Starbucks - Back to Basics

ICMR Case Collection ICFAI Center for Management Research

This case was written by Sachin Govind, under the direction of S.S. George, ICFAI Center for Management Research (ICMR). It was compiled from published sources, and is intended to be used as a basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation. This case won the first prize in the John Molson Case Writing Competition 2008, organized by the John Molson School of Business, Concordia University, Montreal, Canada.

For use by students of Icfai Flexible Learning programs. Not to be reproduced or distributed in any form or by any means.

Starbucks: Back to Basics? BSTR307

2009, ICFAI Center for Management Research. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means- - electronic or mechanical, without permission. To order copies, call 0091-40-2343-0462/63 or write to ICFAI Center for Management Research, Plot # 49, Nagarjuna Hills, Hyderabad 500 082, India or email [email protected]. Website: www.icmrindia.org

For use by students of Icfai Flexible Learning programs. Not to be reproduced or distributed in any form or by any means.

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BSTR/307

Starbucks: Back to Basics?

We [Starbucks] somehow evolved from a culture of entrepreneurship, creativity, and innovation to a culture of, in a way, mediocrity and bureaucracy.1

- Howard Schultz, CEO, Starbucks, at the shareholders meeting in March 2008

The wheels have really come off of this train. Its amazing how fast business has derailed. If sales are down mid-single digits, [then] that is rapid erosion.2

- Larry Miller, Analyst, RBC Capital Markets,3 in April 2008, on Starbucks weak earnings for the first quarter

At some point this [the US] is going to be a mature market. The big question is when does that occur.4

- Bill Hulkower, Analyst, Mintel International, in June 2007, on the impending saturation in the US specialty coffee retail market

INTRODUCTION

On July 30, 2008, Starbucks Corporation (Starbucks) announced a net loss of US$ 6.7 million, for the quarter ended June 20085. This translated to a loss of one cent per share, as opposed to a profit of 21 cents per share (with a net profit of US$ 158 million) recorded for the corresponding period in 2007. This happened despite the fact that the companys net revenue grew 9 percent in the quarter to US$ 2.57 billion. Earlier, Starbucks had announced that it would close down around 600 of its under-performing stores in the US and nearly all of its stores in Australia, in addition to cutting about 1,000 non-store jobs6. Analysts attributed Starbucks falling fortunes as much to its rapid expansion that apparently eroded its competitiveness, as to the worsening US economy, with falling home prices, rising unemployment, and cash-strapped customers. .

The history of Starbucks goes back to 1971 when the first store was opened. Initially, the stores sold coffee by the pound. After Howard Schultz acquired the company in 1987, Starbucks started setting up cafs, where customers could sit and sip their favorite espressos and lattes. Schultz was instrumental in the rapid expansion that the company saw in the 1990s and 2000s. From being a small-sized company with around 165 stores in the US in 1992, Starbucks became a global behemoth with around 15,000 stores in more than 40 countries by early 2008.

1 Brad Stone, Starbucks Plans Return to Its Roots, www.nytimes.com, March 20, 2008. 2 Lisa Baertlein and Nichola Groom, Starbucks off the Boil amid US Downturn, www.brisbanetimes.com, April 25,

2008. 3 RBC Capital Markets is a Premier Investment Bank that provides a set of products and services to institutions,

corporations, governments and high net worth clients in 160 countries. 4 Starbucks Needs a Shot of Caffeine, www.money.cnn.com, June 8, 2007. 5 The companys fiscal year ends on the Sunday closest to September 30. 6 Andrea James, Starbucks Posts First Quarterly Loss, Ever, http://seattlepi.nwsource.com, July 30 2008.


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However, this rapid expansion brought with it some problems. While earlier Starbucks cafs were known for their high level of service, with friendly baristas, by the mid-2000s, they were criticized for their impersonal service. The design of the new stores was also criticized, on the grounds that they lacked character. Some other decisions such as introducing hot food, installing new espresso machines that limited the interaction between baristas and customers, etc., were also received unfavorably.

Schultz, who was the CEO till 2000, assumed the role once again in January 2008, in response to the companys poor performance. Although he immediately began addressing some of the problem areas, even as of August 2008, the company witnessed falling traffic at its US stores. The silver lining though was that its international revenues continued to grow.

BACKGROUND

Starbucks was the brainchild of English teacher Jerry Baldwin (Baldwin), history teacher Zev Siegl, and writer Gordon Bowker (Bowker). They opened the first Starbucks store in 19717 in Pike Place Market, Seattle and called it Starbucks Coffee, Tea and Spice. The first store sold fresh-roasted, gourmet coffee beans and brewing and roasting accessories. Company legend had it that Starbucks was named after the coffee-loving first mate in Moby Dick8. Initially, the firms logo was a two tailed mermaid with the stores name around it, designed by an artist friend of the trio.

By 1980, Starbucks had become the largest roaster of coffee in Washington, with six retail outlets9. In the same year, Zev Siegl sold his share in the partnership to Baldwin and Bowker, and left to pursue other interests.

In 1982, Howard Schultz (Schultz), who then represented Hammarplast10 in the US, was hired as the head of marketing at the company.

