Starbucks an Alex poole strategy case-full text

Starbucks: An Alex Poole Strategy Case

Alex sighed heavily and rubbed his tired eyes. It was the fourth time in the past hour he had read the letter from his grandfather. I dont know what to do, Alex thought. I wish Gramps could

have put someone else in charge of his estate. What if I make a mistake? Then what will Grandma do? Alex Poole was a senior in college, working on a double major in Finance and Management, and a minor in Chinese. He hoped to land a job with a large, multinational company after graduation and move to Hong Kong or Singapore. He was determined to get his foot in the door at a Fortune 100 company no matter how hard he had to work. Alex was used

to hard work. For the past three years, he had held down a part-time job while attending school full time. His philosophy was that he could afford to go to school only if he earned enough money to cover his expenses, so he would find a way to do it.

Alex shuffled some papers on his Grandfathers desk and pulled up the stock chart on Starbucks on his MacBook. This chart is amazing, he thought. After going public at a split-adjusted

$0.53 per share in June 1992, the stock had taken off. A person who had invested $1,000 in Starbucks in the initial public offering would have had shares worth nearly $22,000 on the same day 10 years later. The stock continued its run until late 2006 when the combination of the Great Recession and internal problems caused it to fall from a high of $39.43 per share to a low of $6.80 per share in November 2008. The Board brought Howard Schultz, the iconic founder of Starbucks back as CEO in January 2008 as the company faltered. Schultz engineered a spectacular turnaround of the company. As of November 2013, the stock traded at over $80 per share.

Gramps sure was a savvy investor. When everyone else was saying Starbucks was roasted, he bought the stock. Alex thought. But now what should I do? I could sell it and take profits, but Grandma will end up paying a lot of taxes. I dont know where to put the cash either. If I hold on to it and the stock goes down a lot, Ill feel terrible. Alex yawned and rubbed his eyes again. I guess Id better get some sleep and try to figure it out tomorrow. I think Ill stop by the Starbucks on the corner in the morning and check it out. If its crowded, Ill feel better.

WRRAANNNN! WRRAANNNN! WRRAANNNN! WRRAANNNN! Alex groaned, rolled over

and tried to hit the snooze button on his Clocky alarm clock. The Clocky expertly evaded his hand, rolled off the night table, and on to the floor. In order to cut off the ear-piercing shriek of the alarm clock, Alex was forced to roll out of bed and chase it around the room. Sarah, Alexs girlfriend, had given him the alarm clock after a couple of close shaves in which Alex slid into his seat next to her their 7:30AM investments class just in time to take the weekly quiz. The

professor took missing a quiz as a personal affront and was likely to cold call the miscreant on multiple occasions to ensure the point about being prepared and on time for class was hammered home. Students rarely missed more than one quiz.

Once Alexs brain woke up enough to process information, he realized that it was Saturday so he didnt need to rush to class. He took a quick shower, got dressed and laced up his Asics running shoes. After a brisk 3 mile run, he stopped in at the Starbucks on the corner for coffee and a snack. There was a line of customers waiting, but it was moving fairly quickly. Once he made it

to the head of the line, the Barista at the register greeted him by name with a bright smile and asked how his day was going. Alex ordered a Venti Starbucks Blonde Roast with a slice of iced lemon pound cake. Hed heard a rumor that the chain planned to cut the lemon pound cake from the menu, but it was still available. Prior to the addition of the distinctly lighter flavored Blonde Roast, Alex rarely shopped at Starbucks. He was one of the estimated 40% of Americans that felt

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Starbucks traditional coffee offerings were too dark and too bitter[1] for his taste. The launch of Starbucks Blonde Roast along with its recent converts wanted ad campaign had persuaded Alex to give the new coffee a try. Now, he was hooked on Starbucks and often joked about needing his Starbucks fix to make sure he had a good day.

