. However,the next day Jerry Baldwin called Schultz and indicated that the owners had decidedagainsthiring him becausegeographic expansion was too risky and they did not share Schultz's vision for Starbucks.Schultz was despondent, seeinghis dreamsof being a part of Starbucks' future go up in smoke. Still, he believed so deeply in Starbucks' potential that he decided to make a last ditch appeal; he called Baldwin back the next day and made an impassioned,reasonedcase for why the decision was a mistake. Baldwin agreedto reconsider.The next morning Baldwin called Schultz and told him the job of heading marketing and overseeingthe retail stores was his. In September1982, Schultz took over his new responsibilities at Starbucks.
Starbucks and Howard Schultz: The 1982-1985 Period
In his first few months at Starbucks,Howard Schultz spent most of his waking hours in the four Seattle stores-working behind the counters,tasting different kinds of coffee,talking with customers, getting to know store personnel,and learning the retail aspectsof the coffee business.'By December, Jerry Baldwin concluded that Schultz was ready for the final part of his training, that of actually roasting the coffee. Schultz spenta week getting an education about the colors of different coffee beans,listening for the telltale second pop of the beansduring the roasting process, learning to taste the subtle differences among Jerry Baldwin and GordonBowker's various roasts,and familiarizing himself with the roasting techniquesfor different beans. Schultzmade'apoint of acclimating himself to the informal dress code at Starbucks, gaining credibility and building trust with colleagues, and making the transition from the high-energy, coat-and-tie style of
New York to the more casual, low-key ambienceof the Pacific Northwest (see Exhibit 2 for ~~down on Howard Schultz's background). Schultz made real headwayin gaining the acceptance and respectof company personnel while working at the Pike Place store one day during the busy Christmas seasonthat first year.The store was packed and Schultz was behind the counter ringing up sales of coffee when someone shouted that a shopper had just headed out the door with somestuff-two t;;{pensivecoffeemakersit turned out, one in eachhand. Without thinking, Schultzleaped over the counter and chased the thief up the cobblestone streetoutside the store, yelling, "Drop that stuff! Drop it!" The thief was startled enough to drop both pieceshe had carried off and ran away.Howard picked up the merchandiseand returned to the store, holding the coffeemakers up like trophies. Everyone applauded. When Schultzreturned to his office later that afternoon, his staff haG strung up a banner that read: "Make my day."s Schultz was overflowing with ideas for the company. Early on, he noticed that first-time customers sometimesfelt uneasyin the storesbecause their lack of of knowledge about fine coffe~sand becausestore employees sometimescame across as a little arrogant or superior to coffee novices. Schultz worked with store employeeson customer-friendly salesskills and developed brochuresthat made it easyfor customers learn to about fine coffees. However,Schultz's biggest inspiration and vision for Starbucks' future came during the spring of 1983 when the company sent him to Milan, Italy, to attendan internationalhousewares show.While walking from his hotel to the conventioncenter,Schultz spottedan espresso and went inside to look around. bar The cashier beside the door nodded and smiled. The barista behind the counter greeted Howard cheerfully and moved gracefully to pull a shotof espressofor one customer and handcraft a foamy cappuccino for another, all the while conversingmerrily with thosestanding at the counter. Schultz thought the barista's performancewas "great theater." Just down the way on a side street,he went in an evenmore crowded espresso bar where the barista, whom he surmised to be the
5 told in ibid., p. 48. As
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Part 2 I Casesin Crafting and Executing Strategy
Schultz's It Giornale Venture
With the aid of a lawyer friend who helped companies raise venture capital and go public, Howard Schultz began seeking out investors for the kind of company he had in mind. Ironically, Jerry Baldwin committed to investing $150,000of Star bucks' money in Schultz'scoffee bar enterprise, thus becoming Schultz's first investor. Baldwin acceptedSchultz's invitation to be a director of the new company and Gordon Bowker agreed to be a part-time consultant for six months. Bowker, pumped up about the new venture, urged Howard to take pains to make sure that everything about the new stores-the name,the presentation,the care taken in preparing the coffee-be calculated to lead customers to expect something better than competitors offered. Bowker proposed that the new company be named II Giornale Coffee Company (pronounced iljor NAHL ee),a suggestionthat Schultz accepted. In December 1985, Bowker and Schultz made a trip to Italy, where they visited some 500 espressobars in Milan and Verona, observing local habits, taking notes about decor and menus, sI\apping photographs,and videotaping baristas in action. About $400,000 in seed capital was raised by the end of January 1986, enoughto rent an office, hire a couple of key employees,develop a store design, and openthe first store. But it took until the end of 1986to raise the remaining $1.25 million neededto launch at least eight espresso bars and prove that Schultz's strategy and businessmodel were viable. Schultzmadepresentationsto 242 potential investors,217 of whom said no. Many who heard Schultz's hour-long presentation saw coffee as a commodity businessand thought that Schultz'sespresso conceptlacked anybasis for susbar tainable competitive advantage (no patent on dark roast, no advantage in purchasing coffee beans, no ways to prevent the entry of imitative competitors). Some noted that coffee couldn't be turned into a growth business-<
nsumptionof coffee had beendeclining since the mid-1960s. Otherswere skeptical that people would pay $1.50 or more for a cup of coffee, and the company'sunpronounceable nameturned some off. Being rejected by so many of the potential investors he approachedwas disheartening for Schultz (some who listened to his presentation didn't even bother to call him back; others refused to take his calls). Nonetheless,Schultz maintained an upbeatatti-~
tude and displayed passion and enthusiasm in making his pitch. He ended up raising $1.65 million from about 30 investors, most of which came from nine people, five of whom became directors. The flfSt IlGiornale store opened in April 1986. It had 700 square feet and was located near the entrance of Seattle's tallest building. The decor was Italian, and the menu had some Italian words. Italian opera music played in the background. The baristas wore white shirts and bow ties. All service was stand-up-there were no chairs. National and international papers were hung on rods on the wall. By closing time on the fIrst day, 300 customers had been served, mostly in the morning hours. But while the core idea worked well, it soon became apparent that several aspectsof the format were not appropriate for Seattle. Some customers objected to the incessant opera music, others wanted a place to sit down, and many did not understand the Italian words on the menu. These "mistakes" were quickly fixed, but an effort was made not to compromise the style and elegance of the store. Within six months, the store was serving more than 1,000 customers a day. Regular customers had learned how to pronounce the company's name. Because most customers were in a hurry, it became apparent that speedy service was essential. Six months after the first Il Giornale opened, a second store was opened in another downtown building. A third store was opened in VaIICOUVer, British Columbia, in April 1987. Vancouver was chosen to test the transferability of the company's business concept outside Seattle. Schultz's goal was to open 50 stores in five years, and he needed to dispel his investors' doubts about geographic expansion early on to achieve his growth objective. By mid-1987 sales at the three stores were running at a rate equal to $1.5 million annually.