Shortly thereafter, on a business visit to Milan, Italy, Schultz noticed that every street had coffee bars which not only served espressos and other coffee-based drinks, but also were meeting places where people could socialize. On his return, Schultz tried to convince the owners to enter the restaurant business. Although Baldwin did not share Schultzs enthusiasm, he let him experiment with selling espresso in a corner of the sixth Starbucks store11 that opened in April 1984 in downtown Seattle. This proved very successful, with the store serving 400 customers by the end of the first day (compared to an average of about 250 customers a day in other Starbucks stores). In the next two months, the popularity of the coffee bar grew and around 800 customers visited each day. After much persuasion, the owners allowed Schultz to put espresso machines in two other stores. However, although they realized that the espresso business was proving really successful, Baldwin and Bowker believed that it was a distraction from the main business. Schultz, eventually, decided to start out on his own, and established a coffee house named Il Giornale, meaning The Daily in Italian.

In 1987, Starbucks was put up for sale. In order to raise the required funds of US$ 3.8 million to acquire Starbucks, Schultz presented his business plan to several investors. Schultzs vision was to launch 125 stores in five years time, and he was able to raise the required capital. Schultz renamed his Il Giornale coffee houses Starbucks and converted the six roasting shops that 7 Arthur A. Thompson, John E. Gamble Starbucks Corporation, A Case Study, http://www.mhhe.com, retrieved on

August 20, 2008. 8 Moby Dick is a novel by Herman Melville, written in 1851. The story tells the adventures of the wandering sailor

Ishmael and his voyage on the whaling ship Pequod, commanded by Captain Ahab. 9 Randy Wilson, Starbucks Coffee History, http://ezinearticles.com, retrieved on August 20, 2008 10 Hammarplast is a Swedish maker of stylish kitchen equipment and houseware. In the early 1980s, Starbucks was a

significant purchaser of Hammarplasts plastic drip-brewing thermoses. 11 Arthur A. Thompson and John E. Gamble Starbucks Corporation, http://www.mhhe.com, retrieved on August 20,

2008.


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Starbucks owned into classy and comfortable coffee houses, modeled on Italian espresso bars. He also changed the logo (Refer Exhibit I for the old and new logos). In the 1990s, Starbucks expanded rapidly. When Starbucks went public in June 1992, there were 165 Starbucks coffee houses in operation - surpassing Schultzs target of 125 cafes. By 1997, it had over 1,400 stores in North America and the Pacific Rim. It opened new stores at a rate of more than one per day. The company recorded sales of US$ 967 million in fiscal 1997 with profits of US$ 57.4 million. By the late 1990s, Starbucks was one of the most reputed brands in the US and the company was firmly established as the leading retailer and roaster of specialty coffee in North America.

Starbucks first international outlet opened in Tokyo in 1996.12 In 1998, Starbucks entered the UK by acquiring the UK-based Seattle Coffee Company and renamed the existing stores Starbucks. Starbucks was to be very successful in the UK in fact, in 2005, there were more Starbucks outlets in London than in Manhattan13.

In 1999, Starbucks bought the Tazo Tea company, a Portland, Oregon-based tea manufacturer and distributor. Starbucks acquired Hear Music in 1999, and began selling compiled CDs under the Hear Music brand at its stores. In early 2000, the number of Starbucks outlets in the US reached 2,20014.

In 2000, Schultz stepped down from the post of CEO. Orin Smith (Smith), who till then was the chief operating officer (COO), was made the CEO. Schultz assumed the newly-created role of chief global strategist in addition to continuing to hold the position of chairman. In October 2002, Jim Donald (Donald) was appointed as President of Starbucks. In May 2005, Donald assumed the role of CEO as well, after Smith retired. He also filled Smiths seat on the board of directors.

Starbucks entered continental Europe in 2001 when it opened stores in Switzerland and Austria. From 2001 to 2004, Starbucks opened on an average 1,200 stores every year, and in 2005, the figure touched 1,700. Starbucks entered Oman, Indonesia, Germany, Spain, Mexico, and Greece in 2002; Turkey, Chile, Peru, and Cyprus in 2003; Paris, France, in 2004; and Jordan in 2005. In all, as of 2005, there were more than 10,000 stores worldwide, with 7,300 in the US alone15.

By 2008, the there were around 15,000 stores worldwide, which generated annual sales of about $ 10 billion.16 In 2008, 29 percent of all Starbucks stores were outside the US - in more than 40 countries (Refer Exhibit II for Starbucks global presence)17. New stores were also planned in Algeria, Bulgaria, Colombia, Hungary, Poland and Portugal.

STORM IN A COFFEE CUP?

Beginning 2007, Starbucks saw a slowdown after years of growth.18 The companys shares fell 20 percent by mid-2007, compared to their value in mid-2006. The slide was attributed to several factors, but the main one was the economic situation in the US, believed to be the worst in decades. The plummeting US housing market was at the epicenter of the crisis. The two star

12 Starbucks Corporation, www.answers.com, retrieved on August 23, 2005. 13 Starbucks Thrives on Consumer Coffee Habit, http://www.beveragedaily.com, November, 2005. 14 Starbucks Corporation, www.answers.com, retrieved on August 23, 2005. 15 Starbucks Corporation, www.answers.com, retrieved on August 23, 2005. 16 Louise Dransfield, Starbucks Chokes on its Latte, http://www.independent.co.uk, August 1, 2008. 17 Starbucks was present in Argentina, Australia, Austria, Bahamas, Bahrain, Belgium, Brazil, Canada, Chile, China

(including Hong Kong and Macau), Cyprus, the Czech Republic, Denmark, Egypt, France, Germany, Greece, Indonesia, Ireland, Japan, Jordan, Kuwait, Lebanon, Malaysia, Mexico, Netherlands, New Zealand, Oman, Peru, the Philippines, Puerto Rico, Qatar, Romania, Russia, Saudi Arabia, Singapore, South Korea, Spain, Switzerland, Taiwan, Thailand, Turkey, the UAE, and the UK.

