Did Starbucks Outgrow Its Cozy Essence?

Excerpted from Smart Growth by Edward D. Hess. Copyright 2010 Columbia University Press. Used by arrangement with the Publisher. All rights reserved.

Starbucks ( SBUX) is a story of entrepreneurship, persistence, passion, great success, and recently, some poor growth risk management. Howard Schultz, the founder of Starbucks, was raised in a federally assisted housing project in Brooklyn, New York. His father was a truck driver and, as a young man, Howard watched how his father's employer treated him after he was injured and unable to work, leaving him without a job, benefits, and pension -- a beaten man. Schultz vowed that if he were ever a company leader he would never treat his employees that way. As a leader "he would not leave people behind."

Starbucks
Howard Schultz

The drive to escape poverty and succeed helped make Schultz a super salesman, and his serendipitous introduction to freshly brewed coffee and the idea of becoming a purveyor of coffee became his passion. That passion led to his extraordinary persistence as he spent more than a year persuading the owners of the original Starbucks coffee roasting business first to hire him in 1982 and then to let him open a coffee café. But that was not enough for Schultz, who wanted to bring the coffee experience to even more people and to do so by his own standards for both the coffee and managing the business. To accomplish this, Schultz persisted for over a year to raise money to start his own coffee café business and to build it into a profitable high-growth company while keeping his promise to himself to treat his employees fairly.

In his book Pour Your Heart Into It, Schultz stated that Starbucks was "living proof that a company can lead with its heart and nurture its soul and still make money." In that book, published in 1997, five years after Starbucks went public, Schultz stated: "A company can grow big without losing the passion and personality that built it, but only if it's driven not by profits but by values and people." However, that belief is now being tested.

Starbucks went public in 1992 with Schultz serving as CEO until 2000. When he stepped down at the age of forty-seven, he remained as chairman. During his tenure as CEO, he built Starbucks into the leading international coffee café with approximately 2,500 worldwide locations and revenues exceeding $1.6 billion, making Starbucks a model for employee engagement and partnership by offering health care and stock options widely to its workforce.

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.

This is a remarkable e-mail. First, Schultz talks about the devastating eff ect of the creeping dilution of the Starbucks brand -- several small steps taken in the interests of efficiency and productivity that diluted the brand and the customer experience. This is an important point. Several productivity enhancements were made by Schultz's successors and perhaps no one of them alone would have diluted the brand but, when added together they had enormous and, for Schultz, adverse consequences.

With the ambitious growth agenda implemented by Donald, it is unclear whether anyone seriously considered the impact of such growth on the customer experience. Where were the critical inquiry, the constructive debate, and the constructive dissent? Were Donald and Coles caught up in scoring high quarterly earnings numbers? Did Starbucks consider or debate the risks of growth? Failing to consider these questions about the consequences of growth is risky if an organization wants to avoid diluting the customer experience that made them successful to begin with.

In his e-mail, Schultz implies that the rapid growth-dilution of the Starbucks customer emotional experience made it easier for competitors, such as Dunkin' Donuts and McDonald's, to make inroads against Starbucks. Schultz's e-mail raises other issues as well: Why did Schultz put his concerns into an e-mail that could be widely distributed rather than, as chairman of the board, have a heart-to-heart with his management team?

Second, he does not talk about the potential cannibalization of its existing stores that would likely result from the significant new openings. Last, Schultz was concerned that by its rapid growth Starbucks had lost its essence of who it was, which drove its customer value proposition and competitive differentiator. The drive for operating efficiencies and store opening efficiencies trumped the sight, aroma and feel of coffee. Did Starbucks lose its essence?

Edward D. Hess is a Professor of Business Administration and Batten Executive-in-Residence at the Darden Graduate School of Business at the University of Virginia. He teaches MBA and Executive Education courses on corporate growth and has written eight books, numerous articles, and more than forty Darden case studies on the topic. His commentary has appeared in more than one hundred media outlets, including Fortune magazine, the Financial Times, CNBC, Fox Business News, businessweek.com, Forbes.com, Wallstreetcheatsheet.com, among others. For more information or to contact Professor Hess, please visit www.EDHLTD.com.