Understanding The Business of Starbucks
This is a movie trailer of 2006 Hollywood film Akeelah and the Bee, a heart-touching story about a young Spelling Bee contestant. At the start of the video, you will see Howard Schultz and his company Starbucks promoting the movie. And here’s a photo of a stall inside a Starbucks store, selling music CDs of famous Brazilian musician Sergio Mendes.
Isn’t it strange? Why would a coffee company participate in the in-store promotion of a random Hollywood film, that isn’t even about coffee? What’s the point of selling music CDs of artists like Sergio Mendes, Kenny G, or Paul McCartney in Starbucks stores?
Let's go on a journey to explore the history, ethics, and values of Starbucks, unraveling business strategies and tactics that have played a pivotal role in its success story. You’ll learn how this company went from a small coffee bean store to a multi-billion-dollar enterprise. You’ll also come across interesting business concepts you can use to grow your own business.
Chapter 1: The Origin Story
Starbucks was founded by three friends, Jerry Baldwin, Zev Siegl, and Gordon Bowker in Seattle, Washington in 1971. The trio was passionate about quality coffee and wanted Seattle to have access to the best coffee beans from around the world.
Back then, the coffee culture in the United States was only limited to instant coffee and canned coffee. To cut costs, the American coffee brands used robusta coffee beans that were inferior in taste and quality compared to arabica coffee beans popular in Europe.
The idea behind Starbucks was to provide high-quality, dark-roasted coffee beans from different parts of the world that customers can brew in their homes. At that time, it was just a coffee bean store. Nothing more.
That changed when young Howard Schultz joined Starbucks as director of retail sales and marketing in 1982. During an official trip to Italy, he discovered espresso bars and was quickly drawn to the local coffee culture and how it was indispensable to Italian daily life.
He believed that if Starbucks could emulate Italian coffee culture and serve espresso drinks at its stores, it would be able to differentiate itself and its products from the rest. That’s when the idea of “Starbucks experience” was born.
However, it wasn't a good time to go into the coffee business. After reaching the peak of? 3.1 cups per day in 1961, coffee consumption in the United States began a gradual decline, thanks to the rise in popularity of soft drinks. But when Howard bought Starbucks for $3.8 million with the help of investors and became its CEO, it was clear that he had a vision for Starbucks that the original owners couldn't see for themselves.
Under Howard’s leadership, Starbucks wasn’t a coffee bean store anymore. It was a part of the daily life of hard-working Americans who would come to Starbucks to socialize and enjoy high-quality coffee beverages like espresso and cafe lattes. By 1990, Starbucks had 84 stores across the United States and was on course to go international.
Chapter 2: Starbucks Business Model?
Starbucks knew that although customers enjoy the ambiance and atmosphere at their stores, the premium-quality coffee is the real crowd-puller. While it continued to innovate and reinvent almost every aspect of the business, it didn’t compromise the quality of the coffee. To preserve its legacy as a premium, high-quality coffee brand, the company adopted a vertical integration business strategy.?
Vertical integration is a type of business strategy where a company has direct ownership of the multiple stages of the supply chain. Instead of relying on third-party suppliers and contractors, the company owns and controls two or more stages of production or sales processes. It is usually achieved through mergers and acquisitions.
Starbucks is a vertically integrated company that integrates backward by owning equipment, storage, and coffee roasting facilities. It also maintains a direct relationship with more than 400,000 coffee farmers worldwide, thus controlling its entire manufacturing process.
It also integrates forward by owning coffeehouses, retail outlets, and distribution centers. In other words, from the raw coffee bean to the recyclable coffee cup in the customer’s hand, everything is produced by Starbucks.
This strategy helps Starbucks streamline its business operations, reduce costs, and manage the volatility of global coffee prices due to unforeseeable circumstances.?
As a company, Starbucks always strives for a competitive advantage over its rivals. Since it has a first-mover advantage in the coffee and snack store industry, its management practices have always focused on the continued improvement of its products and services to ensure the Starbucks brand is a notch or two above its rivals.?
One of the management strategies employed by Starbucks is a rapid expansion strategy. With more than 35,000 stores in more than 80 countries, the company isn’t just increasing its footprint, it’s also changing its store mix. For example, instead of opening more dine-in coffeehouses, the company focused on drive-thrus to cater to customers who are always on the move.?
With rapid expansion, the company hopes to achieve economies of scale, which means as the total output grows, its cost per unit of products goes down. It will lead to more profit for the company in the long run.
However, they made it a point to saturate the local markets before venturing out to conquer new ones. For example, they would open 20 or more stores in key cities and neighborhoods to ensure the Starbucks brand becomes an integral part of the local culture. This saturation strategy allowed the coffee giant to establish a loyal customer base, creating a sense of familiarity and reliability.?
