In 1998 Howard Schultz had ample reason to be proud of what Starbucks had accomplished during his past 11 years as the company's CEO. The company had enjoyed phenomenal growth and become one of the great retailing stories of recent history by making exceptional coffee drinks and selling dark-roasted coffee beans and coffee-making equipment that would allow customers to brew an exceptional cup of coffee at home. The Starbucks brand was regarded as one of the best known and most potent brand names in America and the company had firmly established itself as the dominant retailer, roaster, and brand of specialty coffee in North America. It already had over 1,500 stores in North America and the Pacific Rim and was opening new ones at a rate of more than one per day. Sales in fiscal year 1997 were a record $967 million and profits reached an all-time high of $57.4 million. The company's closest competitor had fewer than 300 retail locations. And since going public in 1992, Starbucks has seen its stock price increase nearly ninefold.
Exhibit 1 contains a summary of Starbucks key performance statistics for the 199297 period.
Starbucks began in 1971 when three academicsEnglish teacher Jerry Baldwin, history teacher Zev Siegel, and writer Gordon Bowkeropened a store called Starbucks Coffee, Tea, and Spice in the touristy Pikes Place Market in Seattle. The three partners shared a love of fine coffees and exotic teas and believed they could build a clientele in Seattle much like that which had already emerged in the San Francisco Bay area. Each invested $1,350 and borrowed another $5,000 from a bank to open the Pikes Place store. Baldwin, Siegel, and Bowker chose the name Starbucks in honor of Starbuck, the coffee-loving first mate in Herman Melville's Moby Dick(so company legend has it), and because they thought the name evoked the romance of the high seas and the seafaring tradition of the early coffee traders. The new company's logo, designed by an artist friend, was a two-tailed mermaid encircled by the store's name.
The inspiration for the Starbucks enterprise was a Dutch immigrant, Alfred Peet, who had begun importing fine arabica coffees into the United States during the 1950s. Peet viewed coffee as a fine winemaker views grapes, appraising it in terms of country of origin, estates, and harvests. Peet had opened a small store, Peet's Coffee and Tea, in Berkeley, California, in 1966 and had cultivated a loyal clientele. Peet's store specialized in importing fine coffees and teas, dark-roasting its own beans the European way to bring out their full flavor, and teaching customers how to grind the beans and make freshly brewed coffee at home. Baldwin, Siegel, and Bowker were well acquainted with Peet's expertise, having visited his store on numerous occasions and spent many hours listening to Peet expound on quality coffees and the importance of proper bean-roasting techniques. All three were devoted fans of Peet and his dark-roasted coffees, going so far as to order their personal coffee supplies by mail from Peet's.
The Pikes Place store featured modest, hand-built nautical fixtures. One wall was devoted to whole-bean coffees; another had shelves of coffee products. The store did not offer fresh-brewed coffee by the cup, but samples were sometimes available for tasting. Initially, Siegel was the only paid employee. He wore a grocer's apron, scooped out beans for customers, extolled the virtues of fine, dark-roasted coffees, and functioned as the partnership's retail expert. The other two partners kept their day jobs but came by at lunch or after work to help out. During the start-up period, Baldwin kept the books and developed a growing knowledge of coffee; Bowker served as the "magic, mystery, and romance man."1 The store was an immediate success, with sales exceeding expectations, partly because of a favorable article in the Seattle Times. In the early months, each of the founders traveled to Berkeley to learn more about coffee roasting from their mentor, Alfred Peet, who urged them to keep deepening their knowledge of coffees and teas. For most of the first year, Starbucks ordered its coffee beans from Peet's, but then the partners purchased a used roaster from Holland and set up roasting operations in a nearby ramshackle building. Baldwin and Bowker experimented with Alfred Peet's roasting procedures and came up with their own blends and flavors. A second Starbucks store was opened in 1972.
By the early 1980s, the company had four Starbucks stores in the Seattle area and could boast of having been profitable every year since opening its doors. But the roles and responsibilities of the cofounders underwent change. Zev Siegel experienced burnout and left the company to pursue other interests. Jerry Baldwin took over day-to-day management of the company and functioned as chief executive officer; Gordon Bowker remained involved as an owner but devoted most of his time to his advertising and design firm, a weekly newspaper he had founded, and a microbrewery he was launching (the Redhook Ale Brewery).
