Case Study of Starbucks: An Amazing Business Success Story

Starbucks’ Missteps

Like many companies during the Internet boom, Starbucks over-reached to an extent in its rush to establish an elaborate Internet presence. In 1998, Starbucks began to develop an Internet strategy as another tool to increase sales and strengthen its brand image. Starbucks had already launched a direct-mail catalog program through which consumers, located anywhere in the United States, could order Starbucks coffee and other products. In 1999, Starbucks announced that profits for the current fiscal year would be 10 percent below expectations, due in part to the expensive internet start-up (roughly $4 million), higher labor costs, and a slow-starting Frappuccino supermarket launch.

That same summer, Starbucks made a bid to buy the kitchen and home-goods retailer Williams-Sonoma. Unfortunately for Starbucks, Williams-Sonoma chose to remain independent and rejected the bid. A month later, Starbucks did announce a $20 million investment in Living.com, a start-up that planned to sell non-branded furniture via the Internet.

Uncertain about the practicality of these plans and still reeling from the bad news concerning sales and profits, Wall Street hammered the Starbucks stock, resulting in a drop in share price of 28 percent in one day–a $2 billion loss in the company’s market capitalization. Wall Street seemed to be condemning these plans, accusing Starbucks of losing focus and diluting earnings. Some traditional retail investors interpreted the announcement as an early signal that the company’s core retail business was weakening, while investors regarded Starbucks’ retail locations as excess physical overhead that would hamper its web presence.

In response to the negative reaction, Starbucks revised its web strategy. Instead, the company chose to invest in other net companies such as the Internet chat site TalkCity for $20 million and Cooking.com for $10 million The company stuck to its plan of opening a website for its coffee products and unveiled Starbucks.com in early 2000. These scaled-back web developments assuaged the fears of investors and Starbucks stock began climbing steadily in late 1999.

In 2000, sales of their lifestyle magazine Joe faltered and the project was axed less than year after its launch. In the aftermath of the Internet bubble, investments in Living.com, Cooking.com, and TalkCity all proved to be unsuccessful. Furthermore, citing higher costs for milk, as well as higher rent and health-insurance costs, the company was forced to raise prices by approximately 3 percent in August of 2000. The company also faced increased competition in the cafe business.

Increased Competition

It did not take long for other companies to try and duplicate the Starbucks experience. Whereas Starbucks stores had a hip, urban feel, some competitors tried to broaden this experience by creating a different atmosphere. Caribou Coffee was perhaps the most successful, designing their stores to resemble ski lodges and rustic mountain cabins. “Caribou gets you out of the urban environment and gets you in a different world for a short period of time. In many ways, Starbucks is an extension of the hustle and bustle of a city street,” said Dennis Lombardi, Executive VP at WD Partners, a Columbus, Ohio-based retail design firm. As of 2006, Caribou Coffee, with over 30 locations in 13 states, was the distant number two coffeehouse brand to Starbucks. Gloria Jean’s Coffee and the Coffee Beanery were smaller competitors in this segment.

Perhaps the greatest threat was from Dunkin’ Donuts, who in 2006 had 4,400 locations in the United States and over 6,000 stores in 29 countries worldwide. “Espresso has become mainstream in America, and who does mainstream better than Dunkin’ Donuts?”asked Jon Luther, chief executive of Allied Domecq’s (parent company of Dunkin’ Donuts) restaurant division. Not only had Dunkin’ Donuts introduced cappuccinos and lattes in many stores, but they had eliminated the need for baristas by purchasing machines that churned out quality cappuccinos in less than a minute. The company also offered Wi-Fi service at some locations, expanding its product line to include frozen coffee drinks, and tended to locate its stores in blue-collar communities, an area that Starbuck was just beginning to target. This combination of speed, consistency, and lower prices (up to 25 percent lower than Starbucks) was winning converts, as the company recorded worldwide sales of $3.6 billion in fiscal 2004.

With the total retail coffee sales in the United States of $4.2 billion in 2005, there was no shortage of competitors. Another threat to Starbucks came from fast food heavyweights such as McDonald’s and Burger King. McDonald’s changed its bean blend and equipment system-wide, and offered cappuccinos and lattes in some chains. Burger King tested its own premium blend and planned to offer it under the name BK Joe. Another competitor, Carl’s Jr., launched a new Arabica bean roast, and Dairy Queen began offering a frozen/iced coffee in the summer of 2004.

