How Starbucks Became Starbucks: Lessons for Developing Sustainably Successful Business Enterprises (Part 1)

Author’s Note to Readers: Happy New Year!

This newsletter focuses upon various aspects of the development of “Building Sustainably Successful Organizations.”? For the next few months, the newsletter will focus on the example of Starbucks and how it became a sustainably successful enterprise. It will also focus on the lessons of the Starbucks experience that can be uses by other companies that seek to become sustainably successful enterprises. Our intent is to provide a role model for organizations that need/want to become sustainably successful enterprises. Organizations in “the need to become sustainably successful enterprises category” include Tesla, Zoom, and Uber.

Abstract

This newsletter issue focuses upon the development of “Sustainably Successful Organizations.”? It examines a case example of Starbucks and how it became a sustainably successful enterprise. Our objective is to provide a role model illustration and defined process to achieve this level of success for others to follow.

ONCE UPON A TIME NOT SO LONG AGO….

Once upon a time not so long ago, companies such as Aol.Com, Webvan, and Yahoo! were the darlings of Wall Street with sky high stock prices and PE Ratios. Today’s darlings include Tesla, Zoom, Uber, and others. However, there are many companies which begin with promising starts and then experience dramatic decline or failure. This was graphically illustrated during the Dot.com era with the meteoric rise and meteoric fall of more than 95 % of all start-ups.

THE CORE CHALLENGE THAT CURRENTLY FACES, TESLA, ZOOM, UBER et. al.

The crucial issue for business leaders is how to transform a “promising start” in to a what we term a Sustainably Successful Business Enterprise. This is the core challenge that currently faces, Tesla, Zoom, Uber et.al.

PURPOSE

The purpose of this article is to examine how a company becomes sustainably successful. We will do it by examining the case example of Starbucks. Our ultimate objective is to utilize the example of Starbucks provide a role model illustration and defined process to achieve this level of success for others to follow.

WHY STARBUCKS?

Why choose Starbucks as the illustrative case? There are several reasons. First,

in many ways, Starbucks (while not an obvious choice) is actually the perfect choice to explain how a to transform a promising start in to a Sustainably Successful Business Enterprise. It is a good illustration because, unlike Apple, Amgen, and Alphabet, which each have proprietary intellectual property that provides sustainable competitive advantages, Starbucks is selling a commodity product—coffee—with no intrinsic sustainable competitive advantages. Instead, (and this is a key insight and lesson) Starbucks created its own sustainable competitive advantages by the way it was built and is managed.[1] Another key reason is that as the author I have some special insight into the development of Starbucks as a “participant-observer.” I was invited to work with Starbucks as a consultant in 1994, and continued in that role until 1997. In fact, Howard Schultz (Starbucks CEO for many years) cited my work in his book about the development of Starbucks.[2] Since I was there and involved for a significant portion of the development of Starbucks foundation for success, knew the key principals there and in fact consulted with them and coached some of them, I am drawing upon my experiences and knowledge to tell this story and provide an analysis of what happened. A third reason is that unless the reader has undergone a Rip Van Winkle experience, he/she/they know about Starbucks at least to some extent. I could also write about some other companies that have followed the same methods of Starbucks with similar success in becoming leaders in their space, but are likely less known to readers, including Bell-Carter Foods, Simon Properties, The Kusto Group (Singapore and Kazakhstan), The Riverside Group (China), Techcombank (Vietnam) and many others in places such as divergent as Bulgaria, Canada, and China as well as the USA. But Starbucks is higher profile, and so it has special resonance for people. 

PROLOGUE TO THE STORY OF HOW STARBUCKS BECAME STARBUCKS

The story of how Starbucks transformed from a promising start in to a Sustainably Successful Business is complex with many different facets and several different phases. Accordingly, in this Newsletter, we will examine our plan is to take multiple looks at the process of how Starbucks became Starbucks in a series of related monthly issues beginning with this month’s (January) issue.

Taken together, these multiple views presented in different issues will comprise an in-depth case analysis of how a company transforms from an idea to a globally business champion that is a sustainably successful enterprise. As such it is intended to help elucidate a model for other organizations to similarly become global business champions and sustainably successful enterprises.

