Starbucks at 40

From hippie bastion to symbol of rampant globalisation

Two years ago, Sebastian Simsch started noticing large groups of people crowding into his independent coffee shop in Seattle. As they nosed around, some of the visitors made notes in folders labelled ‘Observation’. “I thought it was funny,” he says. But then he discovered that they were all employees of one of his biggest competitors, Starbucks, and the third time they came in he told them: “If you want to buy something, that’s great. But just to look – that’s not cool.”

Not long afterwards, a couple of the city’s Starbucks branches closed down. Builder’s fences went up, with signs that read: “Your neighbourhood coffee shop is getting a makeover.” And in due course those cafés reopened. Only now they served coffee a new way – dripping slowly through paper filters – as well as beer and wine. They promised evenings of music and poetry. The fittings looked inexpensive, roughed-up, and included discarded theatre seats. Nowhere was the name Starbucks visible.

Make no mistake: these were Starbucks cafés. But they’d been ‘de-branded’, to look homely, independent and ‘authentic’ instead of homogenous and bland. And high time too, you might think. Because as one customer put it in a comment on a blog: “The old Starbucks seems ‘bloated’, ‘suburban’, and ‘irrelevant’ these days – a haunting reminder of flush times now gone.”

It may seem hard to believe, but 2011 marks the company’s 40th anniversary. In the course of four decades the company has changed enormously. When Starbucks was founded, in 1971, it didn’t serve drinks. Customers came in, bought some beans, and left. Nobody hung around. Starbucks became the place we know today only after Howard Schultz joined as director of operations and marketing and – on a trip to Milan – was blown away by the theatrical ethos of baristas, the neighbourhood feel of the cafés and the sheer number of them. He decided to turn his bean retailer into something similar.

It took a while for his partners to let him. It’s hard to imagine now that opening coffee shops could be particularly risky – but this was before the appearance of Friends, the long-running and hugely successful American sitcom substantially set in one. Only after Schultz bought out the others did Starbucks become the place he imagined – a comforting refuge with a sense of community, a third place for people to congregate beyond work or the home, with a layout that could accommodate both fast service and quiet moments. Like in Milan, Starbucks’ baristas (an Italian word that Starbucks drove into everyday English use) became familiar with regular customers, learning their names and their favourite drinks.

The effect on customers’ daily routine was genuinely transformative. “When Starbucks arrived, it had an air of quality and excitement and novelty,” says Peter Backman, managing director of the British restaurant analysts Horizons. “It gave us somewhere that was clean where you could go and relax on the high street. And that was a major thing.”

As if to mark the company’s milestone birthday, Starbucks recently opened a branch in Milan, its spiritual birthplace. And Schultz is publishing a book (his second). “The world has

Clockwise from above: CEO Howard Schultz; the original Starbucks in Pike Place, Seattle; and the company’s distinctive advertising

changed in ways I couldn’t have imagined,” he explained recently. What he didn’t say, but will perhaps investigate in the book, is that the world has changed, in many ways, because of Starbucks.

The company has changed the way businesses operate, and not only in its own sector. It became a significant presence in the record and publishing industries. Having familiarised us with the idea of a space somewhere between play and work, it brought something similar into bookshops, airports and hotels. It’s arguable that Starbucks provided the inspiration for places such as The Hub network, which currently has locations in 12 cities on four continents. Hubs describe themselves as innovative spaces for meeting, working and relaxing – something between a serviced office and a members club – with coffee and other sustenance available at a counter.

And Starbucks’ endorsement of what might be called caring capitalism encouraged others to follow suit. As long ago as 1990, when Douglas Coupland immortalised “low-pay, low-prestige, low-dignity, low-benefit” service-sector work as “McJobs” in his novel Generation X, Starbucks was methodically seeking to attract and retain enthusiastic staff. Even before it became profitable, Schultz offered healthcare even to part-time workers and unmarried spouses.

In part, he was motivated by personal sentiment. He’d seen his father work hard with little to show for it. But he was also convinced that hiring enthusiasts on good terms would have benefits for the company: happy workers contribute value, he would say, and stay in their jobs longer. He was right: while other fast-food retailers lost staff at rates as high as 400% a year, Starbucks’ turnover was a relatively low 65%. With the cost of replacing and retraining at around $3,000 each time, keeping people in employment with healthcare cover would pay for itself. For this insight, Schultz was invited to the White House to brief President Bill Clinton on his own healthcare proposals. For similar reasons, Schultz introduced a stock option for staff, who would no longer be called employees but “partners”. From now on, Starbucks would routinely appear in surveys of the best places to work or most admired companies.

