STANFORD GRADUATE SCHOOL OF BUSINESS

STARBUCKS: A GLOBAL WORK-IN-PROGRESS

INTRODUCTION

The 2007-2009 period was one of much re-evaluation within the senior management ranks of Starbucks. In February 2007, Howard Schultz, chairman and founder of Starbucks, e-mailed a memo to then CEO Jim Donald, in which he expressed concems about what he perceived was a "watering down of the Starbucks experience" (see Exhibit 1). On January 7, 2008, Shultz, who served as CEO from 1987 to 2000, announced that he was returning "as chief executive officer for the long term" and that "Jim Donald is leaving the company" (see Exhibit 2). On March 3, 2008, Lanni Skinner resigned as president ofStarbucks' United States business after less than a year in the post. On July 8, 2008, Schultz announced "the difficult, but necessaty decision to close approximately 600 underperforming U.S. company-operated stores," (see Exhibit 3). On July 29, 2008, Starbucks mmounced that it was closing 61 of its 84 Australian stores (all company-owned). Starbucks' press statement indicated that the decision to close the 61 "underperforming" locations was made to "concentrate its attention and resources on profitable growth, operational efficiencies, and an enhanced experience for customers and partners (employees) globally." On July 30, Starbucks repmted "for the 13-week period that ended June 29, 2008 ... a net loss of $6.7 million compared to net income of $158.3 million for the same period a year ago. Restructuring charges of $167.7 million [in tbe 13-week period ending June 29, 2008] are comprised of asset impairments for the approximately 600 underperforming company-operated stores in the U.S. market."

The closing of600 U.S. company-operated stores and 61 Australian company-owned stores raised the issue ofStarbucks' global strategy. Its entry into international markets had been delayed. From its fust store opening in Seattle in 1971, it reached 11 stores by 1987. In the 1987 to 1995 period, it expanded to 676 stores, all within the U.S. or Vancouver, Canada. It was not

This case was prepared by Professors Antonio Davila (lESE), George Foster (Stanford University), and Ning Jia (Tsinghua University). It draws on an earlier case co-written with Anne Somjen and Corinne Putt.

Copyright © 2006 by the Board of Trustees of the Leland Stanford Junior University. All rights rese1wd. To order copies or request permission to reproduce materials, e-mail the Case Writing Office at: cwo@gsb.stanford.edu or write: Case Writing Office, Stmiford Graduate School of Business, 518 Memorial Way. Stmiford University, Stmiford, CA 94305-5015. No part of this publication may be reproduced, stored in a retrieval system. used in a spreadsheet, or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or othenvise -without the penn iss ion of the Stanford Graduate School of Business.

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' until 1996 that Starbucks started a rollout into international markets. By the end of fiscal 2008, Starbucks had 5,113 of its 16,680 stores (30.65 percent) outside the U.S.A.

Profitability per revenue dollar for the U.S. exceeded profitability outside the U.S. for each year geographical segment data had been disclosed (since 2002).

Table 1: Results for the Operating Ineome to Net Revenue- (01/NR%)

Year United States- 01/NR% Intemational- 01/NR% 2004 2005 2006 2007 2008 15.56% 16.04 15.50 14.69 5.86% 8.07 8.40 8.68 6.14 (before restrncturing 9.37 6.70 5.23 changes) 2008 (after restmcturing changes)

The above 2008 results also highlight the declining profitability in both U.S. and international markets.

Many external observers viewed Starbucks as at a crossroad inmid-2009. The problems that surfaced in both the U.S. and many other countries in 2007 and the first half of 2008 had been exacerbated by the global economic downturn, starting in the latter part of 2008. This global economic downtum added an extra dimension to the debate on Starbucks' global initiatives. There were the ever-present issues of whether and where to further expand its global presence, and the mode of expansion. Should the emphasis be on increasing expansion in existing countries or expanding the number of countries? What role should the lower profitability to date of non-U.S. markets play in any decisions? How should any new strategic initiatives to address the changed post-2008 economic enviromnent be tailored to different parts of the Starbucks global footprint? There were also issues related to the appropriate mix of company-owned versus licensed stores in both U.S. and non-U.S. markets.

All store openings up to 1991 were company-owned stores in U.S.A. and Canada. Starbucks used licensed stores as a way to further its growth starting in 1992. Its intemational store expansion stmied in 1996 with licensed international stores and in 1998 with company-owned intemational stores. (Exhibit 4 presents selected financials for Starbucks covering 1987 onwards. Exhibit 5 presents store information covering 1987 onwards.)

Over time, Starbucks has used the phrase "intemational" in either of two ways- (a) all non-U.S.A. stores, or (b) all non-U.S.A. and non-Canadian stores. Unless clear or specified, this case adopts the (a) interpretation. Starbucks switching back and forth between (a) and (b) arises, in part, due to its early regional expansion from its Seattle base including Vancouver, Canada.

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COMPANY BACKGROUND

Starbucks was founded in 1971 by Jeny Baldwin, Zev Ziegler and Gordon Bowker-three men from Seattle who loved coffee, and wanted to be able to offer the same high-quality experience to Seattle coffee drinkers as Peel's Coffee provided to San Francisco Bay Area residents. Fittingly, they named their company after another coffee lover: Starbuck, the first mate in Herman Melvill's novel Moby Dick.