II Giornale Acquires Starbucks
In March 1987 Jerry Baldwin and Gordon Bowker decided to sell the whole Starbucks operation in Seattle--the stores,the roasting plant, and the Starbucksname. Bowker wanted to cash out his coffee business investment to concentrate on his other enterprises; Baldwin, who was tired of cornrnuting between Seattle and San Francisco and wrestling with the troubles created by the two parts of the company, elected to concentrate on the Peet'soperation.As he recalls, "My wife and I had a 30-second conversation
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Part 2 I Casesin Crafting and Executing Strategy
The result was a new type of store--a cross betweena retail coffee bean store and an espressobar/cafe-that eventuallybecameStarbucks' signature. By December 1987,the mood of the employeesat Starbucks had turned upbeat. They were buying into the changes that Schultz was making, and trust began to build between management and employees. New stores were on the verge of opening in Vancouverand Chicago. One Starbucksstore employee,Daryl Moore, who had startedworking at Starbucks in 1981 and who had voted against unionization in 1985,beganto question the need for a union with his fellow employees. Over the next few weeks, Moore begana move to decertify the union. He carried a decertification letter around to Starbucks stores and securedthe signatures of employeeswho no longer wished to be represented by the union. He got a majority of store employeesto sign the letter and presented it to the National Labor Relations Board. The union representingstore employees was decertified. Later, in 1992, the union representing Starbucks' roasting plant and warehouse employeeswas also decertified.
Market Expansion Outside the Pacific Northwest
Starbucks' entry into Chicago proved far more troublesome than managementanticipated. The first Chicago store opened in October 1987, and three more stores were openedoverthe next six months. Customercounts at the stores were substantially below expectations. Chicagoans not take to dark-roasted did coffee as fast as Schultz had hoped. The first downtown store opened onto the streetratherthan into the lobby of the building where it was located; in the winter months, customers were hesitantto go out in the wind and cold to acquire a cup of coffee. It was expensiveto supply freshcoffee to the Chicago stores out of the Seattle warehouse (the company solved the problem of freshnessand quality assuranceby putting freshly roasted beans in special FlavorLock bags that used vacuum packaging techniques with a one-wayvalve to allow carbondioxide to escape without allowing air and moisture in). Rents were higher in Chicago than in Seattle, and so were wage rates. The result was a squeeze on store profit TDargins.Gradually, customer counts improved, but "ucks lost money on its Chicago stores until, in
1990,prices were raisedto reflect higher rentsand labor costs,more experiencedstoremanagers werehired,and a critical mass of customers caught on to the taste of Starbucks products. Portland, Oregon, was the next market the company entered,and Portland coffee drinkerstook to Starbucks products quickly. By 1991, the Chicago stores had becomeprofitable and the companywas readyfor its next big marketentry. Managementdecidedon California becauseof its host of neighborhoodcenters and the receptiveness Californians to high-quality, innoof vative food. Los Angeles was chosenas the first California market to enter. L.A. was selected principally because its statusas a trendsetterand its culturalties of to the rest of the country. L.A. consumersembraced Starbucks quickly, and the Los Angeles Timesnamed Starbucksas the bestcoffee in America evenbeforethe first store opened.The entry into SanFranciscoproved more troublesomebecauseSan Franciscohad an ordinance against converting stores to restaurant-related uses in certain prime urban neighborhoods; Starbucks could sell beverages pastriesto customersat standand up counters but could not offer seating in stores that had formerly beenused for generalretailing. However, the city council was soon convinced by cafe owners and real estatebrokers to change the code. Still, Starbucks faced strong competition from Peet'sand local espresso bars in the San Franciscomarket. Starbucks'store expansiontargetsproved easier to meet than Schultz had originally anticipated, and he upped the numbers to keep challenging the organization. Starbucksopened15 new storesin fiscal 1988,20 in 1989,30 in 1990,32 in 1991,and 53 in 1992-producing a total of 161 stores, significantly abovethe 1987 objective of 125 stores. From the outset, the strategy was to open only company-ownedstores; franchising was avoided soas to keepthe company in full control of the quality of its products and the character and location of its stores. But company-ownership of all stores required Starbucks to raise new venture capital to coverthe cost of new store expansion. In 1988the companyraised$3.9 million, in 1990 venture capitalists provided an additional $13.5 million, and in 1991 anotherround ofventure capital fmancing generated$15 million. Starbucks was able to raise the needed funds despite posting lossesof $330,000 in 1987,$764,000 in 1988,and$1.2 million in 1989. While the losses were troubling to
CaseI I Starbucks in 2004: Driving for Global Dominance
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Starbucks'board of directors and investors, Schultz's .businessplan had forecastlossesduring the early years of expansion. At a particularly tense board meeting where directors sharply questioned Schultz about the lack of profitability, Schultz said: Look,we're going to keeplosing moneyuntil we can do three things. We have to attract a management team well be,yond expansion our needs.We haveto build a world-classroastingfacility. Ar,d we needa computerinformation systemsophisticated enough to keep track of sales in hundredsand hundredsof stores.9 Schultz argued for patience as the company invested in the infrastructure to support continued growth well into the 1990s.He contended that hiring experienced executives ahead of the growth curve, building facilities far beyond current needs, and installing support systems laid a strong foundation for rapid, profitable growth on down the road. His arguments carried the day with the board and with investors,especially since revenueswere growing by approximately80 percent annually and customertraffic at the stores was meeting or exceeding expectations. Starbucksbecameprofitable in 1990,and profits increasedevery year thereafter except for fiscal year 2000. Exhibit 3 provides a financial summary for 1998-2003.
HOWARD SCHULTZ'S Sl~TEGY TO MAKE STARBUCKS A GREAT PLACE TO WORK
Howard Schultz deeply believed that Starbucks' successwas heavily dependent customershaving a very on positive experience in its stores. This meant having store employees who were knowledgeable about the company's products" who paid attention to detail in preparing the company'sespressodrinks, who eagerly communicatedthe company's passion for coffee, and who possessed skills and personalityto deliver conthe sistent,pleasing customerservice. Many of the baristas 9Ibid., 142. p.
were in their 20s and worked part-time, going to college on the side or pursuing other careeractivities. The challenge to Starbucks, in Schultz's view, was how to attract, motivate,and reward store employeesin a manner that would make Starbucksa companythat people would want to work for and that would generateenthusiastic commitment and higher levels of customerservice. Moreover, Schultz wanted to send all Starbucks employeesa messagethat would cementthe trust that had beenbuilding between management and the company's workforce. One of the requests that employeeshad made to the prior ownersof Starbuckswas to extend healthcare benefits to part-time workers. Their requesthad been turned down, but Schultz believed that expanding heathcare coverageto include part-timerswas the right thing to do. His father had recently passed away with cancer and he knew from his own past experience of having grown up in a family that struggled to make ends meet how difficult it was to cope with rising medical costs. In 1988 Schultz went to the board of directors with his plan to expand the company's heath care coverageto include part-timers who worked at least 20 hours a week. He saw the proposal not as a generous gesture but as a core strategy to win employee loyalty and commitment to the company's mission. Board members resisted because the company was unprofitable and the added costs of the extended coverage would only worsen the company's bottom line. But Schultz argued passionatelythat it was the right thing to do and wouldn't be as expensive as it seemed.He observed that if the new benefit reduced turnover, which he believed was likely, then it would reduce the costs of hiring and training-which equaled about $3,000 per new hire; he further pointed out that it cost $1,500 a year to provide an employee with full benefits. Part-timers, he argued, were vital to Starbucks, constituting two-thirds of the company's workforce. Many were baristas who knew the favorite drinks of regular customers; if the barista left, that connection with the customer was broken. Moreover, many part': time employeeswere called on to openthe stores early, sometimesat 5:30 or 6:00 AM; othershad to work until closing, usually 9:00 PMor later. Providing these employeeswith healthcare benefits, he argued,would signal that the company honored their value and contribution. The board approved Schultz's plan, and starting in late 1988 part-timers working 20 or more hours were offered the same health coverage as full-time
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Part 2 I Casesin Crafting and Executing Strategy
employees.Starbuckspaid 75 percentof an employee's health care premium; the employee paid 25 percent. Over the years, Starbucksextendedits health covemge to include preventive care, crisis counseling, dental care, eye care, mental health, and chemical dependency. Covemge was also offered for unmarried partners in a committed relationship. Since most Starbucks' employeeswere young and comparatively healthy,the companyhad beenable to provide broader coverage while keeping monthly payments relatively low. The value of Starbucks' health care progmm struck home when one of the company's store managersand a former baristawalked into Schultz's office and told him he had AIDS: I had known he was gay but had no idea he was sick. His diseasehad entered a new phase,he explained, and he wouldn't be able to work any longer. We sat together and cried, for I could not find meaningful words to console him. I couldn't composemyself. I hugged him. 10 At that point, Starbuckshad no provision for employees with AIDS. We had a policy decision. Because of Jim, we decided to offer health-care coverageto all employeeswho have terminal illnesses, paying medical costs in full from the time they are not able to work until they are covered by
ees into partners, give them a chance to share in the success the company,and make clear the connection of betweentheir contributions and the company'smarket value. Even though Starbuckswas still a private company, the plan that emerged called for granting stock options to all full-time 3.id part-time employeesin proportion to their base pay. In May 1991, the plan,
dubbed Bean Stock, was presented the board. to
government programs, usually twenty-nine
months. After his visit to me, I spoke with Jim often and visited him at the hospice. Within a year he was gone. I receiveda letter from his family afterward, telling me how much they appreciated our benefit plan. In 1994 Howard Schultz was it\.vited to The White House for a one-on-one meeting with President Bill Clinton to brief him on Starbucks' healthcare progmm.