Howard Schultz Enters the Picture
In 1981, Howard Schultz, vice president and general manager of U.S. operations for Hammarplasta Swedish maker of stylish kitchen equipment and housewaresnoticed that Starbucks was placing larger orders than Macy's was for a certain type of drip coffeemaker. Curious to learn what was going on, he decided to pay the company a visit. The morning after his arrival in Seattle, Schultz was escorted to the Pikes Place store by Linda Grossman, the retail merchandising manager for Starbucks. A solo violinist was playing Mozart at the door, with his violin case open for donations. Schultz immediately was taken by the powerful and pleasing aroma of the coffees, the wall displaying coffee beans, and the rows of red, yellow, and black Hammarplast coffeemakers on the shelves. As he talked with the clerk behind the counter, the clerk scooped out some Sumatran coffee beans, ground them, put the grounds in a cone filter, poured hot water over the cone, and shortly handed Schultz a porcelain mug filled with the freshly brewed coffee. After three sips, Schultz was hooked. He began asking the clerk and Grossman questions about the company, about coffees from different parts of the world, and about the different ways of roasting coffee.
Next, Schultz met with Jerry Baldwin and Gordon Bowker, whose offices overlooked the company's coffee-roasting operation. The atmosphere was informal. Baldwin, dressed in a sweater and tie, showed Schultz some new beans that had just come in from Java and suggested they try a sample. Baldwin did the brewing himself, using a glass pot called a French press. Bowker, a slender, bearded man with dark hair and intense brown eyes, appeared at the door and the three men sat down to talk about Starbucks. Schultz was struck by their knowledge of coffee, their commitment to providing high-quality products, and their passion for educating customers about the merits of dark-roasted coffees. Baldwin told Schultz, "We don't manage the business to maximize anything other than the quality of the coffee."2 Starbucks purchased only the finest arabica coffees and put them through a meticulous dark-roasting process to bring out their full flavors. Baldwin explained that the cheap robusta coffees used in supermarket blends burn when subjected to dark roasting. He also noted that the makers of supermarket blends prefer lighter roasts because they allow higher yields (the longer a coffee is roasted, the more weight it loses).
Schultz was struck by the business philosophy of the two partners. It was clear from their discussions that Starbucks stood not just for good coffee, but rather for the dark-roasted flavor profiles that the founders were passionate about. Top-quality, fresh-roasted, whole-bean coffee was the company's differentiating feature and a bedrock value. It was also clear to Schultz that Starbucks was strongly committed to educating its customers to appreciate the qualities of fine coffees, rather than just kowtowing to mass-market appeal. The company depended mainly on word-of-mouth to get more people into its stores, then relied on the caliber of its product to give patrons a sense of discovery and excitement. It built customer loyalty cup by cup as buyers of its products developed their palates.
On his trip back to New York the next day, Howard Schultz could not stop thinking about Starbucks and what it would be like to be a part of the Starbucks enterprise. Schultz recalled, "There was something magic about it, a passion and authenticity I had never experienced in business."3 Living in the Seattle area also had a strong appeal. By the time Schultz landed at Kennedy Airport, he knew he wanted to go to work for Starbucks. Though there was nothing in his background (see Exhibit 2) that prepared him for the experience, Schultz asked Baldwin at the first opportunity whether there was any way he could fit into Starbucks. The two quickly established an easy, comfortable rapport, but it still took a year of numerous meetings and a lot of convincing to get Baldwin, Bowker, and their silent partner from San Francisco to agree to hire Howard Schultz. Schultz pursued a job at Starbucks far more vigorously than Starbucks pursued him. There was some nervousness at Starbucks about bringing in an outsider, especially a high-powered New Yorker, who had not grown up with the values of the company. Nonetheless, Schultz continued to press his ideas about the tremendous potential of expanding the Starbucks enterprise outside Seattle and exposing people all over America to Starbucks coffeearguing there had to be more than just a few thousand coffee lovers in Seattle who would like the company's products. Schultz believed that Starbucks had such great promise that he offered to take a salary cut in exchange for a small equity stake in the business.
But the owners worried that by offering Schultz a job as head of marketing they would be committing themselves to a new direction for Starbucks. At a spring 1982 meeting with the three owners in San Francisco, Schultz once again presented his vision for opening Starbucks stores across the United States and Canada. He flew back to New York thinking a job offer was in the bag. But the next day Baldwin called Schultz and indicated that the owners had decided against hiring him because geographic expansion was too risky and because they did not share Schultz's vision for Starbucks. Schultz was despondent; still, he believed so deeply in Starbucks' potential that he decided to make a last-ditch appeal. He called Baldwin back the next day and made an impassioned, though reasoned, case for why the decision was a mistake. Baldwin agreed to reconsider. The next morning Baldwin called Schultz and told him the job of heading marketing and overseeing the retail stores was his. In September 1982, Howard Schultz took on his new responsibilities at Starbucks.