The first Starbucks sold primarily whole bean roasted Arabica coffee, tea, spices and some gourmet kitchen supplies. Since the founders had been longstanding, loyal mail-order customers of Peel's Coffee, Alfred Peel agreed to sell coffee to Starbucks under the caveat that as soon as they "got too

' big, they would have to roast their own." After a decade there were four Starbucks stores bringing great coffee to the Seattle area. Baldwin frequently reminded customers and employees, "We don't manage the business to maximize anything except the quality of the coffee."

Howard Schultz joined Starbucks in 1984 as director of operations and marketing and brought a new 4

vision to the company. The former vice president and general manager of Hammerplast, a Swedish home wares company, Schultz was intrigued by the success of the small company. He convinced the owners, who were looking for a manager, that he should be the one to run Starbucks' day-to-day operations. After a trip to Milan, Italy in 1983, Schultz perceived what was absent from the North American landscape-"The Italian coffee bar ... the extension of people's front porch; the third place." He reh1rned home to Seattle convinced that Starbucks should fill this void for its customers.

Schultz faced considerable resistance to this concept from the founders. They thought that serving espresso beverages and brewed coffee was more of a restaurant concept than a notion that fit with their idea of a Starbucks store. In 1985 Schultz left Starbucks to pursue his vision, stmiing up an espresso bar called II Giornale, which proved to be a tremendous success. By 1987, he was operating three such cafes. In the ve1y same year, Bowker and Baldwin, frustrated by quality problems in their Starbucks stores, were looking to sell Starbucks (Ziegler had sold his interest in 1980). II Giornale acquired the assets and the name "Starbucks Coffee Company" and became the Starbucks Corporation.

Schultz hired Howard Behar to the position of director of stores and together the two began a rapid expansion, believing that the only way to stave off competition was to build recognition. A key part of this was building more stores. The company had enonnous needs for cash and was unprofitable for

' the first three years. This initial period of expansion was undertaken solely through organic growth. In a commodity market, Starbucks sought to differentiate itself by building a strong brand and a unique culh1re-a distinctive customer experience. Schultz believed that the only way to ensure success was to maintain full control of the customer experience by building only company-owned stores, which required access to a tremendous

' Starbucks Coffee Company and Intemational Expansion (A), Stanford University, 1999. ' Howard Schultz, Pour Your Heart Juto It, Chapter 2, 1997. ' Starbucks Timeline and Histmy, Starbucks Coffee, http://\\~\~v.starbucks.com/aboutus/timeline.asp ' Starbucks Coffee Company and Intemational Expansion (A), op. cit.

amount of capital not to mention talented people. In 1992, Starbucks became a publicly traded company, raising the necessmy capital to fund its continued expansion.

THE COMPANY TODAY

The Starbucks of the early twenty-first century purchased and roasted high-quality whole bean coffees and sold them, along with fresh, rich-brewed coffees and Italian-style espresso beverages, primarily through company-operated and licensed retail stores. With an objective of establishing Starbucks as the most recognized and respected brand of coffee in the world, the company planned to continue rapid expansion in its retail operations, to grow its direct response and specialty sales operations, and to pursue other opportunities to leverage and grow the Starbucks brand.

The average Starbucks offered regular or decaffeinated coffee beverages, changing "coffees of the day," and a broad selection of Italian-style espresso beverages, as well as distinctively packaged, freshly roasted whole bean coffees, a selection of fresh pastries and other food items, sodas, juices, tea, and coffee-related hardware products and equipment. Beginning in 2007, Starbucks continued to extend its food offerings, including warm breakfast sandwiches, an expanded pastry and dessert

' selection as well as prepackaged lunches. Despite this broad product range, Starbucks was focused on selling "the finest whole bean coffees and coffee beverages." To maintain control of quality and to ensure compliance with its rigorous standards, Starbucks was vertically integrated, controlling its coffee sourcing, roasting, and distribution through its retail stores.

Starbucks stores were typically clustered in high-traffic, high-visibility locations in each market. They could be found in a variety of settings, including office buildings, retail centers, kiosks, airport terminals, and university campuses. In choosing its retail locations, Starbucks looked for stores that were convenient for pedestrian street traffic. Location was important not only to drive customers but for marketing purposes. Starbucks prefened to establish a local "buzz" for its stores through word of mouth rather than media advertising-each store was an advertisement for the company, the

' distinctive store design and colors sparking consumer interest and raising brand awareness.

Product Supply The supply and price of green coffee (the particular variety used by Starbucks) were subject to significant volatility. Although most coffee traded in the commodity market, the special type of high­quality coffee purchased by Starbucks traded on a negotiated basis at a substantial premium above commodity coffee prices, depending upon the supply and demand at the time of purchase. Supply and price could be affected by multiple factors in the producing countries, including weather, political and economic conditions.

Starbucks regularly negotiated fixed-price purchase commitments to secure an adequate supply of quality green coffee and to bring greater certainty to the cost of sales in future periods .

• uStarbucks lntToduces Hot Breakfast Sandwiches/' NACS Online, January 11, 2007, http://www nacsonline.comiNACS/News/Daily News Archives/January2007/Pages/nd0lll075.aspx. ,

The Age, December 5, 2000.

