C-22
Part 2 I Casesin Crafting and Executing Strategy
pedestrian foot traffic and/or drivers. Only a select few were in suburbanmalls. Over the years,Starbuckshad experimented with a broad range of store formats. Special seating areas were addedto help make Starbucksa desirablegathering place where customerscould meetand chat or simply enjoy a peaceful interlude in their day. Flagship stores in high-traffic, high-visibility locations had fireplaces, leather chairs, newspapers, couches,and lots of ambience.The companyalso experimentedwith drivethrough windows in locations where speedand convenience were important to customersand with kiosks in supermarkets, building lobbies, and other public places. A "stores of the future" project teamwas formed in 1995 to raise Starbucks' store design to a still higher level and come up with the next generationof Starbucks stores.The vision of what a Starbucksstore should be like included suchconceptsas an authenticcoffee experience that conveyedthe artistry of espressomaking, a place to think and imagine, a spot where people could gatherand talk over a great cup of coffee, a comforting refuge thatprovided a sense community,a third place of for people to congregatebeyond work or the home, a place that welcomespeople and rewards them for coming,and a layout that could accommodateboth fast service and quiet moments. The team researchedthe art and literatureof coffee throughoutthe ages,studiedcoffee-growing and coffee-making techniques,and looked at how Starbucks' storeshad already evolved in terms of design, logos, colors, and mood. The team came up with four store designs-<>nefor eachof the four stages of coffee making: growing, roasting, brewing, and aroma-each with its own color combinations,lighting scheme,and componentmaterials. Within eachof the four basic storetemplates,Starbucks could vary the materials and details to adapt to different store sizes and settings(downtownbuildings, college campuses, neighborhood shoppingareas).In late 1996, Starbucks began opening new stores based on one of the four formats and color schemes. But as the number of stores increasedrapidly between 2000 and 2003, greater store diversity and layout quickly became necessary. Exhibit 8 showsthe diverse nature of Starbucksstores in 2003. To better control averagestore opening costs,the company centralized buying, developedstandardcontracts and fixed fees for certain item~,and consolidated
work underthose contractorswho displayedgood costcontrol practices. The retail operations group outlined exactly the minimum amount of equipment eachcore store neededso that standarditems could be ordered in volume from vendors at 20 to 30 percent discounts, then delivered just in time to the store site either from company warehousesor the vendor. Modular designs for display caseswere developed.And the whole store layoutwas developedon a computer,with software that allowed the coststo be estimatedas the designevolved. All this cut store opening costs significantly and reduced store developmenttime from 24 to 18weeks. In August 2002, Starbucksteamed up with T-Mobile USA, the largestU.S. carrier-ownedWi-Fi service, to experiment with providing Internet accessand enhanced digital entertainment to patrons at over 1,200 Starbucks locations. Customers using a Wi-Fi notebook computer while at Starbucks locations equipped with wireless broadbandInternet service could surf the Web or take advantageof special Starbucks-sponsored multi~f?dia promotions (e.g., classic blues performances by Howlin' Wolf and Muddy Waters,an array of great blues tunes, and videos of noteworthy musicians sharing how blues music and artists influenced them). The objective was to heighten the "third place" Starbucks experience, entice customers into perhaps buying a secondlatte or espresso while catching up on e-mail, listening to digital music, putting the finishing touches on a presentation,or accessingtheir corporate intranet. Since the August 2002 introduction ofWi-Fi at Starbucks,wireless Internet service had beenadded at 1,200more storesand the numberof accesses in was the millions; internal researchshowedthat the average connection lasted approximately45 minutes and more than 90 percent of T-Mobile HotSpot accesses were during the off-peak store hours, after 9:00 AM.In October 2003, Starbucks announced that it was expanding Wi-Fi capability to additional locations and would have 2,700 storesequipped with wireless Internet access by year-end. During the early start-up years,Starbucksavoided debt and financed new stores entirely with equity capital. But as the company'sprofitability improvedand its balancesheetstrengthened, Schultz'soppositionto debt as a legitimate financing vehicle softened.In 1996the company completed its second debt offering, netting $161 million from the saleof convertibledebentures for use in its capital construction program. This debt was
Starbucks in 2004: Driving for Global Dominance
C-25
