Starbucks and the Perversity of Growth

By Oren Harari

Date: Mar 21, 2008

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Oren Harari believes that growth should be a consequence, not a cause, of sustained competitive success. He demonstrates his point using Starbucks as both a good example and a bad example.

Let me tell you something about growth. Growth is necessary, particularly if you’re a publicly traded company. If you’re not growing, you’re stagnating. Further, having clear growth goals is useful. You have to track progress and hold people accountable for results.

But growth per se is not a strategy; it’s the consequence of a strategy. Strategy reflects key questions like these:

This distinction between growth and strategy has huge implications.

Why Is Your Company Growing?

When a company grows because it’s providing the marketplace with something that excites and intrigues customers (groundbreaking business model, unique value proposition, cool product line), growth is a wonderful thing. It generates the kinds of financials that bring big smiles to investors’ faces. But when growth is the company’s strategy—that is, when leaders see bigger size as financial salvation, or when their strategic intent is to get bigger in the belief that bigger is better and more likely to steamroll over competitors, growth becomes a predictor of organizational malaise, if not decline.

Exhibit A on both accounts: Starbucks.

First, a brief history. As numerous business and management books have noted ad nauseum, the remarkable success of Starbucks in the 1980s and ’90s was its capacity to pump compelling value into what was traditionally an uninspired commodity "coffee" industry. That value, of course, revolved around the unique experience that Starbucks offered the customer: a diverse, constantly changing menu of high-end global coffees within a casual, romantic European ambience. For its increasingly loyal customer base, Starbucks offered a predictably warm, friendly environment that the company defined as a "third place" (between home and work) refuge from the woes of the external world.

Unsurprisingly, with that sort of groundbreaking business model, unique value proposition, and cool product line, Starbucks’ growth (in store locations, same-store sales, customer loyalty, margins, and stock value) exploded—even when, as the satirical jokes went, multiple Starbucks cafés sprang up across the street from each other.

Now fast-forward to 2008. The $10 billion corporation, boasting more than 15,000 stores worldwide, has seen a 1% overall drop in traffic (3% decline in the U.S.) in stores open at least 13 months—the first time that’s ever happened. Starbucks has also seen a drop in profits and a lowering of earnings expectations, a significant hit to its public image and "cool" brand, and a precipitous decline in share value (40% down in 2007, 50% down since late 2006).

What happened? Well, my wife could tell you. She was one of those 20 million plus U.S. customers who used to frequent her particular Starbucks café several times a week. She would drag me along periodically, and I confess I went pretty willingly. That’s because it used to be a warm, inviting place. It was a place that beckoned us with easy familiarity, a place we could hang out in comfort.

No longer. The stuffed chairs and sofa have been removed. A few small tables and wooden chairs remain, pushed to the edges of the room. The baristas no longer seem to know the customers, or care. The whole vibe of the place reeks "fast food": Get people in, pump them for multiple sales, take their order, get 'em out.

This is not an idiosyncratic situation. It’s a predictable consequence of Starbucks’ strategic obsession over the past decade—which has been all about unbridled growth. Launch more stores in more places, full speed ahead! Four new stores per day in 2007, as it turned out, with an immediate goal of 40,000 stores worldwide.

And why? I ask. As I indicated earlier, leaders are wise to view growth as a strategic priority. But when growth becomes the strategic obsession, there’s a real danger that a company will lose its distinction and its soul. That’s what happened to Starbucks.

Diluting the (Coffee) Brand

While Starbucks was compulsively leveraging its unique value experience for über-growth, that very experience became less and less unique as an increasing number of providers—Dunkin’ Donuts, McDonald’s, mall and supermarket cafés, ma-and-pa enterprises, ad infinitum—began to offer their own versions of designer coffee and comfort. McDonald’s, for example, is aggressively installing coffee bars, hiring friendly "baristas," and serving lattés, mochas, and the "Frappe," along with smoothies and bottled beverages. Further, the McDonald’s espresso machines will be displayed at the front counters, so that customers will be able to see the coffee beans being ground and baristas preparing the drinks. It’s also replacing molded plastic booths with oversized chairs, softer lighting, and more muted tones. And don’t forget the WiFi.

