Howard Schultz and the coffee experience
August 2007 (The New Business Road Test)
This case study looks at the history of Starbucks, and how the creator of the company as we now know it, Howard Schulz, was able to drive its expansion.
In 2002, Starbucks operated coffee bars in 20 countries and had grown from its roots as a specialty coffee roaster and retailer in Seattle to one of the world’s best known brands. Howard Schultz made it happen. Here is his story.
Schultz’s passion for coffee awakens in SeattleSchultz grew up a child of ‘working poor’ parents, as he would say later, in the Bayside Projects in Brooklyn, New York. After finding his way to college on an athletic scholarship, he graduated and began his career in 1976 as a sales trainee for Xerox. Realizing his indifference towards word processors and office equipment, Schultz went after three years at Xerox to Perstorp, a Swedish company with product lines in building supplies and consumer durables for the home. While selling Perstorp’s kitchen components in North Carolina, Schultz again found himself less than excited about his product line. It was not until he took the position of vice president and general manager of Hammarplast, Perstorp’s housewares subsidiary, that he became more enthusiastic about the products he sold, stylish Swedish designed kitchen gear.
In 1981, while working for Hammarplast, Schultz noticed that one particular retailer – a Seattle-based company called Starbucks Coffee, Tea, and Spice – consistently purchased large quantities of his drip coffeemakers. In 1981, while working for Hammarplast, Schultz noticed that one particular retailer – a Seattle-based company called Starbucks Coffee, Tea, and Spice – consistently purchased large quantities of his drip coffeemakers.
Starbucks was a coffee drinker’s paradise, selling some 30 different varieties of whole-bean, mountain-grown arabica coffees – from Sumatra, Kenya, Costa Rica and more – as well as high-end coffeemakers. While the store encouraged customers to taste the coffee, they did not sell coffee by the cup.
Schultz was enamoured with the company’s coffee, and was even more impressed with the passion that Jerry Baldwin, one of Starbucks’ three partners, felt toward his product. ‘I had never heard anyone talk about a product the way Jerry talked about coffee’. Schultz was hooked, and he returned to New York determined to find a way to work for Starbucks.
Risk number oneOver the next year, Schultz found ways to spend some time with Baldwin. He believed Baldwin’s concept would sell in New York, Chicago, Boston, everywhere. And Schultz had the marketing experience and drive to help grow the business. He wanted in. At last, over dinner in San Francisco in the spring of 1982 with Starbucks’ partners, Schultz thought he had won the job. But, on the phone the next day, Baldwin called with bad news. ‘I’m sorry, Howard. It’s too risky. Too much change.’ Schultz was shell-shocked. ‘I saw my whole future pass in front of me and then crash and burn’.8 The next day, Schultz called Baldwin and reminded Baldwin of his own vision for Starbucks. A day later, Schultz had the job, along with a steep cut in pay and a tiny slice of equity in the company.
In 1983, Starbucks sent Schultz to Milan for a housewares show. During that visit, he experienced the Italian coffee bar culture. This Italian ritual of drinking coffee and socializing intrigued Schultz. ‘Coffeehouses in Italy are a third place for people, after home and work. There’s a relationship of trust and confidence in that environment’. Schultz discovered that there were 200,000 coffee bars in Italy, with some 1500 in Milan alone. He became fascinated with the idea of bringing such a concept and culture to the USA. ‘The connection to the people who loved coffee did not have to take place only in their homes, where they ground and brewed whole-bean coffee. What we had to do was unlock the romance and mystery of coffee, firsthand, in coffee bars’. ‘Coffee bars are the mainstay of every Italian neighborhood’, he said, ‘That’s what I wanted to bring back to Seattle’.
