Can Starbucks Adapt Before They Become Irrelevant?

Editor’s Note: The following is a guest post by my friend Marc Marmino, defense analyst, coffee lover and resident of the beautiful Pacific Northwest.

Those of us fortunate enough to live near Seattle (if only for the coffee) have the opportunity to visit the original Starbucks in Pike Place Market. If you too live in Seattle, or are visiting sometime in the near future, I strongly recommend forgoing the opportunity to see the “original Starbucks” in the market. Instead, visit the nearby newly “de-branded” store caddy-corner to the market on 1st and Pike. It is a throwback to the original conception of Starbucks, and a concept that has a lot of merit in my eyes as to what the company should strive to return to.

Also, you may be disappointed after waiting in the long line and flustering amongst the impatient crowd at the “original Starbucks” only to learn that it was actually the 4th store built and operated by the company. Actually, you’d never learn that unless I told you, because its location simply lends to a feeling of originality. So Starbucks actually goes along with the white lie that it’s the company’s first storefront. It’s great for business as several thousands of visitors flock through the market daily after disembarking from their cruise ship in the Seattle Harbor.

Speaking of Starbucks, what’s going on with that company nowadays? Last I’d heard: Howard Schultz had returned to the company as CEO after the stock price was greatly diminished, stores were closing all over the globe, and employees were laid off in droves. It seems that regardless of these facts, I still loyally buy almost 3 cups of the best Joe on the planet per week from the store. So where are they now in the face of their recent challenges? I did some research to find out…

As a quick recap of the company’s woes: The company was a part of the massive boom in the coffee industry following the turn of the century when the US retail coffee market recorded a growth of 157% in value terms between 2000 ($3,258 million) and 2005 ($8,372 million). As a leading coffee retailer during this lucrative period for the industry, Starbucks accumulated a large amount capital at a rapid pace. Accordingly, the company began to offer outstanding salaries and benefits to their employees while opening new stores at a feverish-pace. Starbucks was expanding globally and the company’s stock price rose quickly up until FY2007. At that point in time, Starbucks ran into a series of difficult circumstances that ultimately led its financial performance into a downward spiral.

Starbucks Corporation faced several challenges in recent years including:

• intense competition
• low employee productivity
• changing consumer habits from the global economic downturn.

As a result of these challenges, “the company’s profit margin decreased nearly $500 million (an approximate 50% decline) during FY2008 in comparison to FY2007”.

Accompanying this fiscal crunch was the closing of many stores and the termination of thousands of jobs within the organization. Additionally, the anticipated growth of the company came to an abrupt halt in the face of diminished capital. The retained employees received massive cuts to their pensions and a seemingly hollow promise from the revived CEO Howard Schultz that the company would return to its once prominent spot atop the food and beverage industry. While it is apparent that recent results suggest that he is on the right track…some observers remain skeptical.

What has the company done to correct itself?

The coffee giant has taken several steps to address their current problems. First and foremost, it underwent a major restructuring effort that included downsizing the overall size of the company. To improve their balance sheet, Starbucks executives decided to cutout several liabilities in the form closing nearly 700 stores, both existing and under construction. In addition, the company made the difficult decision to lay off several thousand employees in the midst of a recession. The company has also attempted to shed their monopolistic-faux image by undergoing a “de-branding”.

The brand itself began as a local-niche-firm, one that was incredibly inviting and sparked the interest of millions of customers. Inevitably the firm grew quickly and eventually became a global brand that has lost its once niche appeal. According to one coffee advertiser, the relatively rapid success of the company “led to issues of brand depersonalization”. Now, in an attempt to return to its wildly successful roots, the company is de-branding in an effort to regain a community personality and the image of the neighborhood coffee shop.

There is an incredible urgency for this company to return to profitability. Mainly, competitors both small and large threaten to take over the majority of the market share in coffee retail and production. According to Data Monitor, “Starbucks faces intense competition in coffee beverage segment from other specialty coffee shops, restaurants, and doughnut shops”. Namely, McDonalds and Dunkin Donuts have increased their share of overall coffee sales worldwide.

In an effort to not miss out on the market of consumers thirsting for better quality coffee beans, grocery markets have adopted the practice of selling their company’s own higher-quality coffee-beans. In addition, coffee bean companies (i.e. Folgers) that have traditionally used lower-quality beans began offering a higher-quality bean choice to consumers. The urgency in this market shift deals with the risk associated with the recent economic downturn.

Consumers are now making more decisions based upon a cost-benefit analysis vice brand-name recognition. If an organization puts forth a product that is nearly equivalent to a traditionally higher-quality product for a lower price, the consumer is increasingly more inclined to choose the former product. In the case of Starbucks, competitors are doing just this, at a lower price. While the strong brand-name has seemingly protected Starbucks thus far, if they cannot fix their problems soon, many industry experts expect the company to fall further into irrelevancy in the eyes of the global consumer.

Motivation is one of the key elements towards positively changing the progress of the company. No one is more in tune with this concept than the resurrected Starbucks CEO Howard Schultz. Starbucks most recently dropped only 5% in year-on-year sales in the second quarter of 2009 compared to the same period in 2008 (beating analysts’ expectations).

Schultz sees hope in the progress made thus far, but is quick to not discount the work that lies ahead of the company and its employees. This sentiment was readily apparent in Schultz’s rhetoric when he recently stated that “There’s no victory lap going on at Starbucks here…We have a lot of work to do, one quarter [of improving sales] does not make a trend”. This cautious optimism that Schultz maintains is critical towards ensuring that the company does not become overly confident or complacent in its change effort.

If it fails to make the necessary changes, the coffee company will likely lose its majority stake in the marketplace to competitors, and ultimately lose money for its shareholders. A publicly-held company exists solely to make money for its shareholders, and a shrinking company fails to achieve its mission. Such an outcome would draw down levels of capital within the company from outside investors. Lower levels of capital equate to more job losses and store closings. In the worst case scenario, Starbucks would go bankrupt or even become obsolete. These reasons are indicative of why it is so important for Starbucks to make the necessary changes to ensure its viability for years to come.

In these times of financial uncertainty for so many companies, one thing is for certain…God they make great coffee…

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