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Exporters of high-quality coffee had generally been anxious to become Starbucks suppliers because Starbucks purchased more high-quality coffee than anyone else in the world. This desirability of the Starbucks contract allowed the company to enforce its stringent selection processes, sampling each shipment of coffee multiple times to ensure quality standards. At every stage of sampling, Starbucks reserved the right to reject the coffee if it did not meet its quality standards.

Competition Starbucks competed directly against specialty retailers, specialty coffees sold at retail through supermarkets, and a growing number of specialty coffee stores; as well as coffee sold in restaurant beverage outlets, and a growing number of espresso stands, carts, and stores. Competition in the beverage market was generally fragmented. Starbucks historically believed that its customers chose among retailers primarily on the basis of quality and convenience, and, to a lesser extent, on price. This position in more recent years had come under re-evaluation. On the one hand, many observers believed thai its growing list of competitors had reduced the actual (and perceived) quality differential. In addition, a growing number of consumers were becoming considerably more price conscious in their repeat purchase decisions of consumer products.

Human Resources Culture is of utmost importance to the Starbucks formula of high-quality products and service in a pleasant setting-what they termed the "third place" customer experience. "We believe more strongly than ever that at the heart of our continuing success lie the company's two cornerstones,

' coffee and our people." One observer noted that "Starbucks is clearly a brand reputation rather than a product reputation ... every contact with the customer is a test of that brand contract. How are you

" treated in the store, and even after the sale?"

From the outset Starbucks wanted to recognize the service that the frontline employees gave the " company by breaking away from industty norms of low pay and few benefits. All 'partners'

(baristas), irrespective of whether they were full-time or part-time employees, received stock options, healthcare benefits, and an allotment of free coffee per week. Schultz explained, "We had to link shareholder value to the reward system of our employees." The CEO and the barista had the same

" health benefits, retirement plans, and share in stock options. The only difference was the amount of .. salaty and options. Starbucks was viewed as imwvative in its employee relations and it maintained open cmmnunications with its entire staff .

• Starbucks, Richard lvey School of Business, The University ofWestem Ontario, 1999. ' Starbucks' President Howard Schultz and COO Orin Smith (from 1996 Annual Report). " Lany Light, president and CEO of Arcature, a branding consultancy, "Differentiating in an Overbranded World,"

Discount Store News, New York, Sep 7, 1998. " The company addresses all employees as partners. " At the time, giving stock to employees of a retail company was so novel that Starbucks had to ask the pem1ission

of the SEC to develop their Beau Stock stock option program

" Starbucks maintains several stock option plans under which it can grant incentive stock options and non~qualified stock options to employees, consultants and non~employee directors . ..

Howard Behar, class lecture, Stanford University, May 1998.

"

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STARBUCKS GROWTH MODES

Starbucks pursued growth through three key avenues: expanding existing product lines and distribution chatmels, increasing domestic penetration of stores, and international expansion.

The pursuit of growth in the fonn of increased product range and distribution channels potentially strayed from Starbucks' core value propositions of providing the highest-quality coffee in a familiar and comfortable "third place" setting. While such a divergence could lead to dilution of its brand image, it also had the potential of generating increased revenues approached appropriately. Unfortunately, when Starbucks decided to increase its food offerings prior to 2003, it did not meet customers' high expectations. As a result, Star bucks pulled many of the food products from its shelves. In 2007, Starbucks again decided to expand its food offerings, but this time with a focus on quality that would hopefully satisfy customer expectations. The expanded selection included warm breakfast sandwiches, a wider variety of pastries and desserts, as well as prepackaged lunches. Again, concerns arose over the quality of the food and the odor from that food (especially breakfast items).

Starbucks was solely focused on domestic growth up to 1996, especially in targeted geographic areas within the United States and Canada. By 1997, Starbucks was established in only 34 of the 50 states and its stores were heavily concentrated on the West Coast.

Begitming in the mid 1990s, Starbucks entered international arenas (see Exhibit 5 for a timeline of Starbucks international expansion). The company offered the same basic coffee menu ittternationally as it did in its U.S. stores, and the names of items were held consistent around the world. However, the range of food products and coffee accessories stocked in stores varied somewhat according to local

" customs and tastes. (Exhibits 6 and 7 provide consumption infonnation for selected countries around the globe.)

STARBUCKS' EXISTING GROWTH CHOICE MODES

In considering how to grow theit' chain of specialty coffee stores, Starbucks used a combination of organic growth, acquisition, joint venture and franchise.

Organic Growth- United States Starbucks' expansion within the U.S. relied on an organic growth model. As Starbucks was offering U.S. consumers a relatively new value proposition, it was unable to fuel its expansion with acquisitions and had to build its empit'e store by store. Because the key to success was managing and growing the Starbucks brand, strong centralization became essential to maintaining unifonn practices t1n·oughout the growing number of Starbucks stores. By 1991, Starbucks had 105 stores. With the help of additional funds raised through an initial public offering in 1992, Starbucks could be found in 725 U.S./Canadian locations by 1995. From 1996 to 2008, Starbucks' company-operated U.S./Canadian stores grew from 926 to 7,969, while its licensed U.S./Canadian stores grew from 75 to 4,560. The July 8, 2008 announcement that Starbucks would be closing 600 underperfonning company-operating stores was the first systematic setback of its organic growth itt the U.S. (see Exhibit 3).

" "Launching Starbucks in Japan," Seattle Times, Monday 29 July 1996.