18 Howard Schultz, Chief Executive, Starbucks, in the Starbucks Annual Report.


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states - California and Florida - that accounted for one third of Starbucks domestic revenues were among the worst hit by the housing slump. The gloomy economic environment made US consumers cut back on what they perceived as frivolous spending - and expensive coffee figured high on the list of items that they could cut back on.

To add to Starbucks woes, the costs of opening new stores, distribution expenses, as well as material costs were touching new highs. The price of coffee and milk - major raw materials in the business - rose sharply (Refer Exhibit III for trends in the prices of milk and coffee). The price of oil was also touching record levels, increasing fuel costs.

However, analysts also pointed to internal factors that might have played a role in Starbucks disappointing performance. They were of the view that, in many ways, the company had become a victim of its own success.

Starbucks had started out as an upmarket and elegant coffee shop where yuppies19 went, and this had added aspirational value to the brand. It had positioned itself as an expensive and exclusive coffee brand that was not for just anyone. It aimed to become the one place outside of work and home where a person could feel at home. It projected itself as The Third Place, where one could come and meet friends, chat, and generally unwind. However, its rapid expansion during the 1990s and 2000s reduced the exclusivity of the Starbucks brand. Also, the company started to open kiosks at busy areas such as airports and book stores. (Starbucks expansion spree even prompted The Onion, a satirical newspaper, to come up with a mocking article -- New Starbucks Opens in Restroom of Existing Starbucks.) The massive expansion and the crowds meant it no longer was personal. Starbucks built its whole empire on the experience in the store the aroma, the seats, the fact that customers can relax, read a newspaper or work on a laptop. There may have been brand dilution between the airport kiosks, its availability in bookstores, and the coffee beans appearing on shelves. It may have become just another coffee brand,20 said Rick Ferguson, editorial director, Colloquy, a loyalty marketing consultancy.

Earlier in 1999, Schultz had replaced the manual La Marzocco espresso machines with automatic ones. Although the reason Schultz cited then was that the old machines were not ergonomic and caused frequent stress injuries, some analysts believed that the change had been made to improve efficiency. However, the new machines did not allow baristas to make eye contact with customers, robbing Starbucks of some of the theater and drama associated with the coffee experience at its outlets.

Schultzs stepping down from the post of CEO in 2000 was also seen by some analysts as a mistake. Post-2000, Schultz found new interests. He championed causes such as the national health-care legislation, on which he spent considerable time -- before Congress, on television, and in President Bill Clintons Oval Office. In 2001, Schultz became the co-owner of the Seattle SuperSonics21, a professional basketball team. He spent US$ 84 million for a 42 percent stake in the entity and became the principal voice of ownership. When asked whether these other pursuits took him away from Starbucks, Schultz said Even though I was not the CEO, I was around. I wasnt here every day, but I was here enough.22

19 Yuppies are young city or suburban residents with a well-paid professional job and an affluent lifestyle. (Source:

www.answers.com) 20 Richard H. Levey, A Slip between Cup and Lip, http://directmag.com, May 1, 2008. 21 Seattle SuperSonics, also called Seattle Sonics, was a professional basketball team then based in Seattle, Washington

that played in the Pacific and NorthWest divisions of the National Basketball Association (NBA). 22 David Margolick, Tall Order, www.portfolio.com, July 2008.


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In September 2006, the New York Times reported a Center for Science in the Public Interest23 study that claimed that the lattes and frappuccinos sold at Starbucks were as calorie rich as (if not more than) the stuff sold at McDonalds. A 20 ounce-Caf Mocha with whipped cream had 490 calories about the same as a quarter pounder with cheese at McDonalds. Similarly, a 24-ounce Java Chip Frappuccino with whipped cream sold at Starbucks had 650 calories the same as a McDonalds coffee plus 29 packets of sugar and 11 creamers, the report said.

In late 2006, the company was also embroiled in an unexpected controversy when the government of Ethiopia accused Starbucks of blocking trademark protections for the names of the countrys top coffees.

The motivation levels of Starbucks baristas and other employees who formed an integral part of the Starbucks Experience also seemed to be going down. Patrick, an ex-employee, spoke about his experience working for Starbucks -- The Starbucks experience is gone. They expect you to churn out a different complicated drink every 20 seconds, for eight straight hours. Then you need to have a cheesy fake smile on your face, to please some random person you cant stand. For that, theyll give you the minimum wage.24

In an internal company memo (that later became public) dated February 14, 2007, Schultz wrote to his employees -- 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. (Refer Exhibit IV for the Starbucks Experience)25

While Starbucks offered a variety of products like mochas, frappuccinos, tea drinks, fruit smoothies, ice creams and even its own range of breakfast snacks, plus franchised merchandise like T shirts, books and music, its chief revenue earner was the premium coffee. However, it was also something that could easily be imitated by its competitors. In fact, Starbucks was starting to face competition from the likes of Dunkin Donuts and McDonalds. In 2006, McDonalds had announced26 that it would start selling gourmet coffee. According to later reports, McDonalds priced its coffee 60-80 cents lower than the rates at Starbucks. By pricing the coffee low, McDonalds planned to expand the market it wanted to attract those who didnt know what a latte was or who couldnt be bothered to pronounce tall, venti, and grande right (McDonalds simply called them small, medium, and large). With some consumer reports rating McDonalds drip coffee higher than Starbucks, some analysts felt that it might not be too far in the future before Starbucks customers too lined up before McDonalds counters, especially at the time of an economic downturn.

