January 18 2008: 5:08 AM EST
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Starbucks fix

Howard Schultz spills the beans on his plans to save the company he founded.

By Andy Serwer, managing editor

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Howard Schultz reassumed the CEO mantle in early January.

NEW YORK (Fortune) -- Before Howard Schultz agreed to come back to become CEO of Starbucks, the company he built from a Seattle boutique into a global mega brand, he had to get his kids' blessing. After all if Dad was going back to the grind (so to speak), he would be working 15-hour days. And while Mrs. Schultz didn't hesitate, not surprisingly the younger Schultzes needed some convincing. In the end Dad prevailed and in early January, Schultz reassumed the mantle. Since then the CEO redux has kept a low profile, but recently agreed to speak exclusively to Fortune Managing Editor Andy Serwer.

Q: Thanks for returning the call, Howard. First, can you tell us about the process that you went through to compel you to return?

A: The board asked me to return, but I was on a parallel track with them. Obviously, I was a witness to the downturn in the business and had concerns about shareholder value and given my passion for the company I accepted the board's offer. The board and I had conversations over the last few months as we headed into the holiday season. The final decision was made after the holidays.

Q: You say 'witness to the downturn,' but shouldn't you take responsibility for where the company is now?

A: I want to make it clear that I take full responsibility for where the company is now, and also for where it will be going forward.

Q: Did the memo that you wrote last year about Starbucks (SBUX, Fortune 500) 'losing its soul' undermine then CEO Jim Donald?

A: It wasn't intended to. I have great respect for Jim. I have written many memos, this one became public. I don't think it any way pointed a finger at him or any one person. It was a call to arms for our company.

Q: Was he hurt by this decision?

A: You have to ask him that.

Q: Whom did you consult outside the company before deciding to come back as CEO? What advice did they give you?

A: I didn't talk to anyone but family while it was being considered. Since then I spoken to some dear friends who have been through this before, like the names who have been bandied about and I am still talking to them.

Q: You mean like Steve Jobs, Michael Dell, and Chuck Schwab?

A: I'm not going to name names.

Q: In your letter to employees, you said the company must shift its focus away from "bureaucracy" and back to customers. How do you plan on doing that?

A: In the week since announcement we have completely realigned the organization to reflect a laser focus on customers. We have incredible, dedicated partners, but as an organization we were not organized properly over the past few years. We need to put ourselves in the shoes of our customers. That is my new battle cry. Live and breathe Starbucks the way our customers do.

In the past, the U.S. and international operations leadership have also been responsible for not only the business, but also integration and the authority over real estate, marketing and merchandising. But we are too big for that. Those three businesses employ many people. Now real estate, marketing and merchandising will report directly to me. That means that for the heads of the U.S. and international operations, Launi Skinner and Jim Alling, their sole responsibility is customers. And the partners who work with them will be able to focus on customers at every level - from here at our corporate headquarters to our stores.

Q: So what are you going to do?

A: First, this is a healthy company, with more than $9 billion in revenues, more than $1 billion in operating income and 50 million customers in our stores per week. We have vast opportunities in our international business, where we have just scratched the surface. This is not a broken company. Having said that, we need to fix certain critical things, particularly here in the U.S. Yes we became less passionate about customer relationships and the coffee experience. We spent time on efficiency rather than the experience. We never wanted to be transaction driven.

Q: But wait a minute, isn't a problem that the lines are too long?

A: Yes that's one of them. And there are a number of things we are going to do. Also we will do more things to better reward our most loyal and best customers. Some 15 percent of our transactions are on the Starbucks card. And we need to look at store design. We haven't done enough here. In the future, you'll see new store design that significantly improves the customer experience. We cannot embrace the status quo. Going back to the future is not enough; we need a new level of differentiation and innovation.

Q: So does that also mean new drinks coming?

A: Yes. I feel good about 2008, even though we are going to be doing some heavy lifting this year. And I feel even better about 2009 and beyond. We will have announcements...stay tuned.

Q: Aren't you really just a victim of slowing secular growth and that's it? Isn't it really a Wall Street problem more than anything else?