In 2003, in an averageweek, about22 million customers patronized Starbucksstores in North America, up from about 5 million in 1998. Storesdid about half of their businessby 11:00 AM. Loyal customerspatronized a Starbucksstore 15 to 20 times a month, spending perhaps $50-$75 monthly. Some Starbucks fanatics came in daily. Baristas became familiar with regular customers,learning their names and their favorite drinks. Christine Nagy, a field director for Oracle Corporation in Palo Alto, California, told a Wall StreetJournal reporter, "For me, it's a daily necessity or I start getting withdrawals."24Her standard order wasa customdrink: a decaf grande nonfat no-whip nofoam extra-cocoa mocha; when the barista saw her come through the door, Nagy told the reporter, "They just say 'We need a Christine here.'" Since its inception in 2001, 20 million Starbuckscustomershad purchased the reloadable Starbucks Card that allowed them to pay for their purchaseswith a quick swipe at the cashregisterand also to earnand redeemrewards. In the fall of 2003 Starbucks, in partnership with Bank One, introduced the Duetto Visa card, which addedVisa card functionality to the reloadable Starbucks Cards. By charging purchasesto the Visa accountof their Duetto card anywhereVisa credit cards were accepted,cardholders earned 1 percent back in Duetto Dollars, which were automatically loaded on their StarbucksCard account after eachbilling cycle. Duetto Dollars could be used to purchase beverages, food,and storemerchandiseat any Starbuckslocation. The Duetto card was the latest in an ongoing effort by Starbucks'management introduce new products and to experiences customersthat belonged exclusively to for Starbucks;seniorexecutivesdrummed the importance of alwaysbeing opento reinventing the Starbucksex-
perience.
So far, Starbucks had spent very little money on advertising,preferring instead to build the brand cup by cup with customersand depend on word of mouth andthe appealof its storefronts.
joint Ventures
In 1994,aftermonths of meetingsand experimentation, PepsiCoand Starbucksentered into a joint venture to create new coffee-relatedproducts for mass distribution throughPepsichannels,including cold coffee drinks in
24David Bank, "Starbucks FacesGrowing Competition: Its Own Stores," The Wall Street Journal, January 21,1997,
p,Bl,
a bottle or can. Howard Schultz saw this as a major paradigm shift with the potential to cause Starbucks' business to evolve in heretofore unimaginable directions; he thought it was time to look for ways to move Starbucksout into more mainstreammarkets.Cold coffee products had historically met with poor market reception, except in Japan,where there was an $8 billion market for ready-to-drink coffee-based beverages. Nonetheless,Schultzwas hoping the partnerswould hit on a new product to exploit a good-tasting coffee extract that had beendevelopedby Starbucks'recentlyappointed director of research and development.The joint venture's first new product, Mazagran, a lightly flavored carbonatedcoffee drir.k, was a failure; a market test in southern California showed that some people liked it and somehated it. While people were willing to try it the first time, partly becausethe Starbucksname was on the label, repeatsalesproved disappointing. Despite the clashof cultures and the different motivations of PepsiCo and Starbucks, the partnership held togetherbecauseof the good working relationship that evolved between Howard Schultz and Pepsi's senior executives. Then Schultz, at a meeting to discuss the future ofMazagran, suggested, "Why not developa bottled version ofFrappuccino?"25 Starbuckshad come up with the new cold coffee drink in the summer of 1995,and it had proved to be a big hot-weatherseller; Pepsiexecutiveswere enthusiastic.After months of experimentation,the joint venture product researchteam came up with a shelf-stableversion ofFrappuccino that tasted quite good. It was tested in West Coast supermarkets in the summerof 1996; salesran 10times over projections, with 70 percentbeing repeatsales.Salesof Frappuccino reached $125 million in 1997 and achieved national supermarket penetration of 80 percent. Starbucks' management believed that the market for Frappuccinowould ultimately exceed$1 billion. In October 1995Starbucks partneredwith Dreyer's Grand Ice Creamto supplycoffee extract for a new line of coffee ice cream made and distributed by Dreyer's underthe Starbucks brand.The new line, featuring such flavorsas Dark RoastExpressoSwirl, JavaChip, Vanilla MochaChip, Biscotti Bliss, and Caffe Almond Fudge, hit supermarket shelvesin April 1996,and by July 1996 Starbuckscoffee-flavored ice cream was the best-selling superpremium brand in the coffee segment. In 1997, two new low-fat flavors were added to
25 r~lated in Schultzand Yang, Pour YourHeart Into It, As
p.2:?4,
C-26
Part 2 I Casesin Crafting and Executing Strategy
complementthe original six flavors,along with two flavors of ice cream bars; all were well received in the
marketplace.
In 2003, Starbucks'partnershipswith PepsiCoand Dreyer's generatedrevenuesof about $6 million.