Though board members were concerned that increasing the numberof sharesmight unduly dilute the value of the sharesof investorswho had put up hard cash, the plan received unanimous approval.The first grantwas made in October 1991,just after the end of the company's fiscal year in September; each partner was granted stock options worth 12 percent of basepay. Each October since then, Starbucks has granted employees options equal to 14 percent of base pay, awardedat the stock price at the start of the fiscal year (October 1). When the Bean Stock program was presentedto employees,Starbucksdropped the term employee and began referring to all of its people as partners becauseeveryone,including part-timers working at least20 hours per week,was eligible for stockoptions after six months. At the end of fiscal year 2003, Starbucksemployee stock option plan included 39 million-shares in outstanding options; new options for about 10 million shareswere being granted annually.12 Starbucks became a public company in 1992; its initial public offering (IPO) of common stock in June proved to be one of the most successfulIPOs of 1992 and provided the companyaccessto the capital needed to accelerateexpansionof its store network. Exhibit 4 shows the performance of the company's stock price since the 1992IPO.
StarbucksJ Stock Purchase Plan for Employees
The Creation of an Employee Stock Option Plan
By 1991 the company's profitability had improved to the point where Schultz could pursue a stock option plan for all employees,a program he believed would havea positive, long-term effect on the success Starof bucks. I I Schultz wanted to turn all StarbucksemployIOlbid.,p. 129. liAs related in ibid., pp. 131-36.
In 1995, Starbucks implemented an employee stock purchaseplan. Eligible employeescould contribute up to 10 percent of their base earnings to quarterly purchasesof the company's common stock at 85 percent of the going stock price. As of fiscal 2003, about 5.7 million shares had been issued since inception of the plan, and new shares were being purchased at a rate close to I million shares annually by some 11,184 active employee participants (out of almost 35,000 employees who were eligible to partici12Starbucks annual report, 2002,p. 32.
Case
Starbucks in 2004: Driving for Global Dominance
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4
The Performance of Starbucks' Stock, 1992-2003
30~~ 40
~~~:
StocK
Prire
for eligible Kingdom employees was established in
Environment
believed that the company's
'-- ---" -,
with above-average skills and Storeemployees werepaid around c -c. -.. rates for store employees
150 to 400 percent a year, the turnover
---"
to about 50 percent for other chain
for its relativelylow tu~,~!,~r rates:
Starbucks' management used annual "Partner View" surveysto solicit feedbackfrom its workforce of over 74,000 people, learn their concerns,and measure job satisfaction. In the latest sample survey of 1,400 employees,79 percent rated Starbucks' workplace environment favorably relative to other companies they were familiar with, 72 percentreported being satisfied with their presentjob, 16 percentwere neutral, and 12 percentwere dissatisfied. But the 2QQ2 surveyrevealed that many employeesviewed the benefits package as only "average,"prompting the companyto increaseits match of 401(k) contributions for those who had been with the company more than three years and to have these contributions vest immediately. Exhibit 5 contains a summary of Starbucks'fringe benefit program. Starbucks was named by Fortune magazineas one of the "100 Best Companiesto Work For" in 1998, 1999, 2000, and 2002. Still, in 2003, Starbucks'management was concernedby field reports of stores that were suffering from slumping employee morale and store matlagerburnout.
peopleaskif
STARBUCKS' CO RPO RATE VALUES AND BUSINESS PRINCIPLES
During the early building years, Howard Schultz and other Starbucks' senior executives worked to instill some key values and guiding principles into the
"Employee Perks: Starbucks Coffee's ~'~ft" -.", , ",..'-~"" .'-., 15,
C-16 exhibit 5
Part 2 I Casesin Crafting and Executing Strategy
Elements of Starbucks' Fringe Benefit Program
Source: Compiled by the case researchers from company documents and other sources.
