SPOTLIGHT

STARBUCKS' SUCCESS - More than just coffee

Starbucks symbolizes coffee. It has revolutionized the coffee drinking habits of people. With its unique style of selling a commodity, it has grown from 17 stores in 1987 to nearly 7,500 stores worldwide presently. Can it continue the trend?

Howard Schultz should be credited for creating a successful business design out of a commodity product. He entered the business of selling hot gourmet coffees (by acquiring Starbucks) through cafés in the early 1980s, during the time when the growth rate of the coffee industry was declining. Americans drank less coffee, and consumption of coffee declined from a high of 3.1 cups a day in 1962 to 1.67 cups a day. Sales of the major three brands, namely Maxwell House, Folgers and Nescafé were down. By 1988, Maxwell House lost $40 mn on its domestic coffee business.

Against such a not-so-happy business environment, Howard Schultz started offering consumers gourmet, flavored coffee made of expensive Arabic beans. Consumers-gave high value to this novel format. As a result, though gourmet coffee was priced 80-100% more than the traditional coffee, people bought it. In 1988, Starbucks' sales was $10 mn. In late 1992, Starbucks was generating sales of $28 mn a quarter. It was successful in creating a culture and a loyal customer base, because, by 1993 the number of gourmet drinkers in the US grew to 4.5 million, which increased to 21 million in 1999. Today, Starbucks is a fast-growing company, with revenues increasing more than 20% every year.

How the brew grew

Till the emergence of Starbucks, Americans were not exposed to good coffee. Most people were habituated to drinking coffee out of a can that was not fresh, sold by Nestlé, P&G and General Foods. To the consumers' perception, those grounded coffee in the can were undistinguishable. Coffee was treated as a commodity. As a result, coffee consumption in America was falling by 5 to 10% a year. Value was migrating from the industry. In order to increase sales, the established players used price as a differentiating factor to remain competitive. On the other hand, they spent millions on advertising.

Shultz took this as an opportunity. He felt that he could change the perception of the consumers if he introduced great-tasting coffee drinks, like espresso, caffelatte, and cappuccino, in an equally better ambience. He was right. Although gourmet coffee was priced higher than traditional can coffee, consumers liked the idea. To the office goers, buying a cup of gourmet coffee meant that they were buying coffee as good as any CEO or movie star would buy. They were not buying coffee, rather they were buying status. Gary Stein, senior analyst, Jupiter Research, a market research firm based in US, opines, "Coffee was sold as a simple commodity—`goods'. What Starbucks realized was that the average consumer would be interested in buying coffee as a part of a larger experience, one that involved spending time in a particular place and being in a certain mood."

The people connection

To expand, the company also pursued a first-to-market strategy by opening outlets throughout Pacific Northwest and then to Chicago and California. At the same time, Schultz also focused on human capital. Just as desired customers are targeted in deliberate marketing strategies, Starbucks targeted the labor market with a deliberate human resource strategy. Schultz hired experienced executives from corporations like Pepsi to manage finances and human resources. Focus was to build sustainable relationship with the employees. All employees regardless of their position were called `partners', and they along with the part-timers were eligible for health and dental benefits and stock options. The partners were empowered to take decisions on new store development, to identify and select targeted areas for store location and on new product offering. Its coffee brewers were called baristas. Every new barista was given 25 hours of classes on coffee history and the intricacies of preparing quality-brewed coffee. They are also trained to anticipate the customers' needs and explain the customers the various flavors and blends.

Starbucks also invested in infrastructure. Starbucks invested in a world-class roasting facility, and made investment in a computer-information system sophisticated enough to keep track of sales in hundreds of stores. Starbucks has also installed automatic espresso machines in 800 locations to reach out to more customers. It launched an e-commerce site called SeattlesBest.com, from which customers could purchase coffee, coffee flavorings and gift items online. In 2001, it started offering prepaid Starbucks Cards, priced between $5 and $500. The cards cut transition time to half, as it required the store managers to only swipe them to deduct sale. To speed up its service, it launched Starbucks Express. Customers could preorder and prepay for beverages and pastries via phone or Starbucks Express' website. It also connected its cafés with high-speed wireless Internet connections, which enabled the customers to sit in a store and check e-mail, surf the Web or download multimedia presentations with their laptops. The new service allowed Starbucks to attract a new set of customers—the business people and new start-ups, who held meetings, job interviews and did businesses. All these initiatives have earned Starbucks the `third' place in the customers' priority list. The first and second places being the `home' and the `office'.

