In early 2007, the world seemed partly owned by Starbucks. It did not matter what country you were in, or what direction you walked — everywhere you were sooner or later bound to encounter one of the company’s outlets, habitués lined up, sometimes out the door, for some version of their $4 iced or frothed coffee. Inside would be a similar scene — laptops out at some tables, pals gabbing away at others, a cross-generational crowd drawn by one of the most iconic, desired, and ubiquitous brands of the era.
But Howard Schultz, the company’s visionary and former CEO, saw something different when he gazed over the same landscape. Revenue was enviably up, just like always, yet growth was slowing — by a lot. And Schultz thought he knew why: In a march for global dominance — efficiency and stores everywhere — Starbucks had lost its soul and its romance. You still got your latte, but as though on a conveyor belt. From a hand-crafted, ultra-personalized product — a “third place” between the office and home, as Schultz called it — Starbucks had turned itself into a commodity. And that was a deadly wrong turn. Sure enough, over the subsequent months, Starbucks’ share price plunged by 45%.
By last January, if you had invested $10,000 in Starbucks stock at its nadir in December 2008, it would have been worth $236,290.
Schultz took back control of the company, and a few months later assembled some 10,000 store managers and executives in New Orleans. After an appearance by Bono, Schultz dropped the brutal news: Unless something dramatic was done, Starbucks would be insolvent in roughly seven months. It didn’t seem possible, yet it was true. Everyone present could lose their jobs, along with their staffs, some 160,000 people in all. Starbucks needed to go back to basics — high-quality, aromatic coffee at front and center, and the kibosh on smelly hot breakfast sandwiches, DVDs and exotic, non-coffee drinks.
Two months later, the share price bottomed out. By then, Schultz was already on a tear cutting stores, laying off staff, and ridding the menu of malodorous foods, thus allowing the whiff of coffee to again dominate the Starbucks experience. Baristas, meanwhile, were back to grinding whole beans, eschewing the vacuum-packed ground coffee the chain had been using, and relearning how to make the perfect espresso. A little over a year later, Starbucks’ share price had surged by three and a half times. By last January, if you had invested $10,000 in Starbucks stock at its nadir in December 2008, it would have been worth $236,290.
Now, Starbucks is in a new funk. Covid-19 and the deep economic retrenchment have led to the company’s first month-on-month drop in sales since the 2008/2009 financial crash. In Starbucks’ earnings announced this afternoon, third quarter sales fell by 40% and the company lost about $2 billion year on year as urban office corridors, where millions of bustling workers grabbing a morning coffee were the backbone of Starbucks sales, lie all-but empty, and airport locations are barely working. Conditions are not as grave as Schultz described to his managers 12 years ago. But Starbucks’ share price is almost 20% below its January peak, much more than the S&P 500, which is down just 4% from Feb. 19, when the market plunge began.
Oddly, Starbucks has responded with a playbook somewhat resembling the soulless one that Schultz discarded to save the company more than a decade ago. Championing speed and convenience, CEO Kevin Johnson is doubling-down and accelerating the construction of hundreds of drive-thrus and 40 to 50 urban pickup-only stores. In other words: shifting from the experiential model that made Starbucks Starbucks, to that of a glorified food truck.
Prior to the pandemic, Starbucks had seemed to be winning its battle to be all things to all people. At the lower end, it retained most of the customers tempted by latte prices at Dunkin’ Donuts and McDonald’s; at the higher end, it largely fended off third wave coffee chains like Blue Bottle, after upping its own game with fancier reserve coffees and ultra-showy roasteries, including a splashy 23,000-square foot-location in Manhattan, and an even more massive five-story, 35,000-square-foot space in Chicago. Meanwhile, it attempted to meet fast-changing American tastes with a headlong dive into drive thru lanes and a gingerly experiment with pickup-only locations without any seating. The juggling act seemed to be mightily successful, with a two-year, 53% stock price surge in 2018 to 2019 alone.
Then came Covid-19. With a dearth of die-hard customers lining up starting at 5 a.m. in office corridors around the country and the world, the company has gotten left behind. Although 95% of its locations are open, it expects the decline in sales to continue at least through the end of the year.
Starbucks’ struggle is about more than a storied brand, and reflects a broad upheaval in the restaurant industry, a little-recognized pillar of the U.S. economy accounting for 9.5% of total private sector jobs. As of now, more than 3 million of the industry’s workers have lost jobs, and it appears that, short of a $120 billion government bailout sought by independent restaurateurs, up to 85% of the country’s 500,000 non-chain restaurants could be wiped out. According to a survey by Yelp, 60% of currently closed restaurants have shut their doors for good. Chains are in much less trouble, but many of them, too — in particular sit-down restaurants and those, like Starbucks, heavily dependent on urban office customers — face possible bankruptcy.
