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Originally published March 17, 2012 at 8:02 PM | Page modified March 17, 2012 at 8:24 PM

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More thoughtful, still innovative Starbucks back steaming hot

After CEO Howard Schultz acknowledged four years ago that Starbucks had lost its edge, the company heads into its shareholders meeting Wednesday with its stock high and a recovery stronger than many expected.

Seattle Times business reporter

Renewed Starbucks sharpens focus

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In the four years since Howard Schultz swooped in to rescue it, Starbucks has grown up.

Back then, with the stock and housing markets bombed and people eating meals and drinking coffee more at home, Starbucks' future was in question. Sales were sliding, and the stock sank so low that the Colombian National Coffee Growers Federation called for coffee-producing nations to make a bid for it.

Shortly after returning as CEO, Schultz stood before shareholders drawn and contrite.

"We have kind of lost our edge," he said at the company's March 2008 annual meeting. "I promise you, this will not stand."

He was right on both counts.

Starbucks ultimately closed nearly 1,000 cafes worldwide and slashed tens of thousands of jobs. It spruced up remaining stores and lowered the cost of opening new ones, which is now happening at the more sober pace of 800 stores a year, a little more than two a day.

Through painful soul-searching, Starbucks found ways to make money without adding seven stores a day, as it had in 2007. It looked to impress Wall Street without boasting it was aiming for 40,000 locations.

Now, as it heads to its annual shareholders meeting Wednesday, the world's largest coffee-shop chain has bounced back stronger than anyone predicted.

In the fiscal year ended Oct. 2, Starbucks' profit rose 32 percent to $1.25 billion, and the stock trades at all-time highs, above $50 a share. The company has started paying dividends.

Its head count rebounded. After falling from a high of 176,000 employees in late 2008 to 137,000 in 2010, it grew to 149,000 last fall.

And Starbucks got serious about the future.

"There's a lot more thought put behind their initiatives now," said R.J. Hottovy, an analyst at the Chicago-based research firm Morningstar.

Starbucks knows.

"Our innovation had become less innovative," said Chief Financial Officer Troy Alstead.

During its overheated growth, Starbucks sometimes heralded new flavors of Frappuccino as innovative, Alstead said. "And while innovation around Frappuccino is a wonderful thing, it's not the kind of hallmark innovation we needed," he said.

Less gushing

The renewed focus means shareholders Wednesday aren't likely to have their heads spun as they did four years ago, when Starbucks officials gushed about everything from its acquisition of a small Ballard coffee-machine maker to its new drip coffee.

Starbucks now concentrates on building international markets and improving sales in grocery stores — areas that could yield enormous profits and that, until the recession, took a back seat to U.S. expansion.

"International was viewed as a little bit riskier, especially when the economy was strong in the U.S., and that flipped a few years back," said Dan Geiman, an analyst at Seattle-based McAdams Wright Ragen.

Starbucks has fewer than 7,000 stores in foreign countries, compared with 11,000 in the U.S. Of the 800 stores it plans to open this year, 600 will be in international markets. About a quarter of those will be in China, where the chain last fall opened its 500th store.

Starbucks has been in China since 1999, at first with a Chinese corporate partner that handled most of the management and supply-chain issues. As its footprint grew, Starbucks took more control and more profit — a formula it follows in many foreign markets — and now owns and operates more than half of its stores in China.

Locations in eastern China still operate through a joint venture with a Chinese company.

"The economics in China are ridiculously good for Starbucks," said Sharon Zackfia, an analyst at William Blair & Co. Costs such as labor and rent are relatively low, making the company's profit margins for stores there its highest in the world, she said.

Chinese consumers also love the brand, an "affordable luxury" for the country's emerging middle class.

During the first quarter of the current fiscal year, Starbucks posted a 28 percent sales gain for Chinese stores open at least a year. That compares with worldwide same-store sales growth of 9 percent.

Later this year, Starbucks plans to open its long-awaited first store in India, where it hopes to tap an emerging middle class, as in China.

In the U.S., that picture is flipped, with a shrinking middle class and persistently high unemployment worrying even the best-performing retailers.

That's where Starbucks' consumer-products strategy might help. The company's smallest division has long been a unit that sells coffee beans, bottled Frappuccino, coffee ice cream and other products in grocery stores — a more recession-proof business because people never stop grocery shopping.

Consumer products

Starbucks' shift to grocery sales "started a few years back when consumers started consuming coffee more at home, and those trends are continuing," said McAdams' Geiman.

It wants consumer-products sales to rival its stores.

In 2010, Starbucks hired a new consumer-products chief, Jeff Hansberry, who worked at giant Procter & Gamble and at E.&J. Gallo Winery, a business that took what used to be a commodity — like coffee — to new heights.

As part of its effort to boost grocery sales, Starbucks that same year fired 12-year corporate partner Kraft as the distributor of many of its consumer products and started handling distribution itself.

"It's an opportunity to really manage and control the destiny of the brands," Hansberry said. "We can talk to customers with one voice from Starbucks."

Starbucks stores also offer a dream platform for sampling products and other forms of marketing, Hansberry said. "With 50 million visits every week and the relationships baristas have with customers, it's a very powerful model we're still learning about."

For now, the consumer-products division is gathering steam rather than impressing on the bottom line.

Last year, the unit brought in $860.5 million, or 7 percent of Starbucks' revenue. Its operating profit slid 4 percent, partly because of high coffee costs and because Starbucks has invested in new products, including instant coffee, a lighter roasted coffee and single-serve cups of ground coffee for home-brewing machines.

Sign of maturity

The "laser" focus Schultz now talks about suggests a maturity from the earlier inclinations to take on every idea that came up.

But Alstead balks a little at the notion that Starbucks is "mature."

"The only thing I don't like is that people hear 'mature,' and think you're done. We're mature and yet we have so far to go," Alstead said.

It's certainly not sitting still. One analyst even questioned its focus on a recent conference call with executives.

"Why not take maybe a more measured approach versus all these great ideas at once?" asked Michael Kelter of Goldman Sachs.

Schultz, who led the scattershot approach at the 2008 annual meeting, replied: "We're not going to allow ever again at Starbucks for growth to cover up mistakes. We're not going to have unbridled growth that turns into a strategy as opposed to a purpose."

Melissa Allison: 206-464-3312 or mallison@seattletimes.com. On Twitter @AllisonSeattle.

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