While he sipped his coffee, Alex pulled out his iPhone 4S and began to surf the Internet for recent news on Starbucks. After reading the companys press release on 3Q:13 earnings, he moved over to https://www.360docs.net/doc/f912203921.html, to try to gauge investors reactions to Starbucks better-than-anticipated earnings. As usual, the opinions on the stock ranged from buy, buy, buy to great company but overvalued stock. That didn’t help a whole lot. Alex thought. Gramps always said the

companys management team, brand franchise, and business model were a lot more important than the stocks valuation or Wall Street sentiment. He thought a companys balance sheet was super important too. I guess I had better figure out what this company does besides serve a great cup of coffee. I know Gramps thought Howard Schultz was one of the best business leaders of all time, but I sure dont know much about him. Alex waved good-bye to the Barista and headed out the door. He intended to spend the afternoon in his universitys library digging up as much information as possible on Starbucks.

Over the next week, Alex had amassed a lot of information on Starbucks. After visiting the library, Alex had gone back to his apartment and pulled out his previously unread copy of Howard Schultz’s book, Onward. He had been meaning to read it for months, but hadn’t gotten around to it due to his schoolwork and Gramps passing. In the course of his research, Alex found out that Howard Schultz was not the founder of the original coffee roasting and retail business named Starbucks. Schultz purchased the six Starbucks stores and the brand name for $3.8 million in 1987 from the company’s founders. Alex thought about what he had read about Howard Schultz how he had joined Starbucks as its head of marketing in 1982 and had fallen in love

with Italian coffee bars at a trade show in Italy 1983. Schultz was enchanted by the connection between the customers and coffee bar employees. saw something. Not only the romance of coffee, but ... a sense of community. And the connection that people had to coffeethe place and one another, Schultz recalled in a 2013 interview with The Biography Channel. And after a

week in Italy, I was so convinced with such unbridled enthusiasm that I couldn't wait to get back

to Seattle to talk about the fact that I had seen the future.

Schultz persuaded the owners of Starbucks to let him install a coffee bar in one location. Despite the success of the coffee bar test, Starbucks founders were not interested in transforming the company into a restaurant. They had served coffee throughout the 1970s, and even had an

espresso machine in the stores. Nevertheless, Starbucks founders felt the restaurant industry was an unattractive one. Schultz reckoned that Italys 200,000 coffee bars serving a population of just

55 million people meant the US market had huge potential to support his vision of what he called

a third place. The third place would be place outside of the home and the office that would

allow people to congregate and gain a sense of community. Schultz left Starbucks to start his own coffee business, Il Giornale in 1985. Two years later, he purchased Starbucks and merged it with Il Giornale.

The weird thing about it, Alex thought is that anyone would want to be in the coffee business

in the 1980s. From what I can tell, it was a pretty unattractive market. Alex glanced down at

the chart on US coffee consumption [3] he had put together and shrugged his shoulders. According to the USDA data, Americans consumed about 33 gallons of coffee per capita in 1970. By 1987, annual per capita coffee consumption was down to about 27 gallons. That translated into a large drop in the number of cups of coffee Americans drank per day. The decline had started way back in 1962, when Americans consumed 3.12 cups of coffee per day. By 1980,

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average per capita coffee consumption was down to about 2.0 cups per day. US average per capita coffee consumption fell to a new all-time low of 1.67 cups per person per day in 1988. [4] How could someone look at a declining product market a market in which in one generation usage had fallen to 52% of the population from nearly 75% of Americans [5] and see a phenomenal business opportunity? Alex wondered.

Moreover, the competition at retail was brutal. Three large companies -- Procter & Gamble (Folgers), General Foods (Maxwell House, Sanka), and Nestle (Nescafe, Tasters Choice, Hills Brothers) -- dominated the retail coffee business with a combined market share of over 80%. [6] As coffee consumption declined, the roasting companies often relied upon promotions and price cuts to stimulate demand. Moreover, retail prices tended to be tied to volatile coffee commodity prices, as roasters were unable to hold off demands by powerful supermarket buyers to cut prices when bean prices fell. To protect margins, roasters hiked retail prices when bean prices soared, but the price hikes hurt demand and were difficult to maintain. Although discerning Americans began to get interested in high quality coffees at the beginning of the decade, specialty coffee only accounted about $750 million in sales in 1990 or roughly 10% of the market, up from 3% of the market or $210 million in 1983[7] and $50 million in 1979. [8]