Licensed Stores and Specialty Sales
Starbuckshad a licensing agreementwith Kraft Foods to market and distribute Starbucks' whole-bean and ground coffees in grocery and mass-merchandise channel~ acrossthe United States.Kraft managedall distribution, marketing, advertising, and promotions and paid a royalty to Starbucks based on a percentageof net sales. Two-thirds of all coffee was sold in supermarkets. Starbucks coffee sold in supermarkets featured distinctive, elegant packaging; prominent positions in grocery aisles; and the same premium quality as that of coffee sold in its stores. Product freshness was guaranteed by Starbucks' FlavorLock packaging, and the price per pound paralleled the prices in Starbucks' retail stores. Flavor selections in supermarkets,however,were more limited than those at Starbucks stores. Starbucks executives recognized that supermarketdistribution entailed severalrisks, especially in exposing Starbucksto first-time customers. Starbuckshad built its reputationaround the unique retail experience in its stores,where all beverageswere properly prepared-it had no control over how customers would perceive Starbucks when they encountered it in grocery aisles. A second risk concerned coffee preparation at home. Rigorous quality control and skilled baristasensuredthat store-purchased beverages would measure up, but consumers using poor equipment or inappropriate brewing methods could easily conclude that Starbucks packaged coffees did not live up to their reputation. Going into 2004, Starbuckscoffees wereavailable in some 19,500 supermarkets and warehouse clubs (such as Sam's and Costco) and generated 2003 revenuesclose to $160 million. Starbuckshad also entered into a limited number of licensing agreements for store locations in areas where it did not have ability to locate its own outlets. The companyhad an agreementwith Marriott Host International that allowed Host to operate Starbucks
retail stores in airport locations, and it had an agreement with Ararnark Food and Servicesto put Starbucks stores on university campusesand other locations operated by Aramark. Starbucks received a license fee and a royalty on sales at these locations and supplied the coffee for resale in the licensed locations. All licensedstoreshad to follow Starbucks'detailed operating procedures and all managersand employeeswho worked in thesestoresreceivedthe sametraining given to Starbucks managers and store employees. As of 2003, there were 1,422 licensed or franchisedstores in the United Statesand 1,257licensedstoresinternationally. Royalty and license fee revenues from domestic stores generatedclose to $150 million in revenues in fiscal 2003, with international licensed retail storesaccounting for about $250 million in revenues. Starbucks had a specialty sales group that provided its coffee products to restaurants, airlines, hotels, universities, hospitals,businessoffices, country clubs, and selectretailers. One of the early usersof Starbucks coffee was Horizon Airlines, a regional carrier basedin Seattle. In 1995, Starbucks entered into negotiations with United Airlines to serve Starbucks coffee on all United flights. There was much internal debateat Starbucks about whether sucha move made sensefor Starbucks and the possible damageto the integrity of the Starbucksbrand if the quality of the coffee serveddid not measureup. After sevenmonths of negotiationand discussionover coffee-making procedures, United Airlines and Starbuckscame up with a mutually agreeable way to handle quality control on 500-plus planes having varying equipment,and Starbucksbecamethe coffee supplier to the 20 million pas!l~ngers flying United each year. Since then, Starbucks had entered into an agreementto have Starbucks coffee served on Canadian Air flights. In recent years,the specialty sales group had won the coffee accounts at Sheratonand Westin hotels, resulting in packets of Starbucks coffee being in each room with coffee-making equipment. Starbucks had enteredinto an agreementwith Wells Fargo to provide coffee service at some of the bank's locations in California. A 1997 agreement with U.S. Office Products gave Starbucksan entreeto provide its coffee to workers in 1.5 million business offices. In addition, Starbucks supplied an exclusive coffee blend to Nordstrom's for sale only in Nordstrom stores,operated coffee bars in Barnes & Noble bookstores,and, most recently, had begun coffee bar operations for
C-28
Part2 I Casesin Crafting and Executing Strategy
During 2002, a global oversupply of more than 2 billion pounds drove the prices of commodity coffees to historic lows of $0.40-$0.50 per pound. The specialty coffee market, which representedabout 10 percent of worldwide production, consisted primarily of high-quality arabica beans.Prices for specialtycoffees were determined by the quality and flavor of the beans and were almost always higher than prevailing prices for commodity-grade coffee beans. Starbucks purchased only high-quality arabica coffee beans,paying an averageof $1.20 per pound in 2002. Its purchases representedabout 1 percentof the world's coffee-bean
$1.41 for organic green arabica coffee. According to TransFairUSA, an independentnonprofit organization that licensed Starbucks to sell Fair Trade coffee imported into the United States, guaranteed the prices for Fair Trade coffees boosted earnings for small coffee growers enough to allow them to afford basic health care, education, and home improvements. In 2003, Starbucksmarketed FairTrade Certified coffee at most of its retail storesand through some350 university and hotel locations that were licensedto sell Starbuckscoffees.
crop.