The First View: A Chronology of the Highlights of Development of Starbucks

The first view we shall take is based upon a Chronology of the Highlights of the Development of Starbucks. The story of Starbucks begins in 1972. We will review the specific events and examine them for implications about the requirements for developing sustainably successful enterprises.

        The Company’s Origin. The original "Starbucks Coffee Company" began as a “local roaster” of coffee. It opened its first store near Seattle's Pike Place Market in 1971. Another was located in a shopping center across from the University of Washington’s campus in 1972.

        The Original Business Concept. The original Starbucks’ stores did not sell coffee drinks. They sold fresh-roasted coffee beans, imported teas, and spices. However, sometimes the individual behind the counter would brew a pot and serve free samples in Dixie cups.

Starbucks’ founders were three individuals who shared a passion for gourmet coffee: Jerry Baldwin, Zev Siegl, and Gordon Bowker. By the end of the 1970's, they had four retail stores, a mail-order unit and a wholesale company. Their sales were $2 million per year. Zev Siegl sold out in 1980, while Baldwin and Bowker continued to own the firm.

Unlike many entrepreneurs, who do not know what they do not know, Baldwin and Bowker realized they needed someone with greater business experience to help run what they had grown into a serious enterprise. They became acquainted with Howard Schultz, and invited him to run Starbucks.

        The Arrival of Howard Schultz. Schultz, who is now retired from Starbucks, joined Starbucks as Director of Retail Operations and Marketing in 1982. Schultz grew up in Brooklyn and had begun his career in the marketing department at Xerox. At the age of 26, he headed the American Division of Hammerplast, a Swedish housewares firm, before he joined Starbucks.

        The Eureka Idea. Howard Schultz had been with Starbucks for approximately one year when he visited Milan to attend a trade show. While walking the streets of Milan and going back and forth from his hotel to the trade show, he marveled at the ubiquity of the Italian coffee bars. After a few days, he began to be drawn into them himself, because in his words “it was so romantic.”

In describing his experience, Schultz states: “I saw the same faces and the camaraderie. The coffee bar was an extension of peoples’ homes and was truly part of the fabric of the Italian culture. It struck me right across the head -- this is something dynamic and unusual.1“

What struck Howard Schultz was, in part, irony and insight. Starbucks was in the coffee business but: “I thought we had missed it completely, because we had not given people the romance of the beverage and the personal interaction of creating an environment outside their homes where they could enjoy the beverage in a personal, unique way.“ That notion was what Howard Schultz brought back to the United States of America.

        Resistance to Change. Perhaps predictably, the founders of Starbucks, who had been doing very well for a local company, viewed Schultz’s insight with disinterest and a lack of enthusiasm. It took him a year and a half to convince them to allow him to test his idea.

He went back to Italy to do more research and when he came back, he was more convinced than ever that he was on to something. In April of 1984, they tested the idea by opening up a small coffee bar inside a new Starbucks store.

        Instantaneous Transformation of The Business Concept.  Virtually, overnight, an implicit instant transformation of the Company’s Business Concept took place. The store changed. The customer count became higher. The beverage became a treat, and more than that, the relationship with the customer changed. Starbucks’ people were able to develop closer relationships with customers because of the instant gratification and romance people received from the beverage served in this environment.

In an instant, Starbucks had transformed its business from a purveyor of whole bean coffee to something very different. While whole bean coffee remained the core business, Howard Schultz had changed the game at Starbucks. It was the juxtaposition of two simple elements to create a more complex and, in some ways, more wonderful thing; just as the combination of hydrogen and oxygen creates water.

In spite of the “experiment’s” success, the owners of Starbucks balked at adapting their company to the vision Schultz articulated: an American version of the Italian coffee-bar. 

        Founding Il Giorgnale. In 1985, Schultz decided to create his own company and left Starbucks. He called his company Il Giorgnale, named after the daily newspaper in Italy. 

