Starbucks bitter choice

This past Monday, Howard Schultz, chief executive officer of Starbucks outlets are run not by employees, but equals.

“Dear partners,” Mr. Schultz began. “As I sit down to write this note (6:30 a.m. Sunday morning) I am enjoying a spectacular cup of Sumatra, brewed my favourite way – in a French press.”

The communiqué was meant to convey the hallmarks of the Starbucks ethos. Intimacy. Authenticity. A sense of belonging. Starbucks, after all, had famously created the “Third Place” in the psyche of the consumer. One has one's home, and one's place of work. Starbucks was designed to be a home away from home, the Third Place, redolent with the aroma of a latte, the hiss and steam of a freshly tapped espresso, a big comfy chair for a chilly afternoon's embrace.

Except that the romance is fading in the Starbucks customer relationship. First-quarter numbers for fiscal 2008 told a dire tale: a 1-per-cent decline in U.S. comparable store sales and a 3-per-cent decrease in U.S. transactions, causing the dreaded words “negative traffic” to fall from the lips of research analysts. There is the increasing noise in what Mr. Schultz calls the “coffee space,” including the announcement from that it is entering the barista business with coffee bars. And there is the relentless layering of grim economic news south of the border, causing, simply, the U.S. consumer to spend less.

Larry Miller, research analyst at Royal Bank of Canada's investment arm in Atlanta, parses the simultaneous convergence of negative events. The competition has aggressively raised its game in the fast-growing coffee category; Starbucks has cannibalized its own business through rampant expansion; and the U.S. consumer has fallen victim to recession, which Mr. Miller dates to last September. Predictably, the customers in households with incomes under $25,000 (U.S.) annually were the first to fall.

“That accelerated to moderate-income households to, in December and January, high-income households with incomes of more than $100,000,” Mr. Miller says.

THE CULTURE THING

But it is the broader story that holds greater significance. “I'm coming to believe that this sort of moment where Starbucks is a great cultural reference doesn't exist any more,” says Bryant Simon, a visiting professor of history at the National University of Singapore.

Prof. Simon is at work on a book on Starbucks' growth is really about culture, so its fall has to be about culture,” he says.

Then he catches himself. “Not its fall,” he corrects. But rather a permanent change in the company's DNA to something more prosaic.

“It's coffee. It's functional. People have a great need for caffeine.”

Needless to say, this is not the view of Howard Schultz. Eight years ago, Mr. Schultz departed the company he built. Last month he came roaring back as CEO to “reignite the emotional attachment” between the consumer – that would be you – and the coffee. Fittingly, he has imbued his stated mission with something approaching religiosity. “Trust the coffee and trust one another,” he wrote this week. “I will lead us back to the place where we belong.”

But where is that place precisely?

RESHAPING THE MARKET

Mr. Shultz has so far announced the first stages of a reshaping of the American market: Approximately 100 underperforming stores will be closed; scheduled new-store openings, at a still-whopping 1,175, is nevertheless a seismic drop of 34 per cent from 2007. Other decisions are powerfully telling of what has gone wrong: By the end of the current fiscal year, Starbucks will have phased out warmed breakfast sandwiches because, Mr. Schultz wrote last month, “the scent of the warmed sandwiches interferes with the coffee aroma in our stores.” The market testing of an 8-ounce “short cup” of coffee for a buck has the sniff of desperation.

Douglas Holt, who holds the L'Oréal chair of marketing at the Said Business School at the University of Oxford, says the chain has forsaken its brand promise. “The brand promise has changed from being this artisanal coffee offering to this very standardized commodity,” says Prof. Holt, whose book, How Brands Become Icons: The Principles of Cultural Branding, was published in 2004.

In the beginning, continues Prof. Holt, Starbucks wooed customers into its world “where you should treat coffee as one would wine. The consumer as connoisseur was very much a part of the promise, and now they've basically subverted that.”

Starbucks deservedly can claim bragging rights for upgrading the coffee experience. In his biography, Pour Your Heart Into It, Mr. Schultz recounted a childhood not dissimilar to others of his generation when he harkened back to his own mother's consumption of instant coffee. “When company came over, she'd buy some canned coffee and take out her old percolator. I remember listening to it grumble and watching that little glass cap until finally the coffee popped up into it like a jumping bean.”

Under Mr. Schultz's guidance, Starbucks offered North Americans an opportunity to cast off the 1950s and instead embrace the grande latte (and to understand, as a Starbucks employee admonished me the other day, that “We don't say ‘dark' here, we say ‘bold.' ”) The coffee company in turn reaped the financial rewards of an upper middle class seeking, as Prof. Holt says, to “cosmopolitanize” and “aestheticize” their lifestyles.

The early adopters were what writer David Brooks dubbed the bourgeois bohemians, or bobos, a term Mr. Brooks himself called “admittedly ugly,” but which captured the vision of artsy, upscale types with “renovated kitchens that are the size of aircraft hangars.”

