Starbucks

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Starbucks in 2020: Is the Company on Track to Achieve Attractive Growth and Operational Excellence? Arthur A. Thompson The University of Alabama Since its founding in 1987 as a modest nine-store operation in Seattle, Washington, Starbucks had become the premier roaster, marketer, and retailer of specialty coffees in the world, with just over 32,000 store locations in 78 countries as of April 2020 and annual sales of $26.5 billion in fiscal year 2019, ending September 30, 2019. In addition to its flagship Starbucks brand coffees and coffee beverages, Starbucks’ other brands and products included Starbucks Reserve blends of coffee, Teavana teas, Seattle’s Best Coffee, Evolution Fresh juices and smoothies, Ethos bottled waters, Torrefazione Italia Coffee, and Princi bakery products. Starbucks stores also sold baked pastries, cold and hot sandwiches, salads, salad and grain bowls, oatmeal, yogurt parfaits and fruit cups purchased from a variety of local, regional, and national suppliers. In January 2017, then CEO and company founder Howard Starbucks launched a somewhat grandiose strategic initiative to inject more innovation and fresh approaches into the company’s operations and to spur growth: • Open 20-30 Starbucks Reserve™ Roasteries and Tasting Rooms, which would showcase the theater of coffee roasting and brewing in a big, multilevel stores with amazing decorations, seating for upwards of a thousand patrons, multiple types of coffee bars with elaborate menus of innovative coffee beverages and interesting food selections, areas where friends could gather at community tables or in lounge areas with fireplaces, a mixology bar serving traditional Italian cocktails, multiple dining venues, and an upscale Princi bakery where patrons could watch chefs preparing fresh-baked artisanal Italian breads, sandwiches, and pastries being served to diners. Going into 2020, Roasteries had been opened in Seattle, Shanghai, Milan, New York, Chicago, and Tokyo— all attracted local coffee enthusiasts, partiers, nearby shoppers curious to see what the Brewery offered, and visiting sightseers looking to enjoy a very different kind of Starbucks experience. • Open 1,000 Starbucks Reserve stores worldwide to bring premium experiences to customers and promote the company’s recently-introduced Starbucks Reserve™ coffees; these locations were to offer a more intimate small-lot coffee experience and gave customers a chance to chat with a barista about all things coffee. The menu at Starbucks Reserve stores was to consist of handcrafted hot and cold Starbucks Reserve™ coffee beverages, hot and cold teas, ice cream/coffee beverages, and an assortment of small plates, sandwiches and wraps, desserts, wines, and beer. Packages of Starbucks Reserve™ whole bean coffees were to be available for purchase. Plans called for four types of brewing methods for the coffees and teas. Starbucks had 43 Starbucks Reserve locations in February 2020. • Transform about 20 percent of the company’s existing portfolio of Starbucks stores into upgraded Starbucks Reserve coffee bars. However, shortly after announcing the initiative, Howard Schultz stepped down as Starbucks CEO, turning the role over to Kevin Johnson, Starbucks chief operating officer with whom Schultz had worked closely for the past two years—they had adjoining offices connected by a door and usually visited together multiple times a day. Shultz stayed on as chairman of the company’s board of directors and focused his time on social initiatives and plans for the upscale Roastery locations and Starbucks Reserve brand. Schultz exuded confidence that Johnson was the right person to lead Starbucks in the future and that he was well prepared to meet the challenges of continuing to build the Starbucks brand, enhance the consumer experience, and manage its global operations. Johnson fairly quickly scaled back the sizes of all three of the somewhat transformational strategic moves announced by Schultz, chiefly due to their