Source: USDA Economic Research Service

Against that backdrop, Howard Schulz invented the modern Starbucks transforming the coffee roasting company into a retailer that was backward vertically integrated into coffee bean purchasing and roasting. Alex reflected on the incredible success the new concept had enjoyed during its first 20 years. By 1997, Starbucks revenues had grown to $975 million and the balance sheet showed positive net cash position (cash minus debt) of $42 million. About 86% of revenues were derived from the companys 1,325 retail stores. Starbucks tested sales of coffee through 10 West Coast supermarkets expanding to 4,000 grocery stores the next year. By the end of its next decade, Starbucks had over 15,000 company-owned and licensed stores. 2007 revenues came in at $9.4 billion accompanied by operating income of over $1 billion for an operating profit margin of 11.2%. Return on invested capital was an impressive 17.7% in 2007 despite the companys whopping $282 million in cash. The companys average annual sales

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growth of 57% along with its 65% average yearly jump in operating profits over the decade put Starbucks squarely in an elite class of American success stories such as Wal-Mart.

That is right when things turned sour for Starbucks. Alex thought. Howard Schultz stepped

down as CEO in 2000 and took a much less active role in day-to-day operations as the companys Chairman. Store traffic began to slow early in 2007. By Fall 2007, cracks appeared in Starbucks business model. The company announced in November 2007 that traffic at its US stores had fallen for the first time. The company also lowered its projected store openings for fiscal 2008 and lowered its estimates on comparable store sales growth (sales growth in stores open 12 months or longer). Starbucks was feeling the effects of the stagnant economy. At the same time, Starbucks was struggling to offset rising dairy and labor costs, and trying to fight off strong competitive pressure from McDonalds and Dunkin Donuts. The stock dropped nearly 50% in 2007.

Comps, Alex thought. Comps were the companys downfall at least thats what Schultz said

in his book. Alexs Grandfather had given him a copy of the book last Christmas. He had inscribed, To Alex, I hope Howard Schultzs extraordinary leadership and his passion will

inspire you. Love, Gramps. Alex choked up a bit thinking about Gramps and how much he

had tried to stand-in for Alexs Dad. Alex had lost his Dad in a car accident, when Alex was in

the 3rd grade. Alex cleared his throat and went back to reviewing his notes on Starbucks. Comps had gotten really ugly in 2008. Alex thought.

Source: Starbucks 2012 10-K.

Schultz and the Starbucks team spent months diagnosing Starbucks problems. As Schultz noted in Onward, The more rocks we turned over, the more problems we discovered.[9] Operating margins had slumped from a peak of 12.3% in 2005 to 11.2% in 2007, but earnings still increased. That all changed in 2008, when operating earnings plunged nearly -27% excluding restructuring charges, and -52% including charges. Schulz went on to say, From where I sat as

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CEO, the pieces of our rapid decline were coming together in my mind. Growth had been a carcinogen. When it became our primary operating principle, it diverted attention from revenue and cost-saving opportunities, and we did not effectively manage expenses such as rising construction costs and additional monies spent on new equipmentThen, as customers cut their spending, we faced a lethal combination rising costs and sinking sales which meant

Starbucks economic model was no longer viable.[10] Although Starbucks had a sizable presence in international markets, the US still accounted for 76% of company revenues. The US had to be fixed in order to turn around the company.

Schulz spent the next couple of years refocusing Starbucks on the coffee business. He cut breakfast items from the menu, and got managers to think about customer service and selling coffee. Schultz closed all the US stores for a day and retrained baristas on preparing the perfect cup of espresso. He also replaced top management and built up the companys capabilities in supply and logistics. The management team tackled major inefficiencies in the supply chain as well as in the stores. Stores were redesigned to improve efficiency and reduce on the job injuries. He also emphasized the Starbucks experience and the importance of being passionate about coffee. Despite significant pressures from Wall Street, Schultz refused to drop health care benefits for part-time employees as he recognized the barista was one of the fundamental drivers of company performance. Starbucks also closed nearly 1,000 underperforming stores and laid off about 12,000 workers. It slowed dramatically the rate of store expansion from about 1,300 per year in the US to about 300. After a painful few years, the company came roaring back with outstanding results. Schultz vowed never to allow the company to make the same mistakes again. Alex Meets With His Broker

Two weeks later, Alex pushed his books aside and opened his Starbucks folder on his MacBook. He sipped his Tall Salted Caramel Mocha and looked around the Starbucks store. There was a steady stream of customers even at 2:00 in the afternoon on a Monday. Alex had arranged a meeting with his Grandfathers stockbroker, and the broker was 10 minutes late. He glanced down at his blue steel ESQ Movado watch, checked the time for the hundredth time, and drummed his pen on the table impatiently. Gramps broker was an old pro - a self-made man with a flair for stock picking. Gramps and the broker, Harry Wallace, had been close friends. They were both members of the local Rotary Club and avid golfers.

