Are Starbucks’ Big Gambles Paying Off? Too Early to Tell, but Reasons to be Encouraged

Howard Schultz, CEO of Starbucks (from BNET/The Corner Office)

It is without debate that Starbucks began to struggle a few years ago, suffering from issues typical of growth companies that reach a plateau and can no longer boost returns by, in their case, opening additional stores.  As The Onion made clear over ten years ago, the US market (at least) was saturated.  Starbucks needed a new growth model. Businesses can only be in two states – growth or decline – so if you can’t find the first, you are doomed to the latter.

The first step they made was in bringing back Howard Schulz, their original CEO.  Howard had been critical of the company from outside, saying that they had lost their focus on quality in a hunt for efficiency, and vowed to return them to their roots. While the steps he took may have been helpful, they at best provided incremental gains, and Starbucks was beginning to face increased competition from the likes of Caribou, Dunkin Donuts, and, as the economy slowed an consumers became more price sensitive, McDonalds.

Over the past year, Howard stepped up the pace of innovation at Starbucks in an effort to find new avenues for growth.  One step was to open an experimental new store model in Seattle called 15^th Ave. Coffee and Tea.  The stated goal was to recreate the neighborhood coffeehouse feel, which is obviously difficult to do for a large corporation accustomed to rigid processes, design guidelines, and policies.  Starbucks could not resist putting notice on the shop that it was “inspired by Starbucks,” an idea that on its surface seems as corporate-ego driven as GM’s push to put the GM logo on Saab cars.  I am sure this strategy consultant was not alone in predicting failure of the experiment and urging that Starbucks continue to “focus on their core”.

However, The Economist reported a few months back, without much quantification, that the experiment appeared to be a success.  Combined with other ongoing initiatives like training of associates, introduction of value-priced food and drink combos, and increased use of drive-thru facilities, which generate far higher revenue than traditional stores, Starbucks was building momentum.  The stock climbed from a low of $8 to $20 through the first half of 2009, far outpacing the S&P 500, and it has remained at that level for several months.

A bigger gamble was the introduction of the Via™ line of instant coffee.  This flew in the face of conventional wisdom about consumer marketing in many ways:

• At a lower price point, there was high risk of cannibalization (of both in-store and home-use sales) and reduced overall revenues and margins
• Instant coffee is perceived to be of lower quality than traditional brewed styles.
• The effort would distract resources at the company and take away from the “experience” brand image that Starbucks is known for.

While not an expert consumer marketer, I had these same concerns. In fact, Starbucks seemed to be bucking even the most obvious of marketing-101-type advice by positioning their product against their own store brews. Again, the blogosphere and consultant-world shivered.

However, if you step back and consider this more objectively, there is a lot of upside for Starbucks in this strategy:

• It is unlikely that instant coffee would cannibalize coffee-house sales as they are completely different markets (the former is driven more by experience, where the latter is driven by convenience).
• Being confident enough to compare Via to their own store-brewed coffee (and emphasizing the story of its painstaking development) did bring some potential credibility to the brand
• Starbucks position for home consumption had to be minimal; there are a wide range of competitors, and even I, coffee snob that I am, opt for Gevalia^® coffee for our Tassimo^® because it is “good enough” and far less costly.
• The margins on instant coffee per cup of consumption, at $0.99 / serving, have to be far better than the margins on cups made from ground beans; think of how long a bag of beans, even costing $12, lasts.

My market research on this (which basically consisted of asking the barista at the drive-thru this morning how the Via sales were going) indicates that consumers seem to like it, and it did see significant sales, at least initially. Obviously there will be surge out of the gates, and only time will tell the ultimate impact. But I am eager to see the results and hopeful that this will restore some momentum to a great American institution (and I do not own any SBUX stock).

A final thought: bringing back a CEO is always risky, particularly when it is a “growth” CEO brought back to manage a “mature” company.  While Steve Jobs is an obvious exception at Apple, such approaches do not often end well; more typical is the experience of Michael Dell at Dell. What gives it a chance to work in this case is that Starbucks needed to reestablish its growth mentality and take some risks.  The 15^th Avenue effort was just the kind of low-risk high-reward effort to start with (and, it should be pointed out, the prices are actually higher than at Starbucks). Via is a bigger swing, but it won’t sink the company if it fails. Worst case is they lose some time on better ideas, but I am glad to see the company taking chances instead of just making simple tweaks to the business model.

Required (I think) disclosure – I wrote this post while drinking a Venti Americano. But I did pay for it myself. But it was with a Starbucks Card. Which is auto-reloaded by my own credit card. So I think I’m OK, FCC.

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