Starbucks Corporation: Competing in a Global Market

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Revised April 7, 2003




                             Starbucks Corporation:
                           Competing in a Global Market

Starbucks Corporation is a Seattle, Washington-based coffee company. It buys, roasts, and sells whole bean
specialty coffees and coffee drinks through an international chain of retail outlets. From its beginnings as a seller of
packaged, premium specialty coffees, Starbucks has evolved into a firm known for its coffeehouses, where people
can purchase beverages and food items as well as packaged whole bean and ground coffee. Starbucks is credited
with changing the way Americans--and people around the world--view and consume coffee, and its success has
attracted global attention.

Starbucks has consistently been one of the fastest growing companies in the United States. Over a 10-year period
starting in 1992, the company's net revenues increased at a compounded annual growth rate of 20%, to $3.3 billion in
fiscal 2002. Net earnings have grown at an annual compounded growth rate of 30% to $218 million in fiscal 2002,
which is the highest reported net earnings figure in the company's history (See Exhibit 1 ). As Business Week tells it:

       On Wall Street, Starbucks is the last great growth story. Its stock, including four splits, has soared more than
       2,200% over the past decade, surpassing Wal-Mart, General Electric, PepsiCo, Coca-Cola, Microsoft, and IBM in
       total return. Now at $21 [September 2002], it is hovering near its all-time high of $23 in July [2002], before the
       overall market drop.1

To continue this rapid pace of growth, the firm's senior executives are looking to expand internationally. Specifically,
they are interested in further expansion in Europe (including the Middle East), Asia Pacific (including Australia and
New Zealand) and Latin America. Expanding in these three continents represents both a challenge and an
opportunity to Starbucks. While the opportunity of increased revenues from further expansion is readily apparent to
the company's top management, what is not clear is how to deal with growing "anti-globalization" sentiment around
the world.
         This case looks at issues that are arising as Starbucks seeks to dominate specialty coffee markets around
the world and explores what changes in strategy might be required.



This case was written by Professors Suresh Kotha and Debra Glassman, both from the University of Washington, Business School, as
the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Some of
the facts provided in the case have been disguised to protect confidentiality. Copyright  Kotha & Glassman 2003. All rights
reserved.

1
    Planet Starbucks, Business Week , September 9, 2002, p. 100-110.


1
                                                    BACKGROUND

In 1971, three Seattle entrepreneurs--Jerry Baldwin, Zev Siegl, and Gordon Bowker--started selling whole-bean
coffee in Seattle's Pike Place Market. They named their store Starbucks, after the first mate in Moby Dick .2 By 1982,
the business had grown to five stores, a small roasting facility, and a wholesale business selling coffee to local
restaurants. At the same time, Howard Schultz had been working as VP of U.S. operations for Hammarplast, a
Swedish house wares company in New York, marketing coffee makers to a number of retailers, including Starbucks.
Through selling to Starbucks, Schultz was introduced to the three founders, who then recruited him to bring
marketing savvy to their company. Schultz, 29 and recently married, was eager to leave New York. He joined
Starbucks as manager of retail sales and marketing.

A year later, Schultz visited Italy for the first time on a buying trip. He noticed that coffee is an integral part of the
culture in Italy; Italians start their day at an espresso bar and later in the day return with their friends. There are
200,000 coffee bars in Italy, and about 1500 in Milan alone. Schultz believed that, given the chance, Americans would
pay good money for a premium cup of coffee and a stylish place to enjoy it. Enthusiastic about his idea, Schultz
returned to tell Starbucks' owners of his plan for a national chain of cafes styled on the Italian coffee bar. The
owners, however, did not want to be in the restaurant business. Undaunted, Schultz wrote a business plan and
began looking for investors. By April 1985 he had opened his first coffee bar, Il Giornale (named after the Italian
newspaper), where he served Starbucks coffee. Following Il Giornale's immediate success, he expanded to three
stores. In 1987, the owners of Starbucks agreed to sell the firm to Schultz for $4 million. The Il Giornale coffee bars
took on the name of Starbucks.

