New Growth At Starbucks?

Last Monday's Wall Street Journal featured an upbeat article concerning Starbucks.

According to the piece's author, John Jannarone, writing for Heard on the Street, the Seattle-based coffee giant is poised to display strong sales growth in the near future.

Jannarone provided a sketchy analysis to demonstrate that Starbucks has already successfully fought upscale coffee competition from McDonalds. Rereading the evidence, I'm personally not convinced of the conclusions. More likely than stealing Starbucks customers, as Jannarone seems to believe was the point of McDonalds' efforts, I suspect McDonalds is enjoying coffee sales growth that just won't now accrue to Starbucks.

The article concludes by observing that Starbucks has a 19 P/E multiple, which, while judged expensive, is teasingly hinted at being too low considering the potential ahead for Starbucks.

Being inquisitive, I constructed price charts for Starbucks and the S&P500 Index for the past 5 years and the term of Starbucks' public listing. They appear nearby.

Not surprisingly, the past five years have been tough on the coffee roaster. Exhibiting more volatility than the index, which isn't news, it ended up about flat with the index for the period. So the recent past doesn't suggest Starbucks is poised for a breakout due to suddenly-inspired management.

I've written a handful of posts since Howard Schultz returned to the firm as its CEO. Overall, he hasn't had much impact on the firm's performance in terms of leading it to consistently superior gains over the index.

Looking at the two price curves from Starbucks' public trading debut in 1993, the recent five years looks even more significant.

Prior to that time, the firm displayed consistent superiority over the index. I personally held it in equity portfolios in the past, so exceptional were the firm's fundamental and technical performances.

Viewing the firm's share price over such a long period, the recent stall looks more telling, at least to me. It fell precipitously during the recent economic turmoil. Weakening in a time of economic trouble is one thing, but Starbucks' share price did much worse than just that.

My own suspicion is that, like other growth firms, such as Dell and Intel, Starbucks has experienced its days of steady, long periods of consistently superior growth. I think investor expectations and competitions have both affected the firm's share price for the foreseeable future.

Being priced so apparently richly for such average recent performance suggests more wishful thinking than good sense. Sort of like those investors that still feel obliged to stuff Microsoft or GE in their portfolios, in the vain hope that, somehow, those aged, overly-diversified firms will somehow recapture the performances of their much earlier years.

Starbucks Expands Its "Fighting Brand"- Seattle's Best Coffee

Wednesday's Wall Street Journal called attention to Starbucks' plans to push its lower-priced brand, Seattle's Best Coffee, through various distribution channels. The wholly-owned unit, once a Starbucks competitor, is now headed by Michelle Gass, the parent's CEO's one-time strategy aide.

Essentially, rather than repeat its mistake of the past few years by taking the Starbucks brand down-market, causing temporary sales growth but diluting the brand's image, the company is tapping its lower-priced coffee brand to implement this strategy.

One pundit likens it to the Gap's Old Navy brand, but I'm not so sure that comparison works. After all, style, quality of material and price all serve to differentiate Old Navy, while, in the end, moderate-priced coffee is moderate-priced coffee.

Seattle's Best is to be marketed through franchisees, sales of beans in grocers, and the like. I suppose that, if done successfully, this Starbucks division can earn a respectable return. Perhaps, at first, it will add some growth to the parent's income statement and total return through raw revenue growth.

But, over time, what's the likelihood that a middle-market coffee roaster, competing with Dunkin' Donuts and McDonalds, will somehow break out in the segment and prove to dominate a segment known more for its very lack of distinguished flavor?

More than anything, isn't the plan to push growth at Seattle's Best Coffee an implicit admission by Howard Schultz that the Starbucks brand isn't as capable of delivering profitable growth which will enhance shareholder value and consistent total returns in the near future? That the main Starbucks brand is essentially devoid of significant opportunities for growth, having saturated its markets in recent years?

Starbuck's Reconsiders The Details

In yet another chapter in Starbuck's continuing struggles to recapture its former luster, the chain is now planning a significant change in what would seem to be a trivial activity. After what has apparently been intensive study of how and when coffees are brewed in the roaster's many stores, management has decided to focus on having fresher pots of coffee always available.


The Wall Street Journal reported, in a recent article,


"Instead of grinding coffee only in the morning, baristas will grind beans each time a new pot is brewed. Timers will buzz to signal when it's time to make a new batch, according to internal Starbucks documents reviewed by The Wall Street Journal.

The changes are part of the Seattle-based company's effort to reinvigorate the "Starbucks experience" in the face of competition from less-expensive rivals such as McDonald's Corp. and 7-Eleven Inc. With Starbucks' changes, customers will be able to hear the whir of grinders and smell the aroma of fresh coffee all day.


Two years ago, Howard Schultz, then chairman of the company, wrote a memo to executives blaming the chain's excessive focus on growth and efficiency for cheapening the coffee-shop experience he long had championed. Mr. Schultz wrote that an earlier switch to preground coffee had taken the "romance and theatre" out of a trip to Starbucks.

"We achieved fresh-roasted bagged coffee, but at what cost? The loss of aroma -- perhaps the most powerful nonverbal signal we had in our stores," he wrote.


Currently, baristas decide when to brew fresh batches "based on multiple signals ranging from demand (quantity), to expiration and timing," the new documents say, explaining that the revamped process "reduces this complexity by eliminating many of these signals."


