Reference no: EM134813

Question1

After 20 years of phenomenal expansion, the last six months of 2007 saw Starbucks jolted by a decline in share price of 50 per cent and a decrease in customer visits to its outlets in North America. Its share price was hovering around $19 to $20.

Question2

By mid-2008, it had declined to $18. Its fiscal first-quarter profit in 2007 rose by less than two per cent and in January 2008 it announced the closing of 100 U.S. stores. On July 1, 2008, this number was increased to 600.

Question3

While there was no causal relationship between these events, the late-2007 U.S. price increase of $0.09 cents a cup, coming on the tail of several similar price increases over the last four years, was not well-received and might have further harmed the company's image as a brand leader. Coupled with the 2008 change of chief executive officer (CEO) - a reversion to the chain founder, Howard Schultz - these setbacks raised some pertinent questions about the company's future, any prediction of which needed to take into account broader trends in coffee culture and consumption worldwide.

Had the company that introduced many people to the taste and strength of coffee made Italian-style by that very process sharpened the discrimination of its converts and led them to look for varied or even superior products? Had the company reached a crisis in branding, where its ubiquity and over-exposure challenged its down-home appeal? Was the problem one that was likely to affect only the North American market (which constituted just over 70 per cent of the company's outlets)? Did customers perceive that they were still getting value for money? At that time, there were reports of reductions in discretionary spending, consequent on the distressed financial climate following the sub-prime loan crisis. Was the coffee drink market by then mature at the level at which Starbucks operated? Was the coffee competition from McDonald's and others cheaper and lower down the food-provider chain starting to nip at Starbucks' heels?

Question4

Should the company have continued to expand or was it time to reassess its goals and strategies?
The company had been regarded as the complete retailer in its sector. Though the sale of coffee drinks in many varieties headed its activities, most stores sold a variety of roasted beans, paraphernalia for the preparation of coffee, snacks, gifts and the opportunity to just sit and relax for as long as one liked in a smoke-free environment. Sale of the latter commodity (relaxation) might indeed have contributed as much to Starbucks' popularity as the taste of its drinks, especially when the facility was sited within a large bookstore. To some extent it was like a club and it indeed sold itself as "the third place," a location third only to home and the workplace. The company referred to this by calling it "the Starbucks experience."

Starbucks' other strength was in its predictability. Its customers could go to any large city and predict where a store might be found. This was typically in the inner-city center around the commercial, high-end retail or tourist areas, places where there were people with the time or the need for relaxation. Wherever you found the store, you knew what it would provide. This was not the McDonald's sameness, however.

Most stores had a distinctive décor and some arrangements that often reflected something of the local environment. The company also succeeded in presenting itself as an ethical and environmentally concerned organization through its avowed commitment to fair trade coffee and use of a clever logo based on green and paper-bag brown colors. Yet its clean image had been questioned by critical websites, often with contributions from former and current employees.

Question5

It had also faced lawsuits. In early 2008, the state of California awarded complainant ex-baristas of Starbucks $105 million to compensate them for tips which they were allegedly forced to share with shift supervisors.

Question6

In January 2008, the company had more than 15,700 outlets in 37 countries and was aiming at having 40,000 in the future. Should it have pursued this expansionary aim or was it the time to pause and consider more immediate concerns?

COMPANY BACKGROUND

The Starbucks Corporation was founded in Seattle, Washington, in 1971. It was just a coffee bean marketer initially, but shortly after Howard Schultz joined the company, it expanded its bean sales to restaurants and coffee bars. Following a visit to Italy in 1983, Schultz was unable to persuade his partners to open an Italian-style espresso bar like those that he had found so attractive there. Schultz then left the company and started his own espresso bar.
His success in that venture led to his purchase of the Starbucks name from the original owners in 1987.
The subsequent 20 years saw a huge expansion of the company. It went public in 1992 and by 2007 had about 115,000 employees and sales of $9.412 billion, but a market capitalization of $13.629 billion, a drastic decrease from the previous $25 billion. Schultz had been replaced as CEO in 2000, but returned to that seat in January 2008 in a general shakeup of the board and management.

STARBUCKS GOES INTERNATIONAL
Until 1995, Starbucks had a domestic and Canadian presence only, with stores in nearly all states of the United States.

Question7

Many of its outlets were licensed in airports and department stores. Though it had expanded to Canada in its first year, it was not until 1996 that it went overseas, firstly to Japan, where it took over a local chain in a joint venture with a local group. By 2008, it had more than 748 stores in Japan, the largest number outside of the United States. Starbucks opened stores in Singapore also in 1996, via a wholly owned subsidiary, Starbucks Coffee Singapore.