Believing that the continued growth and success of its businessdependedon gaining accessto adequate supplies of high-quality coffees on a year-in, year-out basis, Starbucks had beena leader in promoting environmental and social stewardship in coffee-origin countries. Starbucks' coffee-sourcing strategy was to contribute to the sustainability of coffee growers and help conservethe environment. In sourcing green coffee beans,Starbuckswas increasingly dealing directly with farmers and cooperatives,and its policy was to pay prices high enough to ensure that small coffee growers, most of whom lived on the edge of poverty, were able to cover their production costs and provide for their families. About 40 percentof Starbucks' purchaseswere made under three- to five-year contracts, which managementbelieved enabled the company to purchase its future coffee-bean requirements at predictable prices over multiple crop years. Coffee purchases negotiated through long-term contracts increasedfrom 3 percentin 2001 to 36 percentin 2002. Farmerswho met important quality, environmental,social, and economic criteria-which Starbuckshad developed with the support of Conservation International's Center for Environmental Leadershipin Business-were rewarded with financial incentives and preferred supplier status.
Environmental
Best Practices
Since 1998, Starbucks had partnered with Conservation International to promote coffee cultivation methods that protected biodiversity and maintained a healthy environment. A growing percentageof the coffees that Starbuckspurchasedwere grown without the use of pesticides,herbicides,or chemicalfertilizers; organic cultivation methodsresulted in clean ground wa-
ter and helped protect againstdegradingof local
ecosystems,many of which were fragile or in areas where b.iodiversity was under severe threat. Another environmental conservationpractice involved growing organic coffee undera natural canopyof shadetreesinterspersedwith fruit treesand othercrops; this not only allowed farmers to get higher crop yields from small acreagesbut also helped protect againstsoil erosion on mountainsides.
COFFEE-ROASnNG OPERA nONS
Starbucksconsideredthe roasting of its coffee beansto be something of an art form, entailing trial-and-error testing of different combinations of time and temperature to get the most out of eachtype of beanand blend. Recipes were put together by the coffee department once all the components had been tested. Computerized roasters guaranteedconsistency. Each batch was roasted in a powerful gas oven for 12 to 15 minutes. Highly trained and experienced roasting personnel monitored the process,using both smell and hearingto help check when the beanswere perfectly done--coffee beans make a popping sound when ready. Starbucks' standardswere so exacting that roasterstested
A growing numberor small conee growerswere members of democratically run cooperatives that were registered with Fairtrade Labelling Organizations International; these growers could sell their beansdirectly to importers, roasters,and retailers at favorable guaranteed "fair-trade" prices. Buyers of Fair Trade Certified coffee beanshad to pay a minimum of $1.26 per pound for nonorganic green ar~bica coffee and
C-32
Part 2 I Casesin Crafting and Executing Strategy
accounted for 87 percentof all coffee consumed in the United States in 2002; some industry expertsbelieved that this statistic signaled that the gourmet coffee segment was still emerging. Growing numbers of restaurantswere upgrading the quality of the coffee they served.And both General Foods and Procter & Gamble had introduced pre~ium blends of their Maxwell House and Folger's coffees on supermarket shelves,pricing them several dollars below Starbucks'offerings.
