Fast Company: Why did you decide to buy Hear Music five years ago?
Howard Schultz: If you think about what occurs within a Starbucks store, I think we've known for a long time now that Starbucks is more than just a wonderful cup of coffee. It's the experience. And the experience is defined by what we have characterized for a long time as Starbucks really becoming this "Third Place" between home and work — an extension of people's front porch, or people's home office. As a result of that, we realized early on that we had an opportunity to leverage the equity of the experience and the trust that our consumers have in the brand and in our people, to other products and services.
Music was a natural evolution because we had been playing music in our stores for almost 30 years. For a long time, our customers have actually stopped our people and asked, what is that song? When I saw Hear Music the first time, it was clear that they had cracked the code on the sense of discovery that music should have. We never dreamed that we'd be sitting on the unique opportunity we're sitting on now. We just saw that they were doing for music what we had done for coffee. It was this very respectful way of presenting music that, in a way, had become a lost art.
FC: What was your goal when you originally reached out to them?
Schultz: It was to integrate Hear Music's understanding of the music industry and their acumen as it related to their sense of editorial voice with Starbucks in a complementary way. And in doing so, to also examine whether there was an opportunity to expand Hear Music into other forms of channel distribution or new stores. But at a time when the retail record industry was going through such a very very difficult period, it became a complementary component to the existing Starbucks stores.
FC: Tell me how you found out about them. With all the different record chains out there, why Hear Music for this experiment?
Schultz: At our core, we're merchants. That means we travel the world all the time, looking at and examining the best retailers and merchants, whatever they might be. We're always looking for new ideas and to examine other ways in which people are doing things. In this case, we walked into a Hear Music store.
FC: Do you remember which one it was?
Schultz: The one I walked into is in the Stanford Shopping Center, but our people had also seen one in New England, I think. Then we met Don [MacKinnon], and clearly Don has just an unbelievable sense of quality and integrity in terms of the music industry. The group of people that he brought to Starbucks brought an expertise and a competency that we didn't have on our own. Sometimes I think when you make an acquisition like this, it's not necessarily for what you're thinking of today; it's something you're going to learn and incubate into the company. And here we are with a very, very significant opportunity as a result of that acquisition! We're pretty excited about it.
FC: Why did it take five years to get from acquisition to deciding to roll out this combination store? What happened in those intervening years?
Schultz: We've been pretty busy opening up Starbucks stores. But we've also already been highly successful, although in a narrow way, leveraging Hear Music's talents into Starbucks. We've been selling CDs under Don's thoughtfulness and expertise, primarily in compilations and recently in this new form of Artists' Choice.
But as an example, it's taken us two years to produce a highly anticipated record with Ray Charles. That's a two-year project. This is very unique in that it's a duets album with people like Norah Jones, Elton John, James Taylor — all with Ray. That's in conjunction with Concord Records. This is the first time, really, where Starbucks has created an exclusive album like this, and in doing so, we're also going to distribute this ubiquitously outside of Starbucks stores, with Concord Records. It's going to be everywhere. Worldwide. In a sense, Starbucks is broadening its view of what's possible.
The music industry has been under such severe pressure over the last few years so, really, we've been an exception to the rule. Over the last few years while there's been such a level of attrition in terms of rate of sales of traditional music in traditional stores, Starbucks has been able to bring music to our stores and successfully, one CD after another, see it be received well. It's given us the courage now to do this Ray Charles thing. But you haven't seen anything yet in terms of what's coming.
FC: As the music business continues to fragment and have so many problems, it's a really scary time to say, 'We're in the music business.' Is that what Starbucks is saying? Let's jump into the music business?
Schultz: We're not jumping into the music business. We are leveraging our assets and our core competencies to take advantage of what I would characterize as the perfect storm of what took place over the last three or four years in the retail record industry. At its peak, in the year 2000, the retail record industry was approximately $13 billion. That's a very, very large market. And a number of events took place that began to fracture the industry's growth and potential, as well as the consumer's appetite to buy music. Beginning with the fact that, in my view, the nature of shopping for a CD or a piece of music at a traditional record store is, at its best, a very poor consumer experience. And you can read one research report after another and see that consumers were not satisfied and their expectations were not being met.
FC: What was it about the experience that was poor?
Schultz: When I think about the average music-shopping experience, what I would call the sense of romance about music is gone. Stores were not nurturing new artists. Consumers were overwhelmed by the volume of music but not discovering anything new. I think that is the antithesis of the Hear Music environment that we saw when we first saw Don's stores.
In addition to that, I think the level of training and education that existed behind the counter, for the sales people, was really skewed toward more MTV and a narrower, much younger audience. But the Starbucks customer might want to find a Diana Krall album, a Tony Bennett album, or anything that was not being played on the radio, well, they would have a hard time going into Tower Records. Maybe they'd find the album there, but they could not find someone who could talk to them about it. That consumer has disposable income and has had a long history of buying and enjoying music, but they have nowhere to go.
So first there was a bad shopping experience. Second, about three or four years ago, Best Buy and other discounters broke ranks with the suggested retail selling price and started discounting music. This created a bifurcation in terms of how the retailers were going to market. It also put tremendous pressure on the economic model of Tower Records. And subsequently — not because of this, but one of the manifestation of this, is — Tower Records as you know, has filed bankruptcy.
Continuing on the continuum of this perfect storm was radio. I don't know how old you are, but when I was a kid, the way you discovered music was through the radio. Radio introduced you not only to new music, but the DJ was the editor; he was a trusted friend. Radio has been homogenized to such a point by consolidation that there's no longer an editorial voice, nor can young artists and emerging artists get played on the radio.