Schultz also introduced a corporate mission and made it easy for those partners to point out, anonymously or not, when the management took a wrong course. He reviewed every submission. One early crisis, identified through this mechanism, highlighted a conflict between the company’s attachment to high-quality coffee and customer service: when customers started asking for no-fat milk, Schultz and others concluded that this would not taste as good as full fat. But customers were given what they wanted – and product quality was compromised.

Arguably the biggest change to Starbucks took place in 1992: it went public, gaining access to funds that would allow it to grow rapidly from 500 cafes to 17,000 in 49 countries. At this vast scale, plainly, Schultz would no longer be able to read all his partners’ ideas and feedback.

Following its float, Starbucks launched a dizzying range of new initiatives. It went into a joint venture with PepsiCo to make cold coffee drinks. (The first new product, Mazagran, a lightly flavored carbonated drink, was a failure; more successful was the bottled Frappucino.) And in 1995, Starbucks put its coffee into ice cream and even stout.

It opened stores in airports and bookshops (Barnes & Noble in the US; Borders in the UK). It opened in Wells Fargo banks, on university campuses and in hotel lobbies. In each sector, the effect was considerable. Andrew Sangster, editor of Hotel Analyst, says hotels learned a lot about style and atmosphere. “Hotels woke up to the fact that people don’t want to see them as stuffy people with silver salvers. Starbucks is a pioneer of that approach. Not a direct economic threat, but something to respect and steal ideas from.”

Some years after floating, a store manager who had worked in the music business discovered that hundreds of people had been asking to buy the music played in the café. So Starbucks started to sell music mixes through its Hear Music brand. No other coffee shop is known to have released music, certainly not as ambitiously as Starbucks did in 2007 after signing Paul McCartney to record new material for sale in its 13,500 retail outlets. It was a massively significant event but had nothing whatever to do with coffee. Another legendary artist signed that year was Joni Mitchell.

In 1997, Schultz set up a foundation to give money to community organisations, many of them identified by staff. Starbucks also went into partnership with the sportsman Magic Johnson to open branches in deprived urban areas. It struck Fairtrade deals with suppliers in developing countries and moved to reduce its own environmental impact. The idea in each case was to make the world a better place. Or, as cynics have it, to enhance the Starbucks brand.

As Starbucks got bigger, its initiatives attracted more cynicism. When it did the right thing, in response to public pressure – like ceasing to use milk from cows treated with hormones, or cutting corn syrup – it was not congratulated but criticised for not acting sooner. In some markets it became widely disliked. Communities signed petitions to keep Starbucks out, just as they might have done previously to keep out McDonald’s. Interestingly, McDonald’s had learned a lot from Starbucks, putting espresso machines on its front counters and borrowing the barista monicker.

In a much-quoted case study, John Quelch – a former dean of London Business School and now a professor of marketing at Harvard – wrote that Starbucks’ fundamental problem was its vast size, and that this stemmed from its public company status. “Starbucks is a mass brand attempting to command a premium price for an experience that is no longer special,” he wrote. Sooner or later, chasing quarterly earnings growth targets undermined the brand, Quelch argued. In particular, the company brought out a wide range of new products to broaden its appeal – and in the process, hurt the integrity of the brand for coffee purists and created so much work for baristas that they were no longer able to engage with customers.

“None of this need have happened if Starbucks had stayed private and grown at a more controlled pace,” he added. “To continue to be a premium- priced brand while trading as a public company is very challenging.”

It became more challenging still against a backdrop of global financial meltdown. In the first three months of 2008, net income plummeted to 28% below the same period a year earlier. After eight years on the board as chairman, Schultz returned as chief executive – the latest in a line of high- profile ‘comeback CEOs’, of whom the best known and most successful is Apple’s Steve Jobs. (The best known but least successful was probably Enron’s Ken Lay.)

“We had to admit to ourselves and to the people of this company that we owned the mistakes that were made. Once we did, it was a powerful turning point”, Schultz told Harvard Business Review last July. “When I returned things were actually worse than I’d thought. We seemed to have become the poster child for excess. And all of a sudden we saw a seismic change in consumer behaviour.”

Schultz had replaced Jim Donald as CEO, but Jeff Sonnenfield of the Yale School of Management says the previous strategy of rapid expansion, which got Starbucks into trouble, was Schultz’s as much as it was Donald’s. Indeed, it is said that Donald was in Schultz’s office twice a day to check he was doing the right thing.

Be that as it may, the strategy had to change. In a memo to senior staff, subsequently made public, Schultz anatomised steps the company had taken that, in effect, watered down the “Starbucks experience”. He wrote: “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.” Moves to use automatic espresso machines, and vacuum-packed coffee, removed what Schultz called the romance – the visual and aromatic experience. And designing stores to look similar, for sensible financial reasons, inadvertently lost their varied, neighbourhood feel. “All these effects have tested the loyalty of Starbucks customers.”

