Reference no: EM131245251

Against a backdrop of dropping coffee consumption per capita and high completion among coffee retailers, Howard Schultz invented the modem Starbucks-transforming the coffee-roasting company into a retailer that was backward vertically integrated into coffee bean purchasing and roasting. The Starbucks concept had enjoyed during its first 20 years. By 1997, Starbucks' revenues had grown to $975 million and the balance sheet showed positive net cash position (cash minus debt) of $42 million. About 86 percent of revenues were derived from the company's 1,325 retail stores. Starbucks tested sales of coffee through 10 West Coast supermarkets-expanding to 4,000 grocery stores the next year. By the end of its next decade, Starbucks had more than 15,000 company-owned and licensed stores. Revenues for 2007 came in at $9.4 billion accompanied by operating income of more than $1 billion for an operating profit margin of 11.2 percent. Return on invested capital was an impressive 17.7 percent in 2007, despite the company's whopping $282 million in cash. The company's average annual sales growth of 57 percent along with its 65 percent average yearly jump in operating profits over the decade put Starbucks squarely in an elite class of American success stories such as Wal-Mart.

Eventually things began to turn sour for Starbucks, though. Schultz stepped down as CEO in 2000 and took a much less active role in day-to-day operations as the company's chairman. Store traffic began to slow early in 2007. By fan 2007, cracks appeared in Starbucks' business model. The company announced in November 2007 that traffic at its U.S. stores had fallen for the first time. The company also lowered its projected store openings for fiscal 2008 and lowered its estimates on comparable store sales growth (sales growth in stores open 12 months or longer). Starbucks was feeling the effects of the stagnant economy. At the same time, Starbucks was struggling to offset rising dairy and labor costs and trying to fight off strong competitive pressure from McDonald's and Dunkin' Donuts. The stock dropped nearly 50 percent in 2007.

Schultz and the Starbucks team spent months diagnosing Starbucks' problems. As Schultz noted in Onward, "The more rocks we turned over, the more problems we discovered."? Opera rating margin had slumped from a peak of 12.3 Percent in 2005 to 11.2 percent in 2007, but earnings still increased. That all changed in 2008 when operating earnings plunged nearly 27 percent excluding restructuring charges and 52 percent including charges. Schultz went on to say, "From where I sat as CEO, the pieces of our rapid decline were coming together in my mind. Growth had been a carcinogen. When it became our primary operating principal I it diverted attention from revenue and cost-saving opportunities and we did not effectively manage expenses and rising construction costs and additional monies spent on new equipment... Then as customers cut their spending we faced a lethal combination: rising costs and sinking sales - which meant Starbucks' economic model was no longer viable." Although Starbucks had a sizable presence in international markets, the United States still accounted for 76 percent of company revenues. The United States has to be fixed in order to turn around the company.

Schultz spent the next couple years refocusing Starbucks on the coffee business. He cut breakfast items from the menu and got managers to think about customer service and selling coffee. Schultz closed all the U.S. stores for a day and retrained baristas on preparing the perfect cup of espresso. He also replaced top management and built up the company's capabilities in supply and logistics. The management team tackled major inefficiencies in the supply chain as well as in the stores. Stores were redesigned to improve efficiency and reduce the on-the-job injuries. He also emphasized the Starbucks experience and the importance of being passionate about coffee. Despite significant pressures from Wall Street, Schultz refused to drop health care benefits for part-time employees as he recognized the barista was one of the fundamental drivers of company performance. Starbucks also closed nearly 1,000 underperforming stores and laid off about 12,000 workers. It slowed dramatically the rate of store expansion from about 1,300 per year in the United States to about 300. After a painful few years, the company came roaring back with outstanding results. Schultz vowed never to allow the company to make the same mistakes again.

In late 2010, Starbucks' management announced plans to create long-term shareholder value through a new "blueprint for profitable growth." Schultz said, "Our next phase of growth will come from extending the Starbucks Experie1Jce to our customers beyond the third place to every part of their day, through multiple brands and channels. Starbucks' U.5. retail business and our connection with our customers form the foundation on which we build all of our lasting assets, and we will combine that with new capabilities in multiple channels to accelerate the model we've created that no other company can replicate." Starbucks Chief Financial Officer Troy Alstead went on to say, "Starbucks has reached a critical juncture as we move from a high unit growth specialty retailer focused on coffee in our stores, to a global consumer company with diversified growth platforms across multiple channels."