The documents say that currently, "by using dedicated [containers] to brew coffee, our customers may experience a coffee outage 14 minutes out of every hour, or 23% of the time! This coffee outage occurs for seven minutes during every batch, making brewed coffee unavailable to our customers." As a result, customers can be forced to wait, choose another type of coffee or leave the store empty handed. "To solve the brewed-coffee outage problem, we must change the way we brew coffee," the documents say.


Some baristas said the extra grinding and brewing might slow service and turn off customers with added noise.

But demonstrating to customers that coffee is ground and brewed on the spot could help Starbucks maintain its premium position, especially as rivals tout less-expensive alternatives."


What struck me about Schultz' approach and concerns is that it probably won't attract coffee drinkers the chain hasn't already won over long ago. I'm not a big Starbuck's fan, personally, but I visit their stores with/for my daughters on occasion. The same people are generally in the one we most often frequent.

I honestly don't think more freshly-ground or -brewed coffee aroma will bring (back) Dunkin' Donuts' and McDonalds' coffee drinkers. It's a segmentation issue, and Starbucks long ago sewed up the segment that celebrates expensive coffee and the coffee houses in which one may linger to drink it.

Finally, in these times of government intervention into financial services, auto production and healthcare, I find it instructive how detailed and minute are Schultz' and Starbucks' managers' focus on their business.

Look again at how deeply and precisely the firm's management had studied a specific part of their operation with an eye to customer motivations and need satisfactions.

No governmental civil servant is going to do that. Yet, that's what it takes to succeed in business. Focus on customer wants and needs. Diligent, constant, detailed review of your own business' offerings, strategies, and operations.

Is Schultz right in changing the Starbucks' stores' coffee brewing? I don't know, but I doubt it. Still, he and his managers feel it's an important change to make in order to revive growth, profitability and equity value for the firm.

I just don't see that sort of combination of analytical rigor and imagination from any government hacks trying to oversee, restructure or operate significant portions of the US economy.

Starbucks Muddled Marketing Messages

Yesterday's Wall Street Journal carried a rather surprising article about Starbucks. It seems they have actually been offering some marketing promotions as long ago as last summer, wherein the purchase of a morning coffee led to a discount on an afternoon beverage purchase.

Who knew? As I noted in this post from last April, CEO Howard Schultz and his marketing chief, Michelle Gass, seemed rather confused about what was ailing their firm. They thought it was only their own strategies, and not competition. Somehow, Dunkin' Donuts' and McDonalds' explicit targeting of premium coffee drinkers escaped Schultz' and Gass' notices.

I was amazed to read in yesterday's piece that prices between Starbucks and its two main competitors, McDonalds and Dunkin' Donuts, have narrowed. That, in some instances, on a per-ounce basis, Starbucks is actually less expensive than Dunkin'.

Further, in a total about-face from removing food from their menu, Starbucks is now offering a food-and-coffee combo at a discount. But when asked about simply cutting coffee prices, Gass replied,

"Today, no. But never say never."

I guess the food reversal proves this out. But what I wonder is whether Schultz, Gass and their colleagues actually have any sort of larger marketing and product strategy in mind? Or are they just making these tactics up as they go along?

My own guess is the latter. How could they have reversed on providing food if they had done research and looked at their own customer buying information in the first place? It's not the sort of misstep you typically make if you are a data-driven marketer.

But it does smack of a sort of image- and mission-oriented marketing and business philosophy for which Howard Schultz is well known.

Unfortunately, that sort of business focus can lead to tragic mistakes, as market, customer and competitive realities are tuned out, in favor of 'the mission.'

I suppose a shareholder could be grateful that, as the nearby chart indicates, the company's equity price has pretty much tracked the S&P500 Index for the past six months. After all, this must have been a rocky period for the coffee giant, what with consumer luxury spending declining.

The question would seem to be, though, can Starbucks really manage to breakout above the index, and for a long time- several years? Because if it can't, then it has simply become another fallen star whose prospects for consistent, profitable growth are gone, and for whom competition and a saturated market spell mediocrity for the foreseeable future.

Sad to say, statistics and Schumpeterian dynamics suggest that it will be the latter.

Starbucks Shrinks!

In three posts last year- here, here and here- I discussed the failure of Starbucks' CEO Howard Schultz' growth strategy.

Finally acknowledging a slump in high-end retail sales, Schultz is cutting 6,000 store employees and 700 headquarters staff, as well as closing 300 additional stores above the 600 closures announced last year.

As I have noted in prior posts, the firm exposed itself to this sort of risk when it sought growth from lower-income customers. Those store openings and employee additions, which caused breakneck growth only a few years ago, have now had to be reversed.

The nearby price chart for Starbucks and the S&P500Index shows how the coffee roaster's equity price has fallen by some 40% since late summer, when I wrote the first post noting the beginning of its pullback. The silver lining is that it hasn't lost appreciably more than the S&P.

Meanwhile, McDonalds, which added better coffees to their menu, is running smoothly and posting gains.

Good management shows, and Starbucks clearly still doesn't have it.

Reality Hits Starbucks' Growth Plans

Starbucks is in the news again this week!



In my last post on the coffee retailer, here, I noted that Howard Schultz's vaunted turnaround, for which he returned to the company as CEO, had cratered in a quarterly loss.



This week's Wall Street Journal piece reaffirms the coffee roaster's cutbacks on US store openings, fights with landlords as it closes locations, and even a slowdown in its overseas store openings. According to the Journal piece, same-store sales at Starbucks are down 8% among the conventional 'open at least a year' category.

The nearby 3-month price chart for Starbucks and the S&P500 Index shows the coffee giant falling by more than the market average. Significantly more. Starbucks has lost nearly half its value amidst the market turmoil which began in September.