Then you had technology come in and piracy begin. Between a bad shopping experience, a bifurcation of pricing strategy, the bankruptcy of Tower Records, and the homogenization of radio, you have this very broad audience out there who is the Starbucks core customer. We have 30 million people a week, coming in many many times a month. And we've demonstrated over the last few years that they've given us a license because of the trust that they have in the editorial voice of Starbucks to sell music and create music for them.
FC: Was this all stuff you could see five years ago? Could you see this trend starting to happen?
Schultz: No. We're not clairvoyant! We did not see this. All we saw was the fact that we have an unusual set of assets, that we could take advantage of the way in which we could do music that others weren't doing, and that we could bring our editorial voice and point of view to it.
FC: How did you convince the record industry to play ball?
Schultz: The record industry is looking for new channels of distribution and new partners anywhere they can find them. In addition to the traditional record problems that I described, you also had the video game surge as well as DVDs taking sales — and mindshare — away from traditional movies.
FC: What kind of research did you do to find out that your customers were ready for this?
Schultz: We talk to our customers all the time. Focus groups, exit surveys, things of that nature. Because we own and operate all our own stores, it's very easy for us to have intimate conversation with our customers every day without any formality and talk about music. Most of our customers who buy music have bought CD's from Starbucks, one after another, have the whole collection, and are asking when the next one is coming out. They also suggest what they think we should be doing.
FC: What are your goals for the Hear Music coffeehouses, like the one in Santa Monica?
Schultz: Santa Monica is the first manifestation of a much larger, much more aggressive, more intricate strategy in terms of how music is going to play a significant role in Starbucks, both in our existing stores and in the future of the Hear Music stores like the one you saw in Santa Monica. What we've demonstrated in Santa Monica in just — I think it's been open just five or six weeks at this point — is that the sense of discovery, the sense of romance, and the seduction of music is a lost art that we are recreating. If we can leverage that along with Hewlett Packard's digital technology, 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.
FC: How so?
Schultz: Starbucks has the opportunity to break new artists in ways that no other retailer can today because of the footprint, the breadth, and the loyalty we have. If we found, with a record label, the next Norah Jones, we could have more impact and provide more visibility. We would take one album and put artist on a pedestal. In addition to that, there are hundreds of heritage artists — James Taylor, Carly Simon, Billy Joel, the Eagles, even Elton John — wonderful heritage artists that do not sell records anymore because their music can't get heard.
Our audience is so hungry for that music that it's very possible that we could provide a much better relationship with that customer and that artist, in ways that don't have all of the barriers that prevent these artists from getting heard and getting a record label.
Starbucks can in many ways go direct.
FC: As the global strategic officer, how do you consider new business opportunities? How do you spot what is transformational, what is consistent with your brand and your goals? And how do you separate that out from all the opportunities that would really just be distractions?
Schultz: First of all, you'd be amazed at the number of opportunities, most of which are not only are inconsistent with our values, but are just absolutely not right for Starbucks that come in the door.
FC: How many are you talking about?
Schultz: Thousands every year. And those are just the ones that make it to me. Some of them would shock you.
FC: What's the craziest thing you've ever been asked to consider?
Schultz: The craziest? Starbucks Coffee tanning oil. So you can get a... I don't know. There have been so many strange ones.
FC: When you're vetting new opportunities, is there a series of questions you ask yourself, or things that you walk through to ask, "How do we figure out what fits?"
Schultz: Well, first of all, this is not a one-person band here. There're a number of people in this mix, and we're all trying to examine these opportunities through the screen of the guardrails, the equity of the brand, and the customer experience. In addition to that, we're talking to our board and outside resources. We've done a lot of work within the music industry, talking to Wall Street analysts and to technology companies — not only HP — and really trying to get push-back and answer questions about changes in technology and the retail experience.
At the same time, our asset base is so strong that we can do things that others can't do — not only because of the number of stores we have, but because they're all company owned; we're not in a situation where we've got franchisees. We're also examining these opportunities globally for the first time, which is very different. Any opportunity or any path that we're going down, we want to link that up, we want to thread that globally. Like the Starbucks card: We're getting that ready for the Olympics in Athens this fall.
FC: Where in the lifecycle of a business do you think companies should start looking at expanding into complementary services or extending their brands? Are there particular turning points in the life of a business when you start to think about that?
Schultz: That question is really linked to what the business is. Every business really has to understand what their consumer proposition is and be able to strengthen that at every level within the company and the consumer, at every touchpoint that the consumer has. While doing that, you have to have openness and sensitivity to changes in the marketplace and the need to not just embrace the status quo.The fragile balance, though, is in maintaining your relevancy to the consumer within your primary proposition while refining and innovating to the point where you maintain your leadership position.
FC: If you're using Starbucks as an example, how do you feel like you've strengthened the consumer proposition within the company?
Schultz: Over the years? From 1971-1986, Starbucks sold coffee by the pound; that's all we did. By the pound. The beverage did not really get merchandised and introduced until late 1987. Now the beverage, the core beverage, from 1987-90 or -91, was espresso-based beverages.
Then came Frappuccino. That transformed the company because we demonstrated a different daypart. If you look at the evolution of beverages at Starbucks and the percentage of sales from 1971-87, 80% of what we sold was coffee by the pound. That's less than 15% of our business today. Also, from 1971 until probably 1996, we did the majority of our business before 11 a.m. After Frappuccino, that completely changed.
We're now the "Third Place." The physical environment has become as important as anything we do, including the coffee. The environment and the experience is the brand. It's a very important distinction that people use our stores all over the world as an extension of their daily lives, and sometimes the coffee is subordinate to that. That's a big change.