Executive Insights | September 2011 | By Daniel P. Smith

Over the Hill: 40 Years of SBUX

The company maintains it can regain the unstoppable success it experienced in the past.

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It’s a rainy Monday morning in downtown Park Ridge, Illinois, a Rockwellesque suburb on Chicago’s northwestern edge. The overcast sky feels Seattle-like, a fitting day to observe the ebbs and flows of traffic at Starbucks.

At one stand-alone Starbucks location, once home to a community bank, interior tables fill with soccer moms, retirees, and laptop-wielding students. All morning, the line extends about six people deep.

About 400 meters away in another Starbucks store—this one adjacent to the town’s historic movie house—a similar scene repeats itself: packed tables and a lengthy line of customers paying homage and income to the specialty coffee giant.

The consistent traffic weaves a decisive narrative.

Now celebrating its 40th year, Starbucks has evolved from local whole-bean retailer into a global company rivaling not only the world’s top quick-service restaurants, but the globe’s biggest consumer brands as well.

It’s a reality no one could have predicted four decades before.

Seattle Roots

Founded in April 1971 by Gerald Baldwin, Gordon Bowker, and Zev Siegl, the original Starbucks store in Seattle’s Pike Place Market was a quaint outlet full of character and coffee aroma. The product, namely dark-roasted blends, took center stage. None of the men envisioned a business empire.

Baldwin and Bowker were college roommates at the University of San Francisco, where they became enamored with Peet’s Coffee and Tea, arguably the nation’s patriarch of specialty coffee. Corralling Siegl into the plan, the trio invested about $9,000 to open the original Starbucks.

In Starbucks’ first decade, word of mouth pushed it to expand its operations. Baldwin and Bowker (Siegl would exit in 1980) opened four additional retail spots and the Starbucks name spread.

In his first visit to the store, future Starbucks CEO and chairman Howard Schultz described Starbucks Coffee, Tea, and Spice as “a temple for the worship of coffee.”

The New Yorker, then a kitchen equipment salesman, was smitten.

After courting Baldwin to hire him, Schultz joined Starbucks in 1982 as its marketing chief. During a 1983 trip to Milan, Schultz noted the romance of Italian coffee bars—then rare in the U.S.—and urged Baldwin and Bowker to consider expanding operations to embrace fresh beverages.

“We treated coffee as produce, something to be bagged and sent home with the groceries,” Schultz writes in Pour Your Heart Into It, his 1997 chronicle of Starbucks’ ascent. “We stayed one big step away from the heart and soul of what coffee has meant throughout the centuries.”

Baldwin and Bowker hesitated, concerned that the expansion, particularly for an already profitable private enterprise, would alter the company’s original intent. Schultz continued pressing for a trial of his espresso bar.

In April 1984, Baldwin finally relented when Starbucks opened its sixth Seattle outlet. There, Schultz was given a sliver of the 1,500-square-foot store to sell beverages. The store immediately outperformed the most ambitious expectations.

Starbucks would never be the same.

Still, Schultz, a dreamer type from the Brooklyn projects, imagined bolder possibilities for Starbucks: coffee stores throughout the nation becoming a “third place” for consumers, a common spot they frequent beyond home and work. He had a vision of what Starbucks could be and what it would become.

Yet Baldwin and Bowker, the Starbucks gatekeepers, refused to enter the restaurant business.

In late 1985, Schultz left Starbucks intent to raise $1.7 million to fund his coffee bar idea, a remarkable sum for a novel retail concept. He succeeded. On April 8, 1986, Schultz opened Il Giornale, an Italian-style espresso bar in Seattle.

Sixteen months later, with Baldwin and Bowker seeking change of their own, Schultz captured nearly $4 million from investors and acquired Starbucks, blending the name and the company’s core values with his vision.

By the end of 1987, Starbucks had 11 stores, 100 employees, and a mission to build a national brand.

The Schultz Effect

Throughout the 1990s, Starbucks blossomed into an American giant, growing from a local retail business into a national name with more than 1,300 units.

Much of Schultz’s attention focused on domestic expansion, infrastructure, and management development. He labored to avoid expansion’s pitfalls. Rather than franchising to finance growth, he raised additional capital. He surrounded himself with top talent and became maniacal about real-estate selection.