In short, Starbucks intended to introduce new products and brands in its Starbucks retail stores, establish a base of customers for the new items, and later expand distribution to mass-market channels like grocery stores. The company meant to transform itself from a specialty retailer selling a few coffee and tea products through mass outlets into a global consumer products powerhouse. To do so, Starbucks planned to augment its proven model for new brand development with vertical integration and acquisitions. Management was confident it would be able to build a stable of billion-dollar brands by following the model Starbucks developed with two key products: Frappuccino and VIA.

Frappuccino was a coffee blended with ice and milk. The sugary beverage became enormously popular with Starbucks devotees immediately after its summer 1995 introduction. Frappuccino built up a following in Starbucks stores before Starbucks and Pepsi pushed a bottled version of the product into mass retail outlets. Schultz credited a large part of Frappuccino's retail success to Starbucks having the "unique opportunity every single day to reinforce the equity of the Frappuccino blended product in our stores" The $2 billion global brand commanded nearly two-thirds of the U.S. iced coffee category in 2012.

Similarly, Starbucks introduced VIA instant coffee in its stores in 2009. According to Schultz, the product introduction marked the first innovation other than in packaging in the instant coffee market in 50 years. Schultz regarded the category as one that was "ripe for renewal" Although the U.S. market for instant coffee was relatively small at about $700 million in 2009, Schultz regarded the product extension as a critical one for the company. He felt it would spur innovation within the company, put Starbucks into new retail channels like specialty sporting goods stores, and support the company's objective to be the undisputed coffee authority. The instant coffee market accounted for about 40 percent of worldwide coffee consumption and generated an estimated $21 billion per year in sales. Higher-end instant coffees generated less than 20 percent of instant coffee sales globally, which suggested to Schultz the category was a candidate for "premiumization"- just as the U.S. coffee market had been prior to Starbucks' entry into the market.

In addition, instant coffee consumption had grown at a much faster clip in emerging markets than in the United States, where sales of the product were flat. Global Coffee Review magazine pegged worldwide instant coffee growth at 7 to 10 percent and 15 to 20 percent in emerging markets from 2000 to 2012. Coffee drinkers in emerging markets favored instant or soluble coffee over brewed coffee because consumers often could not afford special coffee-making equipment. Starbucks' management reckoned that it could establish the VIA brand in the United States in its own stores, expand into mass retailing, and then move the brand into Starbucks stores in the United Kingdom, Japan, and emerging markets. (Instant coffee accounted for about 80 percent of all coffee sales in the United Kingdom and 63 percent of sales in Japan.)

Schultz believed Starbucks could use technology to produce a cup of instant coffee that would taste the same as a cup of Starbucks brewed coffee. The challenge for Starbucks was threefold. First, the company had to overcome the stigma of instant coffee being associated with weak, low-quality, poor-tasting coffee in the United States. Second, Starbucks had to convince consumers to pay a hefty premium for VlA, which retailed for $0.82 to $0.98 per serving. Other instant coffees could be purchased for as little as $0.04 to $0.07 per serving. Folgers Instant Coffee Singles were priced at $0.20 per serving. Third, the company had to overcome substantial competition in the segment once it launched the product into supermarkets and other mass outlets.

In order to change consumer perceptions of instant coffee, the company employed extensive use of sampling in its own stores to encourage consumers to taste VIA side by side with Starbucks brewed coffee. The taste tests continued for a year before Starbucks rolled out the product into grocery and other mass retail stores. The company also sent baristas into its network of 3,000 licensed store-within-a-store Starbucks locations in retailers such as Target and Safeway to give out millions of VIA samples to customers. Starbucks created free publicity for the brand by inviting reporters to participate in blind taste tests comparing Starbucks brewed coffee with VIA instant coffee. The evidence from the taste tests overwhelmingly supported Starbucks' claim that VIA was a convenient, less expensive version of a Starbucks coffee rather than a low quality, watered-down version of "real" coffee. (An eight ounce serving of brewed coffee in Starbucks stores cost $1.50 in 2009.) In April 2012, the Huffington Post conducted a blind taste test of instant coffees and concluded that VIA Columbia was not only the best instant coffee on the market but was indistinguishable from regular brewed coffee.

Starbucks had to compete against well-established brands in the United States and elsewhere. Nestle, the worldwide leader in instant coffee and inventor of the product, held about 34 percent of the U.S. instant coffee market in 2010. Kraft General Foods (Maxwell House) was number two in the market with a share of about 26 percent, followed by JM Smacker (Folgers) with about a 21 percent share. Nestle had used its first-mover status to its advantage-holding 51 percent of the global market for instant coffee. In fact, Nestle was the largest manufacturer of packaged coffee in the world with nearly a 22 percent global share due largely to its huge presence in the instant coffee market. Nevertheless, Starbucks grabbed more than 10 percent of the U.S. instant coffee market in VIA's first year on the market.