        Coincident Activities. Within a year after this test occurred, one of the initial founders of Starbucks acquired another company, Peet’s Coffee in Berkeley. After the acquisition, the debt-to-equity ratio of Starbucks was 6 to 1, a very high ratio. This occurred because the founder was averse to issuing equity, which meant a dilution of ownership.

        The Buyout of Starbucks. In August, 1987, Howard Schultz went back to Starbucks with a buy-out offer and a vision to take the concept well beyond the boundaries of Seattle. The high debt burden on the owners of Starbucks made them receptive to Schultz’s offer. Il Giornale acquired the assets of Starbucks, and changed its name to Starbucks Corporation.

        Shultz’s Vision & Leadership. Howard Schultz’s vision or business concept was not only to build a national retail brand; it was to “recreate the paradigm” and transform coffee from a commodity product to a “truly exquisite product” with brand equity. 

        The Role of Corporate Culture. Another aspect of Schultz’s vision concerned his concept of the kind of organization he wanted to build. He had a strong commitment to company-owned stores. To support this idea, he articulated a set of five “Guiding Principles,” which was intended to serve as the basis of Starbucks’ culture. Subsequently, a sixth guiding principle was added to the initial five: “Embrace diversity as an essential component in the way we do business.” All six guiding principles are shown below:

      .  Provide a great work environment and treat each other with respect and dignity.

     . Apply the highest standards of excellence to the purchasing, roasting, and fresh delivery of our coffee.

·      Develop enthusiastically satisfied customers all of the time.

·      Contribute positively to our communities and our environment.

·      Recognize that profitability is essential to our future success.

·      Embrace diversity as an essential component in the way we do business.

Schultz believed that the kind of organization that Starbucks was, and, in turn, the way that it did business would become a source of sustainable competitive advantage. In his words, “... the values of the company and the guiding principles became a unique sustainable competitive advantage.” In effect, Schultz understood the role of culture as a building block of organizational success, but he was not then aware of the concept “corporate culture” per se as a management tool. Instead, it was an intuitive insight for him.

One critical feature of Starbucks’ culture concerned the treatment of people. Schultz wanted everyone in the company to have a stake in Starbucks’ success. In effect, he wanted everyone at Starbucks to be and behave like owners.

From 1987 to 1995, what energized Starbucks were the twin pillars of: 1) the commitment to the quality of its coffee, and 2) the quality of its values. They were synchronized and in Schultz’s word, “seamless.” As Schultz states:

“That’s what attracted people to the company. That’s what sustained us, and that’s what gave us our stake in the ground and we were able to measure our decision against that. Why don’t we franchise? Because it wasn’t part of our value system. Why don’t we sell flavored coffee? Because it is a bastardization of the product. Why do we give everyone health benefits? Why do we give everyone ownership? Because these things are central to our value system and the way we treat people.”

Accordingly, the treatment of people (employees or “team members” as they are called at Starbucks) was central to the core strategy of the firm. As Schultz also has stated: “The way we treat our people affect the way they treat our customers, and in turn our financial performance.” In effect Starbucks was competing with a culture strategy.

           Stated differently, what Schultz contributed to the development of Starbucks involved vision, strategy and culture.

        Schultz’ Leadership and Crucial Events. To fully understand the role that leadership played in Starbucks’ development and, in turn, its transformation into the retail coffee business, it is essential to examine what happened during the three-year period from 1989 to 1991. When asked if there was an untold secret to the Starbucks story, Schultz stated that, “Starbucks lost over $3 million during the three-year period from 1989 to 1991.” He noted that there was tremendous pressure on him from investors and the Board of Directors to change the strategy and the vision. They believed that Starbucks was hiring “too far ahead of the growth curve;” that the infrastructure investment was too great for a company as small as Starbucks; that company owned stores were too expensive; and that the concept wasn’t going to work outside of Seattle. George Bernard Shaw has stated that, “The reasonable man adapts himself to the world. The unreasonable man does not. Therefore, all progress is made by the unreasonable man.”

