Is Starbucks the next AOL?
Is Starbucks the next AOL? Maybe.
Trading at levels last seen in 2003, Starbucks looks like they are in trouble. There is glorious talk about a turnaround for the brand, and a recent investment by Nelson Peltz seems to indicate that there is promise. However, so far, everything I have heard from the company does not seem to indicate what I would be looking for in a possible turnaround.
Starbucks is a little like AOL. AOL came onto the scene in the early 90’s and figured out how to turn the internet into a commodity for consumers. AOL brought the internet to the masses. But AOL did not change as fast as consumers preferences and when faced with new competitors.
In somewhat of the same way, Starbucks did a lot of the same things. They cannibalized the existing café market by opening up on block after block, driving small indie cafes out of business. As a result, more consumers became exposed to coffee. Cafes went from being havens for college students and older left-leaning adults, to symbols of suburbia where teens congregated to appear older and housewives went for their daily boost of caffeine before picking up the kids from soccer practice.
This ubiquity, allowed for people of all walks of life who were not normally associated with gourmet coffee consumption to actually try it and like it. For a while, this worked really well. But exposing the masses to a product that can be commoditized like coffee has its drawbacks, and that’s what I think we’re seeing at the moment.
Schultz mentions that companies are gunning for their consumer, and he’s right. By exposing consumers to coffee, Starbucks did the heavy lifting. They got consumers, to try a pricey product that may have been outside of their comfort zone. All this did though was create a new group of consumers for companies to go after, and they have. McDonalds is unrolling their iced coffee line and Dunkin Donuts has diversified into offering competitive iced drinks that deviate from normal coffee and appeal to the general population. We also know that Starbucks does not serve the best quality coffee, or provide the best experience (lack of real cups and plates). Each of these cases show how easily consumers of Starbucks can be poached to coffee outlets that better serve their needs.
This is precisely why my outlook for Starbucks, at least in its current form, is dim. Schultz is looking at things like bringing better tasting coffees, making the interior more friendly (smelling better, architecturally more welcoming), and bringing healthier options. I don’t buy that these things are enough. None of them are really a game changer and they don’t address some of the wide-scale problems that are affecting Starbucks.
McDonalds and Dunkin Donuts are about to extract an advantage by chipping away at the more working-class consumers who will be more cost sensitive. Cost sensitivity will remain highly important as consumers continue to come to grips with costlier gas and food and it will be tough for Starbucks to compete on this end. For consumers that are health conscious, Starbucks becomes an even more perplexing choice.
Starbucks does not benefit from geographic isolation, they are found on city blocks and corners that are usually filled with other offerings – from traditional fast food/casual dining outlets to places like Jamba Juice which will always appear to be more healthy because of the inherent emphasis on fruit. Then there will also be traditional food outlets that will remain more competitive as well. I know that the only reason I buy a muffin from Starbucks is because I want a sweet baked good, I’m sure many people share the same sentiment (which would also be why the breakfast sandwiches were removed in the first place).
This leaves going after tastier drinks (perhaps inspired from Italy) but again, this doesn’t help too much. Starbucks already offers a wide variety of easy to customize drinks, diluting any kind of effect that a new one may have.
So Starbucks might have to live with new entrants coming onto their turf, taking their customers. Especially competitors who may be able to specialize and cater towards the needs of certain niche groups in the market. This leaves only a few solutions, with no one solution looking like the best course of action.
First, Starbucks could pursue a plan where stores are better differentiated to fit the types of locations they’re in. A Starbucks near a college could offer cheaper drinks/promotions conducive to ordering multiple drinks, making it worthwhile to utilize Starbucks as a study spot. Starbucks in nicer neighborhoods could also reflect that, and could have things like real china to make the atmosphere more hospitable. Perhaps even some higher end coffees.
Regional tastes could be taken account also. For example, McDonalds is adept at catering towards not only national but also regional palettes. Sweet tea is big in the south, but Starbucks really has not offered any unique sweet tea to cater to, they instead offer their existing teas in an iced and sweetened form. Their stubbornness to cave to regional tastes seems reflected by their poor showings in international stores, and would be yet another strike against their one size fits all strategy.
Store differentiation works to an extent. To go further though, I think that an emphasis on franchising is needed. With Cap Ex rising 68% in two years, it must be understood that the current strategy is incorrect. A franchise driven model would help alleviate some of the burdens of running Starbucks and transfer much of the risk into the hands of budding entrepreneurs, after all, store openings are one of the company’s major costs. Shifting that aspect of the business out would allow the company to focus on products more which would also be helpful. The strong competitors that are appearing are all companies that are franchise driven, so it’s possible that they carry an advantage that Starbucks does not in this sense.
Nelson Peltz is a numbers savvy guy who likes good brands – see his purchases of Snapple, Tiffany Co., and Wendy’s. These brands had strong followings but poorly allocated capital, which he sought to change. My belief is that he might agree that franchising could be the way to go for Starbucks.
Finally, there needs to be a de-centralization of the company. If you read articles about Starbucks, you hear everything about the return of Howard Schultz. There’s even comparisons between Schultz and Steve Jobs, perhaps because both pay such close attention to the smallest of details regarding their products and services. Starbucks and Apple are two very different companies. Apple has become successful due to the iPod. It made consumers come over and try a product from a company that they had long forgotten. The iPod served then as a bridge to other Apple products, like their laptop line and iMacs.
Starbucks tries to do this, but in a bad way. You come in for a coffee drink and you are faced with products that bridge into the whole Starbucks “lifestyle”. What is this? CDs (a dying breed), teddy bears (???), and coffee to make at home (who wants to make coffee at home? isn’t this why you go to Starbucks in the first place?).
None of these products had much of a competitive advantage, making the Starbucks strategy very un-Apple. Furthermore, Apple’s products are simpler to group (mp3 players, phones, laptops, PCs, iTunes, operating system). The introduction of a new product line, like the iPhone for instance, has a tremendous effect on the company. I fail to see how the introduction of a fruity drink at Starbucks will have the same level of effect on Starbucks. Consumer preferences here are quite different, Apple caters to status and utility, Starbucks caters to individual palettes – which are extremely fickle.
So Howard Schultz is no Steve Jobs, and maybe the company should start reflecting that more. People think that the founders of companies can solve all of their problems, but just look at Jerry Yang at Yahoo if you want an example of a founder coming back and having trouble. So maybe it is time for stores to have more autonomy, so that decision making will come down from the top to the front-lines and create an environment for more innovation.
Still, even these ideas might not be enough and that’s the trouble with Starbucks. I used to think that Starbucks is a great business that I would love to own at a good price. Now, I’m not entirely sure about that. Howard Schultz is facing competitors who have been serving customers much longer than Starbucks has even existed – while also having to battle new insurgents entering the market. Good luck Mr. Schultz and shareholders at Starbucks, you’re going to need it.