Starbucks aimed to turn VIA into a $1-billion-dollar brand by leveraging its international presence and taking on Nestle head to head. The company launched VIA in the Chinese market in April 2011 where Nestle controlled 75 percent of the instant coffee market. Instant coffee accounted for 80 to 90 percent of coffee consumption in the $11.3 billion Chinese coffee market. Still, by 2012, VIA had generated $300 million in annual worldwide revenues through 80,000 distribution points in 14 countries.

Starbucks acquired premium juice brand Evolution Fresh for $30 million in cash in late 2011. The acquisition was Starbucks' first major plank in a new health and wellness platform for the company. Starbucks intended to expand the brand by launching a chain of juice bars, selling the line through Starbucks coffeehouses, and expanding the brand's retail distribution. Schultz commented, "This is the first of many things we're going to do around health and wellness...We're not only acquiring a juice company, but we're using this acquisition to build a broad-based, multi-million-dollar health and wellness business over time." As it had done in the coffee and instant coffee markets, Starbucks aimed to "reinvent the $1.6 billion super-premium juice segment." Starbucks claimed the company would be able to take "a currently undifferentiated, commoditized product segment and introduce a unique, high-quality product to redefine and grow the super-premium juice market." According to Schultz, "Our intent is to build a national Health and Wellness brand leveraging our scale, resources and premium product expertise. Bringing Evolution Fresh into the Starbucks family marks an important step forward in this pursuit."21 By October 2013, Evolution Fresh juice was sold in 8,000 retail locations-up from 2,000 in 2012-as3weU as in four standalone Evolution Fresh stores. The company opened a $70 million factory in Rancho Cucamonga, California, in late 2013 to support the rollout of Evolution Fresh products across the United States.

Sales of fruit and vegetable juices and juice drinks generated an estimated $20 billion in annual revenues in 2012. Industry sales had not grown appreciably for more than five years. Moreover, per capita juice consumption had declined as Americans turned to other beverages like energy drinks and fortified waters to slake their thirst. Per capita juice consumption declined from 6.1 gallons in 2006 to 5.17 gallons in 2011.22 In contrast, the super-premium juice segment had boomed, and sales jumped to an estimated $2.25 billion in 2013 as "juice cleanses" gained popularity and manufacturers touted the health benefits of cold-pressed juices.

Norman Walker, supposed "health expert" and sometime mountebank, invented cold pressing m1910. His Norwalk hydraulic juicer was still considered by many to be the best on the market in 2013 and retailed for a whopping $2,000. Cold pressuring pulverized fresh fruits and vegetables in order to extract all of the juice from the produce. Evolution Fresh and others placed cold-pressed juices in bottles and then subjected the filled bottles to high pressure while floating in water. The high-pressure pascalization (HPP) process stunted the growth of pathogens and extended the shelf life of the juice from a few days to about three weeks. Mass-market brands such as Tropicana relied on high-heat pasteurization to kill pathogens in juice. Fans of cold-pressed juice claimed it was healthier than pasteurized juices. While there was little scientific evidence to support manufacturers' claims of superior health benefits, so-called juicers asserted the flavor of cold-pressed juice was "closer to fresh" than mass-market stalwarts like Minute Maid or Tropicana. Critics of cold pressing were concerned about the product's safety. They noted that Odawalla juice, a leader in the cold-pressed juice category, introduced flash pasteurization after a batch of apple juice was contaminated with E. coli in 1996. The contaminated apple juice had caused illness in at least 66 people and reportedly led to the death of a 16-month-old child. In fact, the FDA had begun to push cold-pressed juice makers to include HPP or an alternative process as a way to increase the product's safety. Given that each HPP machine cost $800,000 to $2 million, it was difficult for small juicers to jump on the HPP bandwagon. Nevertheless, an E. coli outbreak could generate a consumer backlash against all cold-pressed juices.