The following expansion occurred in the 10 years up to 2008:

The Philippines, 1997; the United Kingdom, Taiwan, Thailand, New Zealand and Malaysia, 1998; Beijing, Kuwait, South Korea and Lebanon, 1999; United Arab Emirates, Hong Kong, Shanghai, Australia, Qatar, Saudi Arabia and Bahrain, 2000; Switzerland and Austria, 2001; Oman, Germany, Spain, Mexico, Puerto Rico, Southern China (Macau and Shenzhen), Greece and Indonesia, 2002; Turkey, Peru, Chile and Cyprus, 2003; France, 2004; Jordan, Bahamas and Ireland, 2005; Brazil and Egypt, 2006; and Romania, Denmark and the Netherlands in 2007. By January 2008, there were 4,588 overseas stores of which just over 60 per cent were licensed and the rest co-operated. In many of these countries, Starbucks seemed to have challenged an existing coffee culture quite successfully and in others found a niche coffee-drinking clientele willing to try the newcomer.

From 1997, Starbucks expanded by steady increments both at home and abroad (see Exhibit 1). From 2001 to 2008, its net income increased by more than three times, from $181 million to $673 million, giving it the dominant position in specialty coffee-drink retailing.

THE PRODUCTS
Starbucks' main product was coffee drink, which came in many styles and varieties, both hot and cold, with regional specialties. Its basic products (espresso and cappuccino) reflected the Italian style of preparation, but its offerings extended far beyond that which would be found in most cafes in Italy.

Question8

The range of sizes and flavorings much more clearly reflected North American retailing. It frequently varied some of the roasts on offer and often had daily specials of coffee and cakes. Its own brand varieties of tea (Tazo) were sold, as well fruit versions of its "frappuccino" (a capuccino with ice and milk served frappe). Customers ordering at the counter confronted a selection of pastries, cakes, muffins, cookies and sandwiches, again mostly reflecting North American tastes and styles, but with a slight nod to Italian biscuits. It also sold its own brand of ice-cream. In order to compete with its fast food rivals, it offered a local breakfast menu in certain locations.

Question9

Starbucks also marketed a variety of Arabica coffee beans sourced from three continents, reflecting its origins as a roaster. Its brands were Torrefazione, Italia and Seattle's Best Coffee, all names of companies taken over by Starbucks. Bean sales had always constituted a small percentage of its annual sales. A variety of coffee-associated paraphernalia was sold in most stores, chief amongst them cups and mugs, some of which were insulated for take-out drinks. Brewing equipment, from high-end to basic, was also sold in many stores, together with seasonal items such as CD-ROMs. Customers could also purchase stored-value cards, which could be used in any Starbucks store or given as a gift. This card could be customized and even reloaded online. This was not insignificant and reflected the presumed IT-savvy of its typical customer. Some stores provided free wireless Internet connections and the company had an agreement with Apple by which customers could download iTunes material via a wireless connection between the companies. These items and services were attractive and played a significant role in Starbucks' marketing. Stores were often located in airports under a licensing agreement, further identifying the company with customers of an identifiable profile.

MARKETING

Different many other companies in the food and beverage industry, Starbucks faced no large-scale competitors in its particular field, particularly in the international marketing of coffee drinks. It marketed itself with its ubiquity and highly recognizable logo, and even more centrally through its customer base, corporate image and espoused philosophy. Perhaps more than any other corporation, it had fostered a customer loyalty based on a "sense of connection."

Question10

This loyalty was further enhanced by promoting the notion of "a Starbucks you call you own." Its familial image extended to staff members, who were referred to as partners. Its corporate image was of an environmentally sensitive, communitarian and socially responsible company. It strongly promoted its commitment to corporate social responsibility by setting itself key performance indicators by which it measured its involvement in farmer equity, fair trade coffee, contributions to charity, volunteerism, conservation of electricity, water and paper, and its promotion of diversity and inclusion in respect of workforce location, purchasing and employment-creation. Taken together, these created a powerful image that needed little further enhancement through the advertising media. Starbucks was reported to have spent only $10 million on advertising in its first 13 years to 1996, a fraction of its budget and a result that any company would have been delighted to achieve. Starbucks' principal marketers were its satisfied customers, whom, it could be said, paid a premium price for the privilege.

Starbucks' cultivation of a distinctive and loyal customer base was summarized by Schultz in his address to the 2007 Shareholders Meeting: "We built our company in a different way. We built it on trust - a trust we have created as the result of the way our partners work together, our relationships with our customers, the respectful way we treat coffee farmers, and our contribution to the communities we serve."