Supplier relationship

To maintain the standard of serving the customers with the best quality coffee, Starbucks extended the customer intimacy to the suppliers of coffee, who were the farmers. It selected suppliers based on Value, Quality, Service, Business Stability and Business Practices. It preferred to develop long-term relationships with its suppliers, instead of buying from the lowest cost producers. Trust is the most important characteristic in Starbucks' relationship with the suppliers. Starbucks works with the suppliers to institutionalize trust in the procurement process. In return, the suppliers receive large volume sales.

The perfect cup starts with the best beans. Finding and purchasing the best beans is the first step that differentiates Starbucks' coffee from the rest. Each variety of coffee beans is selected from the region known for its quality and aroma. To achieve that, Starbucks visits various regions across the world for the perfect combination of climate, soil, elevation, and agricultural practices that come together to produce a great coffee. The purpose of these visits is not only to buy coffee beans, but also to continue to learn about coffee and strengthen relationships with growers and suppliers. It is because of these relationships that Starbucks gets the first pick of the best crops worldwide. Starbucks expects them to treat it as the most preferred customer in terms of pricing and resources committed to the relationship. Starbucks also takes interest in the partners' manufacturing capabilities, productivity, quality improvements and new product improvement.

To foster the relationship with the farmers, Starbucks purchases at a premium, above the prevalent market price. This it does through Fair Trade program. Through this program the farmers' social and economic issues, such as healthcare, education, housing and income are being taken care of. Starbucks is expanding the Fair Trade program with a commitment to purchase one million pounds of Fair Trade coffee and increase its availability in locations throughout North America and internationally. Starbucks has also partnered with the Ford Foundation, Oxfam America and CEPCO (Oaxacan State Coffee Producers Network) to improve the quality of coffee beans.

Strategic moves

Starbucks spends only 1% of its sales in advertising and promotion for new flavors of coffee drinks and new product launches. Instead, it relies on word-of-mouth and aggressive site selection for its stores. The company is remarkably business savvy in choosing its locations. It focuses on spots that provide ready access to consumer foot traffic, typically in densely populated neighborhoods. Stores are located in such a way to blanket a neighborhood and often several of Starbucks' stores competed against one another on the very same street. The strategy called `clustering' increases total revenues and market share, and drives out competitors' desire to open in the same location. It uses cities as the base to further expand into suburbs. Once a city is fully conquered, it focuses on other cities. As a result, Starbucks quickly dominates a local market. In addition, operationally it is cheaper to deliver and manage stores located close together. For example, in Manhattan area of New York, it has more than 120 stores. To maintain a strong grip on its image and quality of the brew, most of the stores are company-owned. This means the company does not have to spend time and resources behind the franchisees, unlike McDonald's.

To increase the brand equity, Starbucks used music. The company compiled music of different artists and sold them to customers. For that, it acquired Hear Music of Cambridge, Massachusetts in 1999. Since then, it has sold about 5 million CDs. As a step further, Seal, an artist, and Starbucks entered into a contract of creating proprietary music for Starbucks. With more than 20 million footfalls every week in Starbucks stores, the entry into music business gave Starbucks a new source of revenue. To increase revenue, also started sales of food and other non-coffee items. It introduced sandwiches, desserts, hot breakfasts, coffee ice cream, and a ready-to-drink coffee beverage. Like Nestlé, it started selling packaged coffee in supermarkets. Lately, like Peet's Coffee and Tea, Starbucks is also selling whole beans. By entering into new businesses, Starbucks is increasing the scope of revenue generation and customer reach using the same asset base.

Strategic alliances

Though Starbucks does not franchise to individuals, however, in situations where other companies could provide improved access to desirable retail space, such as an airport, college and university campuses and hospitals and similar locations, Starbucks enters into strategic alliances and licensing. Through well thought out strategic alliances and licensing, Starbucks is able to leverage its strong brand and sell its coffee and develop new products with the Starbucks name. Strategic alliances help Starbucks to enter businesses that have high cost of entry, like manufacturing and distribution. To maintain its brand image, Starbucks selects its partners carefully based on reputation and commitment to quality, similar values and complementary competencies.