Despite Starbucks' ambitious plans, it was not clear that the juice market could be characterized as "commoditized." The category was bombarded annually with product introductions touting new flavor combinations and health benefits. Some of the more exotic juices introduced into the mass market in recent years included coconut water, acai, beet juice, and Suavva Cacao. Ironically, health concerns had stymied growth in the mass market as consumers became concerned about the high sugar content in juices. While whole fruits had been shown to reduce the risk of type 2 diabetes, the high sugar content in fruit juices had some consumers shying away from the product due to concerns over obesity. PepsiCo had scrambled to find a solution to the sugar problem. While the company continued to experiment with new sugar-free sweeteners, it launched Tropicana Light and Trop50 products under the $6.2 billion Tropicana brand. Tropicana Light was sweetened with sucralose, and Trop50 was sweetened with stevia. Trop50 products also contained only 42 to 43 percent juice as the liberal additional of water allowed PepsiCo to bring down calorie count significantly and increase gross margins. While consumers responded favorably to the new products, PepsiCo management knew the secret to long-term success lay in continued product innovation in sugar replacement. PepsiCo was determined to find a natural sugar replacement to protect its enormous global beverage business.

Juice prices ranged for mass brands to well from a few over $1 per cents per ounce for super premium products. In the super premium segment, large food and beverage companies trying to capitalize on the higher growth in the segment owned by the top four brands. Odawalla (acquired by Coca-Cola in 2001), Naked Juice (PepsiCo), Bolthouse Farms (Campbell Soup), and BluePrint (Hain Celestial Seasonings) together controlled an estimated 51 percent of the super-premium market.

The juice bar business also was crowded with competitors trying to take cash in on demand for healthy foods. Sales at juice bars and smoothie chains nearly doubled between 2004 and 2012, according to Barron's magazine. Barron's pegged sales at the 6,200 juice bars and smoothie operations at about $2 billion. The top five juice and smoothie chains: Jamba Juice, Freshens, Maui Wowi, Smoothie King, and Orange Julius-accounted for more than 50 percent of all of the juice and smoothie retail locations in the United States in 2012. The top 10 operators owned or had franchised about two-thirds of the industry locations. Rivalry appeared to be fierce as the large chains attempted to fight off small local competitors who often positioned themselves as the most "authentic" purveyor of juices. Marcus Antebi, CEO of Manhattan's trendy Juice Press, commenting on Organic Avenue's appointment of a non-vegan CEO to the New York Daily News said, "They'll no longer represent the glossy, sexy brand that they were five years ago, before Juice Press smothered them. I actually water boarded them with green juice."

According to some sources, coffee's popularity in the United States relative to tea stretches back to the Revolutionary War and the Boston Tea Party. In protest to unfair taxation and the granting of a tea monopoly to the East India Company by British Parliament, colonists snuck on board three tea ships (the Dartmouth, the Eleanor, and the Beaver) on December 16, 1773, and dumped 90,000 pounds of tea into Boston Harbor. Colonists went on to boycott British imports, including tea, for many years. Coffee and herbal teas supposedly became popular due to the boycott as substitutes for the colonists' favorite beverage.

Retail and food-service sales of tea generated about $6.5 billion in revenues in the United States and $40 billion worldwide in 2011. Tea was the second-most consumed beverage worldwide, behind water. However, t a remained distinctly less popular with Americans than coffee. The beverage came in at a distant number six among American favorites behind soft drinks, water, coffee, milk, and beer (in that order). Nevertheless, per capita consumption of tea grew about 5 percent from 2001 to 2011 as American sipped slightly more than seven gallons of tea per person. In contrast, per capita coffee consumption fell 1 percent, and carbonated soft drink consumption plunged 16 percent over the period. As tea consumption increased, the number of U.S. tea shops jumped from about 1,500 in 2009 to approximately 4,000 in 2011. Costs to open a tea shop were relativity low with some shop owners estimating it cost $10,000 to $25,000 (comparable with opening a non-franchised pizza place) and others coming in at $100,000 t $250,000 (a bit lower than opening a franchise pizza restaurant).

Starbucks had long been a player in the tea market with its Tazo tea brand, which it had acquired in 1999 for $8.1 million. The company sold Tazo tea in grocery stores and other mass outlets as well as in Starbucks coffeehouses. By 2012, Tazo overall was a $1.4 billion brand for Starbucks. Although the company had been successful in establishing a large tea brand, tea had never been a focal point for Starbucks until it acquired Teavana Holdings. Starbucks announced it would purchase Teavana Holdings for $620 million in cash in November 2012. Teavana was the largest tea shop operator in the United States with 300 retail stores mainly in shopping malls. Founded in Atlanta in 1997, Teavana sold high-end loose-leaf teas exclusively through its own stores.

