Howard Schultz’s master plan extends well beyond the bean

March 19, 2014

Leslie Helm

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Starbucks fortunes were fading six years ago when Howard Schultz, who years earlier had stepped away from day-to-day operations, took back the reins as CEO and engineered a dramatic turnaround. Now, Schultz is using the companys global coffee empire as a launching pad to push into a broad range of new product areas, from health food and pastries to tea and carbonated drinks.

The strategy has had the immediate effect of enticing more customers to Starbucks coffee shops long after the morning rush to pick up yogurt parfaits at lunch, enjoy juice or tea in the afternoon and, at some locations, sip wine in the evening. The company is making more money as customers drop by its stores more frequently and buy more products on each visit.

The long-term strategy is far more ambitious. Starbucks wants to develop many of those products into major new brands that will find homes in supermarket aisles and other channels including, in some cases, entirely new retail chains.

Its an aggressive and complex approach some might call it risky but Schultz is confident it will work because of what he calls the flywheel effect. The term, coined by business guru Jim Collins, refers to the way momentum in one area can carry over to help build success in others, creating an ever-increasing cycle of growth.

We are not like a conventional company, says Schultz. We are unique. We have 20,000 stores in 64 countries. We serve 73 million customers a week. We can introduce a product in our stores and then use social media and mobile payments to draft off that unique asset. That reduces the cost of customer acquisition and creates value.

Schultz says the flywheel works because Starbucks has built a brand with values that resonate among customers across the globe, whether its about helping coffee farmers, building sustainable stores, taking care of employees or creating a third place for people to connect. There is a sense of transparency that has helped us build a large reservoir of trust, he says. Consumers are making choices on price and convenience and quality, but also based on the values of the company.

Starbucks faces plenty of challenges with its new strategy. Although its coffee chain continues to expand the company plans to add 1,500 new stores this year theres a limit to how many products can be sold in each store before baristas are overworked, service slows down and the coffee experience becomes diluted.

Starbucks has had more than a few failures in past efforts to sell new products at its stores, including its own magazine, music CDs and concoctions such as Vivanno, a banana, soy milk and protein drink. Its also unclear whether the reservoir of goodwill built around Starbucks coffee will translate to customers in new markets such as tea and fresh juice.

Yet Schultz has done such a good job of turning the company around in recent years that few are willing to bet against him. He seldom makes a big move that is wrong, says Joseph Michelli, author of The Starbucks Experience: 5 Principles for Turning Ordinary into Extraordinary.

When Schultz took over as CEO in 2008, per-store sales had begun to fall as customers came to regard the coffee store as just another fast-food outlet with overpriced coffee. We had gone through growth spurts that camouflaged underlying issues, says Schultz.

Schultz closed nearly 900 low-performing shops, retrained baristas and, in a meeting of 10,000 store managers in New Orleans, elicited new commitment to the brand and to customers. He brought in new management to overhaul the supply chain, revamped the IT system and introduced lean management principles.

World View. Howard Schultz at the coffee shop in the Commons area of Starbucks corporate headquarters.

Employees were encouraged to find new ways to boost productivity. For example, a store manager figured out that it was more efficient to grind beans before making each new pot of fresh coffee rather than grinding them all in the morning, as was operating procedure. That change, later introduced to other outlets, also brought back the smell of coffee that had been missing from the stores.

The results of those efforts were impressive. Starbucks revenues soared to $14.9 billion in fiscal 2013, up from less than $10 billion in 2009, and revenues are expected to rise an additional 10 percent this year. Meanwhile, operating income shot up to $2.5 billion last year from $562 million four years ago. The company is now valued at about $54 billion, 10 times its value during the depth of the recession.

To tackle what Schultz describes in his 2011 book Onward as a bloated real estate portfolio and stale store designs that had made the Starbucks stores soulless, he brought back as chief creative officer Arthur Rubinfeld, a childhood friend from his days in Brooklyn, New York. Rubinfeld had played an important role in Starbucks early success.

An architect with a strong background in retail, Rubinfeld committed Starbucks to building new stores and renovating old ones to LEED standards of sustainability wherever possible. To help localize the companys stores, he dispersed Starbucks design capabilities, establishing 18 studios around the world that now employ 250 designers. Whether they are picking up items at a local flea market for a store in the Montparnasse district of Paris, adding a chandelier in the shape of entwined brass instruments for a New Orleans store or using unfinished wood to lend the feel of a shrine to a store near Fukuoka, Japan, local designers are adding special touches to make the companys stores more distinctive.

This design ability is critical as Starbucks launches new ventures that must develop their own cultures. For a taste of the variety of experiences the company is now creating, Rubinfeld points to the new retail concepts he is testing at Seattles University Village, where Starbucks operates five stores.

