“As you prepare for the FY 08 strategic planning process, I want to share some of my thoughts with you.
Over the past ten years, in order to achieve the growth, development, and scale necessary to go from less than 1,000 stores to 13,000 stores and beyond, we have had to make a series of decisions that, in retrospect, have lead to the watering down of the Starbucks experience, and, what some might call the commoditization of our brand.
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. For example, when we went to automatic espresso machines, we solved a major problem in terms of speed of service and efficiency. At the same time, we overlooked the fact that we would remove much of the romance and theatre that was in play with the use of the La Marzocca machines. This specific decision became even more damaging when the height of the machines, which are now in thousands of stores, blocked the visual sight line the customer previously had to watch the drink being made, and for the intimate experience with the barista. This, coupled with the need for fresh roasted coffee in every North America city and every international market, moved us toward the decision and the need for flavor locked packaging. Again, the right decision at the right time, and once again I believe we overlooked the cause and the affect of flavor lock in our stores. We achieved fresh roasted bagged coffee, but at what cost? The loss of aroma -- perhaps the most powerful non-verbal signal we had in our stores; the loss of our people scooping fresh coffee from the bins and grinding it fresh in front of the customer, and once again stripping the store of tradition and our heritage?
Then we moved to store design. Clearly we have had to streamline store design to gain efficiencies of scale and to make sure we had the ROI on sales to investment ratios that would satisfy the financial side of our business. However, one of the results has been stores that no longer have the soul of the past and reflect a chain of stores vs. the warm feeling of a neighborhood store. Some people even call our stores sterile, cookie cutter, no longer reflecting the passion our partners feel about our coffee. In fact, I am not sure people today even know we are roasting coffee. You certainly can't get the message from being in our stores. The merchandise, more art than science, is far removed from being the merchant that I believe we can be and certainly at a minimum should support the foundation of our coffee heritage. Some stores don't have coffee grinders, French presses from Bodum, or even coffee filters.
Now that I have provided you with a list of some of the underlying issues that I believe we need to solve, let me say at the outset that we have all been part of these decisions. I take full responsibility myself, but we desperately need to look into the mirror and realize it's time to get back to the core and make the changes necessary to evoke the heritage, the tradition, and the passion that we all have for the true Starbucks experience. While the current state of affairs for the most part is self induced, that has lead to competitors of all kinds, small and large coffee companies, fast food operators, and mom and pops, to position themselves in a way that creates awareness, trial and loyalty of people who previously have been Starbucks customers. This must be eradicated.
I have said for 20 years that our success is not an entitlement and now it's proving to be a reality. Let's be smarter about how we are spending our time, money and resources. Let's get back to the core. Push for innovation and do the things necessary to once again differentiate Starbucks from all others. We source and buy the highest quality coffee. We have built the most trusted brand in coffee in the world, and we have an enormous responsibility to both the people who have come before us and the 150,000 partners and their families who are relying on our stewardship.
Finally, I would like to acknowledge all that you do for Starbucks. Without your passion and commitment, we would not be where we are today.
For me, this memo is instructive, and reveals a plethora of gems about business development and sustainability that investors might find fruitful; some insights I took away include:
1) The Importance of Brand Identity – As you listen to Mr. Schultz discuss Starbucks, you can sense that he is coming from a position of personal connection, rather than a purely financial perspective. His emphasis is centered on what makes a Starbucks different, and how that has been lost in the search for efficiency; ironically, it was the rush to short-term profitability and growth that led to the impending commoditization of the Starbucks brand.
2) The Street’s Misguided Guidance – As Howard notes in the first paragraph, the company sacrificed on the experience in order to achieve the growth, development, and scale necessary to go from less than 1,000 stores to 13,000 stores in just 10 years (that’s an average of more than three new stores each and every day for a decade). A lot of this was in hopes of satisfying the street, which led to decisions focused on short-term growth rather than long-term sustainability. Unfortunately, the commoditization of the cookie cutter model destroys brand equity, and leads to price competition; considering that a cup of black coffee at Starbuck’s is more than twice the cost of a black coffee at McDonald’s (MCD), it appears that management made the right decision in rethinking the brand experience and moving back towards the core: differentiation.
3) Balancing the Qualitative and the Quantitative – It’s important to recognize that Mr. Schultz isn’t oblivious to the financials; as he notes, for example, the store design the company was using at the time was chosen to gain efficiencies of scale and to make sure the ROI would satisfy the financial side of our business. But this cannot be looked at in a vacuum, particularly for someone like SBUX that isn’t looking to compete purely on price. Some of the costs may not seem entirely economical in a spreadsheet, but can add intangibles to the experience or the brand that can be explained in an anecdotal sense – for example, the ability to draw in captive customers who willingly pay more than twice for your product despite the availability of convenient and comparable alternatives.
When this memo was written, Mr. Schultz had spent the previous seven years as chairman of the board after having stepped down from the CEO role at the turn of the century; as discussed in his book, “Onward,” the initial reaction to the memo was a mixture of skepticism and sloth, with few/no serious changes made in the following six months. By the beginning of 2008, the stock had fallen by more than half from its peak in 2006, and Mr. Schultz stepped in to redirect the company from an obsession with growth towards a focus on brand integrity.
While the stock bottomed along with the market in the early months of 2009, it has ballooned more than 7x ever since; since Mr. Schultz returned to the helm, the stock is up more than 175%, while the DJIA and the S&P 500 are both in the red.
To this day, the company finds themselves under constant pressure from McDonald’s, which has continually attempted to replicate their product offerings but at a lower price point; considering the strong business results Starbucks has continually delivered, it’s safe to say that the brand has escaped commoditization as was once feared.
About the author:
I hope to own a collection of great businesses; to ever sell one, I demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.