Apart from this, Starbucks had become its own competitor, with many stores in close proximity to each other. This resulted in cannibalized sales, rather than increased sales made by attracting new customers.

23 Founded by Dr. Michael Jacobson and two others in the 1970s, the Center for Science in the Public Interest seeks to

educate the American public, and advocate government policies that are consistent with scientific evidence on issues concerning nutrition, food safety, and health. (Source: www.cspinet.org)

24 David Margolick, Tall Order, www.portfolio.com, July 2008. 25 Starbucks Chairman Warns of the Commoditization of the Starbucks Experience,

http://starbucksgossip.typepad.com, February 23 2007. 26 In March 2006, McDonalds introduced gourmet coffee, called Premium Roast. The new coffee was sold in

insulated cups, much like Starbucks coffee.


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SCHULTZ RETURNS

In January 2008, Schultz replaced Donald as the CEO of Starbucks. Schultz said in an official communiqu that he would focus on customer experience and innovation to reverse the slide in shareholder value. Howard is the architect of the Starbucks brand and the visionary behind the unique customer experience that is at the heart of this remarkable companys success. Given what the Board believes needs to be done, there is no better person to drive change and ensure that Starbucks is positioned to innovate, execute and relentlessly focus the entire organization on the customer,27 said Craig Weatherup, chairman of the Nominating and Corporate Governance Committee of Starbucks Board.

Soon after taking over again, Schultz started changing the way Starbucks operated. On February 26, 2008, in a gesture that reportedly cost the company around US$ 10 million, Starbucks closed 7,100 stores in the US for three hours so that baristas could relearn the art of coffee-making. The company said that it hoped the three-hour training program would increase motivation levels among the baristas and improve the quality of coffee that they prepared. We believe that this is a bold demonstration of our commitment to our core and a reaffirmation of our coffee leadership,28 said Schultz in a statement. In another significant development, Schultz announced that warm breakfast sandwiches would be removed from the menu by 2008 fall. In short, the scent of the warm sandwiches interferes with the coffee aroma in our stores,29 said Schultz. Analysts saw this as a bold move as the item was a profit earner (contributing average annual revenues of US$ 35,000 per store) (Refer Exhibit V for Starbucks Retail Sales Mix). He also added that the company would stop providing information on same-store sales for fiscal 2008. He justified the decision saying that sales would be erratic while the company implemented new initiatives and brought about changes to the way it operated.

At the annual shareholders meeting on March 19, 2008, Starbucks announced fresh customer-facing initiatives to halt sliding sales. The transformational agenda included five main initiatives. The first was the introduction of Mastrena, a semi-automatic espresso machine. According to the company, the new Swiss-made espresso machines performed much like a manual machine and delivered the perfect shot every time. And importantly, the machines design allowed baristas to make eye contact with customers while they prepared coffee.

The second initiative was the complete reinvention of brewed coffee in-store. Starbucks was to introduce a new blend that would remind customers of the Starbucks of early days. The third was the introduction of a loyalty program that would reward registered cardholders. The fourth was the launch of mystarbucksidea.com, an online community that allowed customers to play a role in the companys future. The fifth initiative was to strengthen Starbucks relationship with Conservation International (CI)30 in an attempt, apparently, to address concerns that the company was not dealing fairly with the coffee growers in developing countries.

At the meeting, Schultz made an impassioned speech promising to go back to the basics. He said, By embracing our heritage, returning to our core - all things coffee - and our relentless commitment to innovation, we will reignite the emotional connection we have with our customers and transform the Starbucks Experience. I am confident that the ground-breaking initiatives weve

27 Starbucks Announces Strategic Initiatives to Increase Shareholder Value; Chairman Howard Returns as CEO,

www.starbucks.com. January 7, 2008. 28 Coffee Break for Starbucks 135,000 Baristas, www.cnnmoney.com, February 26, 2008, retrieved on September

22, 2008. 29 Starbucks to Close Stores and End Sandwich Sales in North America, www.iht.com, January 31, 2008. 30 Conservation International was established in 1987 with the mission to conserve the Earths natural heritage.


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announced today demonstrate our laser focus on living up to that commitment. We know that this is just the beginning, but we also know that there has never been a more exhilarating or promising time in our history.31

Implementing one of the new transformational initiatives, Starbucks announced the launch of Pike Place Roast, a new blend to compete with drip coffee offered by McDonalds and Dunkin Donuts. According to some reports, the new blend was created after several trials.