What should Schultz and, in turn, Starbucks do? A “reasonable man” may have changed the strategy, and stopped hiring the kinds of people that Starbucks was recruiting. Maybe the company should have started franchising as a way to create capital. Maybe they should have looked at Starbucks as a regional company. Howard Schultz was not a reasonable man. His vision was to build a national company. He stated:

“We could not have gotten where we are today if we had not had the commitment to build a national company with a national brand from the beginning. If you’re going to build a 100-story building, you’ve got to build a foundation for 100 stories; but people were getting very nervous.”

Schultz had to continually raise more money. He had to keep saying: “It’s going to work, and we will turn profitable. It was a very tough time, a very vulnerable time.” Howard Schultz’ Board of Directors thought he was being very unreasonable... until Starbucks became very successful.  

ANALYSIS AND LESSONS

This section steps back from the review of the Chronology of the Highlights of Development of the company’s development in order to do an Analysis of How SBUX Became SBUX and identify and identify lessons for other organizations to similarly become global business champions and sustainably successful enterprises.

The Role of the Leader.

As in any true entrepreneurship, Howard Schultz is the embodiment of the company. A great deal of what characterized Starbucks is derived from Howard Schultz’s own background and values. His commitment to Starbucks’ treatment of people, all of whom are called “partners,” was derived from how he saw his own father treated in the business world. Actually, it was the reverse of what his own father experienced.

        Howard Schultz is the first to say that he alone did not build Starbucks. He states that: “I was very fortunate to hire wonderful, gifted people to balance out the weaknesses and the strengths that I had as a business person.” Schultz also stated, “We’ve made each other better like a basketball team. They’ve allowed me to do what I do well.”

 Developing A Leadership’s Molecule at Starbucks

The chemical symbol for water is H2O. It represents the combination of two different elements (hydrogen and oxygen) to create something very different -- water. 

At Starbucks, “H2O" represents something even more different: the combination of two “H’s” or “Howards” (Howard Schultz and Howard Behar) and an “O” (Orin Smith) to create a great company. It was more than a mere play on words. The “H2O” notion at Starbucks implies a team effort. It also symbolizes what I have termed “a leadership molecule.”[4]

           Stated briefly, a Leadership Molecule? is a core “team” (“group” or unit) that cohesively performs a set of five key functional of strategic leadership as a unit rather than as a set of individuals. These functions are:

1.     Creating the vision, 

2.     Defining and managing culture, 

3.     Coordinating operations, 

4.     Overseeing systems development, and 

5.     Leading and managing innovation and change.

It is a “core leadership team” (in true sociological sense) with defined but overlapping and complementary roles. Typically, the roles of vision, culture, operations, and overseeing systems development, are performed by one or more individuals comprising the molecule, while the fifth task of strategic leadership (leading and managing innovation and change) is performed as a collective team.

A Closer look at the Leadership Molecule developed at Starbucks. As noted above, the Leadership Molecule developed at Starbucks included Howard Schultz and Howard Behar) an Orin Smith. We have already examined Howard Shultz’ leadership, so let’s now take a closer look at the other two people (the “atoms” comprising the molecule”) and what they contributed to the molecule.

        Howard Behar. Behar joined Starbucks to help build its retail operations. When Behar joined in 1989, Starbucks had 30 retail stores. He brought with him years of experience from other larger organizations, as well as a passionate commitment to building a different kind of organization. Behar is right-brained creative type, who also has an appreciation for the role that process can play in building a company like Starbucks. He is the kind of person who can “go either way,” right-brained or left, entrepreneurial or professional manager. He is a high energy, very creative type of person, who was perfectly suited to manage Starbucks’ hyper-growth retail strategy.

        Orin Smith. Orin Smith, the “O-element,” joined Starbucks as CFO in 1990. He brought not only a strong financial background, but a lower-key, more deliberate decision making and managerial style. This was a counterpoint to the two H’s, who tend to be passionate, with a strong orientation for immediate action. Howard Schultz stated, “Orin had a great gift to be able to tolerate my recklessness.” Smith was seen as solid and dependable.

