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Starbucks at the Crossroads: Disruption Junction

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I suspect most people have heard by now of the kerfuffle about an internal memo, leaked through a popular Starbucks fan blogsite and ultimately covered by BusinessWeek, the Wall Street Journal, Forbes, CNN, etc. It was penned by the founder and chairman of Starbucks, Howard Schultz.

Certainly the blogosphere is abuzz with the come-to-Jesus nature of Schultz's revelation that Starbucks may have lost its mystique. I counted hundreds of blog postings—right up there with "Britney Spears haircut" and "Anna Nicole Smith" in popularity.

The memo itself was an interesting document that raises eyebrows and questions: Although addressed to the president and other senior execs, had it always been intended to be leaked, via social media, into the mainstream press—and back to the blogosphere? It has certainly created a lot of passionate commentary and free advertising for Starbucks. Was it really intended to tell the public that Starbucks knows that people are complaining and that the competitive sands are shifting? Was it a message to investors that the company needs to slow growth and fix the experience to save the brand and that it's going to cost a bundle?

Or was it just the confessions of a founder and chairman, purging feelings of guilt about a loss of soul, and a plea to executives for salvation? (And which, incidentally made Starbucks look good while rallying those who are still passionate about the brand experience to Starbucks's defense?)

No matter which of these it was, it was a brilliant document; but it may be too little, too late.


Too Little, Too Latte? Starbucks Is the World's Pre-eminent Coffee Brand: How Can It Be So?

It really depends on whether the executives realize that disruption is afoot, and that there's much more going on here than the diminution of brand experience. To properly address this question, and explain why disruption is the real problem, it helps to go back to the beginning and define the innovation that led to Starbucks's becoming a household name with nearly 15,000 stores around the world.

What problem did Starbucks solve for its customers?

Anyone who traveled in Europe BS (Before Starbucks) would have marveled at the quality and variety of coffee, and the cafe culture there. Especially in places like Italy and France. The coffees were strong, but fresh, well-prepared, and a perfect complement to a day of sitting on a sidewalk under an umbrella people-watching—or for ending a perfect meal, or as a delightful jolt to start the day with a pain au chocolat or even just toast and eggs. You would have wondered how everywhere you went coffee could taste so strong yet be so delicious and universally good.

On this side of the pond (outside of your favorite Little Italy restaurant), it was almost impossible to get a decent cup of coffee, and especially to get a strong cup that was drinkable. I remember wondering after every trip why it was that good coffee on our side of the pond was an oxymoron while, on their side, it was impossible to get a bad one.

It wasn't just that most (North) American coffees were made from Robusta versus the superior Arabica beans. It also had to do with poor roasting and poor quality control—and the fact that we got used to crappy coffee during the Second World War, when everything was rationed or watered down. By the '50s, everything was about speed and automation, and so we made matters worse by going from percolated to instant to freeze-dried to Coffee-Mate powdered creamer (another oxymoron). We drank it by the gallon, rotting our stomachs, taste buds, and brains in the process. It was purely about the caffeine and the speed. (Wonder why we never distilled out the caffeine and dispensed it straight via injection?)

Yes, in a few big cities, you could find that rare place that would serve a great European-style coffee, and sometimes even with a bit of the ambiance, but that was so small a percentage of consumption that it barely qualified as an exception to the rule.

The story is apocryphal, published on the Starbucks website (pdf) and in Schultz's book, about how Schultz felt exactly this way on visits to Milano and decided that it was time that Americans got to upgrade their coffee experience. And create not just a better cup of coffee but the same smell and feel and cultured experience and ambiance of a great Italian coffee bar. That was the beginning of Starbucks as we know it.

We'd been upgrading the experience for ourselves, as much as we could, with drip coffee rather than instant more the norm in the '70s and '80s, but the vast majority of Americans had never had a quality cup of coffee nor enjoyed the sensuality of the European coffee culture. So when Starbucks hit Seattle, we were ready for something different.

So What About Disruption?

Disruption theory says that products or services evolve incrementally to better meet the needs of the most demanding customers, but eventually overshoot the needs of most consumers.

In this process, the incumbents that dominate the existing market build processes and operational efficiencies that enable them to maximize profitability and continually introduce new "sustaining innovations." In the short term, these series of decisions that improve processes and efficiency are seen as good management, delivering better profits. In the long term, however, they create the opportunity for a disruptive innovator to enter the scene.

At the time when Starbucks began, the big coffee suppliers had enormously overshot the needs of their customers for a cheap, fast cup of coffee. Yet, each "innovation" they introduced kept on making the product either cheaper or faster to prepare, stripping the product of the original reasons we became addicted to it—its flavor first and foremost, but also its ability to facilitate social interaction and help drinkers to savor a great meal, sit and relax, etc.

So Starbucks was a disruptive innovator. It brought flavor, a friendly social setting (the "third place"), quality, plus the consistency that only a chain can bring. It brought back the smells, the sensuality, and introduced to Americans a "European experience" and what Schultz has described as the sense of theater.

But, you might be saying, Starbucks introduced a high-end innovation—disruptive innovations typically are aimed at the low end markets and low end needs. Well, you'd be right, but the question is, What needs were low end, or more accurately underserved? The characteristic that initially made Starbucks a small niche disruption was the speed. The big producers were optimized for speed above all else, not flavor and certainly not the organic pleasure of a gathering place with great smells where you hang out with your friends.

The characteristic of the Starbucks innovation that was just good enough for the original niche of coffee-culture appreciators was the speed. They were happy to sacrifice the speed of picking up a pot of coffee off the Bunn burner (ironic that they called these things burners, because that's what they do to most pots left on them longer than five minutes) and pouring it straight to the cup and from there to the lips, in order to drink something they truly enjoyed and to experience the coffee-bar ambiance.