Starbucks and Howard Schultz: The 198285 Period
In his first few months at Starbucks, Schultz spent most of his waking hours in the four Seattle storesworking behind the counters, tasting different kinds of coffee, talking with customers, getting to know store personnel, and educating himself about the retail aspects of the coffee business. By December, Jerry Baldwin decided that Schultz was ready for the final part of his trainingroasting coffee. Schultz spent a week at the roaster examining the color of the beans, listening for the telltale second pop of the beans during the roasting process, learning to taste the subtle differences among Baldwin and Bowker's various roasts, and familiarizing himself with the roasting techniques for different beans.
Meanwhile, he made a point of acclimating himself to the informal dress code, blending in with the culture, and gaining credibility and building trust with colleagues. Making the transition from the high-energy, coat-and-tie style of New York to the more casual ambience of the Pacific Northwest required a conscious effort on Schultz's part. One day during the busy Christmas season that first year, Schultz made real headway in gaining the acceptance and respect of company personnel at the Pikes Place store. The store was packed and Schultz was behind the counter ringing up sales when someone shouted that a customer had just headed out the door with some stufftwo expensive coffeemakers it turned out, one in each hand. Without thinking, Schultz leaped over the counter and chased the thief up the cobblestone street outside the store, yelling "Drop that stuff! Drop it!" The thief was startled enough to drop both pieces and run away. Schultz picked up the merchandise and returned to the store, holding up the coffeemakers like trophies. Everyone applauded. When Schultz returned to his office later that afternoon, his staff had strung up a banner that read "Make my day."4
Schultz was overflowing with ideas for the company. Early on, he noticed that first-time customers sometimes felt uneasy in the stores because of their lack of knowledge about fine coffees and because store employees sometimes came across as a little arrogant. Schultz worked with store employees on developing customer-friendly sales skills and produced brochures that made it easy for customers to learn about fine coffees.
Schultz's biggest idea for Starbucks' future came during the spring of 1983 when the company sent him to Milan, Italy, to attend an international housewares show. While walking from his hotel to the convention center, Schultz spotted an espresso bar and went inside to look around. The cashier beside the door nodded and smiled. The barista (counter worker) greeted Howard cheerfully, then gracefully pulled a shot of espresso for one customer and handcrafted a foamy cappuccino for another, all the while conversing merrily with those standing at the counter. Schultz judged the barista's performance as "great theater." Just down the way on a side street, he entered an even more crowded espresso bar, where the barista, whom he surmised to be the owner, was greeting customers by name; people were laughing and talking in an atmosphere that plainly was comfortable and familiar. In the next few blocks, he saw two more espresso bars. When the trade show concluded for the day, Schultz walked the streets of Milan exploring espresso bars. Some were stylish and upscale; others attracted a blue-collar clientele. What struck Schultz was how popular and vibrant the Italian coffee bars were. Most had few chairs, and it was common for Italian opera to be playing in the background. Energy levels were typically high, and the bars seemed to function as an integral community gathering place. Each one had its own unique character, but they all had a barista who performed with flair and exhibited a camaraderie with the customers. Schultz was particularly struck by the fact that there were 1,500 coffee bars in Milan, a city about the size of Philadelphia, and a total of 200,000 in all of Italy. His mind started churning.
Schultz's first few days in Milan produced a revelation: The Starbucks stores in Seattle completely missed the point. Starbucks, he decided, needed to serve fresh-brewed coffee, espresso, and cappuccino in its stores (in addition to beans and coffee equipment). Going to Starbucks should be an experience, a special treat; the stores should be a place to meet friends and visit. Re-creating the Italian coffee-bar culture in the United States could be Starbucks' differentiating factor. Schultz remained in Milan for a week, exploring coffee bars and learning as much as he could about the Italian passion for coffee drinks. In one bar, he heard a customer order a caffè latte and decided to try one himselfthe barista made a shot of espresso, steamed a frothy pitcher of milk, poured the two together in a cup, and put a dollop of foam on the top. Schultz concluded that it was "the perfect drink," and thought to himself, "No one in America knows about this. I've got to take it back with me."5
Schultz's Growing Frustration
On Schultz's return from Italy, he shared his revelation and ideas for modifying the format of Starbucks stores with Baldwin and Bowker. But instead of winning their approval, Schultz encountered strong resistance. Baldwin and Bowker argued that Starbucks was a retailer, not a restaurant or bar. They feared that serving drinks would put them in the beverage business and dilute the integrity of Starbucks' mission as a coffee store. They pointed out that Starbucks was a profitable small, private company and there was no reason to rock the boat. But a more pressing reason for their resistance emerged shortlyBaldwin and Bowker were excited by an opportunity to purchase Peet's Coffee and Tea. The acquisition took place in 1984; to fund it, Starbucks had to take on considerable debt, leaving little in the way of financial flexibility to support Schultz's ideas for entering the beverage part of the coffee business or expanding the number of Starbucks stores. For most of 1984, Starbucks managers were dividing their time between their operations in Seattle and the Peet's enterprise in San Francisco. Schultz found himself in San Francisco every other week supervising the marketing and operations of the five Peet's stores. Starbucks employees began to feel neglected and, in one quarter, did not receive their usual bonus due to tight financial conditions. Employee discontent escalated to the point where a union election was called, and the union won by three votes. Baldwin was shocked at the results, concluding that employees no longer trusted him. In the months that followed, he began to spend more of his energy on the Peet's operation in San Francisco.