The company also unveiled new brewing equipment - the Clover Brewing System. A statement from the company said, Clovers unique brewing process is similar to the coffee press method, but utilizes a special vacuum technology that brings out the complex, rich and distinctive flavors of some of Starbucks rarest and most exotic coffees such as Aged Sumatra and Ethiopia Yergacheffe. The Clover brewing system also adds to the theater and drama of the coffee experience through its highly visual brewing method.32

In March 2008, Starbucks and CI announced a new phase in their decade-long partnership.33 The five year commitment involved both entities putting in efforts to educate coffee growers on the most eco-friendly methods of farming as well as on protecting the land, water, and forests that surround their farms. Starbucks would spend US$ 7.5 million for the first three years on projects in Indonesia and Mexico that would protect standing forests and restore degraded landscapes. By stepping up this partnership we have aligned our existing work, geographies, and success to address this critical issue [of climate change], said Peter Seligmann, chairman and CEO of CI.

MyStarbucksIdea.com was launched in March 2008. The website invited suggestions and ideas from customers who had to first register themselves online. The suggestions/ideas were rated by other registered users. Starbucks would implement the top-rated suggestions. To indicate to visitors that the company was serious about the initiative, the website had an Ideas in Action blog section, which highlighted how the company was taking action on customer suggestions. For example, when a customer suggested that a sticker be placed on sip holes so as to prevent spills, the company immediately tested splash sticks in some stores. When it observed an overwhelmingly positive response, the company decided to roll out splash sticks nationwide.34 This information was discussed in the Ideas in Action section.

In April 2008, Starbucks announced the introduction of a new loyalty program in the US and Canada. Under the program, customers would receive free coffee refills or add-ons such as soy milk or flavored syrup. Free Wi-fi service was also offered for two consecutive hours at company stores. The loyalty program was available to Starbucks prepaid or credit card holders35 who registered themselves online. Customers would also be offered a tall beverage of their choice free with every pound of coffee that they bought.

In April 2008, Schultz decided to do away with the music business36. Ken Lombard, the head of Starbucks entertainment division, was dismissed. Howard is just really focused entirely manically on getting the business back on track, and he will do anything or eliminate anyone to 31 Starbucks Unveiled New Strategic Initiatives to Transform and Innovate the Customer Experience,

www.starbucks.com, March 19, 2008. 32 Starbucks Unveiled New Strategic Initiatives to Transform and Innovate the Customer Experience,

www.starbucks.com, March 19, 2008. 33 Conservation International and Starbucks Launch Initiative, www.conservation.org, March 19, 2008. 34 Amit Chowdhry, MyStarbucksIdea.com, A Consortium of Ideas for Starbucks to Implement Gains Traction,

http:pulse2.com, April 10, 2008. 35 Starbucks launched the Starbucks Card Duetto Visa in October 2003. The card rewarded holders with Starbucks

Duetto Dollars for every Visa purchase and provided Starbucks gifts and benefits with Starbucks Card purchases. 36 In 2004, Starbucks launched the Hear Music Channel 75 on XM, a 24-hour satellite radio service. It also opened a

Hear Music Coffeehouse in Santa Monica where customers could select from around 15,000 CDs or custom-burn their favorite tracks. Two more such coffeehouses were opened in San Antonio and Miami in 2005 and 2006 respectively.


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help him do that.37 said an ex-employee of Starbucks music business. He wants to go back to the point where everyone was happy and everyone loved us and then make a left turn instead of a right,38 another Starbucks executive said. Starbucks entered into an arrangement with Concord Music Group, where the latter would manage its Hear Music label.39

In May 2008, the company reported a 21 percent decline in earnings for the second quarter (January-March 2008). The net income fell to US$ 108.7 million, from US$ 150.8 million. The economic crisis was cited as the main reason for the significant drop in customer traffic and profits. Schultz said, Our stores are in the backyards of these communities [affected by the crisis].40 However, even while admitting that the worsening economy was affecting Starbucks performance, Schultz expressed optimism that his new initiatives would get customers back in to the stores. Fiscal 2008 is a transitional year for Starbucks and, while our financial results are clearly being impacted by reduced frequency to our U.S. stores, we believe that as we continue to execute on the initiatives generated by our transformation agenda, we will reinvigorate the Starbucks Experience for our customers,41 he said.

In mid-2008, in the face of falling earnings, Schultz made efforts to understand how other premium brands such as Coach and Nike fared in economic downturns. He also reportedly met Steve Jobs, the founder of Apple Inc. and Michael Dell, the founder of Dell, Inc. to gain insights into the dangers and opportunities of second acts.

Reports in mid-2008 suggested that the company was all set to introduce a new fruit-based drink that had become quite popular in Italy. This is what we have to keep doing. We have to keep pushing the envelope around innovation, said Schultz.42

OUTLOOK

In July 2008, the company announced that some 600 stores would be shut down across the US, resulting in the loss of 12,000 full and part time jobs. The company also planned to shut down 61 of its 85 stores in Australia43. Schultz said, The current economic environment is the weakest in our companys history, marked by lower home values, and rising costs for energy, food and other products that are directly impacting our customers.44

Most analysts agreed that the US specialty coffee retail market was close to saturation. Starbucks announced that it would slow its expansion in the US, and was planning to open only 400 new stores in 2008 fiscal, a 43 percent decline from the 1,800 units that were opened in fiscal 2007. However, some foreign markets were doing well. In its first quarter of 2008, more than 20 percent of Starbucks revenues came from international sales. This was expected to increase further in the coming months and years. The company expected international sales to account for over 40 percent of its revenues in 2011. The company planned to open 1050 stores outside the US in 2009, 1,150 in 2010, and 1,300 in 2011, especially in countries such as China and Eastern Europe.