Future
Challenges
In fiscal 2004, Starbucks planned to open approximately 1,300 new stores worldwide and to have comparable store sales growth of 3 to 7 percent. Top managementbelieved that it could grow revenues by about 20 percent annually and net earnings by 20-25
percentannually for the next three to five years.To sustain the company's growth and make Starbucksone of the world's preeminent global brands,Howard Schultz believed that the company had to challenge the status quo, be innovative, take risks, and adapt its vision of who it was, what it did, and where it was headed.He was pushing Starbucks executivesto consider a number of fundamental strategic questions. What could Starbucks do to make its stores an evenmore elegant "third place" that welcomed, rewarded,and surprised customers? What new products and new experiences could Starbucksprovide that would uniquely belong to or be associatedwith Starbucks?How could Starbucks reachpeople who were not coffee drinkers? What new or different strategic paths should Starbuckspursue to achieve its objective of becoming the most recognized and respectedbrand in the world? --
'I ~
doc_215036433.pdf
Part 2 I Casesin Crafting and Executing Strategy
pedestrian foot traffic and/or drivers. Only a select few were in suburbanmalls. Over the years,Starbuckshad experimented with a broad range of store formats. Special seating areas were addedto help make Starbucksa desirablegathering place where customerscould meetand chat or simply enjoy a peaceful interlude in their day. Flagship stores in high-traffic, high-visibility locations had fireplaces, leather chairs, newspapers, couches,and lots of ambience.The companyalso experimentedwith drivethrough windows in locations where speedand convenience were important to customersand with kiosks in supermarkets, building lobbies, and other public places. A "stores of the future" project teamwas formed in 1995 to raise Starbucks' store design to a still higher level and come up with the next generationof Starbucks stores.The vision of what a Starbucksstore should be like included suchconceptsas an authenticcoffee experience that conveyedthe artistry of espressomaking, a place to think and imagine, a spot where people could gatherand talk over a great cup of coffee, a comforting refuge thatprovided a sense community,a third place of for people to congregatebeyond work or the home, a place that welcomespeople and rewards them for coming,and a layout that could accommodateboth fast service and quiet moments. The team researchedthe art and literatureof coffee throughoutthe ages,studiedcoffee-growing and coffee-making techniques,and looked at how Starbucks' storeshad already evolved in terms of design, logos, colors, and mood. The team came up with four store designs-<>nefor eachof the four stages of coffee making: growing, roasting, brewing, and aroma-each with its own color combinations,lighting scheme,and componentmaterials. Within eachof the four basic storetemplates,Starbucks could vary the materials and details to adapt to different store sizes and settings(downtownbuildings, college campuses, neighborhood shoppingareas).In late 1996, Starbucks began opening new stores based on one of the four formats and color schemes. But as the number of stores increasedrapidly between 2000 and 2003, greater store diversity and layout quickly became necessary. Exhibit 8 showsthe diverse nature of Starbucksstores in 2003. To better control averagestore opening costs,the company centralized buying, developedstandardcontracts and fixed fees for certain item~,and consolidated
work underthose contractorswho displayedgood costcontrol practices. The retail operations group outlined exactly the minimum amount of equipment eachcore store neededso that standarditems could be ordered in volume from vendors at 20 to 30 percent discounts, then delivered just in time to the store site either from company warehousesor the vendor. Modular designs for display caseswere developed.And the whole store layoutwas developedon a computer,with software that allowed the coststo be estimatedas the designevolved. All this cut store opening costs significantly and reduced store developmenttime from 24 to 18weeks. In August 2002, Starbucksteamed up with T-Mobile USA, the largestU.S. carrier-ownedWi-Fi service, to experiment with providing Internet accessand enhanced digital entertainment to patrons at over 1,200 Starbucks locations. Customers using a Wi-Fi notebook computer while at Starbucks locations equipped with wireless broadbandInternet service could surf the Web or take advantageof special Starbucks-sponsored multi~f?dia promotions (e.g., classic blues performances by Howlin' Wolf and Muddy Waters,an array of great blues tunes, and videos of noteworthy musicians sharing how blues music and artists influenced them). The objective was to heighten the "third place" Starbucks experience, entice customers into perhaps buying a secondlatte or espresso while catching up on e-mail, listening to digital music, putting the finishing touches on a presentation,or accessingtheir corporate intranet. Since the August 2002 introduction ofWi-Fi at Starbucks,wireless Internet service had beenadded at 1,200more storesand the numberof accesses in was the millions; internal researchshowedthat the average connection lasted approximately45 minutes and more than 90 percent of T-Mobile HotSpot accesses were during the off-peak store hours, after 9:00 AM.In October 2003, Starbucks announced that it was expanding Wi-Fi capability to additional locations and would have 2,700 storesequipped with wireless Internet access by year-end. During the early start-up years,Starbucksavoided debt and financed new stores entirely with equity capital. But as the company'sprofitability improvedand its balancesheetstrengthened, Schultz'soppositionto debt as a legitimate financing vehicle softened.In 1996the company completed its second debt offering, netting $161 million from the saleof convertibledebentures for use in its capital construction program. This debt was
