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.

Page 2 of "Thinking Outside The Cup"

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."

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