Starbucks culture. The cornerstonevalue in the effort "to build a company with soul" was that the company would never stoppursuing the perfect cup of coffee by buying the bestbeansand roasting them to perfection. Schultz remained steadfastly opposed to franchising, so that the company could control the quality of its products and build a culture common to all stores. He was adamantabout not selling artificially flavored coffee.beans-"We will not pollute our high-quality beans with chemicals"; if a customer wanted hazelnut-flavored coffee; Starbucks would provide it by adding hazelnut syrupto the drink ratherthan by adding hazelnut flavoring to the beansduring roasting. Running flavored beans through the grinders would leave behind chemical residues that would alter the flavor of beans ground afterward; plus, the chemical smell given off by artificially flavored beanswas absorbedby other beans in the store. Furthermore, Schultz didn't want the company to pursue supermarket sales because it would mean pouring Starbucks' beans into clear plastic bins where they could get stale, thus compromising the company's legacy of fresh, dark-roasted,full-flavored coffee. Starbucks' managementwas also emphatic about the importance of employeespaying attention to what pleased customers. Employees :weretrained to go out of their way, and to take heroic measuresif necessary, to make surecustomerswere fully satisfied. The theme was "Just say yes" to customerrequests. Further, employeeswere encouragedto speak their minds without fear of retribution from upper management-senior executives wanted employees to .~e vocal about what Starbucks was doing right, what it was doing wrong,
and what changeswere needed. Managementwanted employees to be involved in and contribute to the processof making Starbucksa better company. A valuesand principles "crisis" aroseat Starbucks in 19S9 when customers started requesting skim (i.e., nonfat) milk in making cappuccinosand lattes.Howard Schultz, who read all customer comments cards,and Dave Olsen, head of coffee quality, conducted taste tests of lattes and cappuccinosmade with nonfat milk and concluded they were not as good as those made with whole milk. Howard Behar, recentlyhired ashead of retail store operations,indicated that management's opinions didn't matter; what mattered was giving customers what they wanted. Schultz took the position that "We will never offer nonfat milk. It's not who we are." Behar, however,stuck to his guns,maintaining thatuse of nonfat milk should at least be tested-otherwise it appeared as if all the statements managementhad made aboutthe importance of really and truly pleasing customers were a sham. A fierce internal debate ensued.One dogmatic defenderof the quality and tasteof Starbucks' coffee products buttonholed Behar outside his office and told him that using nonfat milk amounted to "bastardizing" the company's products. Numerous store managers maintained that offering two kinds of milk was operationally impractical. Schultz found himself in a quandary, torn betweenthe company's commitment to quality and its goal of pleasing customers.One day after visiting one of the stores in a residential neighborhood and watching a customer leave to go to a competitor's store because Starbucks did not make lattes with nonfat milk, Schultz
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Part 21 Casesin Crafting and Executing Strategy
only had favorabledemographicprofiles but also could be serviced and supportedby the company'soperations infrastructure. For eachtargeted region, Starbucks selected a large city to serve as a "hub"; teamsof professionals were located in hub cities to supportthe goal of opening 20 or more stores in the hub in the first two years. Once stores blanketed the hub, then additional storeswere opened in smaller,surrounding "spoke" areas in the region. To overseethe expansion process, Starbuckscreatedzone vice presidentsto direct the developmentof eachregion and to implant the Starbucks culture in the newly openedstores.All of the new zone vice presidentsStarbucksrecruited came with extensive operating and marketing experience in chain store retailing. Starbucks' strategy in major metropolitan cities was to blanket the area with stores,evenif some stores cannibalized another store's business.18 While a new store might draw 30 percentof the businessof an existing store two or so blocks away,management believed that its "Starbucks everywhere" approachcut down on delivery and management costs, shortened customer lines at individual stores,and increased foot traffic for all the stores in an area. Starbucks' store launches grew steadily more successful. In 2002, new stores generated an average of $1.2 million in first-year revenues, compared to $700,000 in 1995 and only $427,000 in 1990. The steadyincreasesin new-storerevenueswere due partly to growing popularity of premium coffee drinks and partly to Starbucks' growing reputation. In more and more instances, Starbucks' reputation reached new markets evenbefore storesopened. Moreover, existing stores continued to post sales gains in the range of 2-10 percent annually. In 2003, Starbucksposted same-store sales increases averaging 8 percent (Exhibit 3), the 12thconsecutiveyear the companyhad achieved sales growth of 5 percent or greater at existing stores.Starbucks'revenueshad climbed ~ average of 20 percent annually since 1992. In a representative week in 2003, about 20 million people bought a cup of coffee at Starbucks; a typical customer stopped at a Starbucks about 18 times a month-no u.s. retailer had a higher frequencyof customervisits.19 One of Starbucks' core competencieswas identifying good retailing sites for its new stores.The company was regarded as having the best real estateteam in the coffee bar industry and a sophisticated system
18Danie1s, "Mr. Coffee," p. 140. 191bid.
for identifying not only the most attractive individual city blocks but also the exact store location that was best; it also worked hard at building good relationships with local real estaterepresentativesin areaswhere it was opening multiple store locations. The company's site location track record was so good that as of 1997it had closed only 2 of the 1,500 sites it had opened;its track record in finding successfulstore locations was still intact as of 2003 (although specific figures were not available). Exhibit 7 showsa timeline of Star bucks' entry into new market areas,along with other accomplishments, milestones,key events,and awards.
International
Expansion
In markets outside the continental United States (including Hawaii), Starbuckshad a two-prongedstore expansion: either opencompany-ownedand companyoperatedstores or else license a reputable and capable local company with retailing know-how in the target host country to develop and operate new Starbucks stores:ltl most countries, Starbucksused a local partner/licensee to help it recruit talented individuals, set up supplier relationships, locate suitable store sites, and caterto local market conditions. Starbuckslooked for partners/licenseesthat had strong retail/restaurant experience,had values and a corporateculture compatible with Starbucks,were committed to good customer service,possessed talented management and strong financial resources,and had demonstratedbrand-building skills. Starbuckshad createda new subsidiary,Starbucks Coffee International, to orchestrateoverseasexpansion and begin to build the Starbucksbrand name globally via licensees.(See Exhibit 1 for the numberof lic~nsed internationalstoresand Exhibit 7 for the years in which Starbucksenteredmost of theseforeign markets.)Starbucks' management expectedto have a total of 10,000 stores in 60 countries by the end of 2005. The company's first store in France opened in early 2004 in Paris. China was expected to be Starbucks' biggest market outside the United States in the years to come. Thus far, Starbucks products were proving to be a much bigger hit with consumers in Asia than in Europe. Even so, Starbucks was said to be losing money in both Japan and Britain; moreover, the Starbucks Coffee International division was only marginally
doc_641750097.pdf
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exhibit
1
Number of Starbucks Store Locations, 1987-2003
licensed Locations of Starbucks Stores Outside the Continental United States, 2003 --
Source: Company records and reports.
encouragedto learn how to grind the beansand make their own freshly brewed coffee at home. Baldwin, Siegel, and Bowker were well acquainted with Peet's
'~' "-"", ., ~~
whole-bean coffees,while anotherhad shelvesof coffee products.The store did not offer fresh-brewedcoffee so\d by the cup, but tasting samples were sometimesavailable. Initially, Siegelwas the only paid -employee. wore a grocer's apron,scoopedout beans He
for customers,extolled the virtues of fine, dark-roasted coffees, and functioned as the partnership's retail expert. The other two partners kept their day jobs but came by at lunch or after work to help out. During the start-upperiod, Baldwin kept the books and developed a growing knowledge of coffee; Bowker served as the "magic, mystery,and romance man.,,2 The store was an immediate success,with salesexceeding expectations, partly becauseof interest stirred by a favorable article in the Seattle Times. For most of the first year,
2HowardSchultz and Dori JonesYang, Pour YourHeart Into It (New York: Hyperion, 1997),p. 33.
~
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Part 2 I Casesin Crafting and Executing Strategy
Starbucksorderedits coffee beansfrom Peet's,but then the partners purchaseda used roaster from Holland, set up roasting operationsin a nearbyramshacklebuilding, and came up with their own blends and flavors. By the early 1980s,the company had four Starbucks stores in the Seattleareaand had beenprofitable every year since opening its doors. But then Zev Siegel experienced burnout and left the company to pursue other interests. Jerry Baldwin took over day-to-day managementof the company and functioned as chief executive officer; Gordon Bowker remained involved as an owner but devoted most of his time to his advertising and design firm, a weekly newspaperhe had founded, and a microbrewery that he was launching known as the RedhookAle Brewery.