The company took extra steps to ensure the Starbucks stores adapt to the unique culture, taste, and preferences of the local market they are in. Whether it’s interior decor, ambiance, or music, Starbucks has always displayed its deft understanding of the local culture of each region.
This localization strategy is so successful for Starbucks that they have implemented it internationally to great effect. For example, in India, Starbucks introduced masala chai and filter coffee in its menu to suit the Indian palate.
Chapter 3: Starbucks as a Brand
In the realm of marketing and branding, Starbucks has covered all its bases. It has a successful and well-established brand strategy. The company has an acute understanding of what the Starbucks brand means to its customers and how to leverage it to drive growth and profit.
The Starbucks brand rests on three core values that have always been the heart and soul of the company: quality, sustainability, and customer experience. It’s important to understand how these three values affect the brand and its connection with its customers.
Let’s talk about quality first. Starbucks has positioned itself as a premium coffee brand that serves high-quality, freshly roasted coffee. The company uses the finest arabica coffee beans and has unique roasting processes. They roast coffee beans longer than the competitors to bring out all flavors. The longer roasting process leads to an increase in costs as the coffee beans lose 18-25% of their weight, compared to their competitors’ beans, which only lose 10-14%.
However, to Starbucks, it's the price they have to pay to maintain the quality standards and more importantly, its brand image. That’s the brand image for which Starbucks’ loyal customers are happy to pay premium prices for their products.
When it comes to sustainability, the company has always projected itself as an environment-conscious entity and has taken steps to encourage holistic and eco-friendly business practices. The company pledged to apply the LEED (Leadership in Environment and Energy Design) principle to its upcoming stores.
At present, Starbucks has more than 1,000 stores in 20 countries that are LEED-certified, more than any other retailer. In these newly established stores, the company uses recycled materials in its decor as well as LED lighting. To reduce its carbon footprint, it made it a priority to source materials from within 500 miles of the store. Starbucks also reached its target of reducing water consumption by 25% by 2015, thanks to innovative plumbing and water systems.
The company abides by the Coffee and Farmer’s Equity (CAFE) practices that protect the interests of local coffee producers in different regions. This way, Starbucks promotes economic transparency, non-discriminatory hiring, and social upliftment among coffee farmers and workers.
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Lastly, the customer experience. Starbucks CEO Howard Schultz envisioned Starbucks as a “third place” after work and home, where customers can relax and socialize. The “Starbucks Experience” - which sets the company apart from its competitors - is a multisensory customer experience designed to evoke customers’ positive emotions and feelings related to Starbucks.
With free Wi-Fi and a discounted refill policy, Starbucks hopes customers will stay a little longer at the store and turn it into a social hangout point, just like the espresso bars Howard saw in Italy. To coffee lovers, the company offers a diverse range of coffee beverages, from simple and traditional cafe lattes to new and innovative ones like the Mocha Frappuccino. It also serves tea and juice beverages for those customers who prefer the ambiance of a Starbucks store minus the coffee.
Such is the dedication of Starbucks to its customers' preferences, that when a survey revealed that 40% of Starbucks customers prefer a lighter roast compared to the traditional dark roast, the company was quick to innovate and come up with the lighter Blonde Roast, which instantly became popular.
Staying true to its core values, Starbucks has created a cult-like following that is hard to replicate. Its brand resonates strongly with its customers. No wonder the company was ranked 14th in the 2023 World’s Most Admired Companies list by Fortune magazine.
Chapter 4: The Road to Diversification
According to the Ansoff Matrix - a tool used for strategic business planning - a company can increase its sales and grow its business in four different ways:
Starbucks used the first three growth strategies to great effect. For example, in terms of market penetration, Starbucks has more or less reached its objective. In the US coffee and snack store industry, it has the largest market share with 33% and is one of the largest coffeehouse chains in the country, with more than 16,000 stores as of December 2023.
Product development strategy is all about launching new products in an existing market to increase sales. Here too, Starbucks achieved saturation. The coffeehouse giant has a wide variety of coffee beverages to match its customers’ preferences. While it continues to innovate and comes up with new coffee products, there is not much room for high growth.
In terms of market development, where a company finds new markets for its existing products, Starbucks maintains a competitive advantage against its competitors. Outside of the United States, the company has more than 20,000 stores in more than 80 countries. As per the financial reports, the company has made the most of this growth strategy. Its revenue from international operations grew 11% to $2 billion in Q4 of FY 2023 compared to the previous year.
Finally, diversification. Out of the four, diversification is the most riskiest growth strategy. That’s because it involves selling new products in new markets. A company has to acquire not only new skills and knowledge but also new resources, including new technologies and new facilities, which exposes the organization to higher levels of risk.