Initially, potential competitors to Starbucks ignored it because the market wasn't big enough for Dunkin Donuts or McDonald's to care about. To them, Starbucks coffee drinkers were aficionados—a tiny specialized segment that had nothing to do with the mainstream, which they perceived still mostly wanted speed.

This ignorance is typical (and logical) to mainstream vendors that aim to maximize profit by serving the largest market as efficiently as possible. It also allowed Starbucks to "fly under the radar" for a long time—over 20 years of strong growth—allowing it to build its market unimpeded by real competition (yes, there are smaller chain coffee brands, like Caribou and Peet's, etc., but their presence serves to expand the market for all specialty coffee vendors, and benefits the leader—Starbucks—disproportionately), until it became the mainstream and was perceived a real threat to the food-service business of other big companies.

But Starbucks is the leader and still growing. What's this about Disruption?

As noted, disruption can take a long time to play out, and the seeds are sown long before the heavy damage is done. As Starbucks has grown, it has focused on operational efficiencies to grow faster and more profitably. Efficiencies such as automatic espresso machines, flavor-sealed packaging (which eliminates the great smell of a real coffee shop), and expanding merchandise options ("would you like some fries with that doppio mocha latte half-caf with low fat milk?") to extract every last penny of same-store sales growth.

In the process, it has incrementally sacrificed seemingly small parts of the experience—the smell, the theater, the ambiance (who wants a line snaking around the tables while you're trying to relax or have a conversation over a cuppa?), the service quality (rapid growth almost always comes with higher turnover and poorer training—by now, we've all experienced the surly baristas who won't go the extra mile, but still make too many mistakes), etc. In the process, it has reduced itself to serving a pretty-good-but-not-outstanding cup of coffee, too slowly and at too high a price.

And, more importantly, it has overshot the needs of its customers and is ripe for disruption. To speed up coffee service in order to sell everything else too, it installed automatic machines—which can be more consistent, especially for inexperienced operators, but also reduce the flavor and the authenticity of the experience and show competitors how they too can produce a cup just as good as Starbucks (i.e., open themselves to commoditization).

This was an unnecessary and ill-advised "innovation." Customers didn't ask for it and would probably agree that they didn't need it and that they are getting less for their money.

Do I really need a bacon-and-egg (McMuffin) breakfast with my espresso? Again, the more I overlap with my competition, the more I illustrate to them how to compete with me. And now I smell eggs cooking, not coffee beans and fresh espresso. Not wise. Most fanatical customers who still are... were more fanatical 10 years ago. So what have these innovations added?

In becoming ubiquitous, the mystique is demystified; the coffee, which was the central feature, has become a means to sell myriad other food items and irrelevant merchandise (T-shirts, anyone?); and the taste and smell and comfort have all been diminished. Yet, the high price remains. And, therein lie the seeds for potential disruption.

Now, wanting a good cup of coffee has become mainstream, and Starbucks has become focused on speed (but not really), and efficiency, and foodservice, and add-on sales and rapid growth. So it now faces a new reality: It's easy to add a pretty good cup of coffee to the menu. Especially for companies like McDonald's and Dunkin Donuts that already serve coffee.

All they have to do is add middle-of-the-road or better automatic machines to their operation, and they're almost as good. But they excel at real speed and efficiency and are optimized to process customers in seconds or at most a minute or two, whereas Starbucks will never get that fast without redesigning every store and adding a lot more baristas. Moreover, they are value-oriented—i.e., cheap. For McDonald's, $1.25 for coffee is an improvement in margin, but for Starbucks it's impossible to go that low.

So, if I can get something almost as good for one-third the price, is that "good enough"? Heck, even the local QuikTrip service stations can create a relatively decent cup of coffee or espresso now.

And, more than commoditization, Starbucks's real problem now is that the competition is "good enough" to be disruptive and undermine its business.

But here's the real conundrum Starbucks faces: It will be almost impossible to go back.

Replacing the automatic machines with better-quality semi-automatic or going manual, and fresh ground and hand-tamped shots, means throwing out a lot of expensive machines. It means going a bit slower for each coffee, which also means more people and more space for brewing. And, it means increasing training expense enormously.

It will be hard to explain to investors why all the superfluous merchandise needs to come out of the stores and why same-store sales will likely decrease. It will be even harder to recognize that for the mainstream coffee consumer a $1.25 cup of coffee is good enough (even if I can't quite bring myself to visit McDonald's), and so there will be increasing downward pressure on price. If it doesn't want to compete on price, then it probably already has too many stores, because the average consumer won't continue to spend a premium price for a commodity that is only marginally better than the competition.

Coffee Customization at Its Finest

To Schultz's credit, he recognizes that all is not well. And he's recognizing it at a time of apparent strength. Starbucks just announced another record year, when revenue grew 23%, 1177 new stores were added, and same-store sales increased 6% over the previous year (although the rate of increase is slowing, these are still impressive numbers for a $6.7 billion company).

If he can convince his executives and board and investors that a strategic overhaul is required to address the looming disruption, then he may well be able to avert it; but it isn't as simple now as returning to the good old days of better quality machines, better service, less merchandise, whole beans scooped out of bins rather than prepackaged in flavor-sealed bags, more uniqueness in each store, etc.

It will need a plan designed specifically to address the disruption that Starbucks faces from new competitors, or else the disruptor will become the disruptee.

Acknowledging that the market has changed irrevocably and is now attracting disruptive "good enough" solutions for quality coffee, but at a lower price and faster pace... what would you do to re-energize Starbucks and fend off a loss of leadership position in the coming years?

Links for coffee fans:

Note: This article was originally posted on the author's blog, The Anti-Marketer.


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Paul Paetz is a disruption consultant with the Disruption Group (www.thedisruptiongroup.com).

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