Starbucks in 2004: Driving for Global Dominance
C-25
In 2003, in an averageweek, about22 million customers patronized Starbucksstores in North America, up from about 5 million in 1998. Storesdid about half of their businessby 11:00 AM. Loyal customerspatronized a Starbucksstore 15 to 20 times a month, spending perhaps $50-$75 monthly. Some Starbucks fanatics came in daily. Baristas became familiar with regular customers,learning their names and their favorite drinks. Christine Nagy, a field director for Oracle Corporation in Palo Alto, California, told a Wall StreetJournal reporter, "For me, it's a daily necessity or I start getting withdrawals."24Her standard order wasa customdrink: a decaf grande nonfat no-whip nofoam extra-cocoa mocha; when the barista saw her come through the door, Nagy told the reporter, "They just say 'We need a Christine here.'" Since its inception in 2001, 20 million Starbuckscustomershad purchased the reloadable Starbucks Card that allowed them to pay for their purchaseswith a quick swipe at the cashregisterand also to earnand redeemrewards. In the fall of 2003 Starbucks, in partnership with Bank One, introduced the Duetto Visa card, which addedVisa card functionality to the reloadable Starbucks Cards. By charging purchasesto the Visa accountof their Duetto card anywhereVisa credit cards were accepted,cardholders earned 1 percent back in Duetto Dollars, which were automatically loaded on their StarbucksCard account after eachbilling cycle. Duetto Dollars could be used to purchase beverages, food,and storemerchandiseat any Starbuckslocation. The Duetto card was the latest in an ongoing effort by Starbucks'management introduce new products and to experiences customersthat belonged exclusively to for Starbucks;seniorexecutivesdrummed the importance of alwaysbeing opento reinventing the Starbucksex-
perience.
So far, Starbucks had spent very little money on advertising,preferring instead to build the brand cup by cup with customersand depend on word of mouth andthe appealof its storefronts.
joint Ventures
In 1994,aftermonths of meetingsand experimentation, PepsiCoand Starbucksentered into a joint venture to create new coffee-relatedproducts for mass distribution throughPepsichannels,including cold coffee drinks in
24David Bank, "Starbucks FacesGrowing Competition: Its Own Stores," The Wall Street Journal, January 21,1997,
p,Bl,
a bottle or can. Howard Schultz saw this as a major paradigm shift with the potential to cause Starbucks' business to evolve in heretofore unimaginable directions; he thought it was time to look for ways to move Starbucksout into more mainstreammarkets.Cold coffee products had historically met with poor market reception, except in Japan,where there was an $8 billion market for ready-to-drink coffee-based beverages. Nonetheless,Schultzwas hoping the partnerswould hit on a new product to exploit a good-tasting coffee extract that had beendevelopedby Starbucks'recentlyappointed director of research and development.The joint venture's first new product, Mazagran, a lightly flavored carbonatedcoffee drir.k, was a failure; a market test in southern California showed that some people liked it and somehated it. While people were willing to try it the first time, partly becausethe Starbucksname was on the label, repeatsalesproved disappointing. Despite the clashof cultures and the different motivations of PepsiCo and Starbucks, the partnership held togetherbecauseof the good working relationship that evolved between Howard Schultz and Pepsi's senior executives. Then Schultz, at a meeting to discuss the future ofMazagran, suggested, "Why not developa bottled version ofFrappuccino?"25 Starbuckshad come up with the new cold coffee drink in the summer of 1995,and it had proved to be a big hot-weatherseller; Pepsiexecutiveswere enthusiastic.After months of experimentation,the joint venture product researchteam came up with a shelf-stableversion ofFrappuccino that tasted quite good. It was tested in West Coast supermarkets in the summerof 1996; salesran 10times over projections, with 70 percentbeing repeatsales.Salesof Frappuccino reached $125 million in 1997 and achieved national supermarket penetration of 80 percent. Starbucks' management believed that the market for Frappuccinowould ultimately exceed$1 billion. In October 1995Starbucks partneredwith Dreyer's Grand Ice Creamto supplycoffee extract for a new line of coffee ice cream made and distributed by Dreyer's underthe Starbucks brand.The new line, featuring such flavorsas Dark RoastExpressoSwirl, JavaChip, Vanilla MochaChip, Biscotti Bliss, and Caffe Almond Fudge, hit supermarket shelvesin April 1996,and by July 1996 Starbuckscoffee-flavored ice cream was the best-selling superpremium brand in the coffee segment. In 1997, two new low-fat flavors were added to
25 r~lated in Schultzand Yang, Pour YourHeart Into It, As
p.2:?4,
C-26
Part 2 I Casesin Crafting and Executing Strategy
complementthe original six flavors,along with two flavors of ice cream bars; all were well received in the
marketplace.
In 2003, Starbucks'partnershipswith PepsiCoand Dreyer's generatedrevenuesof about $6 million.