Alex, howve you been? Alex looked up and saw Harry Wallace walking toward him, hand outstretched. After the two had exchanged greetings and small talk, Alex got down to business. Harry, Im trying to sort out Gramps portfolio. His largest position is in Starbucks, so I started

there. Alex said. He went on, I need to figure out whether to sell the stock or not. Ive done

quite a bit of research on it already but it would help if you filled in the details on the companys strategy for me. Alex said.

Sure, Id be happy to. Harry said. The stock had been hitting all-time highs until it hit a bump

in the road when an arbitrator decided that Starbucks would have to pay Kraft $2.23 billion plus $537 million in attorneys fees to settle a 3-year old fight between the two companies. Starbucks and Kraft had been partners in the packaged coffee business since 1998. Starbucks supplied the coffee and the brand name. Kraft supplied the distribution to mass retail outlets. In 2004, the two companies re-negotiated their contract and extended it to 2014. In 2010, Starbucks terminated the agreement and claiming Kraft had not upheld its part of the bargain and had failed to work closely with it on marketing decisions and customer contacts. [11] Harry went on to say, Starbucks claimed Kraft had hurt the performance of the Starbucks brand at retail, but Kraft pointed out that it had grown the companys packaged coffee business from$50 million in sales to $500 million in sales. Starbucks maintained terminating the Kraft agreement early was the right thing to do to

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accelerate the growth of its mass retail business. Harry added, The stock sold off -1.5% on the news before rebounding the next day as Starbucks convinced investors that it had ample funds to make the payment.

The companys revenue and earnings growth had been pretty astonishing over the past couple of years as it pulled out of its 2008, 2009 slump. In the short term, the risk in the stock was that investors are looking for another positive earnings surprise when the company commented on holiday sales in a few weeks in Harrys opinion.

Im not all that interested in the short term outlook. You know Gramps always focused on a companys long term prospects. Alex said. Tell me how things look for Starbucks over the

next couple of years. Starbucks has approached long-term growth in a unique way. The way I see it, the companys so-called blueprint for growth has a lot of potential to keep the companys growth high.

Starbucks Blueprint For Profitable Growth

In late 2010, Starbucks management announced plans to create long-term shareholder value through a new blueprint for profitable growth. Howard Schultz said, Our next phase of

growth will come from extending the Starbucks Experience to our customers beyond the third place to every part of their day, through multiple brands and channels. Starbucks US retail business and our connection with our customers form the foundation on which we build all of our lasting assets, and we will combine that with new capabilities in multiple channels to accelerate the model weve created that no other company can replicate. Starbucks Chief Financial Officer, Troy Alstead, went on to say, Starbucks has reached a critical juncture as we move from a high unit growth specialty retailer focused on coffee in our stores, to a global consumer company with diversified growth platforms across multiple channels. [12]

In short, Starbucks intended to introduce new products and brands in its Starbucks retail stores, establish a base of customers for the new items, and later expand distribution to mass-market channels like grocery stores. The company meant to transform itself from a specialty retailer selling a few coffee and tea products through mass outlets into a global consumer products powerhouse. To do so, Starbucks planned to augment its proven model for new brand development with vertical integration, and acquisitions. Management was confident it would be able to build a stable of billion dollar brands by following the model Starbucks developed with

two key products - Frappuccino and VIA.

Frappuccino was a coffee blended with ice and milk. The sugary beverage became enormously popular with Starbucks devotees immediately after its summer 1995 introduction. Frappuccino

built up a following in Starbucks stores before Starbucks and Pepsi pushed a bottled version of the product into mass retail outlets. Schultz credited a large part of Frappuccinos retail success to Starbucks having the unique opportunity every single day to reinforce the equity of the Frappuccino blended product in our stores.[13] The $2 billion global brand commanded nearly two-third of the US iced coffee category in 2012.