Aggressive Expansion

In response to this competition, Starbucks got “back to basics” and focused on new markets. By the end of fiscal year 1998, Starbucks operated 26 stores in Japan, 11 in Singapore, 6 in Taiwan, 5 in the Philippines, and 1 in Thailand. Late 1998 and early 1999 saw the opening of Starbucks specialty coffee stores in Malaysia, New Zealand, and China. In 2001, Starbucks opened locations in Switzerland and Austria. The following year, Starbucks expanded its European presence into Spain, Germany, and Greece. By 2006, Starbucks was in 37 countries, including Argentina, Peru, Brazil, Turkey, Japan, Mexico, Jordan, India, and The Bahamas. Starbucks also achieved further international expansion to the Middle East and new markets in the Pacific Rim.

Investors as well as consumers were clamoring for coffee. In June of 2000, the Hong Kong Stock Exchange added six NASDAQ stocks, of which Starbucks was the only non-tech stock. Starbucks expected that its presence in Asian stock markets would provide the company with more inroads into Asian commerce. By 2006, there were over 200 shops in China and Hong Kong and 150 locations in Taiwan.

Starbucks’ longtime chairman and CEO Howard Schultz had his sights fixed firmly on the international market. In June 2000, he surrendered the title of CEO to then-president and COO Orin Smith. Schultz remained chairman of the company and assumed the new title of “Chief Global Strategist,” a role that enabled him to focus on overseas growth and brand development. Schultz, who estimated that the global market for Starbucks was over 15,000 stores, was certain that Starbucks would continue to enjoy success in Asia. He stated that the growth overseas “will be a mirror image of what we did here (in North America).” Smith remained CEO until 2005, when he was replaced by James Donald, former President of Starbucks North America.

Success Overseas

International success grew at a rapid pace. The company continued to open stores in established markets, while looking for new opportunities. By early 2003, there were a total of 1,532 overseas stores, accounting for 23 percent of total locations. These stores were not immediately profitable, accounting for only 9 percent of sales. It was not until the end of 2003 that the company’s international stores became profitable, narrowly squeezing out operating income of $5 million on net revenues of over $600 million.

Starbucks faced challenges with this rapid international growth. As of 2005, Japan boasted Starbucks’ biggest foray outside the United States After initial success, the Japanese operation see-sawed between being in the black and red in subsequent years. All six Starbucks cafes in Israel shut down in 2003 due to a severe recession and security problems. Starbucks drinks in London were hurt by rivals with lower costs, while in Germany, markets in Frankfurt and Berlin were saturated by Starbucks-like coffee bars.

These setbacks did not deter Schultz or his plans to one day have over 15,000 international locations. Starbucks’ goal was to have 6,500 locations in Asia, fueled in large part by growth in China. The company set aggressive goals for Europe, the Middle East, and Africa with a target of 6,000 stores. Schultz also planned to have 1,500 stores in Latin America, and double the number of outlets in Canada to 1,000.

Starbucks Fights Back

Schultz faced the challenges heading the company and outlined ambitious plans to extend the brand. He wanted Starbucks to be known for more than just offering high quality coffee in comfortable settings. Schultz planned to make Starbucks “the most recognized and respected brand in the world.”

The company began with strengthening its core product, coffee. Starbucks unveiled new Frappuccino flavors, including Chocolate Brownie, Orange Mocha Chip, and Strawberries & Crème, as well as a low-calorie line of drinks. By 2005, Frappuccino was the number one selling ready-to-drink coffee in the United States with $152 million in sales and held an 83 percent market share.In 2002, Starbucks introduced the DoubleShot, a chilled espresso drink sold by grocery stores in 6.5 ounce cans. Three years later, DoubleShot was the number two selling ready-to-drink coffee in the United States with $25 million in sales and a 13 percent market share. In fact, 71 new RTD tea and coffee drinks were introduced throughout the industry in 2005 alone.

That same year, the company launched the Chiantico, an indulgent drinking chocolate, in the hopes of selling more products that would sell during the afternoon and early evening hours. They also added new food products, like Reduced Fat Blueberry Coffee Cake and a Lemon Raspberry Loaf. In 2006, Starbucks introduced Blackberry Green Tea Frappuccino and Tazo Green Tea Latte in hopes of combining tea into their already popular coffee drinks.

