Monday, February 26, 2007

Vindication.... Thy Name Is Howard Schultz

On Feb. 8th ValuePlays subscribers read the following at the end of the post Did SBUX's CEO Donald Really Say That?: " The hard core Starbuck's customer who garners much of their self worth from carrying that cup with the barely exposed green logo around will never abandon them, no matter how much they are forced to pay for their "vente soy non fat half caff white chocolate mocha latte with an extra pump". However, the casual customer will and appears to be. I look at my wife and I (it is always a good idea when investing to look at yourself. No matter how unique you think you are, there are lots of people who think and act very similar to you). She was once a daily visitor for Mr.Donald and SBUX. Now, she runs a very successful law practice, has 3 children at home under 4 and a very tight schedule. She no longer has the 15 - 20 minutes it takes to park, go inside and get a cup of coffee at Starbuck's. Instead, she has discovered that the cappuccino from the Christmas present her thrifty husband bought her is just as good. She can take it with her in her travel mug and avoid walking through the Massachusetts winter weather to get one (that cappuccino machine paid for itself in only 6 weeks). As for me, if I am driving around this winter and want a cup of coffee, rather than lug 2 four year olds out of their car seats and wait in line for one, now that I can get a really good one from inside my car at McDonald's (MCD) while listening to them sing Brooks & Dunn's "Hillbilly Deluxe", why would I choose anything else? We can't be the only two people out there like this and judging from McDonald's (MCD) coffee sales growth, we aren't.

Mr. Donald... Are you paying attention?"

Apparently he wasn't but former CEO and Chairman Howard Schultz was as only six days later he penned....


Starbucks (SBUX) Founder and Chairman Howard Schultz wrote this to CEO Jim Donald earlier this month (a portion follows). The memo's authenticity has been confirmed by Starbucks.

From: Howard Schultz
Sent: Wednesday, February 14, 2007 10:39 AM Pacific Standard Time
To: Jim Donald

"...While the current state of affairs for the most part is self induced, that has lead to competitors of all kinds, small and large coffee companies, fast food operators, and mom and pops, to position themselves in a way that creates awareness, trial and loyalty of people who previously have been Starbucks customers...."

Nothing I have posted to date has received the visceral reaction of the initial SBUX post. From complimentary mentions in industry titans like The Wall St. Journal Online , and Seeking Alpha to websites like TheStockMasters, Value Investing News and others who I would like to apologize to now for not citing, to the hysterical email and post comments it got, I seemed to hit a nerve. I was surprised to be honest at the intensity of the reaction by those who still frequent SBUX daily. Reading them, I got the impression that they would have preferred I insulted their mother or father rather than take their beloved Green Logo'd Cup to task. I could just picture them all hopped up on a "triple vente two pump half calf half soy non fat caramel macchiato with extra drizzle" raging at their computer screens with bloodshot eyes trying to spew venom at me via their keyboard while hopelessly trying to fight off the near seizure inducing effects of enough central nervous system attacking caffeine to cause a meth-amphetamine addict to look at them and vapidly exclaim, "That dude must be crazy!". The really odd part of it all was that as I sat back and looked at those comments, (yes I read them) most of the negative comments just completely missed the point of the post. They were indignant that I would even presume anyone would rather go anyplace else for coffee. This, despite the fact that SBUX management commented on anemic customer growth while McDonald's was practically giddy over theirs during conference calls. The assumption must be McDonald's is growing customers? To those folks I would quote Judd Nelson in the movie "Breakfast Club", "I am trying to help ****, I would expect you you know the difference". Only by pointing out problems can they be addressed and fixed.

My point was not "Starbucks sucks" which is what quite a few of you inexplicably took away from it or that McDonald's was "going to put Starbucks out of business". Quite the contrary. If you read a previous post on Starbucks, you'll see I call it "a great company". The post was not an indictment of the company itself but of Mr. Donald's seemingly arrogant dismissal of impressive competition. The point was, if I can get a good, inexpensive cup of coffee in other places, why go to Starbuck's and deal with the inconvenience that often accompanies the experience? As a consumer, there was nothing "special" to me about Starbucks anymore.

