The State of Starbucks: Inside its Existential Crisis

Dan Mitchell|The Big Money

Most years, Howard Schultz, chairman and CEO of Starbucks, uses the annual shareholders meeting to introduce a major new product or a cool new piece of coffee-making equipment. Something buzzworthy.

At this year's meeting, held in Seattle on Wednesday, there was nothing in the way of buzz, and Schultz introduced nothing new, except for a focus on "value" and a fresh effort to squash the "myth" that "there is a $4 cup of coffee at Starbucks."


Problem is, it's not really a myth. Some of Starbucks'   coffee drinks do cost $4 and even more. But even when they cost less, they are still an extravagance. And in a recession, extravagances are the first thing to go.

These are tough times for Starbucks. It's been closing stores by the hundreds and laying off workers by the thousands. People started skipping Starbucks even before the recession got really bad. Traffic has been falling, likely at a rate faster than 2008's Q1 3 percent drop, for a year.

Before that, of course, Starbucks drove its business through expansion. It went way too far, "watering down the Starbucks experience," as Schultz himself once put it, and turning off customers. Now, the recession has thrust Starbucks into an existential crisis-one that is largely of its own making.

But the company can't afford to stay angsty. It has to work hard to stop customers from fleeing, it has to cut costs, and, to placate shareholders, it has to find new areas of growth.

A major problem for Starbucks is that, these days, you can get a good cup of coffee at a Chevron station. Starbucks' astounding growth-it was opening eight new stores a day just a couple of years ago-was possible because of the dearth of good coffee elsewhere.

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That's no longer true, and the "Starbucks experience" that Schultz constantly refers to is really all he has to offer.

But "experience" (store ambience, personalized service, etc.) is a tough sell during a deep recession, so Schultz is now trying to make the Starbucks experience a "value" proposition. Those two concepts might seem at odds, but so far, anyway, Schultz seems to be pulling it off.

The chain, Schultz promised, will now work to convince people that its coffee drinks aren't so expensive after all. He noted, for example, that half of Starbucks' coffee drinks cost less than $3, and one-third of them cost less than $2.

He's right, but that's still a pricey cup of coffee. Still, the mission here is to retain existing customers-and stop them from fleeing to McDonald's McCafe bars-so reminding them that they aren't really spending all that much at Starbucks could be effective.

The recent introduction of a $3.95 breakfast combo-also part of the chain's effort to retain existing customers-doesn't, as some critics have said, put Starbucks at the level of McDonald's. It's the same stuff Starbucks was already selling but for about a buck less. It does nothing to harm the brand.

Similarly, Via, the chain's "breakthrough" instant coffee product, isn't an example of Starbucks going downscale but of making instant coffee seem upscale. The product is just two weeks old, but the consensus seems to be that while it's not as good as the real thing, it's a lot better than most instant coffees. Via is also clearly a major part of Starbucks' international strategy. People around the world don't look down on instant coffee like Americans do. Globally, instant coffee makes up about 40 percent of the coffee market. Starbucks says it intends to take a big chunk of the $17 billion spent on instant coffee every year.

A World to Conquer

Indeed, the only way for Starbucks to grow is through international expansion. The company says it plans to open 170 stores in foreign markets this year, particularly in China, Brazil, and Russia. Just one-fifth of the chain's sales come from outside the United States, a fraction that should grow quickly over the next few years, assuming the global economy cooperates.

Assuming also that Starbucks can pull it off. Chief Financial Officer Troy Alstead told reporters on Wednesday that the company sees the potential for "much more" growth in China, where it operates 400 stores. But plans to expand into India were dropped, he said, after talks with potential partners and franchisees "didn't come together."

And as much as Alstead talked up international expansion, the chain's plans have been cut back. For instance, it had been planning to open stores in entirely new markets, such as Eastern Europe. Now, it is focusing on markets where it already has stores.

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Expansion overseas might be a lot easier if Starbucks were to close more stores in the United States. But here, the company's former strength-growth-is now its greatest weakness. Starbucks is planning to open 140 new stores in the United States (while closing an additional 200).

The trouble is, Schultz isn't about closing stores; he's all about opening them. He may have complained about overexpansion a few years ago, but he was, after all, the company chairman, and a very involved one at that. And the company still hasn't backed off its goal of someday operating 40,000 stores worldwide. If the ubiquity of Starbucks' stateside stores is a major cause of the company's problems, it's hard to figure why Schultz isn't closing a lot more of them.

For Schultz, the next year, at least, will be a balancing act. He needs to recast Starbucks as affordable without harming its brand of "specialness."

He needs to cut costs while still investing in growth. He needs to fend off gigantic competitors like McDonald's and Dunkin' Donuts without directly competing on price. And, perhaps most challenging of all, he needs to persuade people to drink instant coffee.