Growth beyond Coffee

Starbucks started offering prepackaged sandwiches and other lunch items after realizing that only 10 percent of sales were made between noon and 2 pm. By 2005, they offered lunch items in 2,300 U.S. stores, with plans to expand the service to 70 percent of all stores. Starbucks also began testing a “warming program” in Seattle and Washington, D.C. This initiative required baristas to heat up breakfast sandwiches (e.g. sausage and egg English muffins) in an oven. This service expanded Starbucks’ current breakfast offerings of bagels and pastries, but added complication to already busy baristas during the critical morning hours.

Starbucks began offering stored value cards in 2002 to make it easier for customers to purchase items. These cards offered customers a cash-free way to purchase their favorite Starbucks items and beverages (many of which cost close to $4.00). The cards were an instant hit, and Starbucks soon expanded the idea. The following year they introduced the Starbucks Card DuettoVisa, a first-of-its-kind payment card that blended a traditional credit card and the reloadable Starbucks Card into one. Within two months of its introduction, the Duetto Card was recognized by BusinessWeek, as one of the “Best Products of 2003.”

As the Internet continued its explosive growth and permeated all aspects of daily life, Starbucks teamed with wireless service provider T-Mobile to provide Internet Hot Spots in Starbucks stores. During its first year, the company installed over 2,600 Hot Spots in its stores, and actively explored new ways to introduce technological innovations to encourage customers to stay longer and, hopefully, drink more coffee.

Expansion into Non-Traditional Areas

In an effort to reinvent one of the world’s best-known brands, Starbucks purchased alternative music retailer Hear Music in 1999 for $8 million. Though Starbucks had been selling pre-packaged CDs for years, they used this acquisition to begin offering Hear Music Media Bars in select stores in 2004. Media Bars were kiosks that allowed customers to browse over 150,000 song titles, then choose their favorites and “burn” them to create their own custom CDs. Starbucks further leveraged its ownership of Hear Music with the addition of a Hear Music channel on XM Satellite Radio.

Starbucks invested cautiously in the digital music field. Although the cost per Media Bar was about $20,000 (and eventually installing these in 3,000 stores would cost $57 million), this represented a small portion of the $600 million Starbucks had scheduled for capital-expansion spending in 2005. However, with the recent explosion of iPod use, an increasing number of consumers were more comfortable getting their music in a digital format (such as MP3 files) than more traditional CDs.

Starbucks experimented with music in other ways, too. The company co-produced the late Ray Charles’ Genius Loves Company with Concord Records. Featured prominently in more than 4,500 Starbucks locations, the album won eight Grammy awards and soared to the top of the Billboard R&B charts, all without radio play. This success with a traditional, already popular artist was followed with sheer marketing muscle in promoting Madeleine Peyroux, a relatively obscure torch singer on the independent Rounder Records, who put out her first album in 1996. Her latest, Careless Love, was released in September 2004 to little fanfare. In March 2005, Starbucks started prominently displaying it. Sales tripled in just one week, from 4,849 albums to 16,636, pushing the album to No. 81 on the Billboard Top 200.

Starbucks entered into an agreement with Jim Beam Brands to develop, manufacture, and market a Starbucks-branded coffee liqueur since nearly 50 percent of its loyal patrons consumed coffee liqueurs. Coffee-flavored liqueurs were a big piece of the estimated $4 billion to $5 billion U.S. cordial-and-liqueur market. A print ad campaign sporting the tagline, “The Art of Coffee comes to Cocktails,” helped support the product, which was sold at liquor stores, not Starbucks locations. In an interesting twist, Starbucks’ coffee liqueur squared off against the popular Kahlua brand, made by Allied Domecq (who was also the parent company of competitor Dunkin’ Donuts). Since the introduction of their coffee liqueur, Starbucks had been removed from some socially conscious mutual funds that previously invested in the company.

In 2006, Starbucks entered the film business. The company partnered with Lions Gate, an independent film maker, to promote “Akeelah” a film about an 11-year old spelling bee whiz. Starbucks promoted the film in several ways. Customers received a free “Akeelah” spelling be word on every cup of coffee. The movie’s soundtrack and DVD were sold in Starbucks locations. And, the company gave out free movie tickets to its baristas hoping to encourage them to promote the film through to the end customer. The company also planned to invest much more into the film industry in upcoming years and once reporter called Starbucks the “Oprah’s Book Club of the independent filmmaking world.”