Back to Howard Schultz's memo:

"...we have had to make a series of decisions that, in retrospect, have lead to the watering down of the Starbucks experience, and, what some might call the commoditization of our brand."

It would seem at least Mr. Schultz got the point of my post.

Econ 101. In a commodity business price and availability win. When you buy gas for your car you most likely go for the closest, cheapest station because you do not perceive any difference in the product. This is what has happened to Starbucks. Ten years ago if you wanted a good cup of coffee, Starbuck's was really your only option. Today there are small coffee houses and fast food giant's that have closed the quality gap while providing more convenience. This has enabled them to peel off Starbucks customers. Despite what you ValuePlays doubters may think, Mr. Schultz at least recognizes this.

Now for Mr. Donald (did you think I forgot about him?). His flaccid idea of giving away 10,000 t-shirts needs to be critically looked at. These shirts were customized with the bearers favorite drink on them designed by Mychael Knight, a finalist from the Bravo TV show "Project Runway." I do not know who this is and this is another problem. It does not mean I am "out of touch" because I can tell you that Carrie Underwood, whom my 4 year old sons stare longingly at whenever she is on TV, won "American Idol" last year. This does mean that Mr. Donald concocted an bizarre promotion with somebody most people have never heard of. I am going to go out on a limb here and say that the type of person who would wear their favorite drink on a t-shirt is the same person who if Mr. Donald stood in the entrance of a Starbucks and slapped in the face as they walked in would say "thank you sir, may I have another!", wait to be flogged again and then continue in to order their drink. I on the other hand, after witnessing this event would turn to my kids and say "who wants a happy meal!" It is not necessary to give t-shirts to these people, they are coming tomorrow anyway, maybe twice. Mr. Donald is sadly just preaching to the choir which is easy and feels good but, doesn't accomplish anything. If he wants to do something useful he ought to be trying to figure out a way to lure people like my wife an I back. He has failed to realize is that his initial customer base is aging. We have gone from 20 somethings to 30 (almost 40) somethings with children and careers and all the time consuming activities those responsibilities entail. When you have 1,000 stores we can easily be replace by new 20 somethings, but when you grow to 13,000 stores and have the desire for more, we cannot be replaced, you need us to keep coming in. "How?" you ask. I have ideas and no, they do not include free coffee, muffins or pretentious t-shirts.

As so often happens with a dynamic company when its charismatic founder leaves the CEO post, it flounders. Think Microsoft (MSFT) since Bill Gates left, Dell (DELL) after Micheal Dell left (he has since returned to the CEO post), Apple (APPL) after Steve Jobs left (before his successful return) and a host of others. There is that same listless feeling to Starbucks now. If you are a stockholder I am sure you recognize this as shares are only up 12% since Jan. 2005 despite the S&P's roughly 23% advance. EPS growth is declining also so clearly something must be done. The first thing we need to do is:

1- Mr. Schultz, sorry but it is time to come back to day to day operations. You are brilliant and SBUX needs your help (yes I think he is brilliant, you cannot create what he did unless you are).
2- Mr. Donald, please click here

Next we need to take control and define your brand. Currently it being defined by the very people who would wear those ridiculous t-shirts and are lucky not to get backhanded when they look mockingly at others as they stumble through an order. The Starbucks brand is something you need to nurture and direct, not allow to drift aimlessly like it is now. All the "corporate good citizen" stuff is warm, fuzzy and sweet but it is only relevant to what I think of those of you at HQ in the state of Washington and has nothing to do with the coffee I drink in Massachusetts. You need to make me feel something about your cup other than "great coffee but a hassle". I mean, the fact that the brown sleeve that stops me from scalding my palm on the cup is made from recycled paper, saves the rain forest and has halted the near extinction of the three legged flying pygmy toad is nice and makes for a great press release, but it does not influence a buying decision.

I have said it quite a few times here before that timing in life is everything. I do not know if Mr. Schultz saw my previous post but it's wide circulation and the timing of his memo to the very target of it has me wondering....

Mr. Schultz, I am neither a fanatic nor a hater of Starbucks. You have a great product and too be honest I would love to frequent your establishments more. Give me a reason to. I have ideas, lots of them, and I think they are good. Get in touch and we can chat...


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