Convinced that Starbucks would one day be in every neighborhood in America, Schultz focused on growth. At first,
the company's losses almost doubled (to $1.2 million in fiscal 1990), as overhead and operating expenses ballooned
with the expansion. Starbucks lost money for three years running, and the stress was hard on Schultz, but he stuck to
his conviction not to "sacrifice long-term integrity and values for short-term profit."3 In 1991 sales shot up 84 percent,
and the company turned profitable. In 1992 Schultz took the firm public at $17 a share.

Believing that market share and name recognition are critical to the company's success, Schultz continued to expand
the business aggressively. Schultz observes, "There is no secret sauce here. Anyone can do it." From the beginning,
Schultz has professed a strict growth policy. Although many other coffeehouses or espresso bars are franchised,
Starbucks owns all of its North American stores outright, with the exception of license agreements in airports.
Further, rather than trying to capture all the potential markets as soon as possible, Starbucks goes into a geographic
market and tries to completely dominate it before setting its sights on further expansion. Using this strategy,
Starbucks has grown from 17 coffee shops in 1987 to 5,688 outlets in 28 countries by the end of fiscal 2002 (see
Exhibit 2 ). It also employed over 60,000 individuals, including approximately 50,000 in retail stores at the end of 2002.

Starbucks Corporation is organized into two business units that correspond to the company's operating segments:
North American and International. In 1995, Starbucks Coffee International, a wholly owned subsidiary of Starbucks
Coffee Company, was set up to build Starbucks' businesses outside North America, including opening company-
owned, licensed, and joint-venture-based retail stores worldwide.

A recent article in Business Week notes :

    "Starbucks also has a well-seasoned management team. Schultz, 49, stepped down as chief executive in 2000 to
    become chairman and chief global strategist. Orin Smith, 60, the company's numbers-cruncher, is now CEO and in
    charge of day-to-day operations. The head of North American operations is Howard Behar, 57, a retailing expert



2
  According to Business Week (September 9, 2002, p.103), "The name came about when the original owners looked to Seattle
history for inspiration and chose the moniker of an old mining camp: Starbo. Further refinement led to Starbucks, after the first
mate in Moby Dick , which they felt evoked the seafaring romance of the early coffee traders (hence the mermaid logo)."
3
  Success, April, 1993.


2
    who returned last September, two years after retiring. The management trio is known as H20, for Howard,
    Howard, and Orin."4

Exhibit 3 provides a partial list of Starbucks top management, and Appendix A provides a timeline and history of
Starbucks.

                                            THE STARBUCKS MODEL

Howard Schultz's goal is to: "Establish Starbucks as the premier purveyor of the finest coffee in the world while
maintaining uncompromising principles as we grow." The company's 25-year goal is to "become an enduring, great
company with the most recognized and respected brand in the world, known for inspiring and nurturing the human
spirit." The company's mission statement articulates several guiding principles to measure the appropriateness of the
firm's decisions (see Exhibit 4 ). In describing Starbucks' unique approach to competition, Fortune notes:
    The strategy is simple: Blanket an area completely, even if the stores cannibalize one another's business. A new
    store will often capture about 30% of the sales of a nearby Starbucks, but the company considers that a good
    thing: The Starbucks-everywhere approach cuts down on delivery and management costs, shortens customer
    lines at individual stores, and increases foot traffic for all the stores in an area. Last week 20 million people
    bought a cup of coffee at a Starbucks. A typical customer stops by 18 times a month; no American retailer has a
    higher frequency of customer visits. Sales have climbed an average of 20% a year since the company went
    public. Even in a down economy, when other retailers have taken a beating, Starbucks store traffic has risen
    between 6% and 8% a year. Perhaps even more notable is the fact that Starbucks has managed to generate those
    kinds of numbers with virtually no marketing, spending just 1% of its annual revenues on advertising. (Retailers
    usually spend 10% or so of revenues on ads.)5
Business Week adds:

    Clustering stores increases total revenue and market share, [CEO] Orin Smith argues, even when individual
    stores poach on each other's sales. The strategy works, he says, because of Starbucks size. It is large enough to
    absorb losses at existing stores as new ones open up, and soon overall sales grow beyond what they would
    have with just one store. Meanwhile, it's cheaper to deliver to and manage stores located close together. And by
    clustering, Starbucks can quickly dominate a local market.6

And Schultz points out:
    The market is much larger than we originally thought. ... In most cases local competitors benefit from our arrival
    because of the expansion of the marketplace. Our strategy is never to eliminate or hurt the competition. We never
    under-price our coffee and it's clear that we position ourselves so as not to undercut the pricing structure in the
    marketplace.

