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Starbucks chokes on its latte

What has happened to the siren's magic? For more than two decades along-tressed maiden – more decorous now than when she wasfirst launched upon the world – has been the centrepiece ofone of America's best-known commercial logos, that familiar greencircle with "Starbucks Coffee" in white letters, to be found,seemingly, on almost every city block and main street in the land.

And until lately, the allure of the Starbucks siren had beenirresistible. Howard Schultz, the visionary businessman who ineffect founded today's Starbucks when he bought out its originalowners in 1987, ran the company until 2000. In the process hecreated not just a runaway business success but a small revolutionin American culture. A handful of outlets in Seattle have become aglobal empire of some 15,000 stores, generating annual sales ofabout $10bn (£5bn).

But the company that was a case study in business acumen and grewto be the largest coffeehouse chain in the world is now a casestudy of a less flattering variety – of how complacency andthe laws of the marketplace can bring even the mightiest low.

This year the creeping crisis at Starbucks has exploded into fullview. In January, it sacked its chief executive Jim Donald, andrestored Mr Schultz to his former job. April brought a 28 per centslump in quarterly profit, and news that the company would againcut the number of new stores it planned to open across the UnitedStates, to 600 less than initially planned, and trim its officeworkforce by up to 1,000.

Last month, the trickle of bad news turned into a flood. Some 500stores across America are to be shut, with the loss of 12,000 full-and part-time jobs. And the rot has spread farther afield.Starbucks is closing 61 of its 85 stores in Australia –meaning that henceforth only the residents of Sydney, Brisbane andMelbourne will be able to sample its wares. This week brought thelatest blow, the company's first quarterly loss in 15 years, of$6.7m, compared with a $158m profit a year before.

At one level the news is anything but surprising. The US isengulfed by its worst economic crisis in decades, and consumers arecutting back on non-essential spending, with expensive coffee amongthe first things to go. There is a symmetry too between thetroubles of Starbucks and those of the plummeting US housingmarket, the epicentre of the crisis.

California and Florida, where the company has been opening newstores and which account for one-third of its domestic revenue, aretwo of the states worst hit by the housing slump. As demand hasfallen, the cost of dairy products such as milk have been risingsharply. Not just Starbucks, but any similar business, would behaving problems in these circumstances.

But there is far more to it than that. Starbucks' malaise longpredates the downturn of 2007/2008. In a sense it is a victim ofits very success. Consciously or subconsciously, a company thatstarted life as an exotic shop in the Seattle landmark of PikePlace Market, selling beans and coffee-making equipment, and thendeveloped into one of America's smartest global brands, must havefelt it could do no wrong. In the process, however, it forgot whereit came from.

From the outset, the key to Starbucks success was its upmarketimage. Its coffeehouses were where yuppies went, and those whoaspired to be like them. That the coffee itself was a miteexpensive only added to its snob appeal: Starbucks was not for thehoi polloi. If you wanted cheap coffee, then go to a diner andchoose between regular and de-caf. Its stores were chic andfashionable, where you could spend a little downtime betweenappointments or simply shoot the breeze with friends. Starbucksprojected itself as "The Third Place" – between home and theoffice – and there was much truth to the slogan. Mr Schultz'sgenius was to grasp the market for the concept.

Have a good idea though, and others will copy it. For a long whileStarbucks managed to keep ahead of the game, expanding at breakneckspeed, buying up likely competitors and launching new products thatrivals could not match. On top of lattes, grandes, mochas,espressos, frappuccinos and the rest it offered not just teadrinks, fruit smoothies ice creams and its own range of snacks.Starbucks sold its own franchised merchandise – T-shirts,even its own books and music.

But premium coffee remained the basic product – and oneothers could easily imitate. Of late that challenge has been pickedup by Dunkin' Donuts and above all by McDonalds. In an age ofbelt-tightening the virtues of thift are again evident. McDonalds'coffee was perhaps once best known for being scaldingly hot. Now itoffers premium coffee, not only cheaper than Starbucks' but of aquality that won first place in a survey in March by ConsumerReports here.