FINANCIAL ANALYSIS

Exhibit 1 indicates the rapid expansion of the company in its first 15 years. Exhibits 2 to 4 provide a further breakdown to show company-operated versus licensed stores in the United States, the international market and in total. Starbucks opened 2,199 new stores in fiscal 2006 and had planned to open approximately 2,400 in fiscal 2007. In fact, only 1,342 stores were opened in 2007, with 723 of those in the United States. The target for 2008 had been reduced (by 500 - with 475 of those in North America). By the beginning of 2008, Starbucks operated in 37 countries with 15,756 stores of which 4,588 (29 per cent) were outside of the United States.

Question12

In 1992, there were 143 company-operated and three licensed stores in the United States, and 19 company-operated stores in Canada. The number of stores worldwide had increased about 10-fold in those 15 years.

Global expansion brought revenue increases. Exhibit 5 indicates net revenues and net earnings up to 2008.
Both indices also show 10-fold increases in that decade. On the other hand, the profit growth had slowed down (see Exhibit 6, which shows growth rates of net revenues and net earnings). From 1996 to 2000, the growth rates of net revenue were around 30 to 50 per cent, but after 2001 they stayed around 20 per cent. Subsequently, the growth rate of net earnings was unstable.
Operating margins declined in 2006 and 2007, from 13.2 per cent in 2005 to 11.5 per cent and 11.3 per cent, respectively, in the subsequent years. Comparable store sales also declined over the three-year period.

Net revenue growth in the three years went down from 30 per cent in 2004 (its recent high point) to 21 per cent in 2007.

Question13

Exhibit 7 shows the 2007 balance sheet including working capital and total assets. Total assets were growing steadily, but a working capital deficit emerged in 2005 due primarily to increased current liabilities from short-term borrowings under its revolving credit facility. In August 2006, the company increased its borrowing capacity, under the five-year revolving credit facility, to $1 billion and had borrowings of $700 million outstanding as of October 1, 2006. The sharp decrease was primarily due to strong operating cash flows. Total assets steadily increased as would be expected in an expansionary phase.

Long-term debt decreased drastically since 1998, but it was still $550 million in 2007 when the company issued $550 million in 10-year promissory notes (bonds). Shareholder equity decreased in 2005, but recovered in 2006 and 2007.

Long-term debt had been decreasing drastically since 1998 and short-term borrowings increased in 2006 and 2007 instead. Short-term borrowings in 2006 were $277 million and in 2007 were $700 million.

Exhibit 8 shows total specialty revenues, including licensing, food service and other revenues. The company derived the remaining 15 per cent of total net revenues from channels outside of company-operated retail stores. Licensing revenues were derived from retail store licensing arrangements, as well as grocery, warehouse club and certain other branded product operations. The proportionate increase in revenue from licensing (a 5.5-fold increase over eight years) as opposed to food service (just over two-fold) was highly significant, to the extent that licensing generated approximately 60 per cent of net revenue by the end of fiscal 2007. The increase was primarily due to higher product sales and royalty revenues from the opening of 1,159 new licensed retail stores in the 2007 reporting period and, to a lesser extent, a growth in the licensed grocery and warehouse club business. Food service and other revenues increased primarily due to growth in new and existing U.S. food service accounts.

Exhibit 9 shows the price of Starbucks shares since their initial public offering. Growth in value was consistent over the first ten years but a steep rise began in mid 2003 culminating in a price of around $37.50 at the beginning of 2006. After maintaining that value for 12 months, the price declined at double the rate of the rise, in the process shedding more than 60 per cent of its highest value to that date. One possible reason for this was the short-term borrowings debt. The company had explained that this was due to using its cash flow and liquid investments in the core business and for other new business opportunities. Starbucks had also repurchased shares of its common stock at times, depending on market conditions.

RISK FACTORS

In 2007, the company listed its perceived risk factors.