To re-energise staff and find a renewed focus on values, Schultz took 10,000 store managers to New Orleans to carry out work on houses, planting trees and an urban garden. He set also about pruning some of the previous years’ initiatives. He closed 600 coffee houses worldwide. He closed the Hear Music label. He pulled out of the partnership with Magic Johnson. And he ended a 22-year distribution deal with Kraft Foods Inc.

But it wasn’t just cuts and closures. More positively, Starbucks unveiled a brand of instant coffee called Via across the US, made with 100% natural roasted arabica coffee. Having sent out spies to independent coffee-shop rivals, it started to open its own de-branded branches, where the distressed, pre-used fittings happened to be both trendy and well-suited to a diminished budget for fit-outs. Later that year, Starbucks posted a 4% growth in sales and a 200% rise in profits, and 2010 proved even better. “We confronted these challenges by reaffirming our core values and reinventing our company from the bottom up,” said Schultz.

It seems clear that having shaved $600m off costs, Starbucks is looking to squeeze more money out of its US stores, rather than opening more. In 2010 it showed that this was possible – net revenues rose 9.5% thanks to 4% more traffic in coffee shops and a 3% increase in sales per customer. Looking ahead, could this be improved further? Schultz has emphasised selling food, but for three years food has accounted for less than 20% of sales. Clearly, increasing food sales could make stores even more productive.

It looks far likelier that bigger profits will come from overseas. Starbucks is expecting 80% of growth to take place outside the US, but with its biggest international markets supplied almost to American levels of density, analysts at Morgan Stanley say the company “will need to rely on less proven markets”.

One of these is Central America, which supplies 85% of Starbucks’ coffee beans. The company started selling its coffee in the region at the end of 2010 when it opened a store in San Salvador, the capital of El Salvador. Central Americans mostly drink instant coffee at the moment, but officials and competitors alike hope that Starbucks will help people acquire a taste for specialist fresh-brewed coffees.

In El Savador, the company is using a franchise model – something McDonald’s has done very successfully. Similarly, Starbucks used franchising to open in South Africa, just in time for the 2010 soccer World Cup. The company is also eager to crack the potentially lucrative Indian and Vietnamese markets.

But like every other large Western company, it is pinning many of its hopes on China, where coffee sales climbed 9% in 2009 to RMB4.6bn (€520m), according to Euromonitor International. At the end of 2010, Starbucks had nearly 400 outlets on the mainland, with roughly the same number spread across Hong Kong, Macau and Taiwan. In November, Shultz said China would overtake Japan, which currently has around 900 outlets, to become Starbucks’ biggest market outside North America. Sales at its Chinese coffee shops have more than tripled since 2004, reaching RMB35m in 2009 and notching up a market share of 69.8%. “How fast they embrace change has really surprised us,” Schultz recently noted. “People were drinking black coffee when we got here [in 1999]. Now they are drinking Frappuccinos,”

Nevertheless, according to the World Bank, the average Chinese worker still earns only $5 a day, a quarter of which, says Euromonitor, is spent on food. Several analysts have been quick to point out that substantial profits may be a long time coming. And Starbucks will hardly be short of competition: Gourmet Master Co, which operates the popular 85C chain throughout the region, recently surged 138% on its first day of trading in Taipei after raising funds in an IPO to finance an expansion in China.

Starbucks isn’t just viewing China as a marketplace, though. Last November, it signed a deal with the government of Yunnan, a southern province steeped in thousands of years of tea production, to open its first coffee-bean farm in the country. China has been encouraging farmers to replace tea with coffee to bring in higher revenue and tax dollars. The Yunnan government plans to invest RMB3bn in the next decade to increase coffee production from 38,000 to 200,000 tons annually.

But the chain has grander plans than cultivating a beverage for Chinese palettes. Schultz says that Starbucks aims to “bring the distinctive Yunnan coffee taste” to the global marketplace. It’s anyone’s guess how customers, accustomed to more traditional varieties of coffee bean, will react – not to mention how Chinese working conditions will affect Starbucks’ liberal image. Already, Starbucks is stressing its promotion of responsible practices and is opening a coffee-farmer support centre in Yunnan – its first in Asia and third globally, after Costa Rica and Rwanda. That said, the company is no stranger to audacious plans.

And who knows, maybe one day the resulting brew – which “has a unique flavour and aroma of fruit and herbal spiciness”, according to Huang Jiaxiong, a researcher at the Yunnan Academy of Agricultural Sciences – will be as popular worldwide as the early-morning muffin. After 40 years of innovation, perhaps it’s wise to give Starbucks the benefit of the doubt.

First published in CNBC Business magazine