Howard Picture
Schultz Enters the
In 1981, Howard Schultz, vice president and general manager of U.S. operations for a Swedish maker of company depended mainly on word of mouth to get stylish kitchen equipment and coffeemakers,decided more people into its stores,then built customerloyalty to pay Starbucks a visit-he was curious about why cup by cup as buyers gained a senseof discoveryand Starbuckswas selling so many of his company'sprodexcitement about the taste of fine coffee. ucts. The morning after his arrival in Seattle,he was esOn his trip backto New York the next day,Howard corted to the Pikes Place store by Linda Grossman,the Schultz could not stop thinking about Starbucksand retail merchandising managerfor Starbucks.A solo viwhat it would be like to be a part of the Starbucksenolinist was playing Mozart at the door, his violin case terprise. Schultzrecalled,"There was somethingmagic open for donations. Schultz was immediately taken by about it, a passionand authenticity I had never experithe powerful and pleasing aroma of the coff~es, the enced in business."4 The appealof living in the Seattle wall displaying coffee beans, and the rows of cofarea was anotherstrong plus. By the time he landedat feemakers on the shelves.As he talked with the clerk Kennedy Airport, he knew in his heart he wantedto go behind the counter,the clerk scooped out some Sumato work for Starbucks.At the first opportunity, Schultz tran coffee beans,ground them, put the grounds in a asked Baldwin whetherthere was any way he could fit cone filter, poured hot water over the cone,and shortly into Starbucks. Although the two had establishedan handed Schultz a porcelain mug filled with freshly easy,comfortable personal rapport, it still took a year, brewedcoffee. After taking only three sips of the brew, numerous meetings at which Schultz presentedhis Schultz was hooked. He began asking the clerk and ideas,and a lot of convincing to get Baldwin, Bowker, Grossmanquestionsabout the company,about coffees and their silent partner from San Franciscoto agreeto from different parts of the world, and about the differhire him. Schultz pursued a job at Starbucks far more ent ways of roasting coffee. vigorously than Starbucks pursued hiring Schultz. A bit later, he was introduced to Jerry Baldwin There was some nervousnessabout bringing in an outand Gordon Bowker, whose offices overlooked the sider, especially a high-powered New Yorker who company's coffee-roasting operation. Schultz was had not grown up with the values of the company. struck by their knowledge about coffee, their commitment to providing customers withcquality coffees,and their passion for educating custom.ers about the merits 3Ibid.,p. 34 of dark~roastedcoffees. Baldwin ,told Schultz, "We
4Ibid., p. 36
don't managethe businessto maximize anythingother than the quality of the coffee."3 The company purchased only the finest arabica coffees and put them through a meticulous dark-roastingprocessto bring out their full flavors. Baldwin explained that the cheaprobustacoffees used in supermarketblendsburned when subjectedto dark roasting. He also noted that the makers of supermarketblends preferred lighter roastsbecause it allowed higher yields (the longer a coffee was roasted,the more weight it lost). Schultz was also struck by the businessphilosophy of the two partners. It was clear that Starbucks stood not just for good coffee but also for the darkroasted flavor profiles that the founders were passionate about. Top quality, fresh-roasted, whole-beancoffee was the company's differentiating feature and a bedrock value. It was also clear to Schultz that Starbucks was strongly committed to educating its customers to appreciate the qualities of fine coffees.The
Case I I Starbucksin 2004: Driving for Global Dominance
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Nonetheless, Schultzcontinued to presshis ideas about the tremendous potential of expanding the Starbucks enterpriseoutside Seattleand exposing people allover America to Starbuckscoffee. Schultz ar~ed that there hadto be more than just the few thousandcoffee lovers in Seattlewho would enjoy the company'sproducts. At a meeting with the three owners in San Francisco in Spring 1982, Schultz once againpresentedhis ideas and vision for opening Starbucks stores across the United Statesand Canada.He thought the meeting went well and flew backto New York thinking ajoboffer was in the bag. However,the next day Jerry Baldwin called Schultz and indicated that the owners had decidedagainsthiring him becausegeographic expansion was too risky and they did not share Schultz's vision for Starbucks.Schultz was despondent, seeinghis dreamsof being a part of Starbucks' future go up in smoke. Still, he believed so deeply in Starbucks' potential that he decided to make a last ditch appeal; he called Baldwin back the next day and made an impassioned,reasonedcase for why the decision was a mistake. Baldwin agreedto reconsider.The next morning Baldwin called Schultz and told him the job of heading marketing and overseeingthe retail stores was his. In September1982, Schultz took over his new responsibilities at Starbucks.
Starbucks and Howard Schultz: The 1982-1985 Period
In his first few months at Starbucks,Howard Schultz spent most of his waking hours in the four Seattle stores-working behind the counters,tasting different kinds of coffee,talking with customers, getting to know store personnel,and learning the retail aspectsof the coffee business.'By December, Jerry Baldwin concluded that Schultz was ready for the final part of his training, that of actually roasting the coffee. Schultz spenta week getting an education about the colors of different coffee beans,listening for the telltale second pop of the beansduring the roasting process, learning to taste the subtle differences among Jerry Baldwin and GordonBowker's various roasts,and familiarizing himself with the roasting techniquesfor different beans. Schultzmade'apoint of acclimating himself to the informal dress code at Starbucks, gaining credibility and building trust with colleagues, and making the transition from the high-energy, coat-and-tie style of
New York to the more casual, low-key ambienceof the Pacific Northwest (see Exhibit 2 for ~~down on Howard Schultz's background). Schultz made real headwayin gaining the acceptance and respectof company personnel while working at the Pike Place store one day during the busy Christmas seasonthat first year.The store was packed and Schultz was behind the counter ringing up sales of coffee when someone shouted that a shopper had just headed out the door with somestuff-two t;;{pensivecoffeemakersit turned out, one in eachhand. Without thinking, Schultzleaped over the counter and chased the thief up the cobblestone streetoutside the store, yelling, "Drop that stuff! Drop it!" The thief was startled enough to drop both pieceshe had carried off and ran away.Howard picked up the merchandiseand returned to the store, holding the coffeemakers up like trophies. Everyone applauded. When Schultzreturned to his office later that afternoon, his staff haG strung up a banner that read: "Make my day."s Schultz was overflowing with ideas for the company. Early on, he noticed that first-time customers sometimesfelt uneasyin the storesbecause their lack of of knowledge about fine coffe~sand becausestore employees sometimescame across as a little arrogant or superior to coffee novices. Schultz worked with store employeeson customer-friendly salesskills and developed brochuresthat made it easyfor customers learn to about fine coffees. However,Schultz's biggest inspiration and vision for Starbucks' future came during the spring of 1983 when the company sent him to Milan, Italy, to attendan internationalhousewares show.While walking from his hotel to the conventioncenter,Schultz spottedan espresso and went inside to look around. bar The cashier beside the door nodded and smiled. The barista behind the counter greeted Howard cheerfully and moved gracefully to pull a shotof espressofor one customer and handcraft a foamy cappuccino for another, all the while conversingmerrily with thosestanding at the counter. Schultz thought the barista's performancewas "great theater." Just down the way on a side street,he went in an evenmore crowded espresso bar where the barista, whom he surmised to be the
5 told in ibid., p. 48. As
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Part 2 I Casesin Crafting and Executing Strategy
Schultz's It Giornale Venture
With the aid of a lawyer friend who helped companies raise venture capital and go public, Howard Schultz began seeking out investors for the kind of company he had in mind. Ironically, Jerry Baldwin committed to investing $150,000of Star bucks' money in Schultz'scoffee bar enterprise, thus becoming Schultz's first investor. Baldwin acceptedSchultz's invitation to be a director of the new company and Gordon Bowker agreed to be a part-time consultant for six months. Bowker, pumped up about the new venture, urged Howard to take pains to make sure that everything about the new stores-the name,the presentation,the care taken in preparing the coffee-be calculated to lead customers to expect something better than competitors offered. Bowker proposed that the new company be named II Giornale Coffee Company (pronounced iljor NAHL ee),a suggestionthat Schultz accepted. In December 1985, Bowker and Schultz made a trip to Italy, where they visited some 500 espressobars in Milan and Verona, observing local habits, taking notes about decor and menus, sI\apping photographs,and videotaping baristas in action. About $400,000 in seed capital was raised by the end of January 1986, enoughto rent an office, hire a couple of key employees,develop a store design, and openthe first store. But it took until the end of 1986to raise the remaining $1.25 million neededto launch at least eight espresso bars and prove that Schultz's strategy and businessmodel were viable. Schultzmadepresentationsto 242 potential investors,217 of whom said no. Many who heard Schultz's hour-long presentation saw coffee as a commodity businessand thought that Schultz'sespresso conceptlacked anybasis for susbar tainable competitive advantage (no patent on dark roast, no advantage in purchasing coffee beans, no ways to prevent the entry of imitative competitors). Some noted that coffee couldn't be turned into a growth business-<