It took Howard Schultz nearly a year to convince Jerry Baldwin to let him test an espresso bar. After Baldwin relented, Starbucks' sixth store, which opened in April 1984, became the first one designed to sell beverages and the first one in downtown Seattle. Schultz asked for a 1,500-square-foot space to set up a full-scale Italian-style espresso bar, but Jerry agreed to allocating only 300 square feet in a corner of the new store. There was no pre-opening marketing blitz and no sign announcing Now Serving Espressothe lack of fanfare was part of a deliberate experiment to see what would happen. By closing time on the first day, some 400 customers had been served, well above the 250-customer average of Starbucks' best-performing stores. Within two months the store was serving 800 customers per day. The two baristas could not keep up with orders during the early morning hours, resulting in lines outside the door onto the sidewalk. Most of the business was at the espresso counter; sales at the regular retail counter were only adequate.
Schultz was elated by the test results; his visits to the store indicated that it was becoming a gathering place and that customers were pleased with the beverages being served. Schultz expected that Baldwin's doubts about entering the beverage side of the business would be dispelled and that he would gain approval to take Starbucks to a new level. Every day he went into Baldwin's office to show him the sales figures and customer counts at the new downtown store. But Baldwin was not comfortable with the success of the new store; he believed that espresso drinks were a distraction from the core business of selling fine arabica coffees at retail and rebelled at the thought that people would see Starbucks as a place to get a quick cup of coffee to go. He adamantly told Schultz, "We're coffee roasters. I don't want to be in the restaurant business . . . Besides, we're too deeply in debt to consider pursuing this idea."6 While he didn't deny that the experiment was succeeding, he didn't want to go forward with introducing beverages in other Starbucks stores. Schultz's efforts to persuade Baldwin to change his mind continued to meet strong resistance, although to avoid a total impasse Baldwin finally did agree to let Schultz put espresso machines in the back of two other Starbucks stores.
Over the next several months, Schultzat the age of 33made up his mind to leave Starbucks and start his own company. His plan was to open espresso bars in high-traffic downtown locations that would emulate the friendly, energetic atmosphere he had encountered in Italian espresso bars. Schultz had become friends with a corporate lawyer, Scott Greenberg, who helped companies raise venture capital and go public. Greenberg told Schultz he believed investors would be interested in providing venture capital for the kind of company Schultz had in mind. Baldwin and Bowker, knowing how frustrated Schultz had become, supported his efforts to go out on his own and agreed to let him stay in his current job and office until definitive plans were in place. Schultz left Starbucks in late 1985.
Schultz's Il Giornale Venture
Ironically, as Schultz was finalizing the documents for his new company, Jerry Baldwin announced he would invest $150,000 of Starbucks' money in Schultz's coffee-bar enterprise, thus becoming Schultz's first investor. Baldwin accepted Schultz's invitation to be a director of the new company, and Gordon Bowker agreed to be a part-time consultant for six months. Bowker urged Schultz to make sure that everything about the new storesthe name, the presentation, the care taken in preparing the coffeewas calculated to lead customers to expect something better than competitors offered. Bowker proposed that the new company be named Il Giornale (pronounced ill jor-nahl-ee ) Coffee Company, a suggestion that Schultz accepted. In December 1985, Bowker and Schultz made a trip to Italy during which they visited some 500 espresso bars in Milan and Verona, observing local habits, taking notes about decor and menus, snapping photographs, and videotaping baristas in action.
Greenberg and Schultz
then drew up plans to raise an initial $400,000 in seed capital and another
$1.25 million in equityenough to launch at least eight espresso
bars and prove the concept would work in Seattle and elsewhere. The seed
capital was raised by the end of January 1986, primarily from Starbucks
and two other investors who believed in Schultz and his ideas, but it
took Schultz until the end of the year to raise the remaining $1.25 million.