Meanwhile, many Starbucks location began to offer drive-through windows and "Egg McMuffin" types of breakfast sandwiches.

So who’s who? Sure, the McDonald’s process is still more automated than Starbucks’, and its coffee menu is more limited. But who’s counting? McDonald’s leaders aren’t even targeting Starbucks as a competitor; they’re simply capitalizing on a growing market for espresso and specialty drinks, figuring that in the first year alone their interventions will generate more than $1 billion in sales.

The Danger of Replacing "Uniqueness" with "Bigness"

I argue in my book Break From the Pack: How to Compete in a Copycat Economy that this sort of fragmentation and imitation is what characterizes the "Copycat Economy," which in turn blurs the distinction and unique appeal of a successful company like Starbucks—especially when imitators like McDonald’s offer more time convenience and lower prices. As Todd Sullivan argues on his blog, the data shows that "Starbucks’ ’no growth’ periods in the U.S. coincide 100% to McDonalds’ coffee improvement."

As I also note in my book, there’s one more fat correlate of the Copycat Economy: gradual but relentless commoditization. When both McDonald’s and Dunkin’ Donuts spokespeople recently declared that high-end coffee has become "democratized," you know that what was once a unique, exciting value proposition has itself become a more bland commodity that can be copied more easily by myriad competitors, often for higher volume and lower prices.

What’s interesting is that as part of its growth zeal, Starbucks itself accelerated the commoditization process. Starbucks leaders’ strategic decisions and personal attention revolved around leveraging a static experience to an ever-increasing number of locations in order to increase corporate volume, revenue, and share. Even worse, the rush for bigger size began to fray at the edges of the experience itself. If the best people weren’t hired or properly trained; if bagged coffee replaced the aromas and fresh grinding of beans; if more efficient and sterile automatic espresso machines replaced the theatre of the older, chuggier machines; if the furniture and amenities weren’t regularly revitalized—so be it. Size, efficiencies, and scale ruled. My wife and I experienced it firsthand.

Janet Adamy of the Wall St. Journal is absolutely correct when she notes, "The company’s rapid expansion has distracted it from making its cafés an inviting place with exciting new products and cannibalized business at existing stores." My point is that this distraction and its consequences were inevitable. You can’t demand that your people up and down the ranks obsess about growth as "the" top priority, and at the same time expect them to concentrate on continually innovating and enriching the customer experience in order to maintain unique, compelling, "gotta have it" properties. It simply won’t happen. And it didn’t.

Let me be even more blunt. When "bigness" becomes the de facto strategy of any firm—because of the CEO’s ego; or because of some institutional investors’ misguided pressures; or because of the erroneous belief that scale, synergies, and marketing muscle will on their own yield customer delight and competitive advantage—then the quest for growth can easily become perverse. People on staff aren’t dumb. When they reason that ever-larger size is the raison d’être of the company, they understand what counts. Understandably, they’ll do anything to ratchet up the sales and market share numbers, regardless of impact on innovation, customers, employee commitment, or long-term thinking and financials.

More Perversity

Track the history of PEOPLExpress, the iconoclastic and wildly successful low-priced airline of the early 1980s, the first of its kind, which skyrocketed to a billion-dollar enterprise in less than five years and then focused so hard on no-holds-barred, full-speed growth—more routes, more markets, more hubs, more planes, all at an accelerated pace—that it ultimately burned through its resources and its capacity to deliver anything. Track the history of Krispy Kreme, cited in a 2003 Fortune magazine cover story as America’s hottest brand. The company attracted a growing cult following to its doughnut facilities, which cranked out hot, fresh, mouth-watering product. But Krispy Kreme became so compulsively addicted to growth that it packaged its goods for sale in stores everywhere—freshness and unique taste be damned—even as executives made ethically dubious and financially risky decisions to further fuel growth.

In both cases, the stocks collapsed. PEOPLExpress no longer even exists.