cost and questionable profitability, and proceeded to steer Starbucks back to the strategic path the company had steadfastly pursued for most of the past decade; these included the following strategy elements: • Maintain Starbucks standing as one of the most recognized and respected brands in the world and stay strongly focused on providing customers with a pleasing Starbucks experience that prompted them to patronize Starbucks stores frequently. • Continue disciplined expansion of the company’s store base, adding stores in both existing, developed markets and in newer, higher growth markets like China, which for several years had been singled out as Starbucks best opportunity for opening hundreds of new stores annually. During fiscal 2018 and fiscal 2019, Starbucks opened new stores in China at the rate of 1 every 15 hours; as of March 31, 2020, the company had 4,351 company- operated stores in China. Shanghai alone had over 600 Starbucks stores, more than any other city in the world. Starbucks goal was to have 5,000 stores in China by 2021. • Optimize the mix of company- operated and licensed stores by determining which type of store was best suited to ongoing changes in business and political circumstances in various countries around the world and by recognizing that to the special situations of stores operating in big hotels, resorts, airports, hospitals, major office buildings, and on university campuses sometimes called for licensed stores and sometimes for stores owned and operated by Starbucks. • Continue to offer consumers new coffee and other products in a variety of forms, across new categories, diverse channels, and alternative store formats. • Continue to enhance the company’s social responsibility strategy and increase the company’s efforts to be a good corporate citizen, ethically source high-quality coffee, contribute positively to the communities in which it does business, be an employer of choice, and exert ever-stronger efforts to protect the planet. Exhibit 1 provides an overview of Starbucks performance during fiscal years 2010–2019. EXHIBIT 1 Financial and Operating Summary for Starbucks Corporation, Fiscal Years 2010–2019 ($ in millions, except for per-share amounts) Fiscal Years Ending Sept. 29, 2019 Sept. 30, 2018 Oct. 1, 2017 Oct. 2, 2016 Oct. 3, 2010 INCOME STATEMENT DATA Net revenues: Company-operated stores $21,544.4 $19,690.3 $17,650.7 $16,844.1 $ 8,963.5 Licensed stores 2,875.0 2,652.2 2,355.0 2,154.2 875.2 Consumer packaged goods, foodservice, and other 2,089.2 2,377.0 2,381.1 2,317.6 868.7 Total net revenues $26,508.6 $24,719.5 $22,386.8 $21,315.9 $10,707.4 Final PDF to printer tho35176_case25_C325-C353.indd 327 10/17/20 08:29 AM CASE 25 Starbucks in 2020: Is the Company on Track to Achieve Attractive Growth and Operational Excellence? C-327 Fiscal Years Ending Sept. 29, 2019 Sept. 30, 2018 Oct. 1, 2017 Oct. 2, 2016 Oct. 3, 2010 Cost of sales 8,526.9 $ 7,930.7 $ 8,486.8 $ 8,511.1 $ 4,458.6 Store operating expenses 10,493.6 9,472.2 7,065.8 6,064.3 3,551.4 Other operating expenses 371.0 554.9 518.0 545.4 293.2 Depreciation and amortization expenses 1,377.3 1,247.0 1,011.4 980.8 510.4 General and administrative expenses 1,824.1 1,708.2 1,408.2 1,360.6 569.5 Restructuring and impairments 135.8 224.4 153.5 --- 53.0 Total operating expenses 22,728.7 21,137.4 18,643.5 17,462.2 9,436.1 Income from equity investees and other 298.0 301.2 391.4 318.2 148.1 Operating income 4,077.9 3,883.3 4,134.7 4,171.9 1,419.4 Gain resulting from acquisition of joint venture ---- 1,376.4 ---- ---- ---- Net gain resulting from divestiture of certain operations 622.8 499.2 93.5 5.4 --- Net earnings attributable to Starbucks $ 3,594.6 $ 4,518.0 $ 2,884.97 $ 2,817.7 $ 945.6 Net earnings per common share—diluted $ 2.92 $ 3.24 $ 1.97 $ 1.90 $ 0.62 BALANCE SHEET DATA Current assets $ 5,653.9 $12,494.2 $ 5,283.4 $ 4,757.9 $ 2,756.5 Current liabilities 6,168.7 5,684.2 4,220.7 4,546.8 2,703.6 Total assets 19,219.6 24,156.4 14,365.6 14,312.5 6,385.9 Long-term debt (including current portion) 11,167.0 9,090.2 3,932.6 3,585.2 549.4 Shareholders’ equity (6,232.0)