Similarly, Starbucks introduced VIA instant coffee in its stores in 2009. According to Howard Schultz, the product introduction marked the first innovation other than in packaging in the instant coffee market in 50 years. [14] Schultz regarded the category as one that was ripe for renewal.[15] Although the US market for instant coffee was relatively small at about $700

million in 2009, Shultz regarded the product extension as a critical one for the company. He felt it would spur innovation within the company, put Starbucks into new retail channels like specialty sporting goods stores, and support the companys objective to be the undisputed coffee authority.

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The instant coffee market accounted for about 40% of worldwide coffee consumption and generated an estimated $21 billion per year in sales. Higher end instant coffees generated less than 20% of instant coffee sales globally, which suggested to Schultz the category was a candidate for premiumization - just as the US coffee market had been prior to Starbucks entry into the market.

In addition, instant coffee consumption had grown at a much faster clip in emerging markets than in the US, where sales of the product were flat. Global Coffee Review magazine pegged worldwide instant coffee growth at 7%-10% and 15%-20% in emerging markets from 2000-2012.

[16] Coffee drinkers in emerging markets favored instant or soluble coffee over brewed coffee, because consumers often could not afford special coffee making equipment. Starbucks management reckoned that it could establish the VIA brand in the US in its own stores, expand into mass retailing, and then move the brand into Starbucks stores in the UK and Japan, and in emerging markets. (Instant coffee accounted for about 80% of all coffee sales in the UK and 63% of sales in Japan.)

Schultz believed Starbucks could use technology to produce a cup of instant coffee that would taste the same as a cup of Starbucks brewed coffee. The challenge for Starbucks was three-fold. First, the company had to overcome the stigma of instant coffee being associated with weak, low quality, poor tasting coffee in the US. Second, Starbucks had to convince consumers to pay a hefty premium for VIA, which retailed for $0.82-$0.98 per serving. Other instant coffees could

be purchased for as little as $0.04-$0.07 per serving of coffee. Folgers Instant Coffee Singles were priced at $0.20 per serving. Third, the company had to overcome substantial competition in the segment, once it launched the product into supermarkets and other mass outlets.

In order to change consumer perceptions of instant coffee, the company employed extensive use of sampling in its own stores to encourage consumers to taste VIA side by side with Starbucks brewed coffee. The taste tests continued for a year before Starbucks rolled out the product into grocery and other mass retail stores. The company also sent baristas into its network of 3,000 licensed store-within- a- store Starbucks locations in retailers such as Target and Safeway to give out millions of VIA samples to customers. Starbucks created free publicity for the brand by inviting reporters to participate in blind taste tests comparing Starbucks brewed coffee to VIA instant coffee. The evidence from the taste tests overwhelmingly supported Starbucks claim that VIA was a convenient, less expensive version of a Starbucks coffee rather than a low quality, watered down version of real coffee. (An 8-ounce serving of brewed coffee in Starbucks stores cost $1.50 in 2009.) In April 2012, the Huffington Post conducted a blind taste test of instant

coffees and concluded that VIA Columbia was not only the best instant coffee on the market, but was indistinguishable from regular brewed coffee. [17]

Starbucks had to compete against well-established brands in the US and elsewhere. Nestle, the worldwide leader in instant coffee and inventor of the product, held about 34% of the US instant coffee market in 2010. Kraft General Foods (Maxwell House) was number two in the market with a share of about 26%, followed by JM Smacker (Folgers) with about a 21% share. Nestle had used its first mover status to its advantage - holding 51% of the global market for instant coffee. In fact, Nestle was the largest manufacturer of packaged coffee in the world with nearly a 22% global share due largely to its huge presence in the instant coffee market. Nevertheless, Starbucks grabbed more than 10% of the US instant coffee market in VIAs first year on the market.

Starbucks aimed to turn VIA into a $1 billion dollar brand by leveraging its international presence and taking on Nestle head to head. The company launched VIA in the Chinese market in April