nsumptionof coffee had beendeclining since the mid-1960s. Otherswere skeptical that people would pay $1.50 or more for a cup of coffee, and the company'sunpronounceable nameturned some off. Being rejected by so many of the potential investors he approachedwas disheartening for Schultz (some who listened to his presentation didn't even bother to call him back; others refused to take his calls). Nonetheless,Schultz maintained an upbeatatti-~tude and displayed passion and enthusiasm in making his pitch. He ended up raising $1.65 million from about 30 investors, most of which came from nine people, five of whom became directors. The flfSt IlGiornale store opened in April 1986. It had 700 square feet and was located near the entrance of Seattle's tallest building. The decor was Italian, and the menu had some Italian words. Italian opera music played in the background. The baristas wore white shirts and bow ties. All service was stand-up-there were no chairs. National and international papers were hung on rods on the wall. By closing time on the fIrst day, 300 customers had been served, mostly in the morning hours. But while the core idea worked well, it soon became apparent that several aspectsof the format were not appropriate for Seattle. Some customers objected to the incessant opera music, others wanted a place to sit down, and many did not understand the Italian words on the menu. These "mistakes" were quickly fixed, but an effort was made not to compromise the style and elegance of the store. Within six months, the store was serving more than 1,000 customers a day. Regular customers had learned how to pronounce the company's name. Because most customers were in a hurry, it became apparent that speedy service was essential. Six months after the first Il Giornale opened, a second store was opened in another downtown building. A third store was opened in VaIICOUVer, British Columbia, in April 1987. Vancouver was chosen to test the transferability of the company's business concept outside Seattle. Schultz's goal was to open 50 stores in five years, and he needed to dispel his investors' doubts about geographic expansion early on to achieve his growth objective. By mid-1987 sales at the three stores were running at a rate equal to $1.5 million annually.
II Giornale Acquires Starbucks
In March 1987 Jerry Baldwin and Gordon Bowker decided to sell the whole Starbucks operation in Seattle--the stores,the roasting plant, and the Starbucksname. Bowker wanted to cash out his coffee business investment to concentrate on his other enterprises; Baldwin, who was tired of cornrnuting between Seattle and San Francisco and wrestling with the troubles created by the two parts of the company, elected to concentrate on the Peet'soperation.As he recalls, "My wife and I had a 30-second conversation
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Part 2 I Casesin Crafting and Executing Strategy
The result was a new type of store--a cross betweena retail coffee bean store and an espressobar/cafe-that eventuallybecameStarbucks' signature. By December 1987,the mood of the employeesat Starbucks had turned upbeat. They were buying into the changes that Schultz was making, and trust began to build between management and employees. New stores were on the verge of opening in Vancouverand Chicago. One Starbucksstore employee,Daryl Moore, who had startedworking at Starbucks in 1981 and who had voted against unionization in 1985,beganto question the need for a union with his fellow employees. Over the next few weeks, Moore begana move to decertify the union. He carried a decertification letter around to Starbucks stores and securedthe signatures of employeeswho no longer wished to be represented by the union. He got a majority of store employeesto sign the letter and presented it to the National Labor Relations Board. The union representingstore employees was decertified. Later, in 1992, the union representing Starbucks' roasting plant and warehouse employeeswas also decertified.
Market Expansion Outside the Pacific Northwest
Starbucks' entry into Chicago proved far more troublesome than managementanticipated. The first Chicago store opened in October 1987, and three more stores were openedoverthe next six months. Customercounts at the stores were substantially below expectations. Chicagoans not take to dark-roasted did coffee as fast as Schultz had hoped. The first downtown store opened onto the streetratherthan into the lobby of the building where it was located; in the winter months, customers were hesitantto go out in the wind and cold to acquire a cup of coffee. It was expensiveto supply freshcoffee to the Chicago stores out of the Seattle warehouse (the company solved the problem of freshnessand quality assuranceby putting freshly roasted beans in special FlavorLock bags that used vacuum packaging techniques with a one-wayvalve to allow carbondioxide to escape without allowing air and moisture in). Rents were higher in Chicago than in Seattle, and so were wage rates. The result was a squeeze on store profit TDargins.Gradually, customer counts improved, but "ucks lost money on its Chicago stores until, in
1990,prices were raisedto reflect higher rentsand labor costs,more experiencedstoremanagers werehired,and a critical mass of customers caught on to the taste of Starbucks products. Portland, Oregon, was the next market the company entered,and Portland coffee drinkerstook to Starbucks products quickly. By 1991, the Chicago stores had becomeprofitable and the companywas readyfor its next big marketentry. Managementdecidedon California becauseof its host of neighborhoodcenters and the receptiveness Californians to high-quality, innoof vative food. Los Angeles was chosenas the first California market to enter. L.A. was selected principally because its statusas a trendsetterand its culturalties of to the rest of the country. L.A. consumersembraced Starbucks quickly, and the Los Angeles Timesnamed Starbucksas the bestcoffee in America evenbeforethe first store opened.The entry into SanFranciscoproved more troublesomebecauseSan Franciscohad an ordinance against converting stores to restaurant-related uses in certain prime urban neighborhoods; Starbucks could sell beverages pastriesto customersat standand up counters but could not offer seating in stores that had formerly beenused for generalretailing. However, the city council was soon convinced by cafe owners and real estatebrokers to change the code. Still, Starbucks faced strong competition from Peet'sand local espresso bars in the San Franciscomarket. Starbucks'store expansiontargetsproved easier to meet than Schultz had originally anticipated, and he upped the numbers to keep challenging the organization. Starbucksopened15 new storesin fiscal 1988,20 in 1989,30 in 1990,32 in 1991,and 53 in 1992-producing a total of 161 stores, significantly abovethe 1987 objective of 125 stores. From the outset, the strategy was to open only company-ownedstores; franchising was avoided soas to keepthe company in full control of the quality of its products and the character and location of its stores. But company-ownership of all stores required Starbucks to raise new venture capital to coverthe cost of new store expansion. In 1988the companyraised$3.9 million, in 1990 venture capitalists provided an additional $13.5 million, and in 1991 anotherround ofventure capital fmancing generated$15 million. Starbucks was able to raise the needed funds despite posting lossesof $330,000 in 1987,$764,000 in 1988,and$1.2 million in 1989. While the losses were troubling to
CaseI I Starbucks in 2004: Driving for Global Dominance
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Starbucks'board of directors and investors, Schultz's .businessplan had forecastlossesduring the early years of expansion. At a particularly tense board meeting where directors sharply questioned Schultz about the lack of profitability, Schultz said: Look,we're going to keeplosing moneyuntil we can do three things. We have to attract a management team well be,yond expansion our needs.We haveto build a world-classroastingfacility. Ar,d we needa computerinformation systemsophisticated enough to keep track of sales in hundredsand hundredsof stores.9 Schultz argued for patience as the company invested in the infrastructure to support continued growth well into the 1990s.He contended that hiring experienced executives ahead of the growth curve, building facilities far beyond current needs, and installing support systems laid a strong foundation for rapid, profitable growth on down the road. His arguments carried the day with the board and with investors,especially since revenueswere growing by approximately80 percent annually and customertraffic at the stores was meeting or exceeding expectations. Starbucksbecameprofitable in 1990,and profits increasedevery year thereafter except for fiscal year 2000. Exhibit 3 provides a financial summary for 1998-2003.
