Cover Profile: Tom O’Keefe, CEO of Tully’s Coffee

How could that be? How can a company like Tullys not prosper? We decided to try to unravel the enigma that is Tom OKeefe. We wanted to figure out how one runs a retail business for 16 years and raises more than $60 million to grow the company without ever showing a quarterly profit from operations. It turns out the answer to the Tullys riddle is more complicated and harder to uncover than expected. But certainly a large part of the answer is that Tullys has suffered not only from poor decisions, but also an extraordinary string of bad luck and bad timing.

The OKeefe mystique
With a story like this, all roads lead back to one person: founder and chairman Thomas Tully OKeefe, a man so closely associated with the operation that his middle name is the companys title. Most observers familiar with Tullys say that the coffee company has, to some extent, always been run as a one-man show; OKeefe even carries the unofficial title of head barista.

When talking business with OKeefe, you quickly realize hes a charming throwback to the handshake-is-my-bond kind of businessman. OKeefe, who is also a real-estate developer, who is famous for his boundless energy, tireless work ethic and nocturnal e-mails, appears to have made deals with half the businesspeople in Seattle and worked charitable events with the other half. In short, he knows just about everyone.

OKeefe makes you want to believe and support him. He is always ready with a story or funny anecdote; he jokes that his idea of a focus group is to gather friends and employees for a dinner party and ask them their opinions after a few martinis and a couple of bottles of wine. Hes long been a major Seattle philanthropist, showering his money and support on organizations that fight diseases ranging from cystic fibrosis to juvenile diabetes.

Hes also the consummate salesman with an ego to match. Hes fond of saying that Tullys has a half-billion-dollar brand and only $50 million in revenue. But now that the companys fortunes have increased, he has amended the above saying to: Maybe now we have a billion-dollar brand, with only $100 million in revenue.

His inflated belief in the value of the 160 stores and other operations that make up Tullys may ultimately be his greatest weakness. OKeefe has been the main force behind a dysfunctional management team that has included a parade of CEOs and presidents who have come and gone since he relinquished the chief executive position in 2001. He eliminated the CEO job altogether earlier this year after John Buller quit the post over policy disagreements. And hes loyal, probably to a fault. While this trait is certainly noble, some observers who know OKeefe have said that his devotion to the 6,000 shareholders has blinded him, at times, to the need to make the tough decisions, such as closing unprofitable stores sooner, trimming the workforce or accepting needed venture capital.

OKeefe remains defiant about protecting his shareholders, saying that they are his main motivation. He regularly quotes an old saying from his father when talking about the shareholders: First, you return their investment and then you give them a return on their investment.
I want people to know that there isnt a moment of the day that Im not thinking about our shareholders and employees, OKeefe says. Everything I do is in the hopes of getting all those people a return on their investments … I dont want to say Im a martyr, but Ill tell you whatits pretty darn close in terms of protecting my shareholders. Thats the way I was taught and thats the way I will always be.

From real estate to roasting
OKeefes decision to enter the coffee business was, in many ways, tied to the rise of coffee titan Starbucks.
Back in early 1992, OKeefe was a successful real-estate developer who was approached about leasing a space to Starbucks for a coffee store in one of his shopping centers. Realizing that no one was competing with Starbucks, OKeefe, who had a lifelong love of coffee and an interest in specialty foods, decided to develop a business plan to start his own coffee company. Six months later, Tullys was in business.

Everything you see today, everything you feel today was what wed originally thought of back in 1992, OKeefe says as he waves his arm at the interior of the Pike Place Market Tullys store.

That includes what many consider an easier to drink and less-bitter flavor to its coffee, when compared to Starbucks. OKeefe says the original plan included friendlier baristas, as well as larger, more family-friendly stores that included toys for kids, fireplaces and comfy chairs.

But there are problems with some of these moves. First of all, larger stores with such amenities are much more expensive than the smaller, more austere Starbucks footprint. Also, the artisan, smaller-batch roasting approach used by Tullys costs more than bulk roasting.
Tullys is famous for an early marketing strategy that called for the company to locate stores across the street from existing Starbucks locations, much like Burger King would place a store near a McDonalds. But OKeefe says that today there are only about 10 of the companys 160 stores across the street from its prime competitor.

If one is looking for possible missteps in the coffeemakers development, the first may be that OKeefe and his team didnt focus as much attention on the company as they should have during its initial five years. OKeefe has acknowledged that until 1995, Tullys was more of a hobby.

Today, he says that Tullys was a serious company, but his concentration was on growing the brand rather than seeking profits. Nevertheless, in retrospect, a lack of early focus may have squandered the chance for Tullys to become a legitimate No. 2 in the specialty coffee market behind Starbucks and to organize an initial public offering to capitalize on investor interest. Its similarly sized competitor Caribou Coffee did the trick. Also founded in 1992, the Minneapolis-based chain went public in 2005. In the last 12 months, Caribou posted revenues of $256 million, more than three times those of Tullys.