Clearly, the chain reaction of financial losses to consumer spending has now hit the upscale coffee retailer.



Back in January, I wrote a post concerning the marketing battle brewing between Starbucks and McDonalds. In it, I observed,




"To me, having followed this building story for nearly a year, Schultz' and Starbucks' logic and expectations are wrong. They expanded into more price-sensitive, lower-income segments, and are now struggling to make that business more constant. But it will be precisely those customers who are vulnerable to McDonalds and Dunkin' Donuts. Further, the changes in its product strategies is causing confusion and morale problems among Starbucks' workforce."



This is now coming home to roost big time at Starbucks. As cost-conscious, lower- and middle-income consumers flee the pricey coffee seller's offerings, the other two, more middle-market brands are likely to increase share.

It's not fair to accuse Howard Schultz of not foreseeing this financial-market triggered economic downturn. But he is responsible, never the less. As CEO, he presided over the expansion of the Starbucks brand into ever-lower income customer segments. This was bound to affect sales and profits growth come an eventual economic softening, never mind a serious recession.

Now the full import of the coffee roaster's years of breakneck expansion are coming back to haunt shareholders.

Will Schultz finally admit defeat and just accept that Starbucks' rapid growth phase is over?

Starbucks' Latest Move- Posting Losses!

Only just last month, in this post, I wrote with scepticism of Howard Schultz's most recent plan to revive the company of which he is CEO, Starbucks.

Now comes news, in yesterday's Wall Street Journal, that the coffee roasting giant posted a loss.

The retrenching on which I commented in early July has apparently been a signal that, as I predicted, Schumpeterian dynamics are catching up with Starbucks, and there is little, if anything, they can do about it.

The nearby 6 month price chart for Starbucks and the S&P500 Index shows a net 20% loss of value for the coffee giant- twice that of the index.

It was as bad as nearly 30% only a few days after that post I wrote last month.

In the details of the Journal's article about Starbuck's loss is information that the company is closing 600 US locations. And that

"The company blamed the lower-than-expected revenue growth on a mid-single-digit decline in US comparable-store sales. It described US traffic, measured by average number of transactions per store, as "slow." "

Somewhat comically, at least to me, given my prior posts regarding Starbucks, segmentation, pricing, growth, and Schumpeterian dynamics, the article reports,

"In a conference call with analysts, Mr. Schultz said customers remain loyal, but "they're visiting us less frequently as a result of economic pressures." He said Starbucks will promote value for the fall and holiday seasons, though it will stop short of bundling products at discounted prices. "We're not going to go down the fast-food lane," Mr. Schultz said."

By the way, Schultz reversed himself on breakfast offerings, now keeping them, instead of getting rid of them because their aroma masked that of the coffee in the stores.

Schultz's comments seem to demonstrate he just doesn't understand his market or his own strategy. Some years ago, Starbucks went down market to stoke growth. I noted in articles of that time that this would probably come back to haunt them, and now it is.

Then there was this year's big surprise summer drink offering. What happened to that? Sales are down relative to expectations. And customers apparently aren't buying whatever new brew was introduced.

Now Schultz is promising yet another 'just around the corner' tactical move to rescue the ailing firm.

Can't Schultz and his staff simply acknowledge that they saturated this product/market long ago? That with the more focused competition from Dunkin' Donuts and McDonalds, this market is unlikely, by itself, to be capable of delivering sustained consistently superior total returns anymore?

It's over, Howard. Just admit it, retire, and go spend the fortune you justly earned growing Starbucks in your first era as CEO.

Please stop trying to job your own shareholders.

Starbucks' Latest Move- Retrenching!

I've written nine labeled posts about Starbucks over the past nearly-three years. Perhaps more, since some are still awaiting labels.

This one, from just last May, suggested that returned Starbucks CEO Howard Schultz and his handpicked strategist, Michelle Gass, had it all wrong in predicting a sharp uptick in the coffee giant's imminent performance.

As I scan the headline of the Marketplace section of last Wednesday's Wall Street Journal, "Starbucks to Shut 500 More Stores, Cut Jobs," I see I was right.

If you go back through either the Starbucks- or Schultz-labeled posts, you will note the strong theme of continued growth at the coffee roaster. One of the recent posts observed that Schultz viewed new segmentation strategies as the key to continued growth amidst a weakening US economy.

And now this. The firm currently has 11,000 US stores. I had no idea its footprint was so large. According to the Journal article, 70% of them, or more than 7,000, have opened in the past three years.

Easy come, easy go, Howard and Michelle?

Two problems he didn't have a while ago now plague Schultz- Nelson Pelz and a customer revolt to the new signature brewed coffee at the firm. Seeking to broaden their appeal beyond espresso-based coffees, the new, more mainstream flavor is, of course, quite different and missing the robust cache of the former featured coffee.

I think I was on the mark when I noted, simply, that Starbucks is feeling the effects of Schumpeterian dynamics, and there's really not much they can do to mitigate the consequences, try as they might.

More Trouble at Howard Schultz' Starbucks

Monday's Wall Street Journal provided some additional information regarding Howard Schultz's attempt to revive the firm he founded, Starbucks.

In this recent post addressing returning CEOs, I wrote,

"In Dell's and Starbuck's cases, I question if they ever will (return to consistently superior total return performance). I believe, for reasons I've discussed in labeled posts on both CEOs and their companies, that competition, growth and simple Schumpeterian dynamics have worked to end their time of consistent outperformance."

I still feel that way. The nearby Yahoo-sourced price chart of the coffee seller and the S&P500 Index for the past five years portrays a brand that has run its course.