In truth, Starbucks was a luxury brand that benefited greatly from the trickling down of aspirational desires to the non-elites. You may not be a rich man, but in a pinch you can buy a rich man's coffee.

‘CLASS BANG'

There's nothing new in understanding that people buy goods as much for what they mean, or represent, as for what they do. Michael Solomon, professor of marketing at the Haub School of Business at Saint Joseph's University in Philadelphia, has written, literally, the book on consumer behaviour. “The strategic goal of many firms is not to build market share – it's to build share of mind,” Prof. Solomon says. “ Starbucks is a great example of this deep meaning stuff.”

The “deep meaning stuff” defies rational economic models. “There's nothing rational about paying $4 for a cup of coffee,” Prof. Solomon continues. “You're not buying coffee at Starbucks, you're buying experience at Starbucks … The experience of feeling you're partaking in this community that has elevated coffee far beyond a drink. The coffee was emblematic of a lifestyle.”

Initially, going to Starbucks meant you were separating yourself from the mainstream. Starbucks delivered what Prof. Simon calls a “class bang.” Toting a Starbucks affirmed class. It was, he says, a “performance of self.”

As the chain solidified its position among the upper middle brows, the middle-middle joined in. And so on. “ Starbucks called itself ‘affordable luxury,' ” Prof. Simon says. “But I think what it was, was affordable class making.”

UBIQUITY AS STRATEGY

But there was a catch. “A class payoff does imply some scarcity,” continues Prof. Simon. That notion became obviously contradictory as the Starbucks chain grew like Topsy. (The globe was dotted with 15,756 Starbucks outlets and licensed retail spaces as of the end of last year.) What was once a differentiated product became ubiquitous. As Prof. Solomon says: “The more popular you get, the more trouble you get into.”

Prof. Simon argues that such ubiquity was not inevitable. “That was the strategy adopted,” he says of the company's supercharged growth model. Starbucks fell to the temptations of rampant growth as a jilted lover falls for a heart-mending mocha Frappuccino with whipped cream.

The aftershocks of that strategy were not immediately apparent. Writing in The New Yorker in January, 2003, James Surowiecki wrote that Starbucks had “turned itself into a seemingly recession-proof enterprise,” as it had neatly weathered an economic downturn.

Prof. Holt at Oxford wonders whether something more profound isn't happening in the current environment. “It's almost like the way Sears got pincered,” he says, recalling that moment when the consumer eschewed the department store model and went either high end ( Saks Fifth Avenue) or low end ( Wal-Mart). He senses what he deems not just an economic dissonance, but a psychic dissonance, which he translates as a “populist movement where people are pissed at Wall Street.”

If this is true, then Starbucks faces a new paradigm. “It's a moment of either it's a $1 cup of coffee … or you've really got to do the aesthetic thing better than anybody else,” Prof. Holt says.

CONTRADICTIONS

There is an irony here. Starbucks was the first chain to display an array of unroasted coffee beans and to have the consumer imagine a straight-line connection with coffee growers in Sumatra. But for the consumer, that was only the beginning. “The desire for the artisanal has become inflated,” Prof. Holt says. Today's connoisseur, who will not blink at paying $150 for a small bottle of balsamic vinegar, may turn up his nose at a Starbucks espresso and seek something more, well, authentic.

As the marketplace became more discerning, Starbucks became more mass. Sugary beverages, breakfast sandwiches and gift merchandise all contributed to the watering down of the intimacy of what Mr. Schultz always pledged would be an uplifting, enriching experience. “They started to treat the Starbucks experience as more of an arm's-length exchange,” Prof. Holt says. “Let's see what we can get you to buy.”

There was the “upselling.” And there was the vast expansion and increased automatization of the chain, which increasingly made Starbucks feel like just another fast-food joint. The move to automated espresso machines is a case in point.

“In the old days you walked into a Starbucks and the first thing that hit you was the smell of the coffee,” Prof. Solomon says.

“In the process [of automation] you kill off the very thing that made you distinctive in the first place.”

Even in its early distinctiveness, there were visible contradictions. The competing notions of individuality (I want to be treated as someone special) and predictability (I want consistency and I want speed) would be one. Or, says Prof. Simon: “We want everything green, but we drink everything to-go.”

Starbucks' greenness, or devotion to social responsibility, becomes less evident with every move to sell its coffee in corporate cafeterias, on airplanes, and in takeout boxes. Its website is more visibly about low-cal skinny lattes than humanitarian efforts in Ethiopia, leaving consumers to wonder what is truly distinctive about the brand.

‘THE COFFEE AUTHORITY'

Prof. Holt references smaller, hipper independent chains as the go-to coffee shops. (He particularly favours Café Intelligentsia in Chicago.) The degree to which such outlets can bleed away Starbucks' clientele can be studied in microcosm. RBC's Mr. Miller points out the rather astonishing fact that dropping attendance by a mere six to eight customers per store per day in the U.S. Starbucks chain translates into a full percentage drop in sales.