Starbucks opened 30 new stores in fiscal 1990, the first year the company turned a profit; 32 in 1991; and 53 in 1992. Expansion, profits, and attention intensified.

“Give people good coffee, something they consume every day, and they will support you,” Schultz told The New York Times in 1992.

Amid the growth and increasing attention, Starbucks separated itself from other retailers and quick-service restaurants by offering its employees (partners in Starbucks lingo) a generous benefits package, including health insurance and stock options.

“Treating employees benevolently shouldn’t be viewed as an added cost that cuts into profits, but as a powerful energizer that can grow the enterprise into something far greater,” Schultz writes in Pour Your Heart Into It.

As revenues rose at more than 80 percent a year and unit count exploded, Starbucks went public in 1992. Many wondered whether a trend—a business that had risen so spectacularly as a lifestyle choice—could go public. Starbucks countered by painting itself as a fast-growing enterprise. The initial IPO garnered $29 million to finance growth in new markets and Starbucks began saturating downtown areas in Chicago, San Francisco, San Diego, Los Angeles, Denver, Washington, D.C., Boston, and New York City.

“With national expansion, Schultz was talking in a way unlike anyone else in the specialty coffee business,” says George Howell, who sold his New England–based Coffee Connection chain to Starbucks in 1994. “Sooner or later, you could expect Starbucks in your backyard.”

For Starbucks, the good times rolled, as cafés blanketed Minneapolis, Dallas, Philadelphia, Las Vegas, and many of the nation’s most populous metros. Starbucks coffee then appeared on airlines and in bookstores and supermarkets.

“The consumer couldn’t escape Starbucks,” Howell says.

Then the company began leveraging its brand reputation beyond the walls of its stores, wiggling onto supermarket shelves with Frappuccino, ice cream, and stout beer varieties. Starbucks became a domestic tastemaker, selling CDs and books at its stores. Suddenly, Starbucks wasn’t just a coffeehouse; it was a lifestyle brand, a cultural symbol of affordable luxury.

“Schultz was a master marketer and a master retailer. His knowledge, business moxie, and timing stand at the center of Starbucks’ early success,” says Bruce Milletto, a coffee industry consultant who runs the Portland, Oregon–based Bellissimo Coffee InfoGroup.

In spite of its perceived invincibility, Starbucks could not escape turmoil, including anti-Starbucks backlash.

The siren logo had become recognizable across the nation, a dual sign that Schultz’s dream had reached fruition but, in the process, become big business—often synonymous with heartless, inaccessible, and unresponsive. Fair or not, that was the reality emerging for Starbucks, which tried to cultivate a tone of style and elegance.

“One of Starbucks’ greatest challenges is to try to break the mindset that big can’t be good,” Schultz writes. “If we don’t, we’ll lose the very values that attracted people to us in the first place.”

Yet nothing could slow Starbucks’ surging train.

At the turn of the century, Schultz moved into the chairman’s role, stepping away from the daily grind as CEO to focus on big-picture thinking. Longtime ally Orin Smith took over for a five-year reign before giving way to Jim Donald, an affable man who previously directed Wal-Mart’s grocery operations.

During the opening years of the millennium, store count, profits, and confidence accelerated. Enjoying 20 percent top-line growth year after year, Starbucks continued saturating its existing domestic markets while debuting on six continents. The goal was 20,000 stores.

Starbucks seemed indestructible.

But it wasn’t.

Turmoil & Triumph

By 2007, Starbucks found itself in unfamiliar land: Sales numbers, although still positive, began sliding. Store traffic and stock dropped. For a company knowing only prosperity, the struggles jolted Starbucks’ foundation.

On Valentine’s Day 2007, a disheartened Schultz penned a memo to Starbucks’ leadership team (which was later leaked) sharing his discontent, as well as a challenge to restore the company’s glory.

“Stores … no longer have the soul of the past,” Schultz charged in the memo titled “The Commoditization of the Starbucks Experience.” He continued: “I have said for 20 years that our success is not an entitlement and now it’s proving to be a reality.”