It entered into a successful alliance with Barnes & Noble in 1993. The idea was mutually beneficial. While Starbucks got a readily large size of customers of Barnes & Noble, for Barnes & Noble, Starbucks attracted customers into the bookstore during the morning hours, when people usually do not shop for books. Alliances with consumer product companies, like Kraft, Pepsi, Dreyer's Grand Ice Cream (Dreyer's) and Bank One have helped Starbucks to enter into new businesses. They also allowed Starbucks to share logistics costs and take advantage of the existing distribution networks of its partners. Kraft has allowed Starbucks to sell its whole beans and packaged coffee in retail stores by using Kraft's large salesforce. With Pepsi, Starbucks sells the ready-to-drink coffee beverage, Frappuccino. Starbucks and Dreyer's partnered together to sell a frozen blend of Starbucks' coffee and ice cream. In financial services, Starbucks and bank One teamed up to offer the Starbucks Card Duetto Visa, which allows customers of Starbucks to use it both as a stored-value card and a traditional credit card. For its wireless connection in its cafés, Starbucks has teamed up with Microsoft and MobileStar.

It has licensee agreements with HMS Host, US' largest airport concessionaire, grocery and mass-market retail chains such as Target, Albertson's and Safeway stores, and airlines such as United Airlines and Canadian Airlines, and hotel chain Marriott who serve only Starbucks coffee.

Foreign expansion

To increase revenue and expand, Starbucks began its foreign sojourn through Canada in 1987, Japan in 1995 and later in other countries. Instead of building its brand on its own, Starbucks followed the joint venture route in its foreign markets. It partnered with local parties to open stores in other countries. The joint venture required the local partner to bear most of the capital cost, besides paying an upfront licensing fee; a royalty on sales after operations have started. The company standardized its menu of coffee offerings in most of its foreign locations with exceptions in baked goods and pastries. Even in the case of procurement of coffee supplies, the partners have to buy most of it through Starbucks. To maintain quality standard, the management teams of the stores in foreign countries are given a 13-week training at Starbucks' headquarters in Seattle.

Its joint venture with Tokyo-based restaurant chain Sazaby accounts for around 500 cafés in Japan. With inputs from Sazaby, Starbucks serves Green Tea Frappuccino in line with Japanese preference for green tea, banned cigarette smoking inside stores to prevent destroying the natural aroma of coffee. It served its coffee in paper cups against the perception that the Japanese consumers would not like drinking coffee in them. To attract consumers and gain volume, it also priced its coffee below that of its competitors. It generated a net income of $6.29 mn in the fiscal year 2002. Ranjay Gulati, Michael L Nemmers Distinguished Professor of Strategy and Organizations, Kellogg School of Management, Northwestern University, opines, "since they are so keen on the experience as opposed to only coffee, they realize that the experience may need to be tailored to local cultural needs, making partners helpful both in customizing the experience and also providing local expertise. Growing as fast as they are, makes sense to seek out local partners who can provide capital and expertise and of course entrepreneurial experience."

Starbucks entered the Chinese market in 1995 through a licensing agreement with Beijing Mei-Da, who was a wholesale distributor of Starbucks coffee in major restaurants and hotels. Then in 2000, Starbucks opened its first store in the Forbidden City in Beijing. With its success, Starbucks entered into a joint venture with Shanghai President Coffee, who is also its partner in Taiwan. By 2003, it expanded to more than 70 stores with outlets in Shanghai and Guangzhou. In China, where consumers were more habituated to drinking tea, Starbucks aggressively reached to the customers by educating them in the intricacies of coffee.

In 1998, it entered the European market by acquiring 61 stores of the Seattle Coffee Company, a chain of lower-priced coffee shops, located at the best locations in London. Using UK as the beachhead, it expanded to other European countries. First in Zurich, then in Vienna, Madrid and Berlin. In 2002, it further consolidated its UK operation by acquiring 13 stores of its rival Coffee Republic. Then in 2003, Starbucks acquired the whole of Seattle Coffee. Recently, it has entered the French market by opening its first store in Paris with Spanish partner Grupo VIPS. Today, Starbucks has more than 7,000 stores worldwide stretching from Beijing to Seattle.

What lies ahead?