Typically, a firm once successful at earning consistently superior total returns will fade from either: lack of growth opportunities; competition; regulation, or; investor expectations finally catching up with performance.

Ironically, as I noted in this post, Schultz had been alleging competition had nothing to do with the firm's slumping fortunes,

Perhaps the most amazing comment Schultz uttered in the rather surreal interview this morning on CNBC was, in response to Bartiromo's question about McDonald's,

'Competition- they're just noise,'or words very close to those.

Well, as I noted in this post, regarding Schultz's recent, hand-picked strategist, Michelle Gass, contended,

"She says she hasn't been focused on competitors in developing the new plans. "I think we'd all readily admit that a lot of the situation we're in is self-induced." Sounds familiar, right? At least Gass and Schultz are reading from the same page in the same playbook.

But in that prior post, I went on to note,

"Thus, I find Ms. Gass' comment to be dangerously short-sighted and internally-focused.

Instead, she might wake up to the reality of Schumpeterian dynamics. Between Starbucks' own prior expansion into lower-income segments, and McDonalds' search for growth in kindred products, the former's market dominance was almost certainly going to come to an end, one way or another.

As it is, Starbucks is being bracketed by another coffee retailer on one side, and a fast-food giant on the other. This has less to do with Starbucks' 'self-induced' troubles than it does with recent targeting of the coffee giant's business by two very large, savvy food retailers.

I hope, for Howard Schultz' and Starbucks' sake, that Ms. Gass begins to become aware of this reality."

In this week's Journal piece, however, it reported,

"Reflecting his urgency, Mr. Schultz told workers he no longer wanted to hear about projects that would take as long as 18 months. "We have to defend our position," he said to a few hundred employees shortly after the March annual meeting. "We have lots of companies small and large who want to take a piece of our business away."

Wow. That's some fast reversal of strategic diagnosis, isn't it?

But what is truly disturbing is how personally Schultz is taking Starbuck's natural decline. As the Journal article describes,

But early last year, Starbucks seemed to be losing its edge, a complaint Mr. Schultz himself voiced in a leaked memo. It wasn't setting the agenda with new products but just adding drink flavors and ordinary items like breakfast sandwiches. Stores had grown cluttered with stuffed animals and other noncoffee items. Price boosts were starting to annoy customers.

"I was just depressed," Mr. Schultz says. He launched a personal turnaround routine, consisting of what are now six gym workouts a week and a daily health shake of fruit and cottage cheese.

In public, he appeared humbled. At the annual meeting in March, Mr. Schultz told the crowd to stop applauding when he walked on stage. "I thought I could start crying," he says.

Schultz is so personally invested in the attempt to reverse the age-old forces of Schumpeterian dynamics that he seems to simply deny their existence.

The article cites, through the recounting of many examples, how Schultz has gathered to himself the power to make even the most trivial decisions. It's reminiscent of Steve Jobs, with one big difference.

Jobs' Apple is in a business which creates new products. The best Schultz can now do, having already created a modern version of the old, original Dutch coffee house, is to introduce some marginal new beverage flavors each year.

Hardly the same thing.

It seems to me that people spend a certain amount of money on coffee and beverage purchases at places like Starbucks. Once the firm has penetrated sufficient markets, as I noted in this post, it really has little room for growth. Perhaps growing economies such as India and China provide some opportunities. But if that were all that was needed, the company would have already been growing with those countries' own growth rates.

No, it seems the problems for Starbucks lie more in the realm of simply having been successful long enough to have attracted competition while saturating its primary and secondary market segments.

I doubt Schultz' micromanagement of the firm he created will really change those facts.

But, as always, time will tell.

Starbucks' Howard Schultz On CNBC Today

By chance, I happened to catch Maria Bartiromo's softball interview with Starbucks' recycled CEO, Howard Schultz. Schultz was all a twitter about today's introduction of the firm's latest beverage- a specially-designed, basic brewed cup of coffee.


As the nearby, Yahoo-sourced five-year price chart for Starbucks, McDonald's and the S&P500 Index illustrates, Schultz had better hope it delivers something big for his shareholders.


I've written at least six labeled posts about the company, and probably a few more prior to those. My most significant recent piece was this one, in January, regarding the marketing battle heating up between Starbucks and McDonalds, with Dunkin Donuts also in the mix.


Perhaps the most amazing comment Schultz uttered in the rather surreal interview this morning on CNBC was, in response to Bartiromo's question about McDonald's,


'Competition- they're just noise,'



or words very close to those.



Well, as I noted in this post, regarding Schultz's recent, hand-picked strategist, Michelle Gass, contended,



"She says she hasn't been focused on competitors in developing the new plans. "I think we'd all readily admit that a lot of the situation we're in is self-induced."


Sounds familiar, right? At least Gass and Schultz are reading from the same page in the same playbook.



But in that prior post, I went on to note,

"Thus, I find Ms. Gass' comment to be dangerously short-sighted and internally-focused.

Instead, she might wake up to the reality of Schumpeterian dynamics. Between Starbucks' own prior expansion into lower-income segments, and McDonalds' search for growth in kindred products, the former's market dominance was almost certainly going to come to an end, one way or another.

As it is, Starbucks is being bracketed by another coffee retailer on one side, and a fast-food giant on the other. This has less to do with Starbucks' 'self-induced' troubles than it does with recent targeting of the coffee giant's business by two very large, savvy food retailers.



I hope, for Howard Schultz' and Starbucks' sake, that Ms. Gass begins to become aware of this reality."

