Uh, oh - will Starbucks recover?

Starbucks (see chart here)announced earnings - well sort of (read article here).  Accounting rules are the only thing determining whether Starbucks had earnings or losses.  Let's say the company broke even - because we don't know for sure given the financial machinations.  Starbucks was on a growth tear for a decade, and became a brand synonymous with upward mobility.  Company value is now down 75% in just 2 years.  Revenues are down, and projected to continue declining into 2010.  Earnings have evaporated and company leaders say the only way to create them in the future is continued draconian cost cutting.  Company management would like to lay blame for these horrid results on the crappy economy.  But is that why Starbucks has taken this fall?

Management has to take responsibility for these results - and it's the leadership in place now.  Starbucks was a model of growth.  While the company was expanding its shops the previous CEO looked into the future and developed a series of new businesses to augment the original business: 

• He started adding food - both cold and hot - to increase sales within the stores
• He pushed Starbucks into food service (United Airlines, among others)
• He pushed Starbucks into grocery stores with prepacked beans
• He pushed Starbucks into liquor stores
• He began promoting CD sales and exploring MP3 distribution
• He produced music - including the #1 CD in 2005 (Ray Charles Greatest Hits)
• He began producing movies (Akeelah and the Bee)
• He opened an agency for artists (signing Paul McCartney of Beetle's fame)

These actions all opened White Space for expanding Starbucks when, inevitably, either stores reached saturation or the growing lust for coffee and tea declined.  But he was replaced by Howard Schulz, considered the founding CEO by most.  Schulz demonstrated true "hedgehog" behavior (to coin a term used by Jim Collins in "Good to Great") by rapidly exiting of most of these businesses.  Mr. Schulz felt Starbucks should concentrate on its "roots" - on coffee.  His approach to improving Starbucks was to "focus" on what used to work.  And to cut costs until profits met his goal.

But now we can see the disastrous results of his strategy.  Stores are closing, and revenues in open stores are going down causing total revenues to decline.  And revenues are falling faster than costs, evaporating profits.  Where Starbucks was once a model employer, he is cutting benefits to employees and shows little (if any) interest in the famous barrista experimentation that led to innovations like "Frappucino" which helped add billions to total revenue.  In just a very few months Starbucks has gone from a company willing to Disrupt its Success Formula and use White Space to grow -- into a company exclusively trying to Defend & Extend a strategy from 15 years ago. 

But in the last 15 years, the marketplace has shifted dramatically.  Quality coffee, including specialties like espresso and latte not formerly common in America, have become commonplace as competitors from Caribou Coffee to Panera Bread, Dunkin Donuts and McDonalds have entered the business.  Prices for good coffee have declined, and customers now have other places they can mingle, network or sit and read besides Starbucks.  And increasingly you can obtain a good coffee right where you eat breakfast, lunch or dinner.  The need to pay a "Starbucks premium" has evaporated - like Starbucks' profits.  The new CEO, by following the Jim Collins approach, has ignored the dramatic market shifts which make Starbucks coffee shops a far less profitable business than they were just 5 years ago.  He's more likely to end up like Circuit City than the growth company Starbucks used to be.

As mentioned before in this blog, research for "Create Marketplace Disruption" disclosed that only 7% of the time do companies that hit a growth stall ever grow again at 2% or higher.  Why such dismal performance?  Because the growth stall shows management has missed important market shifts!  Focusing internally on profit improvement - especially with cost cutting or "back to basics" actions - only allows competitors to keep improving their position while the former leader retrenches.  While the competitors are charging forward, the hedgehog company is burrowing into the dirt, allowing himself to get run over.

Markets never run in reverse.  Once someone develops a winning Success Formula competitors emerge.  They copy the leader down to the detail, and even come up with their own advantages (including lower price.)  Some develop a better solution.  And when market shift happens, the leader finds profits decline.  To maintain revenue and profit growth requires leaders use White Space to explore new businesses that can evolve and enhance the Success Formula.  That was the road Starbucks was on.  Until Mr. Schultz took over the reigns.  And now, his "Collins-esque" approach to business is driving Starbucks right into the ground(s). 

Comments

[swag]

Excellent post.

Starbucks biggest problem is they no longer know what they are anymore. Better, more nimble competitors have run circles around them in the past decade on the Quality game. Starbucks can play like they're the best coffee in town, but the army of low-wage, push-button jockeys they had to hire to keep the doors open on their growing armada of stores proves otherwise.

Schultz still wants to believe it's 1995, though. What that does is delay the company's realization that the Quality game has long been lost and Starbucks is now in it for Quantity: the mass market, up against the competition of fast food chains and the like.

If Schultz can swallow some pride and accept what his company has become, they may make fast food quality coffee a very profitable business to stay in. If not -- if he's in denial about the loss of the Quality wars -- the company will be rudderless and will only continue to fight an old war that has already been lost.

[Nancy Munro]

As someone who used to have Starbucks coffee beans shipped to her house before the stores came to the midwest I agree that their model isn't working. I used to see people lined up out the door in front of a Starbucks when I traveld to the West coast for business. Now they have over-saturated the market. Not only have the lost the appeal of their loyal fans the experience isn't the same and I'm no longer willing to spend over $2 for just a plain cup of coffee. I'm wondering at what point does an organization take the time to slow down expansion -- I guess the pressure from shareholders etc forces good organizaitons to continue growth or see that competitors are beginning to copy their success model. I'm curious as to what recommendations you would have for Starbucks --- where is their white space now?

[Crisis Manager]

I believe Starbucks is the one and only company with a phantastic potential potential for innovation. It is just excellently positioned as premium brand and much could be done. What you listed here is on the other hand exactly the opposite. Its an old fashion diversification approiach which will increase the cost base and create more Enthropy.. There are many more things Starbucks can do, I can immediately list five measures, which are cost effective, making use of the premium brand and do not destroy margin or increase cost !
But I guess the intelligence and smarts of people in charge of strategy and innovation is not yet demanded at the highest levels.
Starbucks largest problem is the Debt ratio. With diminishing sales in a premium product the fix cost becoming an issue, which is not easy to solve, unless you cross sell and innovate into other areas.