On July 30, 2008, Starbucks reported a loss of US$ 6.7 million for the quarter ended June 30, 2008 -- the first since it became a public company (Refer Exhibit VI for Starbucks financial highlights). The first loss in fifteen years was quite a jolt to the company, but was mostly reflective of the one-

37 David Margolick, Tall Order, www.portfolio.com, July 2008. 38 David Margolick, Tall Order, www.portfolio.com, July 2008. 39 Starbucks Dumping CDs, www.alleyinsider.com, June 25, 2008. 40 David Margolick, Tall Order, www.portfolio.com, July 2008. 41 Laurie J. Flynn, Starbucks Says Weak Economy behind Earnings Decline, www.iht.com, May 1, 2008. 42 David Margolick, Tall Order, www.portfolio.com, July 2008. 43 Louise Dransfield, Starbucks Chokes on its Latte, http://www.independent.co.uk, August 1, 2008. 44 Lisa Baertlein and Nichola Groom, Starbucks off the Boil amid US Downturn, www.brisbanetimes.com, April 25,

2008.


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time costs it incurred in closing down around 600 stores. On the next trading day, the companys stock fell to 14.5545, losing around 50 cents (Refer Exhibit VII for Starbucks stock performance over the years). The company announced that it aimed to be back in the black in the following quarter.

In an interview on CNBC in mid 2008, Schultz reiterated his commitment to the companys environmental initiatives. He said, now with our stock under pressure, you would think that there would people on the outside, leaders of the company or board members saying, Perhaps this is the time to reduce the expense and the investment in those areas. And there hasnt been one voice like that. And I think that speaks volumes to the fact that people do have confidence and faith in the business model and what we stand for.46

In July 2008, Starbucks announced the launch of Vivanno Nourishing Blends, new health and wellness beverages, in stores across the US and Canada. According to the company, the drinks were nutritious -- the Orange Mango Banana and Banana Chocolate flavored beverages provide at least one serving of fruit, 16 grams of protein, and 5 grams of fiber with 270 calories or less and no artificial colors, artificial sweeteners or high fructose corn syrup4748. According to some reports, the company also planned to bring about drastic changes in its menu by the year end. I have been embarrassed by the food. The food is going to be completely reinvented by fall, Schultz said. Also, Starbucks would experiment with new store designs and layouts.

Despite concerns that smells of hot food interfered with the coffee aroma, Starbucks announced the launch of five new breakfast items in September 2008. The items included oatmeal, a chewy fruit and nut bar, apple bran muffin, a multigrain pastry called the Berry Stella, a multigrain roll and a protein plate featuring a hardboiled egg, whole wheat bagel, peanut butter, cheese and fruit. According to the company, the items did not contain artificial preservatives, colors, or sweeteners.

Although analysts appreciated Schultzs moves to revive the Starbucks brand, some critics were not sure if these efforts would be enough to bring customers back to the stores. Also, according to Jeffrey Sonnenfeld (Sonnenfeld), a professor at Yale School of Management, Schultzs greatest successes had come with Smith who kept Schultz on course. He felt that in Smiths absence, Schultzs impulsive and emotional nature might prevail. Sonnenfeld said, He has to break the romantic attachment to the past. For Howard, its a painful unlearning, and thats what were seeing now.49

45 www.finance.yahoo.com. 46 http://cnbcmedia1.orchistra.net. 47 Nutrition based on 16 fluid ounces. 48 Starbucks Launches Vivanno Nourishing Blends, www.starbucks.com, July 14, 2008. 49 David Margolick, Tall Order, www.portfolio.com, July 2008.


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Exhibit I

Starbucks Logos Old and New

Source: www.answers.com and www.silverspringdowntown.com

Exhibit II

Starbucks International Presence*

Country/Region Type of entry Name of the local partner/company

Year of Entry

Canada Wholly-owned subsidiary Starbucks Coffee Canada 1987

Japan Joint Venture Sazaby Inc 1996

Singapore Wholly-owned subsidiary# Starbucks Coffee Singapore 1996

Philippines Licensee Rustans Coffee Corp 1997

UK Wholly-owned subsidiary Starbucks Coffee UK 1998

Malaysia Licensee Berajaya Group bhd 1998

New Zealand Licensee Restaurant Brands 1998

Taiwan Joint Venture President Chain Store Corp. 1998

Thailand Licensee Coffee Partners Co., Ltd., 1998

Kuwait Licensee M.H. Alshaya Co., W.L.L. 1999

Lebanon Licensee M.H. Alshaya Co., W.L.L. 1999

South Korea Joint Venture Shinsegae Department Store Co., Ltd.

1999


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Year of Entry

China (Beijing) Licensee Mei Da Coffee Co., Ltd. 1999

Hong Kong Joint Venture Maxims Caterers Ltd 2000

China (Shanghai) Joint Venture President (Coffee) Cayman Holdings, Ltd.