In 1997, OKeefe says, he decided to make Tullys a real business. From then until 2000, Tullys pumped millions of dollars into doubling its size in anticipation of an initial public offering. On the advice of investment bankers, Tullys began to churn out stores, opening more than 50 in 2000 alone. The picture looked bright for Tullys, which appeared to have the potential to become that second-tier player in the specialty coffee sector. After moving its roasting operations into the old Rainier Brewery next to I-5 in 1999, the company later added to Seattles skyline, swapping out the buildings iconic red-neon R for a 13-foot-tall green T to greet drivers heading into the city.

By 2000, Tullys was building a strong brand and getting noticed.

Case of bad timing
Around the turn of the millennium, however, Tullys began a stretch of poor timing and plain old bad luck. One of the toughest breaks was the attempt at an IPO, which was sidelined by the dot-com crash. The fact that many Tullys stores were focused in the Seattle and San Francisco markets, the epicenter of the technology industrys meltdown, also hurt sales and expansion plans. Tullys had placed stores in buildings, which, only months before, were jammed with technology workers. In 2001, these locations were virtually empty. OKeefe says it took the company three to four years to recover.

Last year, Tullys made a second attempt at an IPO. But, once again, the timing was off and the markets turned negative, closing the IPO window.

But even before the IPO issues cropped up, trouble was brewing. Before the dot-com meltdown, Tullys had implemented a number of ways to raise funds, including borrowing money and selling shares of the company to angel investors.

While hesitant at first, OKeefe says he soon realized that offering shares was the best option. The reasons were simple: It allowed everybody to get a bite at the IPO apple when the opportunity came; it gave customers and employees a stake in the company and a reason to work for its success; and it raised money without having venture capitalists become part owners. Hed seen other examples in which founders ended up relinquishing control of their firms to investors who then forced them to accept unwelcome changes or even sell the businesses.

There was, of course, a downside to selling shares without actually holding an IPO so the stock could be traded on the open market. Very soon, Tullys had more than 500 shareholders, enough to technically become a public reporting company, according to federal guidelines. That meant the firm was responsible for adhering to all the expensive regulations and accounting rules of a public entity without the big initial payday or a market in which to trade corporate shares. Today, Tullys spends more than $1 million a year just to follow all the regulations controlling public companies. In other words, Tullys inherited all the headaches of being a public company but none of the perks.

On one hand, it was a stroke of genius, OKeefe says of selling so many shares. On the other hand, it was the kiss of death.

OKeefe used his personal shares for everything, from paying investors and raising money to buying various goods and services. He even used shares to pay for construction and real estate. Of the companys 6,000 shareholders today, 2,000 are current and former employees who received shares directly from OKeefe.

Managements revolving door
At about the time of the dot-com implosion, OKeefes financial advisors convinced him that it was time to hire a chief executive to run the coffee company so OKeefe could focus on what he did best: make deals, bring on investors and spread the gospel of Tullys.
What followed was another series of missteps as the business struggled to find an effective leadership team. In February 2001, OKeefe chose former ice cream executive Jamie Colbourne as the companys first outside president. Colbourne lasted all of five months and resigned, telling reporters at the time that the companys financial condition was worse than hed been led to believe when he took the job. He also said he didnt believe he had the full support of the board of directors.

At the time, Tullys was bleeding money, losing more than $23 million in 2001 as it struggled to close underperforming stores, cancel new leases and end business deals that had gone sour.

Marc Evanger, Tullys vice president of corporate planning and development at the time, replaced Colbourne and ran the company for 10 months. During the next six years, Tullys went through a series of top executives, including Tony Gioia, a former president at Baskin-Robbins; Seattle Supersonics executive John Dresel; and John Buller, a senior vice president of sales and marketing for the Bon Marche.

Buller left in January of this year, along with CFO Kristopher Galvin. Buller was reportedly against plans to fire 14 employees from the corporate headquarters. OKeefe then hired Carl Pennington Sr., a 69-year-old former Albertsons executive, as his new president.
OKeefe still fumes about the decision to hire Colbourne, saying it was ridiculous and idiotic for him to listen to the advisors and try to bring in someone from the outside to run the company. He says they both knew Colbourne was the wrong guy within three days of hiring him. As for the other executives, OKeefe declined to speak specifically, but discussed in general terms how some didnt share his sense of obligation to protect the investments of current shareholders or an understanding of what it takes to run a startup and to use money and resources carefully.

OKeefe also mentions that same issue again: shareholders. Apparently, some executives wanted to raise capital by offering venture capitalists shares in the company, a move that could dilute the value of the shares held by the original investors. OKeefe said no.
Im not willing to throw any of my shareholders under the bus, he says.

None of the former executives contacted for this story would comment, but one source close to Tullys says that OKeefe continued to harbor an inflated view of what Tullys was worth in the early 2000s, making negotiations with potential investors problematic.
Tom had the best of intentions, but his support of the shareholders blinded him to reality. He wasnt willing to take the capital at the market price, which valued the company at between $20 million or $30 million, says the source who wished to remain anonymous.

