Back in April of 2006, in this post, I wrote,
"So Howard Schultz is opening more than 10 company stores per week, which would account for the employee growth. That is, 2 company stores per day, plus 5 licensee stores per day, plus turnover. With 'more than 100,000' employees currently, they are adding roughly 1% to their employee base per week. Allow for some Kentucky windage, and they are growing like topsy.
At these rates, I would guess Schultz lies awake nights wondering how his company's culture can withstand this sort of dilution and explosion among its ranks. When the US military saw these levels of growth during WWII, they employed the "cadre" system- seeding new units with experienced combat veterans. Is Starbucks doing this? Can they afford to, if they are moving into new locales?"
Interestingly, Schultz isn't planning to limit growth- he plans to more than triple the current number of stores to 40,000. Rather, he frets over the changes that have been wrought in Starbucks stores in order to maintain revenue and volume growth.
Changes such as automatic espresso machines which are tall and obscure the sight of the "barista" at work. A switch to pre-ground and packaged coffee, so that one no longer smells roasted coffee upon entering a Starbucks store. The aroma of burnt cheese on occasion, as the chain's new breakfast sandwiches cause some mess that is not immediately cleaned out of the ovens.
On one hand, I have to admire Schultz for his ethic in understanding that "success is not an entitlement." I really do admire that realistic attitude in a CEO or company leader. However, when Schultz wrote in his email,
"We desperately need to look into the mirror and realize it's time to get back to the core," just what does he mean? Hire more people and backtrack to more labor-intensive, poorer-quality service levels of the past? Trim the product offerings, and drop skim milk?
Perhaps Schultz is simply confusing limits to growth and consistently superior returns, with his company's own recent history. My proprietary research has found that there is a natural senescence that all successful firms experience. Just as athletes age, firms eventually outgrow their initial markets, attract competition, and simply become harder to lead, manage and grow in a manner that sustains consistently superior total returns than they once were.
This Yahoo-sourced chart (click on the chart to see a larger version) illustrates that, versus the S&P500, Starbucks has actually been stuck in neutral for about two years. While the company's stock price has outpaced the S&P for the last five years in total, it's been flat for the last two. The S&P is higher over that period, while Starbucks has plateaued. In fact, Starbucks is among the better performing shorts in my equity strategy, were we to be using the short strategy right now. It's been superior over several years in terms of total return, but inconsistently.My guess is that Starbucks is simply reaching a Wal-Mart-like limit to profitable growth that can sustain a consistently superior total return performance.
From the Journal article, it appears that Schultz is not exactly a well-educated, deeply knowledgeable businessman. Rather, it notes that he was a salesman who moved to Seattle in 1982 to join the coffee roasting firm. It's just possible that he does not realize what happens when a firm outgrows its initial niche. In Starbuck's case, it must now add food, music, etc., to maintain growth levels. And it has engendered renewed competition in coffee from the likes of Dunkin' Donuts and McDonalds.
I should probably note here that I hold McDonalds in my equity portfolio. And that, truth be told, when offered a choice, I'm a Dunkin' Donuts guy, not a Starbucks aficionado, for takeout coffee. I do, however, religiously buy one-pound bags of espresso beans at Starbucks, because Dunkin' Donuts refuses to sell me bags of the espresso beans they have in the store to brew their own espresso.
However, back to the Schultz email. It surprised me to read that Schultz puts so much emphasis on the "romance and theatre" of a Starbucks store. I guess I really am not their target market customer, because I've never had a romantic or theatrical experience in one of their units. I've had bad service. But I could personally care less if I see the guy/gal - excuse me, the barista- actually make my cup of coffee.
If Schultz and his crew plan to hit their target of 40,000 stores, I think they will find themselves making lots more changes than they have yet anticipated. If anything, a Starbucks will probably become even more distant than Schultz' dreamy original-style store than it already is.
So, kudos to Schultz for being uncomfortable and suspicious of what success his firm has enjoyed. But I'm not sure there's that much he can actually do to avoid the inevitable effects of senescence upon Starbucks.
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