1,175.8 5,457.0 5,890.7 3,674.7 OTHER FINANCIAL DATA Net cash provided by operating activities $ 5,047.0 $11,937.8 $ 4,251.8 $ 4,697.9 $ 1,704.9 Capital expenditures (additions to property, plant, and equipment) 1,806.6 1,976.4 1,519.4 1,440.3 440.7 STORE INFORMATION Stores open at year-end United States Company-operated stores 8,799 9,684 8,222 7,880 6,707 Licensed stores 6,250 7,770 5,708 6,588 4,424 International Company-operated stores 7,035 5,657 5,053 4,831 2,182 Licensed stores 9,172 8,356 8,356 7,082 3,545 Worldwide 31,256 29,324 27,339 25,085 16,858 Worldwide percentage change in sales at company-operated stores open 13 months or longer 5% 2% 3% 5% 7% *Starbucks1 fiscal year ends on a Sunday closest to September 30. Note 1: In fiscal years 2016 and 2010, the cost of sales included occupancy expenses for Starbucks company-operated stores. In fiscal years 2017, 2018, and 2019, occupancy expenses for Starbucks company-operated stores were reclassified and included in-store operating expenses. This change accounts for much of the discontinuity between the cost of sales for 2016 and costs of sales in 2017, 2018, and 2019, and similarly for the big jump between store operating expenses for 2017 versus store operating expenses for 2018 and 2019. Sources: Company 10-K reports for 2011, 2017, 2018, and 2019 and data reporting Starbucks store counts by market posted in the investor relation section at www.starbucks.com (accessed November 1, 2019). COMPANY BACKGROUND Starbucks Coffee, Tea, and Spice Starbucks got its start in 1971 when three academics (English teacher Jerry Baldwin, history teacher Zev Siegel, and writer Gordon Bowker—all coffee aficionados) opened Starbucks Coffee, Tea, and Spice in touristy Pike Place Market in Seattle. The three partners shared a love for fine coffees and exotic teas and believed they could build a clientele in Seattle that would appreciate the best coffees and teas. By the early 1980s, the company had four Starbucks stores in the Seattle area and had been profitable every year since opening its doors. Howard Schultz Enters the Picture In 1981, Howard Schultz, vice president and general manager of U.S. operations for a Swedish maker of stylish kitchen equipment and coffeemakers based in New York City, decided to pay Starbucks a visit. He was curious why Starbucks was selling so many of his company’s products. When he arrived at the Pike Place store, a solo violinist was playing Mozart at the door (his violin case was open for donations). Schultz was immediately taken by the coffee aroma, store décor and ambiance, and the freshly brewed cup of coffee he bought. He began asking questions about the company, the coffees from different parts of the world, and the different ways of roasting coffee. Later, when he met with two of the owners, Schultz was struck by their knowledge about coffee, their commitment to providing customers with quality coffees, their passion for educating customers about the merits and quality of dark-roasted coffees, and their business philosophy. Top quality, fresh-roasted, whole-bean coffee was the company’s differentiating feature and bedrock value. The company depended mainly on word-of-mouth to get more people into its stores, then built customer loyalty cup by cup as buyers gained a sense of discovery and excitement about the taste of fine coffee. By the time he landed on his return trip to New York, Howard Schultz knew in his heart he wanted to go to work for Starbucks. But it took over a year and multiple meetings and discussions to convince the owners to bring in a high-powered New Yorker who had not grown up with the values of the company. In the Spring of 1982, Schultz was offered the job of heading marketing and overseeing Starbucks’ retail stores; he assumed his new responsibilities at Starbucks in September 1982.