While McDonalds has not, historically, been a competitor of Starbucks, it is now. Looking at the three Yahoo-sourced charts in this post- the five-year, two-year and one-year timeframes of Starbucks', McDonalds', and the S&P's price performances- it's clear that the fast food giant has been resurgent for the entire five year period just past.


Starbucks peaked two years ago, and is now struggling to find a way to rekindle its total return performance. Viewing the two firms' looming battle, and now learning that Schultz' latest weapon is a simple, brewed cup of coffee, I really wonder if Starbucks 'gets it.'


They are in the fight of their lives. They no longer own the premium coffee product/market. At least with espresso-based coffees, they had a lot of room to innovate and maneuver.


But brewed coffee? Lower priced, I would guess. And how long will it take Dunkin Donuts or McDonald's to emulate the new flavor, if it's warranted? Dunkin already wins taste tests with its signature coffee.


The shorter time period charts show Starbucks losing 50% of its price over two years, and 40% in just the past twelve months.


In contrast, McDonalds has racked up more than 20% in price appreciation, while the S&P was slightly negative.


My point is not that Schultz and Starbucks have to perform exactly like McDonald's, but that the latter is newly-focused and on a roll, with upscale coffee targeted as one of several important new product/markets.


The end of Bartiromo's interview with Schultz saw him fumbling to handle her question about how investors should view his new brewed coffee initiative. He spat out some tired lines about returning to the firm's roots and values while pursuing international growth, all calculated to


'Return Starbucks to its traditional place in this segment,'


or something close to that statement, which is not an exact quote.


It seems, per my prior posts, that Schultz and his chief strategy lieutenant, Gass, think that all of their company's troubles have been simply a matter of self-inflicted loss of focus and failure to refresh their brand.


In fact, again, per my prior pieces on Starbucks, the truth is more complicated than that. McDonalds is certainly much more dangerous than 'just some noise.'


So is Dunkin Donuts. Starbucks' most recent target segment, lower socio-economic groups, are currently hurting economically. The firm's success has attracted two large, capable competitors.


Are we to believe that one brewed coffee blend is going to reverse a 40% slide in the firm's stock price? With two hungry competitors active in the same market?


I think it's fair to say that the bloom is long off Starbucks' rose.

Starbucks' New Strategy

Thursday's Wall Street Journal featured an article about Michelle Gass, the putative head of strategy for Starbucks' new attempts to recapture its former growth.

Ms. Gass states, per the article,

"I'm not a traditionally trained strategist....I've never worked at McKinsey or Bain."

Well, neither am I, by that measure, but I've been a strategist since my early days at AT&T. For some, strategy is an orientation and way of thinking, not a result of a specific training ground.

Ms. Gass' training and experience involves heavy interest and involvement in consumer research while at P&G, which is quite admirable. And she successfully introduced the Frappuccino at Starbucks.

So far, so good. She is now Schultz' right hand woman on the big makeover at the coffee giant.

However, one line in the Journal story left me with doubts about Gass' and Starbucks' long term success. The story reads,

"She says she hasn't been focused on competitors in developing the new plans. "I think we'd all readily admit that a lot of the situation we're in is self-induced." "

Perhaps Ms. Gass needs one or two courses in strategy, after all.

As I wrote in this post a few months ago, Starbucks is very much locked in a competitive battle with at least McDonalds, as well as Dunkin' Donuts,

"The outcome of this battle royale between two retail food giants, Starbucks and McDonalds, with Dunkin' Donuts also roaming the same terrain, will be fun to watch. If you ever wanted to view a classic marketing struggle between two fairly well-matched firms in a clearly-defined market, this is your chance."

Thus, I find Ms. Gass' comment to be dangerously short-sighted and internally-focused.

Instead, she might wake up to the reality of Schumpeterian dynamics. Between Starbucks' own prior expansion into lower-income segments, and McDonalds' search for growth in kindred products, the former's market dominance was almost certainly going to come to an end, one way or another.

As it is, Starbucks is being bracketed by another coffee retailer on one side, and a fast-food giant on the other. This has less to do with Starbucks' 'self-induced' troubles than it does with recent targeting of the coffee giant's business by two very large, savvy food retailers.

I hope, for Howard Schultz' and Starbucks' sake, that Ms. Gass begins to become aware of this reality.

Starbuck's Latest Turnaround Strategy

This weekend's Wall Street Journal's "Heard On The Street" column discussed Starbuck's turnaround strategy.

For the second time in a few days, I read an article about Starbucks in which the word "segmentation" is used in quotes?

What's with that?

The context is that, according to this piece,

"Mr. Schultz is looking at "segmentation." strategies that would provide an entry point for new customers amid a weak economy."

Now, it was news to me that the Seattle's Best Coffee brand is owned by Starbucks. I think that's fantastic, because I like that brand much better than their flagship one. And as I've written here, about Les Wexner's Limited Brands, it's can be a very smart way to market different product lines.

However, only a few months ago, I wrote this post, which noted, from another Wall Street Journal article of that timeframe,

" 'Much of that may not be Starbucks's fault. Pressures on consumer spending haven't made it any easier for Starbucks to increase sales, particularly because Starbucks's customer base has gradually broadened to include Americans with lower average incomes, a group more likely to cut back. This summer, a spike in dairy costs caused the company to implement its second price increase in less than a year.'

To me, the most telling sentences are those in the fourth paragraph which I have quoted from the article. The company, in order to sustain growth over the past few years, headed down market. Now, those less-wealthy customers are being more affected by recent economic events, including prices of gasoline and food, while even Starbucks' ingredients' price rises are driving them to increase prices, too."