A: Wall Street is separate from the customer issues, but of course also intertwined. Bottom line is we can't exceed expectations of shareholders unless we exceed the expectations of customers first. And we do both by inspiring our partners and refocusing them on the customer.

Q: Why has no strong number two competitor emerged in your business?

A: It's not easy to get into. People sometimes fail to realize that almost unlike any retailer or restaurant, we are completely vertically integrated. We source coffee from 30 countries. We have a proprietary roasting process. We distribute to company owned stores, and finally serve the coffee. Others are resellers of commodity-based coffees.

Q: The average number of customer transactions per store dropped in the most recent quarter for the first time ever. With a recession looming, how do you counter the fact that some people might need to trade down from a $5 cup of coffee to something cheaper?

A: I am concerned about any attrition in customer traffic at Starbucks, but I don't want to use the economy, commodity prices or consumer confidence as an excuse. We must maintain a value proposition to our customers as well as differentiate the Starbucks Experience. That is the key.

Q: Cannibalization by new stores has been a concern in the U.S. Will you pull back on store openings? Do any stores need to be closed?

A: This is another area that needs to be better explained. We do not believe the market is close to saturation. Over the past 15 years our new stores on average cannibalized 30 percent of an existing store nearby, and yet we had same store sales growth of 5 percent or better over 13 of those years, with 20 quarters of consecutive comps.

We think we know real estate and store locations. By the way, the pundits said we were saturated in Seattle in 1992. Since then we have opened 340 stores in the state of Washington.

However, it is the case that we have stretched the real estate selection process further than we have in the past in terms of demographics. And yes that has resulted in some attrition, so we will now open fewer stores and we will close some in the U.S. The size of the prize is still huge. We sell less than 10 percent of the coffee consumed in the U.S. and less than 1 percent outside the U.S. The momentum will come from international. Slower growth in the U.S., accelerating growth overseas. The response to the Starbucks brand has been phenomenal in our international markets.

Q: Some say that the hot food detracts from the coffee smell. Will you make changes to the food you offer, or pull back on selling food?

A: We need to reinvent food at Starbucks. Less could be more. There are no sacred cows. I don't want to say what we will do today. We rely on others for food, because we don't want to be in the bakery business and some of it isn't as good as it should be. We don't want to be a food company. We are a coffee company.

Q: Some say the movie side of the business has become a distraction. Do you agree? Will you back away from movie promotions?

A: We've had great success with music, including our partnership with Apple (AAPL, Fortune 500). Books also. We have not succeeded that well with film. Again, no sacred cows. Entertainment needs to be complementary to the coffee experience. We are examining everything.

Q: Starbucks now does national TV ads, which you once said would never happen, as they would diminish the brand. Are the ads working? Will you continue them?

We are evaluating what happened over the holidays. We have a fair amount of innovation coming, so I am not ruling it out.

Q: Are you looking forward to budget meetings again?

A: I've already been in a few. They were enlightening.

Q: In what way?

A: Probably in terms of people being open and transparent about what's ahead. That hasn't always been positive, but crucial for me to know and be aware of all of this.

Q: Back in 2004, you told us that the company was in the second inning of a nine-inning game. Where are we now?

A: It's still very early. People will look back and recognize the indisputable power of the Starbucks brand.

Q: Did McDonald's (MCD, Fortune 500) announcing it was moving into the coffee business in a bigger way figure in your decision?

A: No.

Q: What is the timetable?

A: On January 30, we will have our quarterly earnings release and conference call. At that time we will lay out some specifics about our plans to slow growth in U.S. Then at our annual meeting on March 19th, there will be a number of announcements. And as I said, while you will continue to see some things coming through 2008, it's also a year for doing some spadework, so in 2009 and beyond some longer-lead time developments will start coming to market.

Q: What has been the reaction internally to you coming back and to the changes that might be on the horizon?

A: We had a company meeting on Monday January 7, and 4,000 people were there. It was very emotional. [A Starbucks exec says Schultz received a standing ovation.] Since then I have received almost 2k e-mails from shareholders, customers and friends wishing us well. To top of page

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