Schultz returned from Milan and pitched the coffee bar idea to the Starbucks partners. Their initial response was a resounding no. They did not want to enter into what they considered the restaurant business, not the best of industries in their view. Schultz finally convinced the partners to add a small espresso bar in their sixth store, which would open in April 1984. Within two months, the store was serving 800 customers a day, compared with the traditional Starbucks stores that averaged 250 customers a day. But even with impressive numbers to support his idea, Schultz could not convince the company’s partners to try the coffee shop concept further. ‘I felt torn in two by conflicting feelings: loyalty to Starbucks and confidence in my vision for Italian-style espresso bars’.
Risk number twoIn 1985, Schultz made one of the toughest decisions in his still-young career. He decided to leave Starbucks to start what seemed to be a very uncertain coffee bar business. At the time, coffee was a seemingly risky game. With the recent disclosure of health risks associated with caffeine, consumption of coffee had been falling in the USA since the 1960s, hardly the most exciting of markets.
At the time, Schultz’s wife was pregnant with their first child and he needed an initial $400,000 in seed capital to open his first store and get the business started – money he simply did not have. As Schultz was planning how to raise the money, Starbucks stepped forward to invest $150,000 in Schultz’s venture, and Jerry Baldwin agreed to serve on the board. Gordon Bowker, Baldwin’s partner in Starbucks, also agreed to help. Shortly thereafter, Schultz received another $100,000 from a local doctor, who said, ‘It appears to me that people who succeed have an incredible drive to do something . . . They spend their energy to take a gamble. In this world, relatively few people are willing to take a large gamble’.
By the time Schultz’s son was born in January 1986, Schultz had raised the rest of the money he needed to open the first store. His real goal, though, was another $1.25 million to open seven more stores and to prove that the idea would work on an extended scale. It took an entire year to raise all the money, during which Schultz approached 242 potential investors, 217 of whom turned him away. Over the course of a year, he raised $1.65 million from about 30 investors, enough to open eight coffee bars. Schultz said, ‘If you ask any of those investors today why they took the risk, almost all of them will tell you that they invested in me, not in my idea’.
Schultz opened the first Il Giornale, as his new coffee bars were called, on 8 April 1986. Il Giornale meant ‘the daily’ in Italian and was the name of the largest newspaper in Italy. On its first day in business, Il Giornale served 300 customers. Within six months, the store was serving 1000 customers a day. Even with just one store, Schultz was dreaming big. ‘At the time, our plans seemed impossibly ambitious. Even then, when nobody had heard of Il Giornale, I had a dream of building the largest coffee company in North America, with stores in every major city’.
The first Il Giornale was not a perfect success. Schultz soon realized that Italian opera was not the preferred music of American coffee drinkers. He also learned that the shops should include seating for those customers wishing to relax and stay awhile. Learning from these mistakes, Schultz opened his next Il Giornale six months after the first in a downtown Seattle high-rise office tower. By mid-1987, there were three Il Giornale stores, and each store was generating approximately $500,000 in annual sales.
Risk number threeIn March 1987, with the first Il Giornale having been open for less than a year, Jerry Baldwin and Gordon Bowker decided to sell their six Starbucks stores, roasting plant and name. Jerry wanted to concentrate on Peet’s, a small chain of stores selling beans and ground coffee that Starbucks had acquired. ‘As soon as I heard, I knew I had to buy Starbucks. It was my destiny’, said Schultz. But it would take nearly $4 million to do it. Having seen Starbucks struggle under an excessive debt burden when it bought Peet’s, Schultz knew the new money would have to be raised through the sale of equity, in spite of the fact that it would dilute his ownership of and control over the business. Schultz looked again to investors, including those who had invested in Il Giornale and others who had passed, to raise the needed capital. His pitch to investors was one of pure passion:
How many things do people in America drink every day? Coffee is such a social beverage, a personal beverage. There’s the romance of coffee, its history. We had an opportunity to utilize the relationship I saw in Italy, the safe haven of the coffee bar, and package it with undeniably great coffee and service that is completely different from most establishments in America. I mean, we can change how people start their day.