Schultz observes that the company is still in its early days of growth worldwide. "We are opening three or four stores
every day," he notes. "We feel strongly that the driver of the equity of the brand is directly linked to the retail
experience we create in our stores. Our commitment to the growth of the company is significant and will continue to
be based on the long-term growth potential of our retail format."


Securing the Finest Raw Materials

Starbucks' coffee quality begins with the purchase of high-quality arabica coffee beans. Although many Americans
were raised on a commodity-like coffee made from lower quality robusta beans (or arabica beans mixed with less-
expensive filler beans), Starbucks coffee is strictly arabica, and the company ensures that only the highest quality


4
  Planet Starbucks, Business Week , September 9, 2002, p. 100-110.
5
  Mr. Coffee. Fortune, March 30, 2003.
6
  Planet Starbucks. Business Week , September 9, 2002, p.103.


3
beans are used. Dave Olsen, the company's then senior vice president and then chief coffee procurer, scoured
mountain trails in Indonesia, Kenya, Guatemala and elsewhere in search of Starbucks' premium bean. His standards
were demanding, and he conducted exacting experiments in order to get the proper balance of flavor, body and
acidity.

From the company's inception, it has worked on developing relationships with the countries from which it buys
coffee beans. Traditionally, Europeans and Japanese bought most of the premium coffee beans. Olsen sometimes had
to convince coffee growers to sell to Starbucks--especially since American coffee buyers are notorious purchasers of
the "dregs" of the coffee beans. In 1992 Starbucks set a new precedent by outbidding European buyers for the
exclusive Narino Supremo Bean crop.7 Starbucks collaborated with a mill in the tiny town of Pasto, located on the side
of the Volcano Galero. There they set up a special operation to single out the particular Narino Supremo bean, and
Starbucks guaranteed to purchase the entire yield. This enabled Starbucks to be the exclusive purveyor of Narino
Supremo, purportedly one of the best coffees in the world.8

Vertical Integration

Roasting the coffee bean is close to an art form at Starbucks. Starbucks currently operates multiple roasting and
distribution facilities. Roasters are promoted from within the company and trained for over a year, and it is considered
quite an honor to be chosen. The coffee is roasted in a powerful gas-fired drum roaster for 12 to 15 minutes while
roasters use sight, smell, hearing and computers to judge when beans are perfectly done. The color of the beans is
even tested in an Agtron blood-cell analyzer, with the whole batch being discarded if the sample is not deemed
perfect.

The Starbucks Experience

According to Schultz, "We're not just selling a cup of coffee, we are providing an experience." In order to create
American coffee enthusiasts with the dedication of their Italian counterparts, Starbucks provides a seductive
atmosphere in which to imbibe. Its stores are distinctive and sleek, yet comfortable. Though the sizes of the stores
and their formats vary, most are modeled after the Italian coffee bars where regulars sit and drink espresso with their
friends.

Starbucks stores tend to be located in high-traffic locations such as malls, busy street corners, and even grocery
stores. They are well lighted and feature plenty of light cherry wood and artwork. The people who prepare the coffee
are referred to as "baristas," Italian for bartender. Jazz or opera music plays softly in the background. The stores
range from 200 to 4,000 square feet, with new units tending to range from 1,500 to 1,700 square feet. In 2003, the
average cost of opening a new store (including equipment, inventory and leasehold improvements) is in the
neighborhood $350,000; a "flagship" store costs much more.

