Thinking Outside The Cup

Surprise! Starbucks barista-in-chief Howard Schultz is making a big, bold push into the music business. He aims to transform the record industry -- and turn Starbucks into the world's biggest brand, period.

So this girl walks into a bar. She holds a tall iced coffee in one hand, and her blond hair is piled high in a ponytail, neon bikini strings peeking out from her tank top. At this bar, however, headphones hang above the stools, and computer screens are embedded in the countertop. The girl looks at the "bartender" quizzically. "So you can burn music here and it's, like, legal and everything?" she asks. The bartender smiles and nods. "Omigod, so you have, like, every song, ever?" Well, not every song, but quite a few: approaching 150,000 -- about 20,000 albums' worth. The girl settles onto a stool and grabs a headset, taking a long drag on the straw in her drink as she starts tapping away on a screen. "That's awwwesome."

It's awesome indeed, this new-concept music store on the trendy Third Street Promenade in Santa Monica, California. It's a beautiful space with warm lighting and wood paneling -- a place where you can buy regular old CDs, or linger with a drink while you listen to music and sift through thousands of songs stored in a computer database to create your very own personalized, mixed-CD masterpiece. In about five minutes, a freshly burned CD, complete with your chosen title and funky artwork on both the disc and the jacket (plus liner notes!) will be ready to take home. It all happens very smoothly, and yet it's a novel and startling experience. But what's most startling about this remarkable new place to buy music is this: It's a Starbucks.

The Hear Music Coffeehouse, as it's known, opened last March as the first of several fully integrated cafe-music stores that Starbucks is launching with its wholly owned subsidiary, retailer Hear Music. This August, Starbucks will install individual music-listening stations, with CD-burning capabilities, in 10 existing Starbucks locations in Seattle. From there, the concept rolls out to Texas in the fall, including Starbucks stores in the music mecca of Austin. With the help of technology partner Hewlett-Packard, Starbucks plans to have 100 coffee shops across the country enabled with Hear Music CD-burning stations by next Christmas, and more than 1,000 locations up and running by the end of 2005. Think iTunes meets Tower Records. With lattes.

"Great companies recognize who they are and who they are not. But they must have the courage to examine transformational opportunities."

Chairman and chief global strategist Howard Schultz's ambitions for this new business operation are vast; it's not just about selling a few CDs from a coffee shop (Starbucks has been doing that, successfully, for about five years already). Schultz wants Starbucks customers to make their own CDs, yes, but he also thinks they will someday use Starbucks' enormous Wi-Fi footprint to buy and store music from the network on any device imaginable -- from laptops and iPods to phones and PDAs. He hopes record labels will develop proprietary material just for the Starbucks network. And that Starbucks itself may help break new artists and develop original material. Indeed, Howard Schultz plans nothing less than to turn the entire music industry upside down. "We are the most frequented retailer in the world," he says. "With hundreds of thousands of songs digitally filed and stored, these Hear Music coffeehouses combined with our existing locations can become the largest music store in any city that we have a Starbucks in. And because of the traffic, the frequency, and the trust that our customers have in the experience and the brand, we believe strongly that we can transform the retail record industry."

There's something even more intriguing going on here, though. This push into music is the start of a daring effort to reinvent one of the world's best-known brands. It is an experiment that asks whether that brand is powerful enough, and Starbucks' relationships with the 30 million customers who pass through its 8,000 stores every week durable enough, that they can be used to completely transform the business.

"Great companies are defined by their discipline and their understanding of who they are and who they are not," Schultz says. "But also, great companies must have the courage to examine strategic opportunities that are transformational -- as long as they are not inconsistent with the guiding principles and values of the core business." And so Schultz finds himself on a precipice, at the edge of just such an opportunity, where he celebrates coffee as both the origins and the core of his business, and yet has dreams of transcending those origins to become something much more.

In effect, Schultz is asking the question famously posed by Theodore Levitt, the Harvard Business School professor and father of modern marketing: What business are you really in? Levitt explained that the once-powerful railroads, for example, were blindsided first by automobiles and then by the airlines. It happened because they had defined themselves too narrowly as being in the railroad business rather than the transportation business. As railroads, they were entrenched and invulnerable; as transportation, they were wide open to attack. Theirs was a failure of imagination -- the inability to reconceive themselves based on the business they were really in.