HOWARD SCHULTZ'S Sl~TEGY TO MAKE STARBUCKS A GREAT PLACE TO WORK
Howard Schultz deeply believed that Starbucks' successwas heavily dependent customershaving a very on positive experience in its stores. This meant having store employees who were knowledgeable about the company's products" who paid attention to detail in preparing the company'sespressodrinks, who eagerly communicatedthe company's passion for coffee, and who possessed skills and personalityto deliver conthe sistent,pleasing customerservice. Many of the baristas 9Ibid., 142. p.
were in their 20s and worked part-time, going to college on the side or pursuing other careeractivities. The challenge to Starbucks, in Schultz's view, was how to attract, motivate,and reward store employeesin a manner that would make Starbucksa companythat people would want to work for and that would generateenthusiastic commitment and higher levels of customerservice. Moreover, Schultz wanted to send all Starbucks employeesa messagethat would cementthe trust that had beenbuilding between management and the company's workforce. One of the requests that employeeshad made to the prior ownersof Starbuckswas to extend healthcare benefits to part-time workers. Their requesthad been turned down, but Schultz believed that expanding heathcare coverageto include part-timerswas the right thing to do. His father had recently passed away with cancer and he knew from his own past experience of having grown up in a family that struggled to make ends meet how difficult it was to cope with rising medical costs. In 1988 Schultz went to the board of directors with his plan to expand the company's heath care coverageto include part-timers who worked at least 20 hours a week. He saw the proposal not as a generous gesture but as a core strategy to win employee loyalty and commitment to the company's mission. Board members resisted because the company was unprofitable and the added costs of the extended coverage would only worsen the company's bottom line. But Schultz argued passionatelythat it was the right thing to do and wouldn't be as expensive as it seemed.He observed that if the new benefit reduced turnover, which he believed was likely, then it would reduce the costs of hiring and training-which equaled about $3,000 per new hire; he further pointed out that it cost $1,500 a year to provide an employee with full benefits. Part-timers, he argued, were vital to Starbucks, constituting two-thirds of the company's workforce. Many were baristas who knew the favorite drinks of regular customers; if the barista left, that connection with the customer was broken. Moreover, many part': time employeeswere called on to openthe stores early, sometimesat 5:30 or 6:00 AM; othershad to work until closing, usually 9:00 PMor later. Providing these employeeswith healthcare benefits, he argued,would signal that the company honored their value and contribution. The board approved Schultz's plan, and starting in late 1988 part-timers working 20 or more hours were offered the same health coverage as full-time
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Part 2 I Casesin Crafting and Executing Strategy
employees.Starbuckspaid 75 percentof an employee's health care premium; the employee paid 25 percent. Over the years, Starbucksextendedits health covemge to include preventive care, crisis counseling, dental care, eye care, mental health, and chemical dependency. Covemge was also offered for unmarried partners in a committed relationship. Since most Starbucks' employeeswere young and comparatively healthy,the companyhad beenable to provide broader coverage while keeping monthly payments relatively low. The value of Starbucks' health care progmm struck home when one of the company's store managersand a former baristawalked into Schultz's office and told him he had AIDS: I had known he was gay but had no idea he was sick. His diseasehad entered a new phase,he explained, and he wouldn't be able to work any longer. We sat together and cried, for I could not find meaningful words to console him. I couldn't composemyself. I hugged him. 10 At that point, Starbuckshad no provision for employees with AIDS. We had a policy decision. Because of Jim, we decided to offer health-care coverageto all employeeswho have terminal illnesses, paying medical costs in full from the time they are not able to work until they are covered by
ees into partners, give them a chance to share in the success the company,and make clear the connection of betweentheir contributions and the company'smarket value. Even though Starbuckswas still a private company, the plan that emerged called for granting stock options to all full-time 3.id part-time employeesin proportion to their base pay. In May 1991, the plan,
dubbed Bean Stock, was presented the board. to
government programs, usually twenty-nine
months. After his visit to me, I spoke with Jim often and visited him at the hospice. Within a year he was gone. I receiveda letter from his family afterward, telling me how much they appreciated our benefit plan. In 1994 Howard Schultz was it\.vited to The White House for a one-on-one meeting with President Bill Clinton to brief him on Starbucks' healthcare progmm.
Though board members were concerned that increasing the numberof sharesmight unduly dilute the value of the sharesof investorswho had put up hard cash, the plan received unanimous approval.The first grantwas made in October 1991,just after the end of the company's fiscal year in September; each partner was granted stock options worth 12 percent of basepay. Each October since then, Starbucks has granted employees options equal to 14 percent of base pay, awardedat the stock price at the start of the fiscal year (October 1). When the Bean Stock program was presentedto employees,Starbucksdropped the term employee and began referring to all of its people as partners becauseeveryone,including part-timers working at least20 hours per week,was eligible for stockoptions after six months. At the end of fiscal year 2003, Starbucksemployee stock option plan included 39 million-shares in outstanding options; new options for about 10 million shareswere being granted annually.12 Starbucks became a public company in 1992; its initial public offering (IPO) of common stock in June proved to be one of the most successfulIPOs of 1992 and provided the companyaccessto the capital needed to accelerateexpansionof its store network. Exhibit 4 shows the performance of the company's stock price since the 1992IPO.
StarbucksJ Stock Purchase Plan for Employees
The Creation of an Employee Stock Option Plan
By 1991 the company's profitability had improved to the point where Schultz could pursue a stock option plan for all employees,a program he believed would havea positive, long-term effect on the success Starof bucks. I I Schultz wanted to turn all StarbucksemployIOlbid.,p. 129. liAs related in ibid., pp. 131-36.
In 1995, Starbucks implemented an employee stock purchaseplan. Eligible employeescould contribute up to 10 percent of their base earnings to quarterly purchasesof the company's common stock at 85 percent of the going stock price. As of fiscal 2003, about 5.7 million shares had been issued since inception of the plan, and new shares were being purchased at a rate close to I million shares annually by some 11,184 active employee participants (out of almost 35,000 employees who were eligible to partici12Starbucks annual report, 2002,p. 32.
Case
Starbucks in 2004: Driving for Global Dominance
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4
The Performance of Starbucks' Stock, 1992-2003
30~~ 40
~~~:
StocK
Prire
for eligible Kingdom employees was established in
Environment
believed that the company's
'-- ---" -,
with above-average skills and Storeemployees werepaid around c -c. -.. rates for store employees
150 to 400 percent a year, the turnover
---"
to about 50 percent for other chain
for its relativelylow tu~,~!,~r rates:
Starbucks' management used annual "Partner View" surveysto solicit feedbackfrom its workforce of over 74,000 people, learn their concerns,and measure job satisfaction. In the latest sample survey of 1,400 employees,79 percent rated Starbucks' workplace environment favorably relative to other companies they were familiar with, 72 percentreported being satisfied with their presentjob, 16 percentwere neutral, and 12 percentwere dissatisfied. But the 2QQ2 surveyrevealed that many employeesviewed the benefits package as only "average,"prompting the companyto increaseits match of 401(k) contributions for those who had been with the company more than three years and to have these contributions vest immediately. Exhibit 5 contains a summary of Starbucks'fringe benefit program. Starbucks was named by Fortune magazineas one of the "100 Best Companiesto Work For" in 1998, 1999, 2000, and 2002. Still, in 2003, Starbucks'management was concernedby field reports of stores that were suffering from slumping employee morale and store matlagerburnout.
peopleaskif
STARBUCKS' CO RPO RATE VALUES AND BUSINESS PRINCIPLES
During the early building years, Howard Schultz and other Starbucks' senior executives worked to instill some key values and guiding principles into the
"Employee Perks: Starbucks Coffee's ~'~ft" -.", , ",..'-~"" .'-., 15,
C-16 exhibit 5
Part 2 I Casesin Crafting and Executing Strategy
Elements of Starbucks' Fringe Benefit Program
Source: Compiled by the case researchers from company documents and other sources.