The chairman’s impassioned plea did nothing. Starbucks’ tumble continued.

Then, the recession hit.

To its credit, Starbucks did not blame the economy for its fading fortunes, a mindset that would have further weakened the brand’s performance. Nor did the company make excuses regarding competitors’ gains. Rather, Starbucks looked inward and saw troubling signs—hubris born out of invincibility, stagnant innovation, and operational inefficiencies among the most plaguing problems.

Enthusiasm bred entitlement. Confidence morphed into arrogance. Decisiveness and creativity stalled.

Starbucks’ obsessive quest for profit and growth covered the ills of declining store traffic and market cannibalization.

“When many of us at Starbucks became swept up in the company’s success … [we] ignored, or maybe we just failed to notice, shortcomings,” Schultz writes in Onward, his 2011 book detailing Starbucks’ turbulence.

At the start of 2008, just after Starbucks reported its worst three-month performance as a public company, Schultz returned as CEO—this time to resurrect, not to build.

Promising to neither cast blame nor dwell on the past, Schultz instituted his Transformation Agenda, a seven-pronged approach to repair the business, reignite the emotional attachment with customers, and create a more sustainable corporation.

Characteristic of the dismal times was Schultz’s February 2008 decision to close all of the company’s 7,100 domestic stores to retrain staff. It was an admission, Schultz would later acknowledge, that Starbucks was no longer good enough.

Over the next two years, Starbucks went on the offensive to resuscitate the brand.

It began slowing U.S. store openings and shuttered hundreds of existing units. Starbucks introduced new products, such as the Pike’s Place Roast and Vivanno Smoothies; reshuffled its executive team and eliminated positions throughout the ranks; upgraded systems and processes, including POS and labor scheduling; unveiled national advertising; introduced its first-ever loyalty program; and focused on an emerging health and wellness platform.

And still the numbers plunged.

Throughout 2009 and into 2010, the company redoubled its efforts: redesigning the company’s cost structure; embracing more strategic international expansion; revamping the supply chain and overhauling IT systems; closing additional stores; and further trimming the workforce. It leveraged digital and social media to control the Starbucks story and looked to other revenue streams, including licensed stores and packaged goods, such as VIA instant coffee, to boost the bottom line.

In the third fiscal quarter of 2009, Starbucks finally saw some positive news: The company had earned $152 million, its first earnings growth since early 2008.

“One quarter does not make a trend, but … results give us tangible evidence that our transformation initiatives are beginning to be reflected in our financial and operating performance,” Schultz said on the third-quarter earnings call.

Momentum regained, Starbucks’ ascent continued into 2010 and 2011, the company’s 40th year. In its second quarter of fiscal 2011, the most recent release, the total net revenues increased 10 percent to $2.8 billion. The global store count, both company-owned and licensed, now approaches 17,000.

“It is possible to rise, fall, and rise again,” Schultz says.

With the lessons of the past fresh in their memories, company leaders are committed to growth through innovation. The company looks to create a portfolio of $1 billion brands; develop its Seattle’s Best Coffee arm; maximize its consumer packaged goods (CPG) business; craft new products, such as the Starbucks Reserve line of premium coffees; and construct strategic relationships that deliver a sustainable future.

In July, the company announced that it would realign its top management with an eye on international growth. The shift created three global regions—Asia, the Americas, and Europe/Middle East/Africa—as opposed to its longstanding U.S. and international divisions.

Schultz said the change would help Starbucks, which has about 6,000 stores outside North America, capitalize on opportunities in emerging nations, such as China, India, and Brazil. Such a move honors the company’s movement into international quarters and CPG since the recession.

“We will continue to innovate and deliver the highest quality coffee and the Starbucks Experience to our customers in all aspects of our business,” Starbucks vice president of CPG marketing Michele Waits says.

As the rain slows and the sun peeks through the clouds above Chicago, the constant lines at the two neighbor Starbucks locations in Park Ridge stand testament to the brand’s appeal and resonance with customers 40 years into its existence.

“Grande caffe mocha,” a customer says.

“Grande caffe mocha,” the barista repeats to his colleague preparing orders.

And so it goes, over and over throughout the day.