Over the years, a handful of companies have taken Levitt's words to heart, reimagining the very definitions of their businesses and their industries each time they reached a critical turning point. Disney was once a little studio that turned out cartoon shorts. Then Walt Disney opened a theme park unlike anything anyone had ever known. Now his company develops, produces, and distributes films of all kinds; has a network of theme parks; and runs a vast media empire. Virgin's Richard Branson turned a little music magazine into a music superstore, then launched an airline, and, most recently, a cell-phone company. And before her ImClone disgrace, Martha Stewart was among this select few: Her home-catering operation became a series of cookbooks, then gave birth to a multimedia company and a lifestyle-products line that sold everything from hand towels to patio furniture at Kmart.

In each case, as the company reached a plateau in one industry category, a visionary leader looked past the original product or service to redefine, in the broadest terms, the business it was in. Disney, Branson, and Stewart reimagined their cartoon, magazine, and food-service operations as entertainment enterprises. Then, when entertainment itself became too constricting, they blew apart traditional industry characterizations altogether. Now what they really sell is a lifestyle. Disney and its idealized view of wholesome, all-American family life; Virgin and its vision of youth, sexiness, adventure, and exuberance; Martha Stewart and her promise that you, too, can lead the elegant, good life. They sell you the dream, then the full suite of products, services, and experiences to achieve it.

And Schultz would like Starbucks to join them. He aims to achieve what so few are able to do -- to reimagine his company as something bigger, better, and more significant than it has ever been. In fact, forget joining them. Schultz plans to surpass them all. "We have the potential to become the most recognizable and respected brand in the world," he says flatly.

That may be hubris, or it may be an attainable goal. Either way, Schultz must still answer Levitt's question: What business is Starbucks really in? Clearly, it's more than coffee shops. Like those other successful marketers, Schultz is selling his own lifestyle dream, one of affluence and comfort, a forward-looking but not-too-trendy community experience wrapped around a steaming cup of coffee in a cozy living room that exists on every block between home and work.

This wouldn't be the first time Schultz has transformed his company with a quantum leap of imagination. When he arrived at Starbucks in 1982 as the director of marketing and retail sales, the company was a coffee roaster and wholesaler. Back then, coffee was a 40-cent cup of brownish water, and Maxwell House reigned supreme. Now millions of coffee drinkers think nothing of paying $4 for a tall vanilla latte. Sure, it tastes better than coffee from the 1980s, but is it really worth 10 times as much? Probably not. And Schultz knows it, because he's not really selling the coffee. What he's really persuading us to pay for is that relaxing world of velvet armchairs and afternoon chats with friends in a home away from home that's filled with . . . yes, music. Or as he puts it, "We've known for a long time now that Starbucks is more than just a wonderful cup of coffee. It's the experience."

And those $4 lattes, with their extra-foamy triple-caffeinated profit margins, sure do add up. Since its IPO in 1992, Starbucks has been a stellar performer by nearly every measure. The stock is up 3,500%, with a market capitalization that increased from $400 million to about $15 billion this year. Starbucks opens three new stores every single day, and now has about 8,000 coffee shops around the world (up from 165 in 1992). It has racked up more than 12 consecutive years of sales growth in existing stores; in each of the last five years, same-store sales have increased by 5% or more. Far from showing signs of flagging, this critical measure of retail performance is looking even better lately. Same-store sales rose 9% in 2003.

And yet it's hard not to wonder whether Starbucks' cup won't someday run dry. With a shop on what seems like every corner, can market saturation be far behind? Schultz dismisses the notion; he's fond of pointing out that Starbucks has just a 7% share of the North American coffee market, which would suggest that there's lots of room to grow. And despite some setbacks, Starbucks has 1,867 stores overseas and has big hopes for China.

"Of course no chief executive wants to say, 'Yes, our market is saturated,' " scoffs Geoffrey Moore, a partner at the Silicon Valley venture-capital firm Mohr, Davidow Ventures and author of the business classic Crossing the Chasm (HarperBusiness, 1991). "But the notion that 7% market share means he still has a big field to go after is silly. His market is not all coffee drinkers. His market is people who buy into an upscale 21st-century cafe society experience, which is much smaller."