So Starbucks is, in fact, looking to reposition itself with its lower-income, newer customers. Apparently through the provision of inexpensive, simple brewed coffee. The Journal piece suggests,

"...and adding a lower-priced tier inside its own stores would be tricky for a brand that built its reputation on upscale cachet."

No kidding. Mr. Schultz, have you taken a look at Wal-Mart's failed 'upmarket' retail strategy of a few years past? It flopped. In their case, new, upscale customers wouldn't rub elbows with lower ones, and Wal-Mart's merchandising was not credible.

In the Starbucks case, you can imagine hordes of teenagers fleeing Starbucks as lower-priced, un-chiche, lower-priced coffees are shoehorned into the stores.

Schultz is also ditching the breakfast sandwich menu. Surprisingly, according to the article, this accounts for about $35,000 of revenue per location per year. That equates to something like $100/day. Isn't that only about 20 breakfasts/day?

Perhaps what's surprising is that they even kept this offering for so long. And that, with McDonalds revving up their coffee offerings, along with the constant pressure from Dunkin' Donuts, anyone wanting food won't visit Starbucks at all now, when they can just buy the same thing, for less money, at either of the other two purveyors.

Schultz holds out hope for Starbucks' line of summer drinks to help it out in the second half of the year. But isn't that a seasonal effect? Don't they already have a summer drink menu?

As the article suggests,

"Starbucks was one of the first major consumer brands to be built using word of mouth- and there are few precedents for how to resurrect a tarnished brand that was built that way."

As the nearby, Yahoo-sourced price chart of Starbucks and the S&P, for the last three months, demonstrates, the coffee roaster's stock is essentially in free-fall.

Schultz has one heck of a job to try to rescue this firm. Personally, I think he's fighting the force of Schumpeterian dynamics. Competition and consumer tastes have altered the competitive and market landscapes since the firm's heyday of some years ago. It's unlikely that Schultz can regain its long term, consistently outperforming total return record anytime soon, if ever.

Returning CEOs: Buying Opportunity, or More Trouble?

Herb Greenberg wrote a fascinating piece in the weekend Wall Street Journal entitled "Why Investors Should Applaud A CEO's Encore Performance."

Drawing on the work of an Ohio State University assistant professor of finance named Rudi Fahlenbrach, Greenberg wrote

"Here is some good news for Howard Schultz and Michael Dell, both of whom have boomeranged back to become chief executives of their respective companies, Starbucks and Dell: History is on their side. It is for their investors, too.

This doesn't guarantee a happy ending, but a study of encore performances led by Rudi Fahlenbrach, an assistant finance professor at Ohio State University, shows that, on average, the stocks of companies run by CEOs on a second tour of duty outperform the market by 6% annually during their comebacks."

I like Herb Greenberg's work and am typically interested in his opinions. So when I read these opening paragraphs to his article, I took notice. My own proprietary research, while not confined to turnarounds involving returning CEOs, found them to be rarely profitable for shareholders. So I was, and am, very interested in Greenberg's and Fahlenbrach's views on this. Greenberg further wrote,

"According to Mr. Fahlenbrach, from 1995 through 2004 at least 75 CEOs at the country's 1,500 largest companies were called back to active duty from either retirement (especially if they still have a large financial stake in the company) or having been relegated to the chairman's outpost.

"One of the most significant predictors of someone coming back is poor stock-market performance of the current CEO," he said.

On average, before the ex-CEO gets the call, the stock has fallen 40% over two years. Starbucks -- a broken stock, not yet a broken brand -- had skidded by a greater amount in a shorter amount of time. Ditto for Dell. When that happens, Mr. Fahlenbrach said, "They're in need of a quick turnaround."

Not that all former bosses are better than their successors. Notable failures the second time around include Gateway's Ted Waitt, Lucent's Henry Schacht and Xerox's Paul Allaire. And don't forget the late Ken Lay, whose return as CEO of Enron coincided with the final stages of the company's downfall."

Greenberg quotes Jeff Sonnenfeld of Yale, who speaks highly of Houghton, thusly,

"Mr. Sonnenfeld says those who succeed in coming back have three qualities. The first is they came back with great reluctance; they weren't trying to undermine their successor. Second is they aren't coming back for some unmet ego need. Many had better things to do with their time, and came back "because they were being drafted by all of their key constituencies -- because of relationships, knowledge and a cultural aura they can do things nobody else can do to fix the problem." Third, and perhaps most important, he said, is "they recognize what they had built isn't a religion. At Corning, Mr. Houghton had to revisit all kinds of decisions he may have been part of making." "

Stepping back, Greenberg lists Jamie Houghton of Corning, Michael Dell of Dell, Howard Schultz of Starbucks, William Stavropoulos of Dow Chemical, and Chuck Schwab of Schwab among those who either have been successful at returning to turn their old company around, or are expected to do so.

Let's have a closer look at these, dispensing with those even Greenberg cited as ineffective- Schacht of Lucent, Waitt of Gateway, and Allaire of Xerox.

Nearby is a long term price chart for Dell, Starbucks, Corning (GLW), and Dow Chemical. Have any of them returned to a consistent path of outperformance of the S&P? Because the 6% per annum mentioned by Fahlenbrach wouldn't be all that spectacular if it only lasts one or two, perhaps even three years.

It's easy to see Dell's slide and Starbucks slowly running out of gas before failing in 2006. Of course, Schultz didn't actually leave the company, just the CEO position. I think Michael Dell was further removed and out of Dell when it finally began to actually decline.