Starbucks and Howard Schultz: The 1982–1985 Period In his first few months at Starbucks, Schultz spent most of his time in the four Seattle stores—working behind the counters, tasting different kinds of coffee, talking with customers, getting to know store personnel, and learning the retail aspects of the coffee business. In December, he began the final part of his training, that of actually roasting the coffee. Schultz spent a week getting an education about the colors of different coffee beans, listening for the telltale second pop of the beans during the roasting process, learning to taste the subtle differences among the various roasts, and familiarizing himself with the roasting techniques for different beans. Schultz overflowed with ideas for the company. However, his biggest inspiration and vision for Starbucks future came during the spring of 1983 when the company sent him to Milan, Italy, to attend an international housewares show. While walking from his hotel to the convention center, he spotted an espresso bar and went inside to look around. The cashier beside the door nodded and smiled. The “barista” behind the counter greeted Schultz cheerfully and began pulling a shot of espresso for one customer and handcrafting a foamy cappuccino for another, all the while conversing merrily with patrons standing at the counter. Schultz thought the barista’s performance was “great theater.” Just down the way, he went to an even more crowded espresso bar where the barista was greeting customers by name, and people were laughing and talking in an atmosphere that plainly was comfortable and familiar. In the next few blocks, he saw two more espresso bars. That afternoon, Schultz walked the streets of Milan to explore more espresso bars. Some were stylish and upscale; others attracted a blue-collar clientele. Most had few chairs, and it was common for Italian opera to be playing in the background. What struck Schultz was how popular and vibrant the Italian coffee bars were. Energy levels were typically high, and they seemed to function as an integral community gathering place. Each one had its own unique character, but they all had a barista that performed with flair and there was camaraderie between the barista and the customers. Schultz liked it immediately, concluding that lattes should be a feature item on any coffee bar menu even though none of the coffee experts he had talked to had ever mentioned coffee lattes. Schultz was also struck by the fact that there were 1,500 coffee bars in Milan, a city about the size of Philadelphia, and a total of 200,000 in all of Italy. Schultz’s 1983 trip to Milan produced a revelation: the Starbucks stores in Seattle completely missed the point. There was much more to the coffee business than just selling beans and getting people to appreciate grinding their own beans and brewing fine coffee in their homes. What Starbucks needed to do was serve fresh- brewed coffee, espressos, and cappuccinos in its stores (in addition to beans and coffee equipment) and try to create an American version of the Italian coffee bar culture. Going to Starbucks should be an experience, a special treat, a place to meet friends and visit. Re-creating the authentic Italian coffee bar culture in the United States could be Starbucks differentiating factor. Schultz Becomes Frustrated On Schultz’s return from Italy, he shared his revelation and ideas for modifying the format of Starbucks’ stores, but the owners strongly resisted, contending that Starbucks was a retailer, not a restaurant or coffee bar. They feared serving drinks would put them in the beverage business and diminish the integrity of Starbucks’ mission as a purveyor of fine coffees. They pointed out that Starbucks had been profitable every year and there was no reason to rock the boat in a small, private company like Starbucks. It took Howard Schultz nearly a year to convince them to let him test an espresso bar when Starbucks opened its sixth store in April 1984. It was the first store designed to sell beverages and it was the first store located in downtown Seattle. Schultz asked for a 1,500-square-foot space to set up a full- scale Italian-style espresso bar, but he was allocated only 300 square feet in a corner of the new store.

The store opened with no fanfare as a deliberate experiment to see what happened. By closing time on the first day, some 400 customers had been served, well above the 250-customer average of Starbucks best-performing stores. Within two months the store was serving 800 customers per day. The two baristas could not keep up with orders during the early morning hours, resulting in lines outside the door onto the sidewalk. Most of the business was at the espresso counter, while sales at the regular retail counter were only adequate. Schultz was elated at the test results, expecting that the owners’ doubts about entering the beverage side of the business would be dispelled and that he would gain approval to pursue the opportunity to take Starbucks to a new level. Every day he shared the sales figures and customer counts at the new downtown store. But the lead owner was not comfortable with the success of the new store, believing that it felt wrong and that espresso drinks were a distraction from the core business of marketing fine Arabica coffees at retail.1 While he didn’t deny that the experiment was succeeding, he would not agree to go forward with introducing beverages in other Starbucks stores. Over the next several months, Schultz made up his mind to leave Starbucks and start his own company. The two owners, knowing how frustrated Schultz had become, supported his efforts to go out on his own and agreed to let him stay in his current job and office until definitive plans were in place. Schultz left Starbucks in late 1985. Schultz’s Il Giornale Venture Schultz spent several months raising money from investors to fund his new venture. An investor suggested naming the new company Il Giornale Coffee Company (pronounced il-jor-nahl’-ee), a suggestion that Howard accepted. The first Il Giornale store opened in April 1986. It measured 700 square feet and was located near the entrance of Seattle’s tallest building. The décor was Italian and there were Italian words on the menu. Italian opera music played in the background. The baristas wore white shirts and bow ties. All service was stand-up—there were no chairs. National and international papers were hung on rods on the wall. By closing time on the first day, 300 customers had been served— mostly in the morning hours. But while the core idea worked well, it soon became apparent that several aspects of the format were not appropriate for Seattle. Some customers objected to the incessant opera music; others wanted a place to sit down; many people did not understand the Italian words on the menu. These “mistakes” were quickly fixed, but an effort was made not to compromise the style and elegance of the store. Within six months, the store was serving more than 1,000 customers a day. Regular customers had learned how to pronounce the company’s name. Because most customers were in a hurry, it became apparent that speedy service was essential. Six months after opening the first store, a second store was opened in another downtown building. In April 1987, a third store was opened in Vancouver, British Columbia, to test the transferability of the company’s business concept outside Seattle. By mid1987, sales at each of the three stores were running at a rate equal to $1.5 million annually. II Giornale Acquires Starbucks In March 1987, the Starbucks owners decided to sell the whole Starbucks operation in Seattle—the stores, the roasting plant, and the Starbucks name. Schultz knew immediately that he had to buy Starbucks; his board of directors agreed. Within weeks, Schultz had raised the $3.8 million needed to buy Starbucks. The acquisition was completed in August 1987. The new name of the combined companies was Starbucks Corporation. Howard Schultz, at the age of 34, became Starbucks president and CEO.