Whether or not Starbucks' own railroad moment is waiting just around the bend, now is probably not a bad time to be thinking of some new and different ways to grow. "Schultz is doing something quite unusual in business," says Adrian Slywotzky, a partner at Mercer Management Consulting and coauthor of How to Grow When Markets Don't (Warner Books, 2003). "He's already looking ahead, doing the arithmetic and saying, 'Well, our current model is not forever.' There are probably a few more years of growth left in coffee shops, and he's asking, 'How do we manage that inevitable slowdown a couple of years from now?' "

There are several ways Starbucks might answer that question, Slywotzky says. It could expand grocery operations, increase corporate sales, or explore entirely new markets. The company has already had some success in the first two categories. It sells bottled coffee drinks, coffee-flavored ice creams, and coffee beans in grocery chains nationwide. And it sells to food-service companies that supply coffee on airlines and in hotels and restaurants.

But all told, these businesses don't add up to a very big hill of beans for Starbucks. They amount to something like 8% of total revenues. And profit margins are slim.

Schultz stumbled on another answer five years ago when he walked into the Stanford Shopping Center in Palo Alto. He was on an idea-hunting trip, the sort of expedition he and other Starbucks executives frequently go on. "At our core, we're merchants," he says. "And that means we travel the world all the time, looking at and examining the best retailers and merchants, whatever they might be." That day, Schultz walked into a Hear Music record store and fell in love.

It wasn't huge by the standards of superstores such as Tower Records, HMV, or Virgin Megastore. Instead of ringing up CDs by the latest top-40 bubblegum princesses, the store clerks talked to Schultz about such artists as jazz greats Ella Fitzgerald and Dinah Washington. "When I think about the average music-shopping experience, what I would call the sense of romance about music is gone," Schultz recalls. "But when I saw Hear Music that first time, it was clear that they had cracked the code on the sense of discovery that music should have."

What Schultz had come across was a group of music stores with something of a cult following in the Bay Area. Hear Music was one of the first stores in the country to introduce the now-universal concept of the "listening station," those headphone-equipped CD stations where shoppers can try their music before they buy. Though the stores carry fewer titles than the music superstores, Hear Music prides itself on introducing customers to music from off-the-beaten-path artists, and the people who work there are passionate about music. A Hear Music employee can almost always suggest singers you might like if you tell him what music you already own. If you don't know the name of a particular tune, he can probably track it down for you.

In its intimacy, quality, and customer focus, Hear Music must have reminded Schultz very much of his own company. And the rest of the music industry, with its commoditization, standardization, and concentration on shoveling millions of Hilary Duff CDs out the door, must have looked a lot like Maxwell House. "We never dreamed we'd be sitting on the unique opportunity we're sitting on now," he says. "We just saw that they were doing for music what we had done for coffee."

On some level, of course, it hardly took a flash of blinding insight to see that music and coffeehouses were made for each other. "Our customers respond to music," says Anne Saunders, senior vice president of marketing. "Part of why they come is as an entertainment destination, for a respite, a break with friends, as a place for community gathering. The idea for the music service is very grounded in why people come to Starbucks."

Since acquiring the company in 1999, Starbucks has sold Hear Music compilation CDs in its stores. And it launched a popular series of CDs called "Artist's Choice," in which musicians from Lucinda Williams to the Rolling Stones share their favorite songs. Nearly 400,000 copies have been sold at Starbucks stores. It was after seeing those results that Schultz and Don MacKinnon, one of the founders of Hear Music and now Starbucks' vice president of music and entertainment (doesn't that title tell you something?), began to wonder whether there was a bigger opportunity to explore.

Schultz and MacKinnon came to believe that the core Starbucks customer, an affluent 25- to 50-year-old who's likelier to be tuned in to NPR than to MTV or one of the nine gazillion radio stations owned by Clear Channel Communications Inc., probably feels ignored by the music industry. The shopping experience at most record stores is off-putting, with customers overwhelmed by the volume of stuff but still unable to discover great new music. At the same time, the consolidated radio industry has gone as bland and homogenized as low-fat milk. "What you're left with is this very broad audience made up of the core Starbucks customer, who loves music and can't find it," Schultz says. "We have a unique opportunity to take advantage of this."

There are clear parallels between the way Starbucks is developing this new music business and the way Schultz developed the core coffee business.