As a result, Starbucks finds itself caught in a new, unweclome,"third place", pressed from below by the fast-food chains from whomits very ubiquity has made it almost indistinguishable in thepublic mind, and from above by a new generation of expensive andexclusive coffee houses – to the modern industry whatStarbucks was 20 years ago.

Such an identity crisis would be bad enough on its own. ButStarbucks has compounded the problem by, in Mr Schultz' words,"cannibalising" itself – opening so many stores, so closetogether, that they attract business not from new customers buteach other. And even the quality may be sagging. In a recentindependent taste test of the main coffee chains in the UK,Starbucks came bottom.

For such structural difficulties, the chief executive admits, thereis no instant fix. The giddy growth of yesteryear will neverreturn, even when the US economy picks up. A solution, almostcertainly, will require a return to first principles. As Mr Schultztold analysts this week, discussing that first-in-15-yearsquarterly loss: " We are not going to go down the fast-food laneand do things that are ... not in the long-term interest of thebrand and the experience."

It would be unwise to count Mr Schultz and Starbucks out, whateverthe current travails. The loss reflected exceptional costs relatingto the closure of 600 stores, and the next quarter will be back inthe black. Wall Street is cheered by the company's readiness toface up to its difficulties. Some foreign markets are still faringwell, and Starbucks is still looking expand in areas such asEastern Europe. New products, among them a milder "regular" coffeecalled Pike Place Roast, have also been introduced at its 11,000American stores. But it will be a while, if ever, before theStarbucks siren regains her former magic.

How a coffee empire was built

1971: Gordon Bowker, Jerry Baldwin and Ziv Siegl open their firststore, selling coffee beans and coffee-making equipment, inSeattle's Pike Place Market. It is named Starbucks after the firstmate in Herman Melville's Moby Dick.

1982: Howard Shultz joins the company as the director of retailoperations and marketing. It begins providing coffee to restaurantsand espresso bars in addition to its own five stores. Shultz,having seen coffee bars in Italy, convinces the founders to try thesame idea in Seattle.

1984: The trial was successful and Starbucks as we know it islaunched. Separately, Shultz creates the company Il Giornale,selling products made from Starbucks coffee beans.

1987: Il Giornale acquires Starbucks assets and it morphs intoStarbucks Corporation, opening stores in Chicago and Vancouver. Itloses money throughout the 1980s as it expands. By 1989 it has 55stores.

1991: The privately owned company offers stock options to employeesand in 1992, starts trading on Nasdaq. It also sets up shops inBarnes and Noble bookstores and Nordstrom department stores and in1994 started providing coffee to ITT/Sheraton hotels (nowStarwood).

Mid-nineties: Starbucks branches out with various deals thatinclude making coffee ice cream with Dreyer's Grand Ice Cream, apartnership with PepsiCo to sell bottled Frappuccino drinks and alicensing deal with Kraft Foods to sell its brand in supermarkets.It also expands overseas, in Asia and then the UK, where it buysthe Seattle Coffee Company chain. It launches a music businessthrough its acquisition Hear Music and also buys Tazo, anOregon-based tea company.

2000: Mr Shultz becomes chairman and chief global strategist,ceding the post of chief executive.

2004: It jumps on the Wi-Fi bandwagon, offering high-speed wirelessinternet access in many restaurants. Through Hear Music, itreleases Ray Charles's Genius Loves Company CD with ConcordRecords, which goes on to win eight Grammy Awards. A new recordlabel is created between Starbucks and Concord Music Group todistribute recordings. Paul McCartney becomes the first artist, in2007, to sign.

2007: After falling sales, Jim Donald, the chief executive, quits.Shultz returns to that role and announces that the group will slowUS growth and accelerate international expansion. Starbucks now has15,756.

2008: Starbucks cuts jobs and close stores worldwide.

Louise Dransfield

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