2000

Australia Joint Venture Markus Hofer 2000

The UAE Licensee M.H. Alshaya Co., W.L.L 2000

Qatar Licensee M.H. Alshaya Co., W.L.L. 2000

Saudi Arabia Licensee M.H. Alshaya Co., W.L.L. 2000

Bahrain Licensee M.H. Alshaya Co., W.L.L. 2000

Israel Joint Venture Delek Corporation** 2001

Austria Licensee Bon Appetite Group** 2001

Switzerland Licensee Bon Appetite Group** 2001

Germany Joint Venture KarstadtQualle AG 2002

Greece Joint Venture Marinopoulos Brothers 2002

Mexico Joint Venture SC de Mexico 2002

Indonesia Joint Venture PT Mitra A diperkasa 2002

Puerto Rico Joint Venture Puerto Rico Coffee Partners 2002

Spain Joint Venture Grupo Vips 2002

Oman Licensee M.H. Alshaya Co., W.L.L. 2002

Cyprus Joint Venture Marinopoulos Brothers S A,

2003

Turkey Licensee Shaya Kahve Saniye Ve Ticaret

2003

Peru Joint Venture Delosi SA 2003

Chile Joint Venture Grain Red SA 2003

France Joint Venture Grupo Vips 2004

Jordan Licensee M.H. Alshaya Co., W.L.L. 2005

Ireland Wholly-owned Subsidiary Starbucks Coffee Ireland 2005

Bahamas Licensee Coffee Cay Ltd. 2005

Brazil Joint Venture Alsea S.A. de C.V. 2006

Egypt Licensee Alshaya Egypt LLC 2006

Denmark 2007

Romania Joint Venture Marinopoulos Holding 2007

Russia Licensee M.H. Alshaya Co., W.L.L. 2007


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Year of Entry

Argentina Joint Venture Alsea S.A. de C.V. 2008

Belgium Joint Venture Autogrill 2008

The Netherlands Licensee Servex 2008

The Czech Republic Joint Venture AmRest Holdings NV 2008

# since 2004

* This list is not exhaustive

** Starbucks closed its operations in Israel and bought out the stakes of its partners in Austria and Switzerland in 2003.

Compiled from various sources.


13

Exhibit III A. International Coffee Prices in US Cents per LB

Annual Average

ICO Composite*

Columbian Mild

Other Mild Arabicas

Brazilian Naturals

Robustas

2001 45.59 72.05 62.28 50.7 27.54

2002 47.74 64.90 61.52 45.23 30.01

2003 51.90 65.33 64.20 50.31 36.95

2004 62.15 81.44 80.47 68.97 35.99

2005 89.36 115.73 114.86 102.29 50.55

2006 95.75 116.80 114.40 103.92 67.55

2007 107.68 125.57 123.55 111.79 86.60

July 2008 132.78 151.18 147.36 134.88 115.23

August 2008

131.44 151.03 146.43 133.28 112.56

September 2008

126.69 148.36 143.27 130.26 105.38

*International Coffee Organization (ICO) Composite is determined by weighting different coffee varieties according to their market shares

Source: www.ico.org.

B. Reduced Fat (2%) # Milk* Prices in the US

Month/Year Price* in US Dollars per Gallon

2006^ 3.10 2007^ 3.51 January 2008 3.74 February 2008 3.72 March 2008 3.69 April 2008 3.67 May 2008 3.67 June 2008 3.70 July 2008 3.84 August 2008 3.83

# In May 2007, Starbucks switched from whole to reduced fat (2%) milk as the default option in all its North American stores

*Simple average of 30 cities

^ Average of 12 months

Source: www.ams.usda.gov


14

Exhibit IV The Starbucks Experience

The Starbucks Experience involves three aspects people, place, and product.

Starbucks tried to establish a connection between the baristas and the customers. Apart from operational skills, the baristas were trained in Star Skills three guidelines for on-the-job interpersonal skills -- maintain and enhance self-esteem; listen and acknowledge; and ask for help. Employees in general were asked to be helpful and just say yes.

Each Starbucks store acted as a billboard for the company, helping in building the brand as well as the corporate image. All efforts were made to ensure that each store was inviting, and stimulating. Store fixtures, merchandise displays, colors, artwork, and music were carefully chosen to reflect the personality of the neighborhood. Starbucks did not allow smoking inside its stores as it would affect the aroma of the coffee.

Starbucks was obsessed with quality, with purchasers and tasters carefully choosing coffee beans from all corners of the world. It had elevated the process of roasting to an art form. Employees were trained to follow strict rules, and had to discard an entire lot if the roasted beans didnt measure up to prescribed standards.

However, with time and rapid expansion, Starbucks changed. With the installation of automatic machines to improve efficiency, the customer could no longer see the drink being made and thus there was little or no interaction between the baristas and the customer. More and more customers complained that Starbucks had become impersonal. Also, to cut costs and enhance efficiency, Starbucks made changes to its store layout and ambience. This did not go down well with some customers who felt that the stores were sterile, and cookie-cutter. Also, by selling hot food and other food stuff, the coffee aroma got diluted.

Source: Arthur A Thompson and John E. Gamble, Starbucks Corporation, www.mhhe.com and other sources

Exhibit V Starbucks Retail Sales Mix

Fiscal Year Ended 2004-2005 2005-2006 2006-2007

Beverages 77% 77% 75%

Food 15 15 17

Coffee making equipment and other merchandise

4 5 5

Whole bean coffee 4 3 3

Source: www.starbucks.com.