Follow that blond girl into the Hear Music Coffeehouse in Santa Monica, and you'll start to see what Schultz means. Down on the Promenade, it's early on a Sunday afternoon, and the cobblestone sidewalks are full of people. They flock to the Starbucks storefront between Broadway and Santa Monica boulevards for iced-coffee confections. Customers order at an outdoor bar, and are directed inside the store to pick up their drinks on the other side of the doorway. More often than not, once folks step inside, they decide to stay.

A smooth R&B tune is grooving over the sound system, and a quick look at the wall over the music bar reveals a projected-light sign: "Now Playing: 'When It Hurts So Bad,' by Lauryn Hill, from the album The Miseducation of Lauryn Hill." The store is crowded. More than 60 people are in the small space -- 3,000 square feet, just large enough to accommodate the coffee and music bars, two short aisles of CD racks, plus space to mill around near the center of the store.

Now take a peek around the corner, at the Tower Records on Santa Monica Boulevard. It's easily four times as big as the Hear Music Coffeehouse, and there are just 10 people inside. None are interacting with a Tower employee, and none are using the listening stations -- perhaps because three of them are broken. (Tower's parent company filed for Chapter 11 bankruptcy in February.) And here's the Borders, just three doors down from Hear Music. It has an entire floor dedicated to music and movies, but there are no employees and just two customers -- both looking at DVDs.

Back at the coffeehouse, each of the seven listening stations at the CD-burning music bar is in use, and -- though you wouldn't believe there was enough space for this many -- all of the 55 other HP Tablet PC-based listening stations around the store are in use, too. Three more stations outside at the coffee bar make 65 places in all where customers can listen to as many songs as they have the patience to sample.

There are no restrictions on what songs you can listen to, or for how long. Pick up any CD from the racks, wave its bar code under the scanner at the bottom of the listening stations, and a complete list of the songs on the album appears on screen, along with a description of the artist and links to other records. "The scanning thing is pretty rad," says Nathan Hill, 26, who comes by often to check out the selection. "It helps me find stuff." If Hear Music has written reviews about, conducted interviews with, or produced compilations that include the artist, those are linked, too. The tablets are simple ATM-style touch screens. And often there are recommendations: "If you like Norah Jones, you might try Shelby Lynne."

There are clear parallels between the way Starbucks is developing this new music business and the way Schultz developed the core coffee business over the past two decades. Though his ambitions are global and his product is mass market, each coffee drink is personalized and created individually. Like all Starbucks executives, Saunders, the marketing chief, worked in a store when she first arrived on the job. "I waited on hundreds of customers while working the cash register and was struck by how every single one of them ordered something different," she says. "A flavor shot, extra hot, half-caf, maybe all those things together. Every single person coming in here has a different experience, designed the way they want it."

At the Hear Music Coffeehouse, the personalization is even more . . . personal. Choose your cover art. Create an album title. Select your songs. Move them around into a different order. Pick music by mood, by artist, or by genre -- it's your choice. "We have a marketing tagline on the wall to reinforce how important we think that personalized experience is," says Saunders. "It reads: 'It'll be your favorite CD because you picked every song.' " And the product itself is high quality and perfectly packaged. "So many people aren't ready for digital music if they approach it on their own," says MacKinnon. "Here, there is no barrier to exploration, and you take something home that is tangible and beautiful."

And here's who MacKinnon has in mind: a woman with a head of unruly gray hair who has been tapping intently on a screen at the music bar for nearly two hours now. It's Mother's Day, and Kerry Smallwood, 47, just received a gift certificate to the store. A friend brought her here when the Hear Music Coffeehouse first opened. Today is her sixth visit. "I pretty much just listen to the CDs I make here now," Smallwood says. Her playlist so far has songs by Norah Jones, Rufus Wainwright, Sting, and Oscar Petersen.

Has she ever burned a CD for herself on a computer at home? Smallwood's expression is completely blank. "No, no, I've never done that. I don't know how." She's exactly why Starbucks thinks it can go up against Apple's more technology-oriented iTunes service. Smallwood will never know that there is a mini server farm hidden behind the service door at the back of the store. She just knows that for $6.99 for her first five tracks and $1 for each additional song, plus about a five-minute wait, she gets another beautifully packaged, personalized CD.