Situational Design. A tangle of brass instruments became a light fixture at a Starbucks store on Canal Street in New Orleans.

Consider the Teavana Fine Teas + Tea Bar, one of two new tea shops Starbucks has built to test concepts for its big push into tea. When Starbucks acquired Teavana in 2012 for $620 million, the company already had a chain of 300 stores selling loose tea, mostly in malls. The new store, which also serves food, has an ambience suited to the calm culture of tea drinking. The wood siding and beams are charred, using a Japanese technique developed to make wood more resistant to insects but now used for its subtle beauty. Japanese teapots are displayed on one wall, while another is covered with color-coded tins of tea ranging from simple breakfast tea to elaborate blends like Maharaja Oolong Chai, Schultzs personal favorite.

Schultz has ambitious plans to expand the Teavana chain, with a particular focus on Asia. Globally, tea is a larger opportunity than coffee. Its ripe for innovation, says Schultz, noting that sales of hot and iced tea total $90 billion a year globally. We have people in Japan and China looking at tea shops to see how its done, says Schultz. Since Asians have drunk tea for thousands of years, he adds, We have to approach this market with respect.”

Just a short walk from the Teavana store at University Village is an Evolution Fresh store. Starbucks acquired Evolution Fresh in 2011 to get into the multibillion-dollar premium juice market. If the Teavana store is subdued, the juice store (theres a second one in Bellevue and a third going up in Los Angeles) is all about color and light. The seats are gleaming white, and a giant video screen features beets, carrots and pineapple in vibrant purple, orange and yellow. A juice bar with multiple taps allows parons to custom-order drink combinations. Were using these stores to learn about this booming market category, says Rubinfeld.

Starbucks has already put Evolution Fresh bottled juices in 8,000 Starbucks stores and Whole Foods Market outlets, and sales have been so good the company recently built a large factory in California to quadruple its juicing capacity. Schultz, long a juicer, says he favors Sweet Greens, a drink whose ingredients include celery, cucumber, parsley, kale, lime, wheatgrass, apple, spinach, romaine, lemon, parsley and clover sprouts. Schultz sees Evolution Fresh as a platform for a line of health food products starting with nuts and fruit bars. Greek yogurt will be produced in a joint venture with the French food giant, Groupe Danone.

Take Tea and See. Starbucks acquisition of Teavana reaffirmed Schultzs belief that the worldwide appetite for tea is crucially important to the companys future prospects.

Starbucks new products tap into growing interest among consumers in food and beverages perceived as being healthy and which come in many varieties. Its important to be fresh and on trend, says Todd Bargman, partner and retail expert at PwC (formerly PricewaterhouseCoopers).
Bonnie Riggs, restaurant analyst at the Chicago-based NPD Group, says iced tea is a particularly important market. Close to 10 percent of the 61 billion annual restaurant visits in the U.S. result in an order of iced tea, and the number continues to grow.

But with specialty coffee growing even faster, its not surprising that even as Starbucks diversifies its doubling down on its core business. The company will add 750 new stores in Asia this year with a focus on large, fast-growing markets like China and India. In the United States, where connoisseurs often deride Starbucks as a milk company, the retailer is upping its game in coffee.
Two of the Starbucks stores at University Village are among 500 Starbucks Reserve locations. Situated mostly in urban areas, these spots sell and serve small-batch coffees that can cost as much as $100 a pound. Starbucks buyers had previously identified many of these sun-dried coffees as outstanding but did not purchase them because they werent produced in large enough volume to supply all of its shops.

A Starbucks Reserve store occupies the first floor of University Villages new parking garage. Walk through the heavy doors and you find yourself in a space that feels like an old French cafe, with its giant antique mirrors and chalkboard menus. A wine rack, bottles of beer and a display of small plates of food such as bacon-wrapped dates remind customers to return for a drink after work. Also on display are pastries from La Boulange, the San Francisco bakery Starbucks acquired last summer for $100 million.Those bakery products are now available in 3,500 Starbucks stores.

A key element of Schultzs flywheel concept involves taking products like coffee beans, instant coffee, juice, tea and pastries popularized by Starbucks coffee, Evolution Fresh and Teavana retail stores, and selling them through new channels such as groceries, hotels, restaurants and airlines.

Plenty of Juice. Evolution Fresh represents the start of Starbucks substantial investment in the health food business.

Schultz believes the Starbucks packaged goods business, now worth about $2 billion worldwide, could eventually be worth $10 billion in the United States alone.

Potential in the grocery business is so great that Schultz told analysts recently it was worth the $2.8 billion Starbucks had to pay Kraft Foods to settle a lawsuit after the company prematurely terminated an agreement under which Kraft had sold packaged Starbucks coffee in supermarkets.

