Thinking Outside The Cup

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.