Starbucks as a Private Company: 1987–1992 The Monday morning after the deal closed, Howard Schultz returned to the Starbucks offices at the roasting plant, greeted all the familiar faces, and accepted their congratulations. Then, he called the staff together for a meeting on the roasting plant floor:2 All my life I have wanted to be part of a company and a group of people who share a common vision. . .. I’m here today because I love this company. I love what it represents. . .. I know you’re concerned. . .. I promise you I will not let you down. I promise you I will not leave anyone behind. . .. In five years, I want you to look back at this day and say “I was there when it started. I helped build this company into something great. Schultz told the group that his vision was for Starbucks to become a national company with values and guiding principles that employees could be proud of. He aspired for Starbucks to become the most respected brand name in coffee and for the company to be admired for its corporate responsibility. He indicated that he wanted to include people in the decision-making process and that he would be open and honest with them. For Schultz, building a company that valued and respected its people, that inspired them, and that shared the fruits of success with those who contributed to the company’s long-term value was essential, not just an intriguing option. He made the establishment of mutual respect between employees and management a priority. The business plan Schultz had presented to investors called for the new 9-store company to open 125 stores in the next five years—15 in the first year, 20 the second, 25 the third, 30 the fourth, and 35 the fifth. Revenues were projected to reach $60 million in 1992. But the company lacked experienced management. Schultz had never led a growth effort of such magnitude and was just learning what the job of CEO was all about, having been the president of a small company for barely two years. Dave Olsen, a Seattle coffee bar owner who Schultz had recruited to direct store operations at II Giornale, was still learning the ropes of managing a multi-store operation. Ron Lawrence, the company’s controller, had worked as a controller for several organizations. Other Starbucks employees had only the experience of managing or being a part of a six-store organization. Schultz instituted a number of changes in the first several months. To symbolize the merging of the two companies and the two cultures, a new logo was created that melded the designs of the Starbucks logo and the Il Giornale logo. The Starbucks stores were equipped with espresso machines and remodeled to look more Italian than old-world nautical. Il Giornale green replaced the traditional Starbucks brown. The result was a new type of store—a cross between a retail coffee bean store and an espresso bar/café— that quickly evolved into Starbucks’ signature. By December 1987, the mood at Starbucks was distinctly upbeat, with most employees buying into the changes that Schultz was making, and trust was beginning to build between management and employees. New stores were on the verge of opening in Vancouver and Chicago. One Starbucks store employee, Daryl Moore, who had started working at Starbucks in 1981 and voted against unionization in 1985, began to question the need for a union with his fellow employees. Over the next few weeks, Moore began a move to decertify the union. He got a majority of store employees to sign a de-certification letter and presented it to the National Labor Relations Board. The union representing store employees was decertified. Later, in 1992, the union representing Starbucks roasting plant and warehouse employees was also decertified. Market Expansion Outside the Pacific Northwest The first Chicago store opened in October 1987 and three more stores were opened over the next six months. Initially, customer counts at the stores were substantially below expectations because Chicagoans did not take to dark-roasted coffee as fast as Schultz had anticipated. While it was more expensive to supply fresh coffee to the Chicago stores out of the Seattle warehouse, the company solved

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