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Joint Venture- Japan

With the exception of Canada (considered by Starbucks to be a part of its North American region), the Joint Venture in Japan was Starbucks' first international foray. As Howard Behar stated, "With over half of the world population living within five and a half hours from Singapore, it made a lot of sense to focus on the Asia Pacific region." At the time of the venture, Japan had the second-largest

" economy in the world and was consistently among the top five coffee importers in the world. (See Exhibit 6 -8 for worldwide coffee consumption.) With an attractive market and a preexisting taste for coffee, Japan was selected as the logical enhy point for the region. Starbucks set itself a large goal in establishing its Japanese presence. "The greatest thing that could happen is that someone in Japan would think that Starbucks stmted in Japan." Yet at the same time "American customers will feel

" right at home in our Japanese stores."

Starbucks' management debated at length about the right way to enter the Japanese market. Their concems centered on Starbucks' lack of local knowledge and human resources to build the Japanese business quickly enough. Starbucks was acutely aware that there were significant market differences between Japan and the U.S., and that it was inexperienced in navigating these waters. Operating costs were predicted to be double those ofN01th America, and Starbucks would have to pay to ship coffee to Japan fi·om its roasting facility in Kent (near Seattle). In addition, retail space in Tokyo was two to three times as expensive as in Seattle. Just finding rental space in such a populous city might prove to be a tremendous challenge. Starbucks concluded they needed to fonn an alliance with a local group that had experience with complex operations and real estate.

Wonied about loss of control and insufficient knowledge transfer to leam from the experience if they licensed the operations, Starbucks contracted an investment bank to search for suitable partners. So critical were consistency of values, culture and community development goals between Starbucks and any future partner that, after an extended search, all of the shortlisted candidates were deemed

" unsuitable. Reluctant to back away from the opp01tnnity, Starbucks approached Sazaby Inc., operators of upscale retail and restaurant chains, whose president had approached Starbucks years earlier about the potential to open Starbucks stores in Japan. Starbucks and Sazaby signed a 50:50 joint venture agreement. The two companies were equally represented on the board of directors of Starbucks Coffee Japan (the incorporated company resulting from the venture). Starbucks was the sole decision-making power in matters relating to brand, product line advertising and corporate communications, while decisions about real estate, operational issues and human resources were Sazaby's province.

Once launched, Japan boasted the single largest number of Starbucks stores outside North America. In 2008 there were 814 stores in Japan (all "licensed stores"), compared to 664 (all "company-operated stores"), in the United Kingdom, the country with the next-highest number of stores.

" 17

lnternational Coffee Organization.

Howard Behar, fonner president of Starbucks Intemational. '" Kathy Lindemann, vice president of operations, Starbucks Coffee International.

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Acquisition - The United Kingdom

Unlike its expansion into Asia and (later) the Middle East, in the U.K. Starbucks chose to acquire rather thau pattner in a joint venture or licensing agreement. Starbucks entered the U.K. market in May 1998 through the acquisition of the Seattle Coffee Company. This fast-growing chain was modeled on Starbucks' own style of operations. Through this purchase, Starbucks acquired 56 retail units. By the end of2000, this had grown to 156 units and by the end of2008, 664 units.

In mid-to-late 1997, as Starbucks began to contemplate the first steps into Europe, the U.K. was already experiencing its first exposure to the specialty coffee chain. The Seattle Coffee Company had begun to open retail units in major urban centers and was expanding rapidly. With the possibility that the lucrative U.K. coffee chain market could become crowded with competitors within a short space of time, Starbucks moved quickly to secure a major presence. The culture, language, legal environment, management practices and labor economics in the U.K. were considered sufficiently similar to those that Starbucks management ah·eady faced in the U.S. that a 100 percent-owned U.K. subsidiary could be successfully established from the outset. Starbucks chose Seattle Coffee Company as its acquisition target because of its focus, its relatively small valuation, and its established retail units.

Licensing- e.g. China Starbucks entered many intemationalmarkets through minority share licensing agreements with high-quality, experienced local pmtners to minimize market en!ly risks. Under these agreements the local pattners absorbed the capital costs (real estate, store constmction) of bringing the Starbucks brand abroad. This eliminated substantial general and administrative expenses for Starbucks and enabled it to establish a presence in foreign markets much more quickly than if Starbucks had to invest

" its own capital and absorb start-up losses.

Risk was a big consideration when Starbucks chose to enter the Chinese market. While offering high­volume opportunities in an untapped coffee market, China's culture and politics posed significant problems for intemational companies. Precedent did not bode well for the company. In April 2000, Beijing city authorities ordered Kentucky Fried Chicken to close its store in Beihai Park (a scenic

" imperial garden near the Forbidden City) when its lease expired in 2002. McDonald's had removed its " golden arches from outlets near Tianamnen Square.

According to Chen Junqui, an official of the palace museum, "It's about a certain conflict and misunderstanding between China and the West." China appeared to hold an ambiguous attitude about

. growing Westem economic and culh1ral influence. While Communist officials ranted at what they called decadent Western culture and "hegemonism" in world affairs, younger Chinese either craved Westem brand names and visas or did not understand what the fuss was about when Western brands

" sought to begin operations in the Chinese market.

" "

"Starbucks Corporation: Think Coffee, Not Intemet," JP Morgan, June 1999.

" "Tempest in a Coffee Cup," ABC News, 29 November 2000.