Licensed Stores and Specialty Sales
Starbuckshad a licensing agreementwith Kraft Foods to market and distribute Starbucks' whole-bean and ground coffees in grocery and mass-merchandise channel~ acrossthe United States.Kraft managedall distribution, marketing, advertising, and promotions and paid a royalty to Starbucks based on a percentageof net sales. Two-thirds of all coffee was sold in supermarkets. Starbucks coffee sold in supermarkets featured distinctive, elegant packaging; prominent positions in grocery aisles; and the same premium quality as that of coffee sold in its stores. Product freshness was guaranteed by Starbucks' FlavorLock packaging, and the price per pound paralleled the prices in Starbucks' retail stores. Flavor selections in supermarkets,however,were more limited than those at Starbucks stores. Starbucks executives recognized that supermarketdistribution entailed severalrisks, especially in exposing Starbucksto first-time customers. Starbuckshad built its reputationaround the unique retail experience in its stores,where all beverageswere properly prepared-it had no control over how customers would perceive Starbucks when they encountered it in grocery aisles. A second risk concerned coffee preparation at home. Rigorous quality control and skilled baristasensuredthat store-purchased beverages would measure up, but consumers using poor equipment or inappropriate brewing methods could easily conclude that Starbucks packaged coffees did not live up to their reputation. Going into 2004, Starbuckscoffees wereavailable in some 19,500 supermarkets and warehouse clubs (such as Sam's and Costco) and generated 2003 revenuesclose to $160 million. Starbuckshad also entered into a limited number of licensing agreements for store locations in areas where it did not have ability to locate its own outlets. The companyhad an agreementwith Marriott Host International that allowed Host to operate Starbucks
retail stores in airport locations, and it had an agreement with Ararnark Food and Servicesto put Starbucks stores on university campusesand other locations operated by Aramark. Starbucks received a license fee and a royalty on sales at these locations and supplied the coffee for resale in the licensed locations. All licensedstoreshad to follow Starbucks'detailed operating procedures and all managersand employeeswho worked in thesestoresreceivedthe sametraining given to Starbucks managers and store employees. As of 2003, there were 1,422 licensed or franchisedstores in the United Statesand 1,257licensedstoresinternationally. Royalty and license fee revenues from domestic stores generatedclose to $150 million in revenues in fiscal 2003, with international licensed retail storesaccounting for about $250 million in revenues. Starbucks had a specialty sales group that provided its coffee products to restaurants, airlines, hotels, universities, hospitals,businessoffices, country clubs, and selectretailers. One of the early usersof Starbucks coffee was Horizon Airlines, a regional carrier basedin Seattle. In 1995, Starbucks entered into negotiations with United Airlines to serve Starbucks coffee on all United flights. There was much internal debateat Starbucks about whether sucha move made sensefor Starbucks and the possible damageto the integrity of the Starbucksbrand if the quality of the coffee serveddid not measureup. After sevenmonths of negotiationand discussionover coffee-making procedures, United Airlines and Starbuckscame up with a mutually agreeable way to handle quality control on 500-plus planes having varying equipment,and Starbucksbecamethe coffee supplier to the 20 million pas!l~ngers flying United each year. Since then, Starbucks had entered into an agreementto have Starbucks coffee served on Canadian Air flights. In recent years,the specialty sales group had won the coffee accounts at Sheratonand Westin hotels, resulting in packets of Starbucks coffee being in each room with coffee-making equipment. Starbucks had enteredinto an agreementwith Wells Fargo to provide coffee service at some of the bank's locations in California. A 1997 agreement with U.S. Office Products gave Starbucksan entreeto provide its coffee to workers in 1.5 million business offices. In addition, Starbucks supplied an exclusive coffee blend to Nordstrom's for sale only in Nordstrom stores,operated coffee bars in Barnes & Noble bookstores,and, most recently, had begun coffee bar operations for
C-28
Part2 I Casesin Crafting and Executing Strategy
During 2002, a global oversupply of more than 2 billion pounds drove the prices of commodity coffees to historic lows of $0.40-$0.50 per pound. The specialty coffee market, which representedabout 10 percent of worldwide production, consisted primarily of high-quality arabica beans.Prices for specialtycoffees were determined by the quality and flavor of the beans and were almost always higher than prevailing prices for commodity-grade coffee beans. Starbucks purchased only high-quality arabica coffee beans,paying an averageof $1.20 per pound in 2002. Its purchases representedabout 1 percentof the world's coffee-bean
$1.41 for organic green arabica coffee. According to TransFairUSA, an independentnonprofit organization that licensed Starbucks to sell Fair Trade coffee imported into the United States, guaranteed the prices for Fair Trade coffees boosted earnings for small coffee growers enough to allow them to afford basic health care, education, and home improvements. In 2003, Starbucksmarketed FairTrade Certified coffee at most of its retail storesand through some350 university and hotel locations that were licensedto sell Starbuckscoffees.
crop.