According to Greenberg's piece, Houghton and Stavropoulos returned to their respective firms in 2002, the former for three years, the latter for two.

I can't honestly see a difference in Dow from 2000 until now. Corning fell after Houghton returned, and seems to have only clawed back to even by the time he left. Since then, it's climbed a bit, but has only matched the S&P for the past two years.

This next chart displays recent price activity more clearly. Corning is definitely still wandering aimlessly since early 2006. That's a two-year stint of inferior performance. So much for Sonnenfeld's admiration for Houghton. In fact, if he left in 2005, it seems that things actually took off, briefly, for a year after his departure, before running out of steam again.

Dow, too, clearly has not been giving shareholders consistently superior returns, either, since 2004.

How about Chuck Schwab? He returned in mid-2004, making him CEO for the past 3 1/2 years. The nearby chart seems to show he's done better than the other examples in Greenberg's article.

Even so, he has yet to get Schwab back to consistent outperformance. But he may be close. If he can continue the firm's total return performance path in 2008, he'll have done it. And it looks as if he is the only one of those mentioned by Greenberg and Fahlenbrach who actually has done so.

Why do you suppose that Fahlenbrach, and Greenberg, are so enamored of a few short-run CEO return successes, and a few who didn't even manage that?

Personally, I think it demonstrates how low most analysts and observers set the bar for 'excellent' performance. To paraphrase Fahlenbrach and, by inference, Greenberg, a two or three years of besting the S&P by only 6 percentage points draws notice.

My own research shows this is actually well within the range of pretty average performance. Many companies can do that, and don't need to be turning around while they do it.

Why do you suppose that these CEOs, as a group, mostly failed to move their firms to consistently superior total return performance?

In Dell's and Starbuck's cases, I question if they ever will. I believe, for reasons I've discussed in labeled posts on both CEOs and their companies, that competition, growth and simple Schumpeterian dynamics have worked to end their time of consistent outperformance.

Dow and Corning represent, I think, business models which have been uneven at best for a long time. They don't tend to have even been consistently superior growth firms to begin with. Given their stock price paths, it's clear that holding the S&P instead of ever holding the those companies' shares would have been a safer and more profitable choice for over twenty-five years.

In the final analysis, while I enjoyed reading Herb Greenberg's piece on Fahlenbrach's work, I found the conclusions to be largely unsustained. I guess my expectations of outstanding CEO and investment performance are higher than those of either of those two guys.

McDonalds vs. Starbucks- A Marketing Battle You Just Have To Love

Yesterday's Wall Street Journal featured an article on the marketing battle currently brewing (yes, I know- a bad pun) between McDonalds and Starbucks over upscale coffee.

The Journal article displayed a one-year stock price chart for the two companies. I prefer two other timeframes- two and five years.

The nearby two-year chart for McDonalds, Starbucks and the S&P500 Index clearly show Starbuck's recent decline. It was holding flat, even up a bit in mid-2006, then slumped monotonically beginning in October of that year, rising nearly without pause since then.

McDonalds' stock price over the same period is almost directly opposite. Its price was truly flat for mid-late 2006, then took off in September of that year.

The next, five-year price chart for the same entities reveals how Starbuck's decline is a serious departure from its prior, longterm trend. The red curve, depicting the coffee giant's price over time, enjoyed two years of growth which outstripped the S&P in 2003-4, then flattened in 2005-6, and began to fall.

McDonalds have been on a steady upward trajectory over the entire five year period.

With that backdrop, I found the article suggestive that McDonalds is about to take a major piece out of Starbucks' recently-earned volume growth. McDonalds' move into higher-end coffee is the next in a series of revitalizing moves that have turned around the formerly-ailing fast-food giant.

For Starbucks, however, as I've written in prior posts, here, here and here, their expansion strategy has brought new headaches, as they try to buck the natural limits to growth of their business model. To me, it seems a clear indication of Schumpeterian dynamics at work, signaling an end to Starbucks' salad days of growth and total return superiority.

Particularly worrisome, as was also voiced this morning on CNBC, is Howard Schultz' preoccupation with 'returning to the core' of Starbucks. For example, in this passage from his nearly year-ago internal memo, Schultz wrote,

"We desperately need to look into the mirror and realize it's time to get back to the core,"

Thus, this morning's announcement that Schultz forced out his CEO, Jim Donald, and is resuming that title and role at the coffee roasting titan.

However, McDonalds' push into coffee has more to do with raw market opportunity than simply competing with Starbucks. That is, as the Journal article notes,

"The confrontation between Starbucks Corp. and McDonald's Corp. once seemed improbable. Hailing from very different corners of the restaurant world, the two chains have gradually encroached on each other's turf. McDonald's upgraded its drip coffee and its interiors, while Starbucks added drive-through windows and hot breakfast sandwiches.

The growing overlap between the chains shows how convenience has become the dominant force shaping the food-service industry. Consumers who are unwilling to cross the street to get coffee or make a left turn to grab lunch have pushed all food purveyors to adapt the strategies of fast-food chains.

It also shows how the chains' efforts to adapt to a changing market have had drastically different results on their bottom lines. McDonald's is entering the sixth year of a successful turnaround, while Starbucks has begun struggling after years of strong earnings and stock growth.

McDonald's executives watching the growth of Starbucks at the beginning of this decade realized that they were missing out on the fastest-growing parts of the beverage business. Data showed that soda sales had flattened while sales of specialty coffee and smoothies were growing at a double-digit rate outside McDonald's. Customers were buying food at McDonald's, then going to convenience stores to get bottled energy drinks, sports drinks and tea, as well as sodas by Coke competitors."