        A Deeper Look at Schultz’ Leadership. As noted above, what Schultz contributed to the development of Starbucks and the leadership molecule involved vision, strategy and culture. However, there is another important aspect and contribution of Schultz that need to be examined. Specifically, why did Howard Schultz see opportunity where others did not? Why did he see the possibility of transforming coffee from a commodity into something very different after visiting Milan, which has been visited by countless others for many, many years? Typically, after an entrepreneur like Schultz has had a brilliant insight, others can recognize the concept and think that it was “obvious.” It was not obvious. If it was so obvious, why did Schultz have difficulty convincing the original founders of Starbucks about the merits of the idea? Why did it take a year and a half to convince investors to provide the $1 million? Why did he have to struggle to keep the support of his Board of Directors?

Schultz’s vision, although expressed clearly and simply in retrospect, had great subtly and texture. It had the same subtly and profundity that allowed Nike to transform “sneakers” into “athletic shoes,” and Disney to transform animated characters into theme parks.

     Did Schultz’ have a Corporate Role Model? When asked if there are any companies that he admired, Schultz replied, “Nike is a model, because they took a commodity product (sneakers) and they have become bigger than their product. They are known worldwide."

THE BOTTOM LINE

What Schultz said about Nike can also be said about Starbucks. Specifically, Starbucks has become a leading example of how to build a sustainably successful enterprise. Accordingly, it is a worthy corporate model to emulate by Tesla, Zoom, and others who want to achieve the same status.  

THE NEXT PERSPECTIVE AND ISSUE                                       

In the current issue, we have examined the development of Starbucks by reviewing the Chronology of the Highlights of Development of the company’s development. Our intent it to ultimately provide an illustrative role model for organizations that need/want to become sustainably successful enterprise as well as a defined process to achieve this level of success for others to follow. Organizations in “the need to become sustainably successful enterprises category” include Tesla, Zoom, and Uber.

In the next issue (February), we will take a different perspective. Specifically, we shall examine the development of Starbucks through the lens of the “Pyramid of Organizational Development.” 

Author's Note: The “Pyramid of Organizational Development” is a conceptual framework that I developed and empirically validated[4]. It serves as a lens for organizational assessment and as a template for building sustainably successful organizations. I facilitated its application at Starbucks in 1994 as the template for their strategic planning process during the years I was a consultant to the firm. I believe it helped contribute to Starbucks becoming a global leader. But that is the next chapter of this history, as will be examined in the February Issue of this Newsletter.

Meanwhile, a very happy and safe New Year to all.

About the Author_________________________

Eric Flamholtz is Professor Emeritus, Anderson School of Management, UCLA. He is the founder and President of Management Systems Consulting Corporation, 10940 Wilshire Boulevard, Suite 600, Los Angeles California, 90024. He has served on the faculties of Columbia University, The University of Michigan, and UCLA. His latest book (co-authored with Yvonne Randle, is The Crisis Leadership Playbook, Vandeplas Publishing. See Also: WWW.Mgtsystems.com.

For a more detailed look at the development of Starbucks, see Eric G. Flamholtz and Yvonne Randle, Changing the Game: Organizational Transformations of the First, Second, and Third Kinds, with a Foreword by Howard Schultz, Oxford University Press, 1998.

References

[1] Howard Behar with Janet Goldstein, It’s not About the Coffee: Leadership Principles from a Life at Starbucks, Portfolio, 2007. 

[2]Howard Schultz with Dori Jones Yang, Pour Your Heart into it: How Starbucks Built a Company one Cup at a Time, Hyperion, 1997.

[3] Eric Flamholtz, “The Leadership Molecule: Implications for Entrepreneurial Firms,” International Review of Entrepreneurship, 2011.

[4] Eric G. Flamholtz and Yvonne Randle, Growing Pains: Building Sustainably Successful Organizations, Fifth Edition, Wiley, 2016 See also: www.Mgtsystems.com. 

[5] Eric G. Flamholtz and Yvonne Randle, Changing the Game: Organizational Transformations of the First, Second, and Third Kinds, with a Foreword by Howard Schultz, Oxford University Press, 1998.