In a conference call with analysts 10 days ago, Mr. Schultz, who declined an interview request for this story, says the chain needs nothing less than a transformation. But he also insisted that the competition in the “coffee space” isn't the problem. “Let me emphasize we don't see that as the issue,” he said.

Rather, the challenge as Mr. Schultz defines it is to recreate that sense of differentiation in the marketplace. His message to the investment community: “We intend to reaffirm our position as the coffee authority.”

The word “authority” implies that Mr. Schultz seeks to recapture the heart of the most discerning coffee drinkers. Prof. Holt believes the company can't turn back the clock and reclaim the high end of the market. “The bobo end of the market, that's just not going to happen,” he says. “I don't think that's the game. The game is really the mass-market offering. What can they do to refresh the brand for the mass market?”

It can be done. RBC's Mr. Miller cites the Olive Garden as an example. “The Olive Garden was in worse straits than Starbucks is today,” Mr. Miller. The company injected a renewed authenticity to their food – “a Tuscan angle,” Mr. Miller says – appended to a higher-quality marketing message. “It's been one of the best turnarounds in the restaurant space, brand-wise,” he says.

REINVENTION?

Prof. Solomon describes the Starbucks dilemma as an “inflection point.”

“You have to make a decision, either become a fast-food vendor or scale back,” he says. But scale back to what? A year ago, Starbucks was a $33 (U.S.) stock; yesterday it closed at $18.26. Can the company make Wall Street happy by retrenchment?

A couple of years ago, Prof. Solomon had an opportunity to check out the McCafé's at headquarters. “They were the same layout as Starbucks; pastries in the display case. But everything is a dollar [or more] cheaper.” Specialty coffees are now “in test,” as they say, in roughly 800 outlets in the U.S. There are no plans as yet to introduce the concept to the Canadian market.

Prof. Simon suggests that spinning off a higher-end brand might lend Starbucks an opportunity to reinvent itself. That, perhaps, is the company's longest shot. Mr. Schultz has said that the company will not tip its hand about any of its strategies prior to its annual meeting in mid-March.

The Fulbright grant that took Prof. Simon to Singapore has landed him in a city-state with 45 Starbucks outlets. “This is a good town,” he says, meaning a good town for Starbucks' march toward global domination continues.

“Do I think it's going to go out of business?” Prof. Simon asks. “No. But it's no longer going to be a cultural bellwether.”

If he's right, the trouble in which Starbucks finds itself in is one that not even Howard Schultz, for all his missionary zeal, can fix.

STARBUCKS

CULTURE CLUB

It has been 20 years since Seattle-based Starbucks launched its international expansion by alighting, as it happens, in Vancouver. In the two decades since, the coffee empire has left an unavoidable imprint on the cultural landscape.

The siren call of coffee

She's everywhere. The twin-tailed Starbucks mermaid, that is. In her youth, she was bare-breasted and Rubenesque, an appropriately luscious icon for coffee desire. Today, she appears to be less voluptuous, though it's hard to tell as she is much more modest. Even her navel has disappeared.

Geography is flavour

Perhaps a cup of Colombian Narino El Tambo? Starbucks' great gift to the coffee consumer lay in training the taste buds to appreciate the appeal of the coffees of Guatemala, as distinct from the coffees of Kenya, as distinct from the “low notes” characteristic of the beans of Indonesia. Komodo Dragon Blend, anyone?

Do you hear music?

Possibly Starbucks music. Tie-ins via what was once a simple coffee house may have reached its zenith last year when erstwhile Beatle Paul McCartney was signed as the first musician slated to release an album on the coffee chain's Hear Music label. Said Mr. McCartney: “It's a new world now.”

What language is that which you speak?

No snapshot of the Starbucks influence would be complete without a reminder that before there was Starbucks, there was no Frappuccino. The company trademarked the term, which has become as common in today's parlance as café au lait. A Venti Frappuccino? That's a trademark times two.

Jennifer Wells

Starbucks fact

There are more than 15,000 Starbucks outlets<240> in 42 countries. More than 800 are in Canada

Starbucks fact

Founded in 1971, in Seattle's Pike Place Market and originally called Starbucks Coffee, Tea and Spices

Starbucks fact

Introduced a reloadable payment card in 2001, which surpassed $2.5-billion (U.S.) in activations last year

Starbucks fact

Completed an IPO, closing at $21.50 on its first day of trading. Its store total for the year: 165

Starbucks fact

Opened its first Canadian store in 1987, <240>in Vancouver. By the end of the year, the company had a total of 17 stores.

Trouble brewing

Stores open at fiscal end

‘02 5,886
‘03 7,225
‘04 8,569
‘05 10,241
‘06 12,440
‘07 15,011
   

Comparable store sales

(Company-operated stores open 13 months or longer)

‘02 6%
‘03 8%
‘04 10%
‘05 8%