He made presentations to 242 potential investors, 217 of whom said no.
Many who heard Schultz's hour-long presentation saw coffee as a commodity
business and thought that Schultz's espresso-bar concept lacked any basis
for sustainable competitive advantage (no patent on dark roast, no advantage
in purchasing coffee beans, no way to bar the entry of imitative competitors).
Some noted that consumption of coffee had been declining since the mid-1960s,
others were skeptical that people would pay $1.50 or more for a cup of
coffee, and still others were turned off by the company's hard-to-pronounce
name. Being rejected by so many potential investors was disheartening
(some who listened to Schultz's presentation
One of Howard Schultz's earliest moves during the start-up process was to hire Dave Olsen, who in 1974 had opened a coffee bar, Café Allegro, near the busiest entrance to the University of Washington campus. Olsen was a long-standing Starbucks customer, having discovered the quality of Starbucks' coffee beans, gotten to know the owners, and worked with them to develop a custom espresso roast for use in his café. Olsen's successful Café Allegro had become known for café au lait, a concoction equivalent to the Italian caffè latte. When Olsen heard of Schultz's plans for Il Giornale, he called Schultz and expressed an interest in being part of the new companyhe was intrigued by the Italian coffee-bar concept and was looking for a more expansive career opportunity. Olsen not only had coffee expertise but also had spent 10 years in an apron behind the counter at Café Allegro. Schultz immediately picked up on the synergy between him and Olsen. His own strengths were in forming and communicating a vision, raising money, finding good store locations, building a brand name, and planning for growth. Olsen understood the nuts and bolts of operating a retail café, hiring and training baristas, and making and serving good drinks. Plus, Olsen was fun to work with. Schultz put Olsen in charge of store operations, made him the coffee conscience of the company, and gave him the authority to make sure that Il Giornale served the best coffee and espresso possible.
The first Il Giornale store opened in April 1986. It had a mere 700 square feet and was located near the entrance of Seattle's tallest building. The decor was Italian, the menu contained Italian words, and Italian opera music played in the background. The baristas wore white shirts and bow ties. All service was stand-upthere were no chairs. National and international papers hung from rods on the wall. By closing time on the first day, 300 customers had been served, mostly in the morning hours. Schultz and Olsen worked hard to make sure that all the details were executed perfectly. For the first few weeks, Olsen worked behind the counter during the morning rush.
But while the core idea worked well, it soon became apparent that several aspects of Il Giornale's format weren't appropriate for Seattle. Some customers objected to the incessant opera music, others wanted a place to sit down, and many didn't understand the Italian words on the menu. These "mistakes" were quickly fixed, without compromising the style and elegance of the store. Within six months, Il Giornale was serving more than 1,000 customers a day and regulars had learned how to pronounce the company's name. Because most customers were in a hurry, it became apparent that speedy service was a competitive advantage.
Six months after opening the first store, Il Giornale opened a second store in another downtown building. A third store was opened in Vancouver, British Columbia, in April 1987. Vancouver was chosen to test the transferability of the company's business concept outside Seattle. To reach his goal of opening 50 stores in five years, Schultz needed to dispel his investors' doubts about geographic expansion. By mid-1987 sales at the three stores were equal to $1.5 million annually.
Il Giornale Acquires Starbucks
In March 1987 Jerry Baldwin and Gordon Bowker decided to sell the whole Starbucks operation in Seattlethe stores, the roasting plant, and the Starbucks name. Bowker wanted to cash out his coffee-business investment to concentrate on his other enterprises; Baldwin, who was tired of commuting between Seattle and San Francisco and wrestling with the troubles created by the two parts of the company, elected to concentrate on the Peet's operation. As he recalls, "My wife and I had a 30-second conversation and decided to keep Peet's. It was the original and it was better."7
Schultz knew immediately that he had to buy Starbucks; his board of directors agreed. Schultz and his newly hired finance and accounting manager drew up a set of financial projections for the combined operations and a financing package that included a stock offering to Il Giornale's original investors and a line of credit with local banks. While a rival plan to acquire Starbucks was put together by another Il Giornale investor, Schultz's proposal prevailed and within weeks Schultz had raised the $3.8 million needed to buy Starbucks. The acquisition was completed in August 1987. After the papers were signed, Schultz and Scott Greenberg walked across the street to the first Il Giornale store, ordered themselves espresso drinks, and sat at a table near the window. Greenberg placed the hundred-page business plan that had been used to raise the $3.8 million between them and lifted his cup in a toast"We did it," they said together.8 The new name of the combined companies was Starbucks Corporation. Howard Schultz, at the age of 34, became Starbucks' president and CEO.
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