"McDonald's to Move Beijing Restaurant," The New York Times, December 2, 1996, http://www nytimes.com/ J 996/ J 2/02/business/mcdonald-s-to-movc-bei Hug-restaurant .html. " "Starbucks Brews Stonn in China's Forbidden City," CNN News, December 11 2000.

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Another key concern regarding operations in China was recmiting the right staff, with demand for managers far outsh·ipping supply. "Focusing on the development of employees so that they can deliver [the Starbucks experience that the brand is famous for] is our priority now," explained Lawrence Maltz, the head of Starbucks' Chinese operations. Sending recruits to the U.S. for training was helping to attract qualified individuals to Starbucks. Catherina Chau, deputy general manager of Beijing Mei Da Coffee Co., explained that "the success of the Starbucks brand in the U.S. strengthens trainees' confidence in the company." Uniformity of customer experience and coffee quality drove the Starbucks brand, so failure to recmit staff who could maintain these key criteria would not only mean failure for the Chinese retail outlets but could harm the company's consumer image globally.

The early expansion into China was via licensed stores-9 in 1999 and 28 in 2000. Starbucks stmck a deal with Beijing Mei Da Coffee Co. to open Starbncks franchise coffee shops, starting in the

" Chinese capital.

Reliance on the licensing model for China was being reduced over time. After attending a June 2006 " "Investor Meeting," Bear Steams reported the following:

"

Starbucks is clearly targeting a much greater presence iu China and has shown and expressed a desire to pursue a company-operated business model, as opposed to proceeding with a heavy .licensing emphasis as a way of managing the development of this market that has potential to be as significant as the U.S. market on a long term basis. The company has already increased its equity ownership in its Southern China business to 51 percent with agreements in place for that stake to become 70 percent if certain developments occur. Starbucks has also raised its stake in the Shanghai market from 5 percent to 50 percent and has an option to buy a 50 percent stake in Beijiug, a market in which it cunently has no ownership percentage. The company noted that in the past[,] discussions around 50 percent buy-in options have led to an even greater investment in some markets and in some cases to a l 00 percent buyout. In addition, there are regions in China not covered in any existing licensing agreement that can be pursued as company markets.

Meanwhile, Starbucks is building a China iufrastructure to develop the market. In China, the average ticket is in line with Starbucks check across the rest of the world; transaction counts are significantly lower than average; but operating costs, especially labor, are also significantly lower so stores are profitable. China is currently profitable for Starbucks but as the licensed business model transitions into a higher equity stake model, the business may lapse into losing money stah1s as infrastruch1re commensurate with the market opportunity is put into place. We were reminded that the larger the market potential, the longer it can take to become profitable because of spending against that potential. China is an important part of

Joatme Lee-Young, "Delivering Starbucks to China," The Asian Wall Sh·eet Joumal Weekly, 1998, http://w\\~V faqs.org/abstracts/Business-intemational/Delivering-Starbucks-to-China-China-shouldnt-abandon-big­projects html. " ustarbucks Corp., 11 Bear Steams, June 7, 2006.

the company's long term plans but is not being counted on as a contributor to eamings in the next several years.

By 2008, there were 178 company-operated stores and 269 licensed stores in China. In 2005, 6 Southern China stores switched from licensed status to company-operated status. In 2007, 61 Beijing stores switched from licensed status to company-operated status.

Geographic Disclosures

Starbucks began expanding intemationally in 1996 with stores in Japan, and continued in 1997 with stores in Singapore. (Exhibit 4shows revenue disclosures for United States and International (non-U.S.) starting in 1997.) Profitability disclosures for United States and International started in 2002. Prior to 2008, relative profitability in its intemationalmarkets was considerably below that of the U.S. market. In 2008, the profitability difference between these two geographic segments was much reduced (largely due to the marked reduction in U.S. profitability).

GLOBAL CHALLENGES

In the United States, Starbuck's was the first company to introduce the "third place" concept. This was not the case in many international markets, where competitors were already established. This intense competition resulted in less traction for Starbucks in some intemational markets, where it was forced to push harder to compete with the existing players rather than being the first mover, as it was in the U.S. In Japan, Starbucks was initially a huge success and became profitable two years earlier than anticipated. However, just two years after Starbucks Japan had tumed profitable, it announced a $3.9 million loss in what was at the time its second­largest market. Although initially Japanese coffee drinkers flocked to Starbucks due to their intrigue with U.S. brands, later they began turning their attention to other coffee houses where the flavor better matched their

" tastes.

Starbucks' mode of entry caused additional challenges. Many of Starbucks' international operations were through joint ventures. Although this provided Starbucks with local knowledge about the market and a low-risk ently into unproven ten·it01y,joint ventures did not always reap the anticipated rewards.

" Starbucks found it difficult to control the costs in a joint venture, often resulting in lower profitability. Starbucks generally set up joint ventures with less than 20 percent ownership, reserving the option to purchase up to 50 percent of the venture at a pre-agreed valuation. In countries with higher profitability, Starbucks usually opted for this higher ownership percentage. In countries where profitability was lower, such as Gennany, Austria, and Switzerland, Starbucks purchased additional ownership either because the pattner wanted out of the business or Starbucks represented a small portion of a larger company that was stmggling with its core product.