Believing that the continued growth and success of its businessdependedon gaining accessto adequate supplies of high-quality coffees on a year-in, year-out basis, Starbucks had beena leader in promoting environmental and social stewardship in coffee-origin countries. Starbucks' coffee-sourcing strategy was to contribute to the sustainability of coffee growers and help conservethe environment. In sourcing green coffee beans,Starbuckswas increasingly dealing directly with farmers and cooperatives,and its policy was to pay prices high enough to ensure that small coffee growers, most of whom lived on the edge of poverty, were able to cover their production costs and provide for their families. About 40 percentof Starbucks' purchaseswere made under three- to five-year contracts, which managementbelieved enabled the company to purchase its future coffee-bean requirements at predictable prices over multiple crop years. Coffee purchases negotiated through long-term contracts increasedfrom 3 percentin 2001 to 36 percentin 2002. Farmerswho met important quality, environmental,social, and economic criteria-which Starbuckshad developed with the support of Conservation International's Center for Environmental Leadershipin Business-were rewarded with financial incentives and preferred supplier status.
Environmental
Best Practices
Since 1998, Starbucks had partnered with Conservation International to promote coffee cultivation methods that protected biodiversity and maintained a healthy environment. A growing percentageof the coffees that Starbuckspurchasedwere grown without the use of pesticides,herbicides,or chemicalfertilizers; organic cultivation methodsresulted in clean ground wa-
ter and helped protect againstdegradingof local
ecosystems,many of which were fragile or in areas where b.iodiversity was under severe threat. Another environmental conservationpractice involved growing organic coffee undera natural canopyof shadetreesinterspersedwith fruit treesand othercrops; this not only allowed farmers to get higher crop yields from small acreagesbut also helped protect againstsoil erosion on mountainsides.
COFFEE-ROASnNG OPERA nONS
Starbucksconsideredthe roasting of its coffee beansto be something of an art form, entailing trial-and-error testing of different combinations of time and temperature to get the most out of eachtype of beanand blend. Recipes were put together by the coffee department once all the components had been tested. Computerized roasters guaranteedconsistency. Each batch was roasted in a powerful gas oven for 12 to 15 minutes. Highly trained and experienced roasting personnel monitored the process,using both smell and hearingto help check when the beanswere perfectly done--coffee beans make a popping sound when ready. Starbucks' standardswere so exacting that roasterstested
A growing numberor small conee growerswere members of democratically run cooperatives that were registered with Fairtrade Labelling Organizations International; these growers could sell their beansdirectly to importers, roasters,and retailers at favorable guaranteed "fair-trade" prices. Buyers of Fair Trade Certified coffee beanshad to pay a minimum of $1.26 per pound for nonorganic green ar~bica coffee and
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Part 2 I Casesin Crafting and Executing Strategy
accounted for 87 percentof all coffee consumed in the United States in 2002; some industry expertsbelieved that this statistic signaled that the gourmet coffee segment was still emerging. Growing numbers of restaurantswere upgrading the quality of the coffee they served.And both General Foods and Procter & Gamble had introduced pre~ium blends of their Maxwell House and Folger's coffees on supermarket shelves,pricing them several dollars below Starbucks'offerings.
Future
Challenges
In fiscal 2004, Starbucks planned to open approximately 1,300 new stores worldwide and to have comparable store sales growth of 3 to 7 percent. Top managementbelieved that it could grow revenues by about 20 percent annually and net earnings by 20-25
percentannually for the next three to five years.To sustain the company's growth and make Starbucksone of the world's preeminent global brands,Howard Schultz believed that the company had to challenge the status quo, be innovative, take risks, and adapt its vision of who it was, what it did, and where it was headed.He was pushing Starbucks executivesto consider a number of fundamental strategic questions. What could Starbucks do to make its stores an evenmore elegant "third place" that welcomed, rewarded,and surprised customers? What new products and new experiences could Starbucksprovide that would uniquely belong to or be associatedwith Starbucks?How could Starbucks reachpeople who were not coffee drinkers? What new or different strategic paths should Starbuckspursue to achieve its objective of becoming the most recognized and respectedbrand in the world? --
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