It's all very smooth, it's all very seamless, and it all seems to make so much sense. But does it? Can Schultz and his team carry off a transformation like this? Is it really a smart move for a coffee company to reimagine itself as a lifestyle-entertainment enterprise and to start by serving up music? After all, the mere fact that a certain sort of music and a certain sort of coffee appeal to the same sort of customer doesn't necessarily mean that they should be sold at the same store. By such logic, what would stop Starbucks from selling, say, hiking shoes, or take-'em-home versions of the new-agey furniture in its stores, or earth-friendly kids' toys? That's why Mohr, Davidow Ventures' Moore cautions Schultz to tread carefully. "It's a very interesting experiment, but if I was on their board of directors, I'd be more concerned that they not corrupt the brand," he says. "If Starbucks is just trying to find more ways to monetize the traffic that comes through, this is a bad idea. At some point the customers will start to feel abused."

Though he acknowledges the risk, Schultz sees his company poised at a turning point -- and he's confident the music service is the next step along Starbucks' path toward becoming, yes, the world's biggest brand. "The hardest thing is to stay small while you get big, to figure out how to stay intimate with your customers and your people, even as your reach gets bigger. We want to be a respectful merchant so that we're not trying to sell anything that would in any way dilute the experience," he says. The music business won't do that, he vows; rather, it will enhance that experience. "Great retailers recognize that they're in the business of constantly surprising and delighting their customers," he says. This big, bold push into music, he expects, will do both.

Fast Take: Redefining your Business

To Howard Schultz, Starbucks isn't in the coffee business. It's in the people business. Once you start looking at things that way, the horizons get a lot wider. Here's Schultz's guide to contemplating life beyond the cup.

Think like an athlete.

Whenever you reach a plateau, it's time to rethink. If you're number one or number two in your category, maybe it's time to reconsider the category in which you compete: Create a broader definition of the industry, and develop a new plan to conquer it.

Team up with like-minded partners.

Hear Music and Don MacKinnon approach their business the same way Starbucks does: Customer interaction is vital, intimacy is important, and the shopping experience is everything. That's what made launching a music service together smart, not crazy.

Dream big.

A corollary to finding a new industry definition: Make its boundaries as wide as possible. "We have the potential to become the most recognizable and respected brand in the world," Schultz says. Not the biggest coffee company but the biggest brand, period. "When you're building a business, you have to dream as big as you can possibly imagine -- otherwise, what's the point?"

Stay small.

Everyone loves the convenience of a widely available product or service; no one likes to feel anonymous. Even as Starbucks goes global, adding new products and new businesses, Schultz and his team strive to maintain the intimacy and personalized feel of every single Starbucks encounter. "Our biggest challenge is to get big but stay small," he says.

Fast Take: A Coffee-Klatsch with Mr. Schultz

Words of wisdom from the architect of Starbucks' phenomenal success:

"Customer loyalty is not an entitlement."

Whether you have 30 customers or 30 million (like Starbucks), customers are fickle. They're bombarded with newer products and snazzier messages every day. Companies must continue to prove their worth -- or lose it. Says Schultz: "We know we need to win back our customers' loyalty every day. Our success is based on their continued trust in our people and our environment over long periods of time."

"Great brands aren't built on ads or promotions."

Redefining the industry you're playing in doesn't just mean hiring an agency to think up a fancy new slogan. To make it work, you have to offer high-quality new products and services that customers actually want, and that will reinforce the value offered by your core brand and expand the emotional connection your customers feel with it.

"It's no fun being a pioneer."

When launching a new product, service, or business unit, remember that experience still counts. Even though the Hear Music Coffeehouse experience is unique, developing it with folks familiar with the music business was vital. "It's always best to surround yourself with people who've done it before, in some form or another," Schultz says.

"Stay humble. There is no room for arrogance."

Customers can tell when a new product or service is an authentic outgrowth of the company's mission, and when it's an overblown gimmick designed to feed the buzz machine. Be aggressive with your business performance goals -- not your ego.

Sidebar: The Chairman's Mix

  • Bobby Darin, Mack the Knife
  • Duke Ellington, Mood Indigo
  • Nat King Cole, I Get a Kick Out of You
  • Simon & Garfunkel, Homeward Bound
  • Diana Krall, Peel Me a Grape
  • Joss Stone, Some Kind of Wonderful
  • Miles Davis, So What
  • Sarah McLachlan, Angel

Alison Overholt (aoverholt@fastcompany.com) is a Fast Company staff writer with a penchant for tall soy lattes and compilations of jazzy lounge music.

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