" "For Starbucks, There's No Place Like Home," Business Week, June 9, 2003. " Ibid.

p. II

GOING FORWARD

Observers continued to focus on the economic viability of Starbucks' stores, in both the U.S. and internationally, before the company reached "market saturation." The culture at Starbucks, however, did not accept "numerical limits" on size or types of activities. Starbucks sought to increase both its top and bottom lines while deciding whether and how to enter additional markets, especially several with very large total coffee consumption (see Exhibit 8). A significant portion of its growth would come from its international operations.

Starbucks' 2004 enhy to France (sixth-highest total coffee consumption in the world) was late relative to other European countries whose populations consume less coffee (in absolute amounts). As of 2008, Starbucks had not yet entered Italy, which boasted the fifth-highest coffee consumption in the world and a reputation for quality brews. Indeed, Italy was the country that gave Schultz the notion of a "third place." Brazil was another high coffee consumption counhy where Starbucks had yet to enter the marketplace. At end of its first decade on the global stage, Starbucks' global rollout was a "work­in-progress" with many decisions still to be made.

The July 2008 decisions by Starbucks to close 600 U.S. company-owned stores and 61 Australian company-owned stores added further grist to the debate over the relative merits of further U.S. vs. intemational expansion. Jim Donald, the former CEO fired in 2007, reflected that "my worst decision

" was not investing earlier in international." The slowing of Starbucks' revenue growth had sizable implications for its market capitalization. On July 24, 2006 it had a market capitalization of $26.99 billion. By June 8, 2009 its market capitalization had declined to $11.19 billion (see Exhibit 9).

The concern about market saturation raised the question of whether the Starbucks branded store concept (and associated Starbucks branded products) should be its only platform for future growth. Many new beverage concept stores had emerged (such as Jamba Juice, Juice It Up, Maui Wowi, and Smoothie King). Starbucks had attempted to meet this broadening consumer demand by increasing beverage and other options within its own "coffee-branded" stores concept. An alternative approach was for Starbucks to introduce other "branded store concepts" as additional growth platforms. Such an approach would be a major departure from the single-brand model strategy on which Starbucks had always relied.

A March 18, 2009 Starbucks' press release included the following report related to its March 2009 " Atmual Meeting of Shareholders:

"

Howard Schultz, Chairman President and CEO, outlined the company's strategy to grow for the long term.

"Despite the challenging economic environment, Starbucks is profitable, has a strong balance sheet and generates solid cash from operations," said Schultz. "Our

Patricia Sellers, "Lessons of the Fall," Fortune, May 29, 2008, http://moncy.cnn.com/2008/05/27/magazinesifortunc/lcssons fall sellers. fortune/index htm. " "Starbncks Details Strategy for Profitable Growth," Starbucks press release, March 18, 2009, http://news.starbucks.com/article _ display.cfm ?article _id~ 184.

customers' connection with, and trust in the Starbucks brand remains at a high level. We are laser-focused on delivering the finest quality coffee and getting the customer experience right evety time."

"We've also been putting our feet into the shoes of our customers and are responding directly to their needs," said Schultz. "Our customers are telling us they want value and quality and we will deliver that in a way that is both meaningful to them and authentic to Starbucks."

During the Annual Meeting, Troy Alstead, Executive Vice President, Chief Financial Officer and Chief Administrative Officer, underscored the company's strong financial position and outlined a two-fold growth strategy for the company.

Starbucks has focused its attention on increasing profits in existing stores by:

• Aligning the company's cost structure to its cu11'ent business strategy with a plmmed $500 million structural expense reduction in fiscal 2009; Improving operational efficiencies and making technology investments; Meeting customers' needs for value and quality; and

• Investing in the tools and training store managers need.

The company is also making strategic investments in key initiatives by:

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• Entering the $17 billion instant coffee market earlier this month with the launch of Starbucks VIA TM Ready Brew instant coffee;

Growing its consumer products, licensed stores and foodservice channels; Focusing on disciplined global store expansion in key markets.

"Our customers like the changes we've been making, even as the economic environment is impacting the way customers interact with companies and brands," said Schultz. "The health of the company, the continued relevance of the brand and our disciplined go-forward plan make us optimistic about Starbucks' future."

A high level of optimism was a hallmark of much of Schultz's leadership at Starbucks. Some observers began to questions the practicality of such optimism. The phrase "the age of thrift" was being used by business observers to describe a post-2008 economy where many consumers in key

" sectors shuggled to balance the value of their purchases with reduced and limited disposable income. How Starbucks navigated this new era around the globe would determine its ongoing position as a leading global consumer brand.

" "The New Age of Thrift," Get Rich Slowly, May 4, 2009, http://www.getrichslowly.org/blog/2009/05/04/thenew-age-of-thriftl.

IB74 Starbucks: A Global Work-/11-Progress p.l3

Exhibit 1 Starbucks 2007- Internal Memo

Starbucks' chairman warns of "the commoditization of the Starbucks experience" Starbucks chairman Howard Schultz wrote this to CEO Jim Donald earlier this month. 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 Cc: Anne Saunders; Dave Pace; Dorothy Kim; Gerry Lopez; Jim Alling; Ken Lombard; Martin Coles; Michael Casey; Michelle Gass; Paula Boggs; Sandra Taylor

Subject: The Commoditization of the Starbucks Experience

As you prepare for the FY 08 strategic planning process, I want to share some of my thoughts with you.