I argued in my November 9, 2007 blog that this perverse focus on growth was one of the causes of Citigroup’s $18 billion write-down due to losses on sub-prime mortgage-related securities. Over the past two decades, the sprawling Citi empire was built by frenetic serial acquisition in order to get bigger, be everywhere, and do everything. It wasn’t necessary to be unique or innovative in products or customer care. The premise was that size alone—with its correlates of scale, scope, and cross-marketing synergies—would bring in boatloads of customers and cashflow.

For a long time, the Street bought the story. But eventually, when it became clearer that many customers and prospective customers weren’t "cooperating" with the plan because Citi had become a huge, complex, unimaginative bureaucracy with "me too" products and services, it’s not surprising that investor confidence flattened. But the corporate beast was ravenous. Artificially built for mega-size in the first place, it now demanded billions of new dollars in annual growth in order to satisfy investors. The corporate culture, in turn, demanded of everyone on staff: Do whatever it takes to feed the beast. Is it any wonder that Citi professionals jumped headlong into the enticing but highly volatile sub-prime market as an easy quickie financial fix, regardless of long-term adverse consequences?

Contrast these tales of woe with those of companies like Toyota and Trader Joe’s, which have focused on careful, prudent, profitable growth while judiciously cultivating their instincts for providing uniqueness and excitement in quality, design, products, and customer care. Leaders in both companies have always been careful not to allow the market’s exuberant reaction to their products and services to hypnotize them to compulsively seek growth as "the" strategic priority.

Meanwhile, Back at Starbucks

I believe that Howard Schultz, the acknowledged founder of the Starbucks chain, now understands all this—although perhaps belatedly. On February 14, 2007, as a worried chairman of the company, he emailed then-president Jim Donald a memo with the subject tag "The Commoditization of the Starbucks Experience." In this memo, he described a series of decisions that led to the "watering down of the Starbucks experience[...]and the commoditization of our brand." These decisions included some of the ones that I’ve described here—those that aimed for growth and efficiencies of scale to the point that the stores became, in Schultz’s words, "sterile, cookie cutter[s]" without the soul and the passion for coffee of the past. "Some stores," bemoaned Schultz, "don’t have coffee grinders, French presses from Bodum, or even coffee filters."

Maybe Schultz figured out the adverse consequences of his company’s growth imperative in 2007. If so, he should have stepped in back then as CEO, rather than simply fretting, because today the chickens have come home to roost. Starbucks has become a big, "mature" company with eroding buzz and market cap. Today, my wife and I are more apt to go to the funky local coffee shop around the corner from Starbucks to get our espresso fix, and a BloggingStocks.com entry concludes that Starbucks "will never be cool again."

Is that necessarily so? Maybe not. Schultz has done a few things right recently:

Can he pull this off? Some believe that even with a slower growth rate, it’s too late for Starbucks to go back to the golden era of innovation, coolness, and buzz. They argue that the company’s salvation will be its ability to use its scale and efficiencies to cut prices in order to build traffic and revenues gradually, and hopefully thus grow its market cap slowly as a mature company. Others, like me, think that revitalization for coolness and investor buzz is doable, but only if Schultz goes really deep with change. Just mouthing platitudes, or just tinkering at the edges, or hoping to straddle the goals of turbo-fast growth and great customer experience, or trying to be all things to all people—they’re all fool’s gambits. Halfway steps, or simply more of the same, won’t cut it. Schultz and his team must figure out how to remake the Starbucks feel, finishes, ambience, looks, design, and contextual tapestry to once again be a special, desirable, delightful, and maybe even magical place to spend time. As a woo-able ex-customer and a long-time investor, I selfishly wish him luck!

So here’s the moral of the story. Growth per se is a consequence, not a cause, of sustained competitive success. Starbucks’ competitive success came from providing the market with something that was extraordinary, unique, and valuable to customers. That success led to healthy growth. Like many companies, Starbucks executives then got mesmerized by the sexy lure of growth for its own sake and forgot who "brung them to the dance."