Teavana's mission was to establish its brand //as the most recognized and respected brand in the tea industry by expanding the culture of tea across the world/'29 As noted by Seattle's Crosscut.com reporter Ronald Holden "Just as a wine aficionado can wax on (and on and on) about grape varieties and legendary vintages, a devotee of tea can cite literally hundreds of varieties of camellia sinensis leaves (white, green, oolong, black), and their methods of 'withering/ (steaming, pan-firing, shaking, bruising, rolling, drying, oxidizing). Then there are the tea-like drinks that don't contain camellia sinensis, like prepared herbal infusions, rooibos (red teas) and the green-powdered mates."

Teavana management identified the key elements of its strategy as developing and sourcing the world's finest assortment of premium loose-leaf teas and tea-related merchandise, locating stores in high-traffic areas primarily in shopping malls and lifestyle centers, and creating a "Heaven of Tea" retail experience for customers. Teavana's emphasis on training "passionate and knowledgeable teaologists" to "engage and educate customers about the ritual and enjoyment of tea"31 allowed it to charge premium prices and develop a loyal following in the United States.

Indeed, Teavana's approach to the market had been a very successful and profitable one with sales soaring to $168.1 million and operating profits of $32.6 million. Teavana's highly productive stores generated nearly $1/000 per square foot in sales and comparable store sales growth of nearly 9 percent in 2011 and more than 11 percent in 2010. New stores had an average cash payback period of just a year and a half. The retailer believed it could drive tea category growth in the United States by educating consumers about the health benefits of tea and the culture of tea drinking. Each Teavana store included the "Wall of Tea, which allowed customers to "experience the aroma, color, and texture" of any of the store's approximately 100 different varieties of single-estate and specially blended teas.32 Like Starbucks and its coffee culture, Teavana emphasized a company culture that celebrated a passion for tea. To that end, Teavana had a policy of promoting from within company ranks, extensive employee training, and teaologist career development. Management recognized that retail success was heavily dependent upon teaologists m the same way Starbucks' success rested upon the barista.

Starbucks intended to develop Teavana as a major growth platform beginning with the U.S. market. In late October 2013, Starbucks opened the first Teavana tea bar on Manhattan's ultra-wealthy Upper East Side. Schultz told reporters the company expected 1/000 tea bars in the United States over the next five years.33 Schultz was confident that Starbucks could transform the U.S. tea market with Teavana in the same way it had transformed the coffee market. Some industry observers were not as sanguine about Teavana's prospects.

Brian Suzy of Belus Capital Advisors noted to Forbes magazine, "I don't believe Teavana will ever grow into what the Starbucks brand has become for one simple reason: tea lacks the major caffeine count." He added, "That sounds silly, but the bottom line is that in this day and age of frantic tech-driven lifestyles, people want to run on 100 mg of caffeine, the contrast between Teavana and Starbucks products was stark at the cultural level. Coffee typically was associated with early-morning commutes and midday pick-me-ups.

While Starbucks had done a great job creating a welcoming atmosphere in its coffeehouses, the pace of each shop was quick and energetic, particularly during the morning rush hour, Tea culture was one associated with tranquility and relaxation. Teavana's new tea shop invited customers to slow down and find some quiet time while their tea brewed.

According to a University of Northumberland study consisting of 180hours of testing and 285 cups of tea, it took eight minutes to brew the perfect cup of tea-two minutes of soaking the tea bag in boiling water (100°C or 212°F), removal of the tea bag, addition of milk, and a six-minute wait for the temperature to drop to 60°C or 140°F.

Going forward, management had to ask if Starbucks could successfully expand beyond the coffee shop business in a meaningful way without destroying its core business. Could the company create value through its diversification strategy? How would McDonald's and Dunkin' Donuts come into play as they each made decisions for their product offerings that could bring their value propositions closer together or further apart?

After reading about Starbucks, respond to one (or more) of the prompts below. Try to tie in what you've learned from Chapter 7 in your textbook.

What was the flaw in Starbucks economic model? In order to fix these issues what diversification tactics were implemented?

By taking the leap into the health and wellness industry and acquiring the premium juice brand Evolution Fresh, which type of diversification strategy was Starbucks implementing? Was this a good decision or should Starbucks have remained within the coffee industry?

Starbucks acquisition of Teavana is proving to be a big success due to their emphasis on coffee/tea culture.

Do you believe there is future for Starbucks in adult beverages such as beer and wine, following the same business structure and emphasis on the culture as they have in the past? Would this strategy be considered a limited, related or unrelated corporate diversification?

How did Starbucks use corporate diversification to increase the value of their economies of scope? Of the economies of scope described in the book, which do you think is most important in aiding Starbucks in increasing or decreasing costs?

What was the main motivation for Starbucks for implementing diversification strategies? Do you believe their diversification strategy created competitive advantage in terms of value, rarity and imitability? Why?