Over the past ten years, in order to achieve the growth, development, and scale necessary to go from less than 1,000 stores to 13,000 stores and beyond, we have had to make a series of decisions that, in retrospect, have led to the watering down of the Starbucks experience, and, what some might call the commoditization of our brand.

Many of these decisions were probably right at the time, and on their own merit would not have created the dilution of the experience; but in this case, the sum is much greater and, unfortunately, much more damaging than the individual pieces. For example, when we went to automatic espresso machines, we solved a major problem in terms of speed of service and efficiency. At the same time, we overlooked the fact that we would remove much of the romance and theatre that was in play with the use of the La Marzocca machines. This specific decision became even more damaging when the height of the machines, which are now in thousands of stores, blocked the visual sight line the customer previously had to watch the drink being made, and for the intimate experience with the barista. This, coupled with the need for fresh roasted coffee in every North America city and every international market, moved us toward the decision and the need for flavor locked packaging. Again, the right decision at the right time, and once again I believe we overlooked the cause and the (e]ffect of flavor lock in our stores. We achieved fresh roasted bagged coffee, but at what cost? The loss of aroma - perhaps the most powerful non-verbal signal we had in our stores; the loss of our people scooping fresh coffee from the bins and grinding it fresh in front of the customer, and once again stripping the store of tradition and our heritage? Then we moved to store design. Clearly we have had to streamline store design to gain efficiencies of scale and to make sure we had the ROI on sales to investment ratios that would satisfy the financial side of our business. However, one of the results has been stores that no longer have the soul of the past and reflect a chain of stores vs. the wann feeling of a neighborhood store. Some people even call our stores sterile, cookie cutter, no longer reflecting the passion our partners feel about our coffee. In fact, I am not sure people today even know we are roasting coffee. You certainly can't get the message from being in our stores. The merchandise, more art than science, is far removed from being the merchant that I believe we can

IB74 Starbucks: A Global Work-/11-Progress

Exhibit 1 (continued) Starbucks 2007 - Internal Memo

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be and certainly at a minimum should support the foundation of our coffee heritage. Some stores don't have coffee grinders, French presses from Bodum, or even coffee filters.

Now that I have provided you with a list of some of the underlying issues that I believe we need to solve, let me say at the outset that we have all been part of these decisions. I take full responsibility myself, but we desperately need to look into the mirror and realizeit's time to get back to the core and make the changes necessary to evoke the heritage, the tradition, and the passion that we all have for the true Starbucks experience. While the current state of affairs for the most part is self induced, that has led 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. This must be eradicated.

I have said for 20 years that our success is not an entitlement and now it's proving to be a reality. Let's be smarter about how we are spending our time, money and resources. Let's get back to the core. Push for innovation and do the things necessary to once again differentiate Starbucks from all others. We source and buy the highest quality coffee. We have built the most trusted brand in coffee in the world, and we have an enormous responsibility to both the people who have come before us and the 150,000 partners and their families who are relying on our stewardship.

Finally, I would like to acknowledge all that you do for Starbucks. Without your passion and commitment, we would not be where we are today.

Onward ...

Source: All exhibits are pl'!i~ by Starbucks Coffee unless otherwise noted.

IB74 Starbucks: A Global Work-/11-Progress

Exhibit 2 Starbucks 2008- January 7, 2008 Press Release

SEATTLE; January 7, 2008 Howard Schultz Transformation Agenda Communication #1

Letter To: All Partners ·From: Howard Schultz

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Twenty-five years ago, I walked into Starbucks' ftrst store in Seattle's Pike Place Market, and from that day forward we have taken the road less traveled. Working with an exceptional group of people and summoning all the courage we could muster, we created a new kind of place - one that served the kind of coffee that most people had never tasted, an environment that didn't look like any other store, and hiring people who were fanatically passionate about coffee and celebrated their interaction with customers. To do this, we focused every ounce of our beings on creativity and innovation. Over the years, together we have built one of the most recognized and respected brands in the world. When we went public in June 1992, we had 119 stores. We now have more than 15,000 stores and a significant and growing presence in 43 countries, serving 50 million customers a week. These customers have placed their trust in us, and for them and for each other we need to ensure that our future is as exciting as our past.

If we take an honest look at Starbucks today, then we know that we are emerging from a period in which we invested in infrastructure ahead of the growth curve. Although necessary, it led to bureaucracy. We will now shift our emphasis back onto customer-facing initiatives, better aligning our back-end costs with our business model. We are fortunate, though, that the challenge we face is one of our own making. Because of this, we know what needs to be done to ensure our long-term future success around the world.

Transforming the Starbucks Experience .

The Board decided that I should lead this transformation. Given this, effective immediately, in addition to my existing role as chairman, I have returned as chief executive offlcer for the long term. Jim Donald is leaving the Company. I want to pay tribute to Jim's leadership. He was a passionate and tireless advocate for Starbucks, and his contribution to our company cannot be overstated.

Looking ahead, the reality we face is both challenging and exciting. It's challenging because there are no overnight fixes. Rather, our success will come in the rigorous execution of several new strategic initiatives - that capitalize on our heritage to drive our successful future. And our reality is exciting because there is so much opportunity ahead for Starbucks.

Our new transformation agenda includes: - Improving the current state of the U.S. business: by giving our store partners better training and tools, launching new products - some of which will have an impact as significant as Frappuccino® products and the Starbucks Card - and introducing new concepts in store design, among other enhancements to the Starbucks Experience. At the same time, we will slow the pace of our U.S. store openings and close a number of underperforming locations, so we can renew our attention on store-level unit economics and be laser-focused on flawless execution.