Question14

The major ones identified were the following:

• A regional or global health pandemic could severely affect Starbucks' business

• Market expectations for Starbucks' financial performance are high

• Declines in actual or estimated comparable store sales growth rates and expectations

• Failure to meet annual targets for store openings, as a result of delays in store openings or failure to identify and secure sufficient real estate locations

• Failure to penetrate and expand into emerging international markets, such as China

• Failure to generate sufficient future positive operating cash flows and, if necessary, secure adequate external financing to fund its growth

• Declines in general consumer demand for specialty coffee products

• Increases in the price of high-quality Arabica coffee beans, dairy products, fuel, energy or other
consumables, and the company's inability to obtain a sufficient supply of such commodities and consumables as its business grows

• Increased labor costs, including significant increases in health care benefits and worker's compensation insurance costs

• Starbucks is highly dependent on the financial performance of its United States operating segment

• Starbucks is increasingly dependent on the success of its international operating segment in order to achieve its growth targets

• The China market is important to the company's long-term growth prospects - doing business there and in other developing countries can be challenging

• The enforceability of intellectual property and contract rights

• Effectively managing the company's rapid growth is challenging

• The loss of key personnel or difficulties recruiting and retaining qualified personnel could jeopardize the company's ability to meet its growth targets

• Starbucks faces intense competition in the specialty coffee market

• Adverse public or medical opinions about the health effects of consuming the company's products could harm its business

• Significant increases in the market price or decreases in availability of high-quality Arabica coffee could harm the company's business and financial results

• Failure of the company's internal control over financial reporting could harm its business and financial results

SWOT ANALYSIS

A SWOT analysis undertaken in early 2008 by the authors identified the following situation for the company:

Strengths

Starbucks has unique strengths and a distinctive market position. It was on the list of "Fortune's Top 100 companies to work for" in 2007. It was also ranked fourth among the world's most influential brands by brandchannel.com. In 2006, Interbrand ranked Starbucks 91st in its survey of the 100 Best Global Brands.

Question15

• The company had, up to 2007, achieved 15 consecutive years of a same-store growth rate exceeding five per cent.

• Brand establishment. What sets Starbucks apart from its competitors is its high-end atmosphere with an affluent customer-base.

• It has maintained "standardization" as an important step in brand-building, despite its rapid expansion.

• Its fundamental business is lucrative. A cup of coffee is estimated to cost between $0.10 and $0.50
for ingredients (coffee, milk, paper cup) and provide up to a 300 per cent return on investment.

• Until 2008, it had successfully combined growth and profitability to its competitive advantage.

• The organization espouses strong ethical values. Starbucks is one of the largest purchasers of fair trade-certified coffee in the world, purchasing approximately 14 per cent of the global supply.

• It generally provides quick service.

• It enjoys fierce customer loyalty.

• It has a strong, sophisticated and highly developed supply chain.

• It values its workforce. Starbucks has also developed a good reputation for treating its employees well. It pays above-award rates. In 1991, it became the first privately owned company in history to establish an employee stock option program that included part-timers (working above 20 hours per week). Starbucks also offers health and dental benefits to both full- and part-time employees.

• It offers a specialty coffee, which is uniform and reliably available in all its stores. This differentiates Starbucks from other coffee retailers.

• It is not just a place to have good coffee, but also a place to relax for as long as one wishes.
Competitors such as Dunkin' Donuts or McDonald's, in contrast, are not places where people will typically sit around for hours.

• In 2005, Starbucks received the Gold Medal Award from the World Environment Centre, recognizing the company's leadership in the development of C.A.F.E Practices.

Question16

• Its logo and brand recognition are certainly amongst its strengths.
Weaknesses

• Issues such as market saturation, high prices, long waits in some of its shops (inefficient and inexperienced baristas) and confusingly-named sizes have affected the company.

• Its coffee is often described as bitter. In this respect, it suffers in competition with European roasts, which tend to be smoother but no less strong.

• Its food is uniform and not very attractive. It tends to reflect American tastes. There seems to be little attempt to offer foods that reflect the taste or culture of the host country.

• Its ubiquity challenges the exclusivity of the brand image.

• When crowded, service can be slow and seats can be hard to find.
Opportunities

• Coffee is a ritual purchase and due to today's coffee culture, more people are drinking coffee throughout the day, which means more selling opportunities.

• The recent hiring of more managers, the streamlining of menus and moves aimed at filling orders more quickly may improve its general service.

• It has opportunities to branch out beyond coffee, due to its favorable brand image.

• Retailing of pre-packaged coffee drinks by convenience stores, as it does, for example, in Japan.

• The possibility of going up-market or competing with established coffee shops, especially in the
European market.

• There is room for domestic (urban and suburban area) as well as international growth (in emerging markets like India, China, Russia and Brazil).

• World prices paid to growers for coffee beans have been at record lows for many years. The supply glut has mainly been in lower quality beans, however.

• The China market has huge possibilities for Starbucks. Its 165 stores have been showing significant
growth (30 per cent per annum in Beijing in 2008). China will soon become the company's biggest market outside of North America.