The rest of the story
Schultz realized that taking over a company was not an easy task. His initial goals were twofold: to win the support of the existing Starbucks employees, and to hire a winning team of managers. In his first meeting with the Starbucks employees, Schultz announced his mission of building a national company whose values and guiding principles they all could be proud of. Schultz had to make sure the existing employees were on board in order to move forward with his plans. He also recognized that as his company grew, he would need to rely on the expertise of others. ‘I knew I had to go out and hire executives with greater experience than I had’.
Schultz did just that. He hired a number of experienced people to lead his management team. He lived by a simple philosophy: ‘Hire people smarter than you are and get out of their way’.18 Finding and retaining top people was one of Schultz’s ways to lay a solid foundation for growth.
In October 1987, Schultz and his team opened the first store under the Starbucks name in Chicago. It was their first attempt away from the west coast. In the following six months, three more stores opened in Chicago. The results were less than stellar. With distribution and logistics costs added in, the cost of goods sold was much higher in Chicago than in Seattle. And, Chicagoans showed less interest in the coffee shop experience than their Seattle compatriots. In 1987, the company lost $330,000.
But those financial losses didn’t faze Schultz and his team. Schultz could show investors the attractive unit economics at each store to convince them the business model was viable. Overall losses were necessary in order to invest in the people and systems necessary for his company to reach its potential. Investors could also see that the specialty coffee business all over the country, both in supermarkets and coffee bars, was becoming as hot as a freshly brewed cup of espresso. Starbucks kept growing:
• In 1988, Starbucks opened 15 new stores and developed its first mailorder catalogue, but losses grew to $764,000 for the year.
• In 1989, the company opened more stores and lost another $1.2 million.
• In 1990, with another 30 new stores, the company turned profitable.
By that time, the company had received three major rounds of private funding: the $3.8 million to acquire Starbucks, $3.9 million in early 1990 to finance additional growth, and $13.5 million later in 1990 from venture capital investors who saw the potential that the Starbucks story represented.
By 1992, Starbucks’ revenues were rising at approximately 80 per cent per year. In June of that year, Starbucks went public, raising $29 million to support even faster growth in new stores. At the time of its initial public offering, Starbucks had 2000 employees and 600,000 customers weekly. That year, 53 additional stores were opened, bringing the grand total of Starbucks coffee bars to 140.
By 1993, Starbucks ranked among the 40 fastest growing companies in the USA according to Fortune magazine. And the company was not just a model for growth. In 1994, Schultz received an award from the Business Enterprise Trust for courage, integrity and social vision in business. And the growth continued:
• In 1997, Starbucks’ revenues exceeded $1 billion.
• A year later, the company had 1500 outlets and 25,000 employees, and was beginning to sell its coffee in supermarkets.
• By 1999, stores were averaging $800,000 in annual revenue and there were 80 Starbucks stores in Great Britain and 53 stores in Japan.
In 2000, Schultz decided to cede his CEO position to his president and COO, Orin Smith. Not ready to leave Starbucks, Schultz remained as chairman and chief global strategist. The company didn’t miss a beat:
• By the end of 2001, Starbucks was serving 2 million customers a week from its 5000 outlets worldwide, and had delivered 121 consecutive months of positive comparative store sales.
• That year, profits grew by 92 per cent to $181.2 million on sales of $3 billion.
• By 2002, Starbucks operated 1200 stores outside the USA in 20 countries, up from 281 international stores in 1999.
Starbucks’ stock had soared more than 2200 per cent over the past decade, outpacing Wal-Mart, General Electric and Microsoft in total return. Schultz’s shares alone were worth $400 million. The lad from the projects in Brooklyn had done quite well.
Lessons learnedNot every entrepreneur can start a company and lead it to greatness in just 15 years. Some are good at the start-up stage and pass the leadership baton once things are well under way. Others grow their businesses slowly and steadily, sometimes taking decades to reach their dreams. Only a few can take the business all the way from conception to stardom as quickly as did Howard Schultz. What can would-be entrepreneurs learn from Schultz’s story?