IB74 Starbucks: A Global Work-/11-Progress

Exhibit 2 (continued) Starbucks 2008 - Press Release

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-Re-igniting our emotional attachment with our customers by restoring the connection our customers have with you, our coffee, our brand, and our stores. Unlike many other places that sell coffee, Starbucks built the equity of our brand through the Starbucks Experience. It comes to life every day in the relationship our people have with our customers. By focusing again on the Starbucks Experience, we will create a renewed level of meaningful differentiation and separation in the market between us and others who are attempting to sell coffee.

- Building for the long term, which has two distinct pieces: re-aligning Starbucks organization and streamlining the management of the organization to better support customer-focused initiatives by ensuring our support and planning functions - from back-end IT systems to store operations - are most effectively dedicated to the customer experience. This will help us to make smarter decisions about new products and initiatives and bring them to market more quickly than ever in our past.

- Expanding our presence around the world, by building a profitable business outside the U.S., and capitalizing on the enormous, untapped potential for our brand. We will redeploy a portion of the capital originally earmarked for U.S. store growth to the international business. Though we have 5,000 international stores today, we are just at the beginning.

Taken together, these initiatives will help drive our enduring success. And they will come with changes in our organization ... some big and some small. I will be decisive in making them. Right now, I can tell you they will include a realigmnent of our leadership structure, as well as a series of actions to reduce costs and reallocate resources to customer-focused initiatives. But even as we execute this transformation, there are certain integral aspects of our company that will not change at all. These include our commitment to treating each other with respect and dignity, providing health care and Bean Stock for all of our eligible full- and part-time partners, and our commitment to our community efforts, our ethical sourcing practices and encouraging our coffee suppliers to participate in our CAFE practices program in our origin countries.

Stay Tuned

I know that you may have a number of questions. Attached is a brief Question and Answer document that answers some of them. And you have my commitment that there will be more information to come over the next few weeks and I will keep you informed. Specifically, I will be meeting with the leadership of the Company in the near future to discuss our transformation agenda, and in the coming weeks we will communicate these details with you, including your role in it.

In the meantime, I want to thank you for your dedication to Starbucks and for your commitment to earning the trust of our customers every day. Our success is up to us. We know what we need to do to win, and we will do it.

Onward, Howard

IB74 Starbucks: A Global Work-In-Progress

Dear Partners,

Exhibit 3 Starbucks 2008- July 8, 2008 Press Release

SEA TILE; July 8, 2008 A Message from Howard

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As you are all aware, last week we made the difficult, but necessary decision to close approximately 600 underperforming U.S. company-operated stores. Poor real estate decisions that were made, coupled with a very troubled economy, convinced us that these stores would not reach acceptable levels of profitability.

With any decision of this magnitude, I want to be sure that our partners, customers and shareholders understand the reasons for the decision and how we will move forward. While the past few months have been difficult for our partners, we have a very clear strategy and we are extremely optimistic about our go-forward plans.

We cannot allow others to define who we are. And, I believe it will continue to be important for me and the leadership team to engage directly and consistently with you as we chart the course forward. To enhance communications, we will take several steps over the next few weeks to ensure that everyone is operating with the same information and we are going to do our best to be as proactive as possible.

With regard to the store closings, they are necessary to position us for future growth, both in the U.S. and globally. We have been criticized by some observers for not publicizing the complete list of store closures at the time of the announcement. Out of respect, we felt that it was important to first inform our partners in the stores target~d for closure. We plan to complete this communication by mid-July and soon after we will post the first 50 store closings on the Starbucks Store Portal, Partner Portal and Starbucks.com.

The balance of the impacted stores have closing dates that will be staggered over the next several months. Each month, after a 30-day closing notice has been communicated to all affected partners, we will post a list of the stores that are scheduled to close. As we stated last week, we are also taking significant steps to place as many affected partners as possible into available positions at nearby stores. We are so proud of the contributions you make everyday and I can't stress enough this decision in no way reflects the exceptional service our partners in these stores have consistently delivered. We believe that if we can reassign these partners, we will also be delivering on our promise to customers to elevate the experience, with knowledgeable and passionate partners.

We are focused on strengthening the foundation of our core business. At the same time, we are pleased with the progress we have made, which includes offerings to improve the overall customer experience. There are many exciting products and innovations that we will be offering over the coming weeks and months.

IB74 Starbucks: A Global Work-Ill-Progress

Exhibit 3 (continued) Starbucks 2008 - Press Release

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We have always aspired to be a relevant part of the daily lives of our customers, a trusted brand and a place for people to enjoy the best coffee in the world, served by our passionate partners. We must hold true to who we are and have always been, and ensure that our customer's experience is the best of what we have to offer ... the highest quality coffee in the world, and the best people, who deliver our unique Starbucks Experience.

Your continued commitment, support, energy and hard work are truly valued and critical to the path forward. There is a great quote from the German writer Goethe that has irispired me over the years: "At the moment of commitment, the entire universe conspires to ensure your success." I believe that our focus on delivering a better customer experience will guide us through this tough time. And, I am confident that the best days of Starbucks are ahead of us.

Thank you for all you do for our company.

Onward, Howard