One recent success in supermarkets has been the sale of VIA instant coffee, K-cup and single-serve products popularized through Starbucks stores. Sales are so strong that Starbucks is building a manufacturing plant in Augusta, Georgia. It will employ 140 people and be capable of producing 4,000 tons of soluble coffee products used in instant coffees and in coffee-based products such as Frappuccino drinks.

The effort to sell Starbucks packaged products through new channels has been steadily ramping up and now includes 500 people, up from just 50 three years ago. Jeff Hansberry, who led the channel development business globally from Seattle, is now working in the China and Asia Pacific regional headquarters in Hong Kong to expand Starbucks reach in Asia far beyond its retail stores.

Skeptics say Starbucks could find it far more challenging to dominate the massive health foods and tea markets than it has coffee. More and more people are getting into tea, but Starbucks cant dominate this market, says James Norwood Pratt, a tea authority and author of James Norwood Pratts Tea Dictionary. The parallel is with wine, not coffee. There is too much diversity of products. You cant be a one-trick pony.

And some wonder if the Starbucks experience could get diluted if the company adds too many products to its stores. One of the first things Schultz did when he took over was to unclutter the stores and streamline the companys various initiatives, says Dan Geiman, an analyst at Seattle-based McAdams Wright Ragen. Now, you could argue they are going in the opposite direction, although they may be doing it in a more meaningful way.

Suresh Kotha, professor of strategy and entrepreneurship at the University of Washingtons Foster School of Business, expects the new push to raise marketing costs. Theyve added three major brands in recent years, says Kotha. He expects Starbucks will be forced to increase its advertising budget as it moves into grocery stores, where it will run up against such giants as Nestle.

Daily Bread. Baked goods from San Francisco-based La Boulange, now owned by Starbucks, are available in 3,500 Starbucks outlets.

One Starbucks advantage is its culture of social responsibility across brands. Schultz says that culture was a strong consideration in Starbucks acquisitions of LaBoulange, Evolution Fresh and Teavana. Culture trumps strategy, says Schultz. You need strategy and execution, but if they are not aligned with shared values that is not sustainable.
Another advantage the powerful force that drives momentum across all parts of Starbucks business is its technology and social media savvy.

Starbucks has long had a successful card-based payment program. Its cards have become popular gift items in 28 countries. In the United States and Canada, nearly 10 million customers use Starbucks mobile payment app. Together, mobile and Starbucks card use accounts for nearly a third of all payments in the United States, more than any other consumer products company.

This technology gives Starbuck enormous advantages. In the last three months of 2013, customers loaded $1.4 billion onto their cards. Starbucks has free use of that money and if customers link the cards to online accounts to get rewards, it also obtains their email addresses. Finally, since customers upload money to their cards or apps only periodically, then use them for individual transactions, Starbucks acquires the information about how and where an individual spends the money, information that a credit card company would have otherwise collected.

Equally powerful is the impact those cards and apps have on consumer behavior. App users and cardholders can receive rewards for purchases at Starbucks, Teavana and Evolution Fresh stores as well as for buying Starbucks products at the supermarket. You can buy coffee by the pound at the grocery store and get rewards at the Starbucks store, says Schultz. No other brand offers that.

The Starbucks card and app have other advantages. Because transactions are faster, they shorten lines and wait times. And they can easily be tied to campaigns that tap Starbucks strength in social media, where it has 65 million Facebook fans and six million Twitter followers. A Valentines Day Facebook post that offered a second latte for anyone buying a drink between 2 p.m. and 5 p.m. received 262,829 likes, helping bring thousands of people into Starbucks stores during the afternoon hours when the stores tend to be quietest.

We are laying the rails for a more accelerated digital experience, says John Culver, group president for Starbucks Coffee China and Asia Pacific, channel development and emerging brands. That opportunity for mobile payment will be introduced in China and elsewhere around the world.
Starbucks social responsibility efforts also work well with its mass-media strength to build its brand. For instance, a Starbucks citizens petition was promoted through stores and social media posts last fall to end the United States federal government shutdown; the petition collected two million signatures in two weeks and garnered huge media attention.

Such social media efforts, in turn, bring more followers into Starbucks sphere of influence, allowing it to market drinks, cards and apps to a broader universe of loyal customers. The average spend of a customer with a Starbucks card or app is higher, says Geiman.

For Paul Freed, managing partner of Herd Freed Hartz, a Seattle executive search firm, its all about convenience. Ever since he downloaded the Starbucks app, Freed says, he has found himself visiting Starbucks more frequently, whether hes looking for a coffee or taking a break with his family. He says he has been to Starbucks so often that his 18-month-old daughter now recognizes the Starbucks logo. Its become a game for us, says Freed. We say Starbucks and she looks and points to a Starbucks logo. Its her first brand experience.

With endorsements like that from a whole new generation and a line of products in popular new categories like health food and tea, the Starbucks flywheel is spinning faster.