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Exhibit VI

Starbucks Financial Highlights

1996 1997 1997 1999 2000 2001 2002 2003 2004 2005 2006 2007

No. of stores at fiscal year end

(International stores)

1,015

(11)

1,412

(48)

1,886

(131)

2,498

(281)

3,501

(792)

4,709

(1,234)

5,866

(1,644)

7,225

(2,024)

8,569

(2,392)

10,241

(2,888)

12,440

(3,544)

15,011

(4,327)

Net revenues (USD bn) 0.7 0.98 1.31 1.68 2.2 2.6 3.3 4.1 5.3 6.4 7.8 9.4

Operating income (USD mn)

(Operating margin %)

56.6 86.2 109.2 156.7 212.2 280.2 316.3 424.7 606

(11.5)

781

(12.3)

894

(11.5)

1,054

(11.2)

Comparable store sales growth 7% 5% 5% 6% 9% 5% 6% 8% 10% 8% 7% 5%

Net Earnings (USD mn)

(Return on Equity %)

42 55 68 102 94.5 180.3 212.7 268.3 391.8

(17%)

494

(20%)

564

(25%)

673

(29%)

Source: www.starbucks.com.


16

Exhibit VII

Starbucks Stock Price (in US$) between 1999 and 2008

Volume

Source: www.starbucks.com


17

References & Suggested Readings:

1. Matt Andrejczak, Starbucks Ramps up Food Menu, Including New Egg Sandwich, www.marketwatch.com, September 23, 2008.

2. Oatmeal becomes Starbucks Top-Selling Food, www.foxnews.com, September 23, 2008.

3. Starbucks to Open New Stores in Indonesia, Says Executive, www.drinks-business-review.com, September 10, 2008.

4. Starbucks Expands Breakfast Menu, www.silobreaker.com, September 03, 2008. 5. Louise Dransfield, Starbucks Chokes on its Latte, http://www.independent.co.uk,

August 01, 2008.

6. Arthur A. Thompson, John E. Gamble Starbucks Corporation, A Case Study, http://www.mhhe.com, retrieved on August 20, 2008.

7. Paul R. La Monica, Wishing on a Fallen Starbucks, http://money.cnn.com, July 30, 2008.

8. Andrea James, Starbucks Posts First Quarterly Loss, Ever, http://seattlepi.nwsource.com, July 30, 2008.

9. Starbucks Launches Vivanno Nourishing Blends, www.starbucks.com, July 14, 2008.

10. David Margolick, Tall Order, www.portfolio.com, July 2008. 11. Starbucks Dumping CDs, www.alleyinsider.com, June 25, 2008. 12. Starbucks Needs a Shot of Caffeine, www.money.cnn.com, June 08, 2007. 13. Lisa Jennings, Starbucks Scales Back New Stores, Expects New Drinks to Perk up

Traffic, http://findarticles.com, May 12, 2008.

14. Richard H. Levey, A Slip between Cup and Lip, http://directmag.com, May 01, 2008. 15. Laurie J. Flynn, Starbucks Says Weak Economy behind Earnings Decline,

www.iht.com, May 01, 2008.

16. Lisa Baertlein and Nichola Groom, Starbucks off the Boil amid US Downturn, www.brisbanetimes.com, April 25, 2008.

17. Starbucks Plans China Expansion, 80 New Stores to Open in 2008, www.china-briefing.com, April 22, 2008.

18. Amit Chowdhry, MyStarbucksIdea.com, A Consortium of Ideas for Starbucks to Implement Gains Traction, http:pulse2.com, April 10, 2008.

19. Brad Stone, Starbucks Plans Return to Its Roots, www.nytimes.com, March 20, 2008.

20. Starbucks Unveiled New Strategic Initiatives to Transform and Innovate the Customer Experience, www.starbucks.com, March 19, 2008.

21. Conservation International and Starbucks Launch Initiative, www.conservation.org, March 19, 2008.

22. Coffee Break for Starbucks 135,000 Baristas, www.cnnmoney.com, February 26, 2008.


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23. Starbucks to Close Stores and End Sandwich Sales in North America, www.iht.com, January 31, 2008.

24. Starbucks Announces Strategic Initiatives to Increase Shareholder Value; Chairman Howard Returns as CEO, www.starbucks.com. January 07, 2008.

25. Starbucks Expands in Europe, http://business.techwhack.com, December 19, 2007.

26. Starbucks Chairman Warns of the Commoditization of the Starbucks Experience, http://starbucksgossip.typepad.com, February 23, 2007.

27. Joseph Michelli, The Starbucks Experience: 5 Principles for turning Ordinary into Extraordinary, 2007.

28. Howard Behar, Its Not about the Coffee: Leadership Principles from a Life at Starbucks, 2007.

29. Starbucks Thrives on Consumer Coffee Habit, http://www.beveragedaily.com, November, 2005.

30. Starbucks Expands Partnership with Conservation International and Supports Innovative Verde Ventures Loan Fund, www.celb.org, January 22, 2004.

31. Starbucks Expands Reach of Unique Coffee Experience to Southern China with Opening of First Store in Guangzhou; Entrance into Guangzhou Builds on Starbucks Expansion Plans in China, http:goliath.ecnext.com, August 29, 2003.

32. Yardena Arar, Starbucks Expands Wireless Internet Offering, http://pcworld.about.com, August 21, 2002.

33. Starbucks Expands its Line of Superpremium Ice Cream Offerings with Six New Flavors, www.allbusiness.com, 1999.

34. Randy Wilson, Starbucks Coffee History, http://ezinearticles.com. 35. Starbucks Corporation, www.answers.com. 36. www.starbucks.com 37. www.finance.yahoo.com. 38. http://cnbcmedia1.orchistra.net.

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Starbucks - Back to Basics