Instead, he thought the company was worth $100 million or $120 million.

Continued fiscal trouble
In spite of all these difficulties, one main question remains unanswered: why isnt Tullys profitable? After all, its competitors, such as Caribou Coffee and San Francisco-based Peets Coffee, have faced the same hurdles as Tullys and yet theyve continued to grow, expand and even launch successful IPOs.

While OKeefe has excelled at raising money by finding short-term loans, new investors and developing Asian licensing agreements, he has had major problems controlling corporate costs, reacting to market changes and breaking away from the shadow of Starbucks.
OKeefe maintains that revenues for the fiscal year that just ended may reach nearly $70 million. In 2009, he predicts revenues of between $90 million and $100 million. He says that the Tullys retail stores and the wholesale divisions are growing and profitable.

But costs associated with the firms corporate management structure are creating the overall losses. Positive effects from the cutbacks implemented late last year and early this year, he says, will begin to show up on the companys financial statements in fiscal year 2009, which runs from April 2008 to March 2009.

According to the most recent financial statements, OKeefe appears to be right. Retail store sales increased from $29.4 million for the first three quarters of 2006 to $32.4 million during the same period in 2007.

The wholesale division, which includes grocery-store sales, office coffee services and institutional businesses, jumped from about $16 million in the first three quarters of last year to nearly $21 million for the same period this year. But the company still lost nearly $7.9 million during the first three quarters of the 2008 fiscal year, ending Dec. 30, 2007.

One major financial problem appears to be, at least on the surface, that the company employs far too many people in comparison to its competitors. With a workforce of 1,167, Tullys has only 436 fewer employees than Caribou, a company which earned $256 million in the last 12 months and operates about three times as many stores as Tullys (484 stores, including 52 franchises). Peets, with 166 stores, employs only 687 people while posting sales of $259 million.

Some experts also question why Tullys management doesnt try harder to move out of the oversized shadow of Starbucks.
My opinion is Tullys has never done a very good job of differentiating themselves from Starbucks. I mean they even have just about the same colors, says Mary Ann Odegaard, director of external management programs at UWs Foster School of Business at the University of Washington. I dont think its too late. But I do think they need to really attack the idea of who is Tullys and why [customers should] come there.

Looking to the future
As he has so many times before, OKeefe is promising that Tullys is getting its financial act together and that this timefor realit is on the road to profits. And, as always, his excitement is infectious.

He praises new corporate president Pennington, whom he describes as a no B.S. kind of leader who understands how to run a successful business.

Pennington appears to be tackling some of the issues laid out by Odegaard by increasing margins and cutting costs. He declined to say why he thinks the company has failed to be profitable, but in an interview with the Seattle Post-Intelligencer, Pennington said that the company was looking to streamline operations and expand both the wholesale and retail divisions.

The companys bad luck overseas may also be coming to an end. After a successful franchising experience in Japan, OKeefe entered into a deal to license the rights to Tullys name in Asia, except Japan, for $12 million to the Ueshima Coffee Company (UCC). But the deal went sour in recent years, with UCC opening only one Tullys in all of Asia over six years. That store, in South Korea, soon closed. OKeefe terminated the agreement and UCC sued. That lawsuit was settled this year, with Tullys agreeing to pay UCC $6 million.
Tullys was then paid $6 million by its original Japanese franchisee to enter into a new joint venture for Asia. With operations based in Singapore, OKeefe expects strong growth in China and India in the coming years.

He also sees major growth in the wholesale sector, including the Keurig single-serving coffee service, introduced last year for office and home use. Tullys officials initially expected to sell between 10 million and 12 million of the individually packaged servings, which can be used in specific machines to brew a single cup of coffee. Instead, the company sold nearly 30 million. OKeefe wont even guess how many may be sold this year.

Early this year, OKeefe announced that he had hired the consulting firm D.A. Davidson to help develop options for the company to best increase shareholder value. While OKeefe is mum about negotiations, he denies speculation that Tullys will be sold. Instead, he has hinted that the company may get yet another cash infusion to keep it going and growing.

Critics say that OKeefe has always counted on an IPO to solve the companys financial ills and to secure a return to his loyal shareholders. But now that other players have passed Tullys by, there are those who wonder whether the window of opportunity has already closed.

OKeefe remains undeterred. He jokes that hes going to make a success out of Tullys if it kills himand some days he feels as though it just might. But through all the ups and downs, he continues to believe that Tullys has done great things.

If nothing else, he says, hes been able to support the community and raise millions of dollars for the charities he cares about deeply. That is success enough right there. When asked why he continues to deal with the aggravations of Tullys, he circles back to the overriding theme that appears to rule all his corporate decisions: his responsibility to his shareholders.

I could never quit this company, OKeefe says. How the hell could I when all those people trusted me with their money? That is what has kept me going all these years.