These new initiatives helped stores increase sales substantially. In 1999, an average Starbucks store posted $750,000 in sales. By 2004, this per store number had surged to $940,000. However, there was concern whether this same-store sales growth could continue. Analysts were especially concerned about market growth and saturation.

Continued Growth

Starbucks continued its ambitious international growth plans in 2004 and 2005, adding stores in France, Cyprus, Jordan, the Republic of Ireland and the Bahamas. In fiscal 2006, the company planned to open 1,800 stores–more than they had opened during the first 25 years of the company’s history. To further differentiate itself from increased competition, Starbucks developed the Coffee Master certification program. Upon passing a series of tests on the intricacies and nuances of coffee, Starbucks employees earned the right to wear a distinctive black apron. The company’s goal was to have at least one black apron-clad Coffee Master in every store. The company raised prices by another 3 percent in the fall of 2004. This did not appear to hurt the company; by 2005 Starbucks’ stock had climbed over 3,500 percent since its 1992 IPO, and hit record numbers in 2006.

The question remained whether this rapid expansion in retail, product inventory, and strategic partnerships would harm Starbucks brand equity and run the risk of becoming a cookie-cutter chain. In an April 2005 interview, CEO James Donald addressed this very issue:

“Our success comes down to the way we connect with our customers, our communities, our farms–with each other. We just had a four-day leadership conference. The theme was human connection. We didn’t once talk about sales and profits. We talked about how we continue to grow and how we connect. You know, Howard [Schultz] has always said that we’re not in the coffee business, serving people; we’re in the people business, serving coffee.

Starbucks’ ability to grow without alienating large segments of their consumer base would hinge on the public’s perception of the company.

Conclusion

Many viewed Starbucks’ meteoric rise from a tiny local retailer to an international coffee powerhouse as one of the great success stories in American business in the last decade. Incredibly, Starbucks achieved its market leader position largely without aid from advertising campaigns (in 2004, only 1.3 percent of sales was spent on marketing). Instead, the company built the brand by relying on the quality of their products and services to induce free word-of-mouth “advertising” from customer to customer.

As Starbucks continued to push for new product innovations and business opportunities as a way to differentiate itself from its competitors and maintain its growth, the company ran the risk of straying too far from its original focus of spreading its passion for fine coffee. Even with $6.4 billion in sales in 2005 and a soaring stock in 2006, Schultz vowed to keep Starbucks “small” in terms of its close interactions with employees and customers. However, the ballooning size of the corporation suggested that the quality of Starbucks products and services, and the strength of the company’s relationships with its most valued people, would need to be closely monitored. A larger, global Starbucks had to find the right balance in pursuing product, people, values and sales-driven objectives.

Questions to Discuss:

  1. What were the keys for success for Starbucks in building the brand? What were its brand values? What were its sources of equity?
  2. How would you evaluate Starbucks’ growth strategy? Are there things you would do differently? How would you evaluate its partnerships (e.g. with United Airlines)? How do you know whether it is a “good” or “bad” partnership?
  3. What does it take to make a world class global brand? Can Starbucks become one? What hurdles must its overcome? In terms of the American market, what do you see as Starbucks’ biggest challenges?
  4. Evaluate Starbucks’ move into non-coffee areas like credit cards, music, and film. Are these natural extensions of the Starbucks brand, or has the company gone too far in creating a “lifestyle” brand? Where should Starbucks go next?
  5. Do you agree with Starbucks international expansion? Should the company continue its aggressive expansion plans? Are there markets where Starbucks cannot expand?
  6. Who represents the biggest threat to Starbucks? Direct competitors in the coffee market, such as Dunkin’ Donuts? Chains like McDonald’s that are expanding their coffee quality? Panera Bread and other locations that might be the new “third place”?
  7. How much are customers willing to pay for the Starbucks Experience? Can the company continue to raise prices on its coffees and drinks? Is there a market for $400+ coffee makers?

Credit: The initial draft of this case was written by Peter Gilmore, Dartmouth ’99 and Keith Richey with assistance from Emmanuelle Louis Hofer under the supervision of Professor Kevin Lane Keller as the basis for class discussion. Revisions and updates were later completed by Jonathan Michaels.

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