The fact that McDonalds wasn't originally remotely considered a competitor of Starbucks makes this a fascinating marketing battle. It's like watching a football wide receiver and his defender both leap for a pass, each having an equal 'right' to catch the ball, neither having especially wanted to collide with the other. But the ball is in only one place, so there they all are- the receiver, defender, and the ball.

In this case, it's the fast food and drink consumer, McDonalds and Starbucks. If McDonalds had identified something else, such as upscale desserts, or pizze, or what have you, somebody else might be in their way. Or perhaps nobody.

But as it is, Starbucks moved so far downscale, and reprogrammed so much of America to drink better coffee, that they created a market too tempting for McDonalds to avoid. And Starbucks developed its business model to be perilously close to that of McDonalds, in terms of satisfying instant consumer demands for food and/or drink, but being less efficient in its provision.

Chance are good you can learn to make better coffee more easily than you can instill a new, faster service ethic in your sprawling employee base. For what its worth, I happened to have sampled McDonalds' upscale coffee salons in New Zealand several years ago, and found it every bit as acceptable as Starbucks or, for that matter, Dunkin' Donuts.

In this passage, the Journal piece provides a wonderful insight into how McDonalds used classic, grass roots market research to unearth the opportunity they are developing,

"McDonald's researchers contacted customers of Starbucks and other coffee purveyors and conducted three-hour interviews where they videotaped the customers talking about their coffee-buying habits. The researchers got in the cars of the customers and drove with them to their favorite coffee place, then took them to McDonald's and had them try the espresso drinks.
"There was a surprise factor," says Patrick Roney, a director of U.S. consumer and business insights at McDonald's. "The people who were on the fence...there was an opportunity to get those." "

And McDonalds is using some of its classic strengths- ubiquity and reasonable prices, to move into the upscale coffee product/market, as seen from this passage,

"Heather Pelis, a 19-year-old babysitter from Rayville, Mo., says she didn't like the McDonald's vanilla latte when she tried it. "It was a little syrupy tasting," Ms. Pelis said recently while drinking a drip coffee at a McDonald's in Liberty, Mo. But she says she'd be willing to try another espresso drink because they are cheaper than the caramel macchiatos she buys at Starbucks, and because McDonald's is more conveniently located. The nearest Starbucks is a 30-minute drive from her, she says.

McDonald's franchisees say they think the new coffee drinks will be particularly helpful in drawing young consumers who prefer them to drip coffee. Gary Granader, a Detroit-area McDonald's franchisee, has started seeing groups of teenagers at some of his restaurants after school since he added espresso drinks a year ago. Mr. Thompson says McDonald's also is considering adding some type of music-downloading service at its locations."

Toward the end of the Journal article, it discusses Starbucks' reaction to its current dilemma,

"Starbucks executives have attributed the slowdown in sales growth and store traffic in the U.S. to the weak economy.

Mr. Schultz has said that new competition actually helps Starbucks by expanding the specialty-coffee category. "Those consumers over time are going to trade up," he told investors in November. "They're going to trade up because they are not going to be satisfied with the commoditized experience or the flavor." He has emphasized that Starbucks's baristas, who are instructed to memorize customers' drink orders and make genuine conversation with patrons, will continue to set the chain apart.

But some Starbucks baristas say that the chain's push into food and drive-through service has made that a lot more difficult. Some workers say their managers instruct them to ask customers whether they want a breakfast sandwich with their coffee -- a selling technique that feels unnatural when they know the customer doesn't want one.

"The more and more business they get in the store, the more it seems like another fast-food job," says Joe Tessone, a Chicago barista who has worked at Starbucks for three years."

To me, having followed this building story for nearly a year, Schultz' and Starbucks' logic and expectations are wrong. They expanded into more price-sensitive, lower-income segments, and are now struggling to make that business more constant. But it will be precisely those customers who are vulnerable to McDonalds and Dunkin' Donuts. Further, the changes in its product strategies is causing confusion and morale problems among Starbucks' workforce.

In today's article on Schultz takeover of the CEO spot, they write,

"Mr. Schultz wouldn't specifically address the coming competition from McDonald's but said he will work to make the experience at Starbucks more distinctive. "We have to be able to restore that in a way that significantly differentiates us from everyone else," he said."

Clearly, this makes sense. It's simple, basic marketing- provide a clearly differentiated offering if you have different price points than your competitors. Doing that, however, after having lost the magic, is a pretty tall, or is that venti or grande, order. However, they also quoted from Schultz' recent internal letter to employees,

"Some of Mr. Schultz's objectives stated in the letter, such as "re-igniting the emotional attachment with customers," are so difficult to measure that it may be hard for investors to know whether they are happening."

Maybe it's me, but I don't really want an emotional attachment to my coffee purveyor, when I do buy coffee from a retailer. I guess that's why I've been a Dunkin' Donuts guy up until now. I only buy whole espresso beans from Starbucks, although my children will sometimes ask to buy a drink when I stop to do that.

Of course, I'm only one coffee drinker, albeit a fussy one. The outcome of this battle royale between two retail food giants, Starbucks and McDonalds, with Dunkin' Donuts also roaming the same terrain, will be fun to watch. If you ever wanted to view a classic marketing struggle between two fairly well-matched firms in a clearly-defined market, this is your chance.

Starbucks' Schultz Sees Senescence

Saturday's Wall Street Journal carried a lengthy article concerning an internal email from Howard Schultz, the firm's chairman, regarding his concerns for the firm.

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.