Starbucks culture. The cornerstonevalue in the effort "to build a company with soul" was that the company would never stoppursuing the perfect cup of coffee by buying the bestbeansand roasting them to perfection. Schultz remained steadfastly opposed to franchising, so that the company could control the quality of its products and build a culture common to all stores. He was adamantabout not selling artificially flavored coffee.beans-"We will not pollute our high-quality beans with chemicals"; if a customer wanted hazelnut-flavored coffee; Starbucks would provide it by adding hazelnut syrupto the drink ratherthan by adding hazelnut flavoring to the beansduring roasting. Running flavored beans through the grinders would leave behind chemical residues that would alter the flavor of beans ground afterward; plus, the chemical smell given off by artificially flavored beanswas absorbedby other beans in the store. Furthermore, Schultz didn't want the company to pursue supermarket sales because it would mean pouring Starbucks' beans into clear plastic bins where they could get stale, thus compromising the company's legacy of fresh, dark-roasted,full-flavored coffee. Starbucks' managementwas also emphatic about the importance of employeespaying attention to what pleased customers. Employees :weretrained to go out of their way, and to take heroic measuresif necessary, to make surecustomerswere fully satisfied. The theme was "Just say yes" to customerrequests. Further, employeeswere encouragedto speak their minds without fear of retribution from upper management-senior executives wanted employees to .~e vocal about what Starbucks was doing right, what it was doing wrong,
and what changeswere needed. Managementwanted employees to be involved in and contribute to the processof making Starbucksa better company. A valuesand principles "crisis" aroseat Starbucks in 19S9 when customers started requesting skim (i.e., nonfat) milk in making cappuccinosand lattes.Howard Schultz, who read all customer comments cards,and Dave Olsen, head of coffee quality, conducted taste tests of lattes and cappuccinosmade with nonfat milk and concluded they were not as good as those made with whole milk. Howard Behar, recentlyhired ashead of retail store operations,indicated that management's opinions didn't matter; what mattered was giving customers what they wanted. Schultz took the position that "We will never offer nonfat milk. It's not who we are." Behar, however,stuck to his guns,maintaining thatuse of nonfat milk should at least be tested-otherwise it appeared as if all the statements managementhad made aboutthe importance of really and truly pleasing customers were a sham. A fierce internal debate ensued.One dogmatic defenderof the quality and tasteof Starbucks' coffee products buttonholed Behar outside his office and told him that using nonfat milk amounted to "bastardizing" the company's products. Numerous store managers maintained that offering two kinds of milk was operationally impractical. Schultz found himself in a quandary, torn betweenthe company's commitment to quality and its goal of pleasing customers.One day after visiting one of the stores in a residential neighborhood and watching a customer leave to go to a competitor's store because Starbucks did not make lattes with nonfat milk, Schultz
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Part 21 Casesin Crafting and Executing Strategy
only had favorabledemographicprofiles but also could be serviced and supportedby the company'soperations infrastructure. For eachtargeted region, Starbucks selected a large city to serve as a "hub"; teamsof professionals were located in hub cities to supportthe goal of opening 20 or more stores in the hub in the first two years. Once stores blanketed the hub, then additional storeswere opened in smaller,surrounding "spoke" areas in the region. To overseethe expansion process, Starbuckscreatedzone vice presidentsto direct the developmentof eachregion and to implant the Starbucks culture in the newly openedstores.All of the new zone vice presidentsStarbucksrecruited came with extensive operating and marketing experience in chain store retailing. Starbucks' strategy in major metropolitan cities was to blanket the area with stores,evenif some stores cannibalized another store's business.18 While a new store might draw 30 percentof the businessof an existing store two or so blocks away,management believed that its "Starbucks everywhere" approachcut down on delivery and management costs, shortened customer lines at individual stores,and increased foot traffic for all the stores in an area. Starbucks' store launches grew steadily more successful. In 2002, new stores generated an average of $1.2 million in first-year revenues, compared to $700,000 in 1995 and only $427,000 in 1990. The steadyincreasesin new-storerevenueswere due partly to growing popularity of premium coffee drinks and partly to Starbucks' growing reputation. In more and more instances, Starbucks' reputation reached new markets evenbefore storesopened. Moreover, existing stores continued to post sales gains in the range of 2-10 percent annually. In 2003, Starbucksposted same-store sales increases averaging 8 percent (Exhibit 3), the 12thconsecutiveyear the companyhad achieved sales growth of 5 percent or greater at existing stores.Starbucks'revenueshad climbed ~ average of 20 percent annually since 1992. In a representative week in 2003, about 20 million people bought a cup of coffee at Starbucks; a typical customer stopped at a Starbucks about 18 times a month-no u.s. retailer had a higher frequencyof customervisits.19 One of Starbucks' core competencieswas identifying good retailing sites for its new stores.The company was regarded as having the best real estateteam in the coffee bar industry and a sophisticated system
18Danie1s, "Mr. Coffee," p. 140. 191bid.
for identifying not only the most attractive individual city blocks but also the exact store location that was best; it also worked hard at building good relationships with local real estaterepresentativesin areaswhere it was opening multiple store locations. The company's site location track record was so good that as of 1997it had closed only 2 of the 1,500 sites it had opened;its track record in finding successfulstore locations was still intact as of 2003 (although specific figures were not available). Exhibit 7 showsa timeline of Star bucks' entry into new market areas,along with other accomplishments, milestones,key events,and awards.
International
Expansion
In markets outside the continental United States (including Hawaii), Starbuckshad a two-prongedstore expansion: either opencompany-ownedand companyoperatedstores or else license a reputable and capable local company with retailing know-how in the target host country to develop and operate new Starbucks stores:ltl most countries, Starbucksused a local partner/licensee to help it recruit talented individuals, set up supplier relationships, locate suitable store sites, and caterto local market conditions. Starbuckslooked for partners/licenseesthat had strong retail/restaurant experience,had values and a corporateculture compatible with Starbucks,were committed to good customer service,possessed talented management and strong financial resources,and had demonstratedbrand-building skills. Starbuckshad createda new subsidiary,Starbucks Coffee International, to orchestrateoverseasexpansion and begin to build the Starbucksbrand name globally via licensees.(See Exhibit 1 for the numberof lic~nsed internationalstoresand Exhibit 7 for the years in which Starbucksenteredmost of theseforeign markets.)Starbucks' management expectedto have a total of 10,000 stores in 60 countries by the end of 2005. The company's first store in France opened in early 2004 in Paris. China was expected to be Starbucks' biggest market outside the United States in the years to come. Thus far, Starbucks products were proving to be a much bigger hit with consumers in Asia than in Europe. Even so, Starbucks was said to be losing money in both Japan and Britain; moreover, the Starbucks Coffee International division was only marginally
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