For most of its history, Starbucks shied away from this strategy. However, it had to expand outside the saturated coffee market to increase sales significantly. And that’s what it did by adopting a diluted form of diversification, known as related diversification. In this strategy, the company diversifies by entering a new industry similar to its existing one.
In the case of Starbucks, the company expanded its product line by adding tea beverages and fruit juices to its wide selection of coffee beverages. In 2012, it acquired Teavana - a retail chain specializing in brewed and packaged tea - for $620 million.
It also bought a fruit and vegetable juice company Evolution Fresh for $30 million (later sold to Bolthouse Farms). It further expanded its horizon by acquiring food-related businesses like bakery chain La Boulange for $100 million in 2012.
Each of these strategic acquisitions highlights Starbucks' efforts to break into new categories - health food, bakery, and tea. And it worked. In 2017, Starbucks’ tea business had grown 40% since acquiring Teavana five years ago. Since La Boulange’s acquisition, its food sales revenue has also seen an impressive growth from $2 billion in 2012 to $7 billion in 2022.
In its quest for rapid growth, it turns out related diversification worked wonders for Starbucks. However, outside of coffee, the success of the tea and bakery segments led them to believe that they could sell anything on the planet. However, this time, they pushed their luck too far.
Chapter 5: Flew Too Close to the Sun
When the acquisition of companies like Teavana and La Boulange proved successful, the top brass at Starbucks overestimated the company’s ability to achieve similar success in other verticals. They decided to adopt the risky unrelated diversification strategy. It is when a company enters an unfamiliar industry that has no similarities with its existing industry.
A good example of unrelated diversification is when a soft drinks company bought a movie studio. Coca-Cola purchased Columbia Pictures for $750 million and sold it to Sony for $3.4 billion just seven years later.
Fortunately for Coca-Cola, their investment paid off. However, most companies are not that lucky and incur heavy losses instead. Starbucks was no different. During the dot-com bubble in the early 2000s, the coffeehouse giant tried to enter into the furniture and home decor industry. It invested $20.6 million in Living.com, an online furniture retailer.?
However, when the dot-com bubble burst and NASDAQ came crashing down, Living.com couldn’t sustain itself and filed for bankruptcy. Starbucks was forced to write off its investment.
The company should have learned from its mistakes. Instead, it doubled down. This time it tried to take on the music industry. Back in the 90s, CDs were a popular way to listen to music. Starbucks started selling music albums. In 2007, it even acquired a record label and signed artists like Paul McCartney and Ray Charles.?
It installed kiosks at its stores that allowed customers to create customized playlists of songs and burn them into CDs for a fee. The kiosk feature failed to attract attention, mostly because Apple’s iPod had already arrived in the market and had revolutionized the way people consume music. Music CDs quickly went out of fashion, and so did Starbucks' music business.
Desperate to get into the entertainment business, Starbucks struck a partnership deal with independent film studio Lionsgate and entered Hollywood. As per the deal, in return for in-store promotion of Lionsgate-produced movies, Starbucks would receive a cut of the box office profits and DVD sales.
In 2006, Lionsgate released Akeelah and the Bee, a family-friendly drama film about a young spelling bee contestant. Starbucks promoted the film in its stores with coasters, signs, spelling bee trivia games, merchandise, etc. Despite the efforts, the film fared poorly at the box office.
It did the same for another Hollywood production - Paramount’s Arctic Tale, a documentary focusing on climate change. Here too, Starbucks promoted the movie in its stores with stuffed animals and branded coffee cup sleeves. The film turned out to be a box-office bomb, making only $1.8 million worldwide. As a result of these failures, Starbucks closed its entertainment division and left the industry for good.
Unrelated diversification is a high-risk, high-reward growth strategy. While Starbucks did great with the related diversification, unrelated diversification took the wind out of its sails. It failed to pull it off.
But that doesn't mean the strategy itself is flawed. Instead, when done right, it allows companies to grow at an unprecedented pace and become multinational conglomerates that have business interests in multiple industries. General Electric, Samsung, PepsiCo, and Procter & Gamble are great examples. However, unrelated diversification is not for everybody.
Starbucks realized that as a brand, it's not possible to sell anything under the sun. A company’s brand values in one industry may not translate well in another. The coffeehouse giant curtailed its diversification strategies and went back to what it was doing best - selling high-quality beverages and creating memorable experiences for its customers. It gave up the idea of expanding too far outside its scope of expertise. At least for now.
Epilogue
Since its first coffee bean store in 1971, Starbucks has become a brand admired by its customers worldwide. That’s because it used the power of human connection to grow its brand through “branded experiences” rather than a product through brand loyalty or “brand tribalism”.
It created a greater perceived value by selling coffee not as a commodity but as an experience. It revived the coffee culture in the United States and introduced the masses to high-quality coffee only available in Europe until then. In doing so, it elevated itself to become the largest coffeehouse chain in the world.