Threats

• Emerging competition from McDonald's, Dunkin Donuts and Peet's Coffee & Tea, and their generally lower prices.

• Overexposure of the company can threaten its exclusivity.

• Financial crises can affect consumer discretionary spending and thus Starbucks' sales. The sub-prime mortgage crisis of 2007-2008, with turmoil in the housing and credit markets, and high fuel prices, was an example of its vulnerability.

• Further diversification can affect its point of differentiation and can endanger the brand.

• Food safety issues (such as the previously disclosed use in the United States of milk from cows with rBGH - a genetically engineered bovine hormone) can tarnish its image.

Question17

• Its clean image has always been under attack. Starbucks' avowed commitment to fair trade and organic produce has been closely scrutinized and attacked by consumer advocates such as www.organicconsumers.org. In 2006, only six per cent of Starbucks coffee was obtained through fair trade.
• Any worldwide price increases in coffee, sugar or dairy products may further necessitate price rises for coffee drinks.

• Regulations on foreign company incursions may limit its penetration in some markets, a case in point being the tough scrutiny Starbucks faced in India.

• Community pressure in some locations can generate resistance to the setting-up of a Starbucks outlet.
There have been many cases where the company has faced local resistance, especially in older areas designated as being of historical or architectural interest.

• Consumers may become more concerned about inequities in the price paid to growers. The bean price (2008) is just $0.24 a pound, against the average price of $3.60 at which the multinational companies
on-sell it, that in turn being approximately the price of one large cappuccino in Starbucks Japan.

Question18

• The company's claim of social and environmental responsibility, and fair workplace arrangements has been challenged widely on the Internet, in some cases by its "partners" (staff members). Further adverse public perceptions may harm it.

• Starbucks finds it necessary to include a link ("rumors") on its website devoted to combating adverse and harmful rumors about the company.

• Its corporate commitment to diversity in respect of gay, lesbian, bi-sexual and transgender (GLBT) issues may result in threats of boycotts by opponents of this kind of liberalism. Starbucks strongly supports gender and racial diversity in its employment policies.

• Further price rises can influence customers to consider the Latte Factor

Question19

more seriously

SWOT SUMMARY

The preponderance of strengths over weaknesses would indicate that the company should have been solidly positioned in its market and in the food and beverage sector generally. This should temper any gloomy assessment of the problems the company faced. The opportunities would be seen as generally promising, but the threats, especially from down-market competitors and a general consumer perception of Starbucks' ubiquity, which devalued its exclusivity, might have offset the opportunities.

COULD STARBUCKS BOUNCE BACK?

The strengths of the company had always been clear. Its reversion to the leadership of Howard Schultz offered a chance to gain the direction and focus that might have been missing in its concentration on rapid expansion over the five years prior to his re-accession. Its board of directors appeared to be a strong one.

Schultz announced new strategies in a conference call in January 2008. In addition to reducing store numbers in North America, he emphasized: "Improving the current state of the U.S. business by refocusing on the customer experience in the stores, new products and store design elements, and new training and tools for the company's store partners to help them give customers a superior experience."

The company's strategy prior to 2008 had been to expand business globally, but Schultz clearly wanted to change its focus from store numbers to store quality. The potential of the China market appeared to be enormous, but was that enough to offset the diminished expectation of the company's shareholders for the core market in North America and would Starbucks be able to withstand the threat of its newer, cheaper competitors? This was a turning point for Starbucks. Market expectations were very high in spite of the poor revenue and earnings growth. Those expectations seemed to demand a strategic change for Starbucks and a fresh breeze to blow through management. A vital factor perhaps was how well Schultz would be able to steer the company against the stronger wind of shareholder reluctance and customer resistance. He indicated his course in the following statement to the shareholders: "We started to lose sight of our focus on the customer and our commitment to continually and creatively enhance the Starbucks experience."

Question20

All of the above leads to the question: would shareholders be content with hearing such a message?

Upon reading the case, the analysis portion (at least 3 pages) must address the next questions:

1. What was the main cause of Starbuck's problems that emerged in 2007 and 2008? What could the company have done to revive itself?

2. Analyze the growth of Starbucks and identify three or four factors that distinguished it as a company and led to its rapid growth.

3. Could Starbucks have reduced prices and still made a profit? How?

4. Should Starbucks have expanded into new international markets in 2008 or consolidated its position more thoroughly in its home territory?

5. What can we learn from the case as it relates to Marketing Management in general? What are the key takeaways of the case?

6. What 3-5 recommendations you can make to the company executives?