With more than $4 bn in annual sales and $268 mn profit in 2003, Starbucks is one of the fastest growing companies in the world. To maintain growth, the company in the past aggressively entered new markets, leveraged its success of the coffee brand by accommodating adjacent businesses like ice cream, whole beans and packaged coffee. Stein opines, "Their growth has been so spectacular that it would be extremely difficult to sustain. However, it also doesn't seem to be abating. They are smart, though, in finding very clever ways to spur growth, particularly by placing coffee shops inside of other stores and environments, such as grocery stores, bookshops and gas stations." In 2001, it opened around 1,100 stores worldwide. It also entered new businesses like marketing a selection of premium tea products after acquiring Tazo. It started selling drinks 24 hours a day in some stores. Currently, it is experimenting with new formats. For example, it is also planning to open stores with drive-through windows in the US by the end of 2004.

Though Starbucks is one of the few companies, which were successful in maintaining growth, despite the recent downturn, everything is not hunky-dory for Starbucks. It is also facing slump in morale and burnout among its store managers and baristas, mainly due to dissatisfaction over odd hours and little pay increase. In 2001, some of the store managers in California sued Starbucks for refusing to pay legally mandated overtime. The company settled the suit for $18 mn in 2002. The Japanese unit of Starbucks incurred a net loss of $3.87 mn in the financial year 2002.

Taking advantage of Starbucks developing the drinking habit of gourmet coffee, new players are entering the coffee retailing business. This means competition has also increased. In the US, besides the local gourmet coffee shops, Wal-Mart has teamed up with Hollywood image-maker Benny Medina to open a Starbucks-style coffee store in one of its Texas outlets. Its price is 25% less than that of Starbucks. In Japan, the local player Doutor Coffee has opened new stores offering premium coffee, thereby affecting Starbucks' earnings. As a result, Starbucks is forced to change its plan on a number of stores it had initially planned to open. In China, a Vancouver-based coffee chain, called Blenz, has opened outlets in Beijing, Shanghai and Guangzhou. In London, imitators like Caffè Nero Group are selling coffee at a much cheaper price ($2.12) compared to that of Starbucks ($2.93). In Germany, imitators have saturated Frankfurt and Berlin with Starbucks-like coffee bars. The company had to buyout partners in its troubled Swiss and Austrian stores. It has also closed six unprofitable Starbucks stores in Israel. In France, the company has to work hard to remain profitable against France's arcane regulations and generous labor benefits.

Another reason, which might be affecting Starbucks' overseas revenues is the mode of entry into the foreign markets. The complex series of joint ventures has made the company difficult to control costs and reduce profits by 20-50% compared to that in the US. Profit killers like, real estate and labor costs are far higher than those in the US.

The question is, will Starbucks be able to maintain its growth in the future? It has to look for new growth opportunities, like launching innovative products, entering into new ventures and new markets like India. One positive aspect, as Stein puts it, "Starbucks is entering into cultures in which coffee holds a distinct cultural significance. Partnering will help them to handle these issues." Stein also opines, "Starbucks has to continue to innovate, and particularly be seen as a higher-quality brand. Competition is tending to come from below. They must retain an exclusivity around their products." However in the past, Starbucks also shared failures in these areas. For example, Mazagran, a carbonated coffee beverage developed with Pepsi flopped. It also partnered with Time to publish a coffeehouse magazine called Joe, which lasted only for three issues.

To succeed in India, there are challenges to be overcome. The per capita income in India is very low compared to other countries where Starbucks has its operations. It has to sell its coffee at a much lower price. It also has to face competition from the established players like Barista and Café Coffee day. Both these coffee chains have more than 150 outlets in the major Indian cities. Besides, it might not be the right move to adopt the clustering strategy in India, because India might not have that many coffee aficionados. As it cannibalizes the customers of closely located stores, there is every possibility that revenues from each store will be on the lower side. On the positive side, Starbucks need not have to develop the coffee drinking habits due to the existence of established players in India.

With more than 7,500 stores worldwide, Starbucks has been successful in leveraging the `Starbucks Experience' to attract customers. It has plans to open 1,300 new stores worldwide in 2004. The more Starbucks expands, the more difficult it will be for the company to remain aligned with its mission. Customers will visit the stores as long as their priorities are met. Prof. Gulati says, "All successful companies face imitation. The successful ones look for some way to create a competitive advantage that is sustainable for a period of time. As long as Starbucks is a moving target and evolves its strategy in the face of competition, it will be fine." True, till now Starbucks has been able to beat everyone and everything. But in future, Starbucks needs to continuously rewrite the `Starbucks Experience' to remain ahead of competition. Lest, there is every possibility of it becoming a mature company, similar to that of McDonald's.

Reference # 1-2004-03-13