Building a Unique Culture

While Starbucks enforces almost fanatical standards about coffee quality and service, the policy at Starbucks
towards employees is laid-back and supportive. They are encouraged to think of themselves as partners in the
business. Schultz believes that happy employees are the key to competitiveness and growth.




7
  This Colombian coffee bean crop is very small and grows only in the high regions of the Cordillera mountain range. For years,
the Narino beans were guarded zealously by Western Europeans, who prized their colorful and complex flavor. It was usually
used for upgrading blends. Starbucks was determined to make them available for the first time as a pure varietal. This required
breaking Western Europe's monopoly over the beans by convincing the Colombian growers that it intended to use "the best beans
for a higher purpose."
8
  The Canada Newswire, March 1, 1993.


4
     We can't achieve our strategic objectives without a work force of people who are immersed in the same
     commitment as management. Our only sustainable advantage is the quality of our work force. We're building a
     national retail company by creating pride in--and stake in--the outcome of our labor.9

On a practical level, Starbucks promotes an empowered employee culture through generous benefits programs, an
employee stock ownership plan, and thorough employee training, Each employee must have at least 24 hours of
training. Classes cover everything from coffee history to a seven-hour workshop called "Brewing the Perfect Cup at
Home." This workshop is one of five classes that all employees must complete during their first six weeks with the
comp any. Reports Fortune:

     It's silly, soft-headed stuff, though basically, of course, it's true. Maybe some of it sinks in. Starbucks is a
     smashing success, thanks in large part to the people who come out these therapy-like training programs. Annual
     barista turnover at the company is 60% compared with 140% for hourly workers in the fast-food business. 10

Starbucks offers its benefits package to both part-time and full-time employees. The package includes medical, dental,
vision and short-term disability insurance, as well as paid vacation, paid holidays, mental health/chemical
dependency benefits, an employee assistance program, a 401k savings plan and a stock option plan. They also offer
dependent coverage that includes same-sex partners.11 Schultz believes that without these benefits, people do not
feel financially or spiritually tied to their jobs. He argues that stock options and the complete benefits package
increase employee loyalty and encourage attentive service to the customer.12

Employee turnover is also discouraged by Starbucks' stock option plan known as the Bean Stock Plan. Implemented
in August of 1991, the plan made Starbucks the only private company to offer stock options unilaterally to all
employees.

Starbucks' concern for employee welfare extends beyond its retail outlets to coffee producers. The company's
guidelines call for overseas suppliers to pay wages and benefits that "address the basic needs of workers and their
families" and to allow child labor only when it does not interrupt required education.13 This move has set a precedent
for other importers of agricultural commodities.

Leveraging the Brand

Multiple Channels of Distribution. Besides its stand-alone stores, Starbucks has set up cafes and carts in hospitals,
banks, office buildings, supermarkets and shopping centers. Other distribution agreements have included office
coffee suppliers, hotels, and airlines. Office coffee is a large segment of the coffee market. Associated Services (an
office coffee supplier) provides Starbucks coffee exclusively to thousands of businesses round the United States.
Starbucks has deals with airlines, such as an agreement with United Airlines to provide Starbucks coffee to United's
nearly 75 million passengers a year. Starbucks, through a licensing agreement with Kraft Foods Inc., offers its coffee
in grocery stores across the United States.

Brand Extensions. In 1995, Starbucks launched a line of packaged and prepared teas in response to growing demand
for tea-houses and packaged tea. Tea is a highly profitable beverage for restaurants to sell, costing only 2 cents to 4



9
  Inc., January, 1993.
10
   Fortune, December 9, 1996.
11
   The decision to offer benefits even to part-time employees (who represent roughly two-thirds of Starbucks 10,000 employees)
has gained a great deal of attention in the press. According to a Hewitt Associates L.L.C. survey of more than 500 employers,
only 25% of employers offer medical coverage to employees working less than 20 hours a week. It was difficult to get insurers to
sign Starbucks up since they did not understand why Starbucks would want to cover part-timers.
12
   Inc., January, 1993.
13
   The Wall Street Journal, October 23, 1995.


5
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