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TheStreet Open House

Did Starbucks Outgrow Its Cozy Essence?

Stocks in this article: SBUX

Orin Smith, who had joined Starbucks as CFO in 1990, succeeded Schultz as CEO from 2000 through March 2005. Under his leadership Starbucks grew from $1.6 billion in revenue to $4.5 billion. At the end of 2004, Starbucks operated 8,569 locations. Under Smith's five-year tenure, Starbucks added approximately 6,000 locations.

Jim Donald, who had joined Starbucks in 2002 after a career in the grocery industry, including stints at Safeway, Albertsons, Wal-Mart and Pathmark, succeeded Smith as CEO. Under Jim Donald's three-year tenure, the push to expand Starbucks accelerated sharply. Donald added another 6,414 locations, translating into nearly 180 stores per month. Donald opened more stores in his three years than Smith did in five and more than Starbucks did in its first ten years.

Starbucks

Donald's chief operating officer, Martin Coles, joined Starbucks in 2004, having come from Reebok. This is important because the two top leaders of the company came from outside the industry and from businesses with different customer value propositions than Starbucks.

At the end of Smith's five-year tenure in 2004, Starbucks had total liabilities of $916 million with $2.47 billion in shareholder equity. At the end of Donald's reign in 2007, Starbucks's total liabilities had surged to $3.06 billion -- an increase of over $2 billion in debt, much of it financed as short-term debt, with total shareholder equity of $2.3 billion.

February 14, 2007, was an auspicious day in the history of Starbucks. On that day Schultz sent an e-mail to Donald, copying the other members of the executive team, entitled "The Commoditization of the Starbucks Experience." That e-mail also mysteriously appeared on the Internet and was widely read. Because of its importance, I have included it in its entirety below:

From: Howard Schultz
Sent: Wednesday, February 14, 2007 10:39 AM Pacific Standard Time
To: Jim Donald
Cc: Anne Saunders; Dave Pace; Dorothy Kim; Gerry Lopez; Jim Alling; Ken Lombard; Martin Coles; Michael Casey; Michelle Gass; Paula Boggs; Sandra Taylor
Subject: The Commoditization of the Starbucks Experience As you prepare for the FY 08 strategic planning process, I want to share some of my thoughts with you.

Over the past ten years, in order to achieve the growth, development, and scale necessary to go from less than 1,000 stores to 13,000 stores and beyond, we have had to make a series of decisions that, in retrospect, have lead to the watering down of the Starbucks experience, and, what some might call the commoditization of our brand. Many of these decisions were probably right at the time, and on their own merit would not have created the dilution of the experience; but in this case, the sum is much greater and, unfortunately, much more damaging than the individual pieces. For example, when we went to automatic espresso machines, we solved a major problem in terms of speed of service and efficiency. At the same time, we overlooked the fact that we would remove much of the romance and theatre that was in play with the use of the La Marzocca machines. This specific decision became even more damaging when the height of the machines, which are now in thousands of stores, blocked the visual sight line the customer previously had to watch the drink being made, and for the intimate experience with the barista. This, coupled with the need for fresh roasted coffee in every North America city and every international market, moved us toward the decision and the need for flavor locked packaging. Again, the right decision at the right time, and once again I believe we overlooked the cause and the affect of flavor lock in our stores. We achieved fresh roasted bagged coff ee, but at what cost? The loss of aroma -- perhaps the most powerful non-verbal signal we had in our stores; the loss of our people scooping fresh coffee from the bins and grinding it fresh in front of the customer, and once again stripping the store of tradition and our heritage? Then we moved to store design. Clearly we have had to streamline store design to gain efficiencies of scale and to make sure we had the ROI on sales to investment ratios that would satisfy the financial side of our business. However, one of the results has been stores that no longer have the soul of the past and reflect a chain of stores vs. the warm feeling of a neighborhood store. Some people even call our stores sterile, cookie cutter, no longer reflecting the passion our partners feel about our coffee. In fact, I am not sure people today even know we are roasting coffee. You certainly can't get the message from being in our stores. The merchandise, more art than science, is far removed from being the merchant that I believe we can be and certainly at a minimum should support the foundation of our coffee heritage. Some stores don't have coffee grinders, French presses from Bodum, or even coffee filters. Now that I have provided you with a list of some of the underlying issues that I believe we need to solve, let me say at the outset that we have all been part of these decisions. I take full responsibility myself, but we desperately need to look into the mirror and realize it's time to get back to the core and make the changes necessary to evoke the heritage, the tradition, and the passion that we all have for the true Starbucks experience. While the current state of aff airs for the most part is self induced, that has lead to competitors of all kinds, small and large coff ee companies, fast food operators, and mom and pops, to position themselves in a way that creates awareness, trial and loyalty of people who previously have been Starbucks customers. This must be eradicated. I have said for 20 years that our success is not an entitlement and now it's proving to be a reality. Let's be smarter about how we are spending our time, money and resources. Let's get back to the core. Push for innovation and do the things necessary to once again differentiate Starbucks from all others. We source and buy the highest quality coffee. We have built the most trusted brand in coff ee in the world, and we have an enormous responsibility to both the people who have come before us and the 150,000 partners and their families who are relying on our stewardship. Finally, I would like to acknowledge all that you do for Starbucks. Without your passion and commitment, we would not be where we are today.

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