• Schultz was clear about his mission: to build a company that brought the Italian coffee bar culture to the USA, to serve only the finest coffee, and to run an organization that valued its employees. His clear sense of purpose helped him focus his energies.
• His personal aspirations were audacious: to build a large, prominent and profitable company that would change how Americans started their day. Simply running a few coffee shops in Seattle was not his cup of tea.
• He was willing to repeatedly take risks to achieve his goals.
MissionHoward Schultz didn’t choose coffee because coffee was hot. In fact, American coffee consumption had been declining for years before Schultz and other espresso entrepreneurs came along and reversed its direction. He chose coffee because he was hooked. Hooked on the taste and aroma of dark-roasted arabica coffee, so different from what he had known as coffee before. Hooked on learning about coffee and different ways to roast it. And hooked on the idea of introducing the Italian coffee culture to the USA and, thereafter, the world.
Schultz’s passion for coffee served him – and Starbucks – well. It helped him attract committed employees like coffee aficionado Dave Olson, who came to personify the company’s passionate attitude toward coffee. It helped him win investors, without whom his story never would have played out. It helped him win believers among suppliers who would go on to benefit greatly from Starbucks’ growth.
While for many investors the mission is simply to make money, for entrepreneurs a burning desire to make money is not enough on its own. It’s almost impossible for an entrepreneur to be wildly successful in a business they don’t care about deeply. Without a greater purpose than money, the battles are simply too tough to tackle simply for money’s sake. As Jeff Hawkins, founder of Palm Computing and Handspring (whom we will hear about in the next chapter), says, ‘Do something you believe because you believe it.’
Early in his career, Schultz was successful in selling copiers and housewares, but he could never have matched what he achieved selling the coffee experience if he had tried his own venture selling, say, office supplies. Schultz’s story suggests that if you don’t feel passionate about your opportunity, then you might be better advised to find a venture that does light your fire.
There’s another mission-related aspect of Schultz’s story that offers lessons to learn. At the beginning, Schultz was focused clearly on a single direction that his business would take – coffee bars in urban settings. Would-be entrepreneurs sometimes lack Schultz’s single-minded mission, seeing multiple paths that they might pursue. For Schultz, his passion for great coffee could have been pursued in other ways. Coffee specialty stores like Jerry Baldwin’s original Starbucks stores were one possible choice. Roasting better coffee for the supermarket trade was another. What makes more sense for a would-be entrepreneur – a laser-like focus on a single direction, or hedging one’s bets?
Experienced entrepreneurs know there are two serious drawbacks to the latter approach. First, attempting multiple things with the typically scarce resources that most entrepreneurs have at hand results in doing none of them well. Less is more. It’s far better usually to devote all one’s energies to the most promising path. If the path turns out to be blocked, then something will likely have been learned that can identify a more promising one. Probably one of the reasons you’re reading this book is that you’re trying to identify just what your best path is and whether it’s good enough to be worthy of placing your bet.
A second drawback is that having multiple paths in mind can detract from your ability to attract employees, investors and suppliers to your cause. If you lack the confidence and commitment to choose the best path for your business, then why should these other stakeholders get on board? Singleminded focus wins every time with these groups.
Personal aspirationsDifferent entrepreneurs have different aspirations. For some, their entrepreneurial dream is simply to make a satisfactory living for themselves and their family, or to escape the humdrum world where they work today. Others, like Hero Honda’s Brijmohan Lall Munjal, India’s Mahatma Ghandi and Starbucks’ Howard Schultz, want nothing less than to change the world in some way. There are three questions every aspiring entrepreneur should ask:
• How big do I want this business to become – in sales, profits, number of employees, number of locations, or by some other measure?
• What role do I want in this venture: do I want to do, to manage or to lead?
• For how long do I want to remain involved with it?
Some entrepreneurs or entrepreneurial teams have aspirations to run a business just large enough to meet certain objectives: to provide a living for their family, to provide multiple roles in which two or more partners can work, and so on.
Others, like Schultz, want to build something big. In Schultz’s words, ‘If you want to build a great enterprise, you have to have the courage to dream great dreams. If you dream small dreams, you may succeed in building something small. For many people, that is enough. But if you want to achieve widespread impact and lasting value, be bold’.
Reaching the kind of scale that Starbucks has reached is not something a single individual can do ordinarily. Entrepreneurship played for these kinds of stakes is a team sport. Not every entrepreneur has the capacity, courage and willingness to do this. And with size comes complexity. Some simply don’t want this sort of complexity in their business lives, or they may prefer to devote significant energies to their personal lives – family, avocations and so on. Building a fast-growing venture takes all one can give. As Schultz says, ‘You have to work so hard and have so much enthusiasm for one thing that most other things in your life have to be sacrificed’.26 It’s not for everyone. Is it for you?
The question of roles is also worth some thought for a would-be entrepreneur. As small businesses grow into large ones, the roles of those who lead them must inevitably evolve. At the outset, what entrepreneurs do is do. Schultz roasted coffee, made espressos, raised capital, and found locations for his next stores. But it simply was not possible for him to do these things himself forever. As it turned out, Schultz was happy bringing on ‘people smarter than me’ and letting them do what they’d been hired to do. As Schultz puts it:
There’s a common mistake a lot of entrepreneurs make. They own the idea, and they have the passion to pursue it. But they can’t possibly possess all the skills needed to make the idea actually happen. Reluctant to delegate, they surround themselves with faithful aides. They’re afraid to bring in truly smart, successful individuals as high-level managers.
But managing and delegating is not what every entrepreneur wants. If you are an architect whose work is admired, then do you want to do architecture and keep designing interesting buildings, or do you want to grow your business and manage architects and let them exercise their own creativity? It’s an important choice, and one not to be taken lightly. Make it consciously, not by default.
Then there’s the question of how long you want to manage or lead your business. Do you want to stay the course for many years to manage and build your business yourself? Or are you happy to get it started, exit early if possible, and move on to something else? Is it creating, i.e. the early-stage work, or the managing, i.e. the later-stage work, that turns you on? It’s another choice to take seriously. What is it that you really want out of being an entrepreneur?
Risk propensityMost successful entrepreneurs do not regard themselves as risk-takers. Managers of risk, yes. But risk-takers, no. Their job is to offload the inherent risk in their ventures to suppliers, investors, landlords and whoever is willing to bear it. In their hearts, most entrepreneurs see little risk – naively, perhaps – given their belief that theirs is one new venture that will buck the long odds and succeed.
But, as Schultz’s story points out, there are repeated risks to be taken along the way. The obvious ones include money – yours and others’ – and months or years of your life and the opportunity costs of doing something else with that time. There are other risks that are less obvious. There’s the risk that your investors may at some point decide that you should go. Is this a risk you are willing to bear to raise investment capital, or is maintaining control, even at the cost of limiting the scale of what you can accomplish or the resources you can assemble, a crucial factor for you? And what about the risk propensity of those you love who are sure to bear some of the costs of your entrepreneurial pursuits? Marriages have been broken as entrepreneurs and their spouses fail to agree on what should be risked. Dinner with the family? The house? The security of a regular salary? What level of risk are you willing to bear? Is that level of risk acceptable for the upside your opportunity offers? As Schultz tells it:
For me, the thrill of business is in the climb. Everything we try to achieve is like climbing a steep slope, one that very few people have managed to scale. The more difficult the climb, the more gratifying the effort put into the ascent and the greater the satisfaction upon reaching the summit. But, like all dedicated mountain climbers, we’re always seeking a higher peak.