In the strange list of unexpected pandemic winners (Shopify, King Arthur Flour, and Roomba, to name a few), pizza and burger chains rank near the top. Americans, stuck at home and limited in their choices, have flocked to Domino’s, McDonald’s, Jack in the Box and Papa John’s, all of which have either almost caught up to or surpassed pre-virus sales, cashing in with convenient, outsized family meals with enough for leftovers. Given Starbucks’ deep bench of brand status-addicted loyalists, one would think it would enjoy the same Covid indulgences. Part of the reason it hasn’t is that people aren’t pressed to get anywhere at breakfast time, when Starbucks normally would be racking up 60% of its sales.
Analysts generally assume that after 18 months or so, the virus will pass, the economy will bounce back, and Starbucks will restore its pre-pandemic revenue stream, only this time with Johnson’s all-in on apps and drive-thrus. In other words, Starbucks in function, McDonald’s in form. Nick Setyan, an analyst with Wedbush, said that by 2022, he expects Starbucks to be back to pre-Covid revenue and 3% to 4% annual growth.
Those are a lot of assumptions.
Starbucks is in a rare commercial and socio-cultural pantheon that includes the iPhone, the Tesla, and the courier-delivered Amazon package — a phenomenon that swept in and changed society utterly and everywhere. But when it was founded in 1971 in Seattle, it was only a merchant for fancy whole beans, the brainchild of a local entrepreneur named Jerry Baldwin and two co-founders. Eleven years later, that’s what Schultz happened on when he walked into Starbucks’ Pike Place store and, as he has put it, was bowled over by the founders’ passion. He pleaded to join the fun, and Baldwin hired him as head of marketing. In 1987, Baldwin sold the bean dispensary outright to him for $3.8 million, equivalent to a year of sales.
Starbucks was all of six stores, entirely in Seattle. The U.S. had no European-style coffee culture to speak of. Restaurant-bought coffee typically came either in a cup and saucer, or in Styrofoam, and cost around 50 cents, with free refills from a transparent carafe. A four-dollar coffee? The idea was so absurd as the basis of a national brand that, for years, potential rivals left Schultz alone to build as many stores as his vision compelled him.
Now, the reality created by the pandemic has played further into the hands of Starbucks’ cheaper rivals. Coffee drinking habits seem to have changed.
But by 1992, Schultz was up to 140 locations and he launched the company’s IPO. By 1999 — just seven years later — the chain was up to 2,500 locations, and its shares had split 2-for-1 three times. The next year, there were 3,500 locations. Along the way, Starbucks triggered and profited from several cultural shifts. One was a new global lexicon, including phrases such as, “Double tall origin vanilla soy latte, please.” Long before there was WeWork, Starbucks also invented the co-working space, providing electric sockets so customers could keep their smart phones and laptops charged while hanging out for hours at the slim cost of a caffeinated drink.
But those shifts came with something of a straitjacket. Starbucks did not invent the café-as-living-room, but now sofas and deeply upholstered leather chairs became de rigueur in copycat European cafés that sprang up around the country, of which there are now some 35,000. Hence, the trouble that arose when, in the mid 2000s, customers perceived that Starbucks, replacing visible grinders with hulking espresso machines that physically and psychologically separated customer from barista, had forsworn its roots. When Schultz noticed this dissatisfaction, expressed in the capture of market share by unworthy establishments like Dunkin’ and McDonald’s, he said such competition needed to be “eradicated.”
For Schultz and Johnson after him, a maddening part of Dunkin’s and McDonald’s’ invasion of haute coffee was that neither promised any experience other than a paper cup with java. While challenging Starbucks’ mastery of the latte, they offered little more than a bargain price, with fast drive-thru and none of the third-way accouterments. That they in part succeeded made it worse. Starbucks retained its stature as the biggest U.S. coffee seller, with 40% of the pre-Covid U.S. market, but Dunkin’ grabbed 26% of sales, too, according to the latest available figures.
Now, the reality created by the pandemic has played further into the hands of Starbucks’ cheaper rivals. Coffee drinking habits seem to have changed. In Australia, people have snapped up grinders to brew upscale beans at home. In Canada, people are buying both fancy beans and instant coffee in higher quantities, according to a survey.
But perhaps the better way to put it is that fancy coffee drinkers are in hibernation. Northeast of Washington, DC, near the University of Maryland, Chris Vigilante is the owner of Vigilante Coffee, a two-café chain of high-end barista houses. Last month, he reopened both locations for takeout after a three-month coronavirus lockdown. Sales are down by half, but Vigilante’s online business — selling grinders and specialty beans like $16 twelve-ounce bags of Ethiopia Natty Cheffe — has doubled. His online strategy centers on an email list of about 1,000 clients whom he showers with attention, using Instagram. Every week, Vigilante posts a brewing video, demonstrating how to best produce a delectable cup of coffee, and suggests a new type of bean. “We are a bit lucky because consumer habits haven’t changed,” he says.
Even when restaurants re-open in the U.S. and elsewhere, they predict that coffee sales will return to pre-Covid levels only by 2024.
When Vigilante says that his customers’ habits haven’t changed, he means that, even though foot traffic is down, his clientele, now part of an Instagram community, still cherish a meticulously brewed cup of high-end coffee. His experience is easy to disregard, since he’s a small business owner serving a premium-minded niche. Yet, Vigilante is all-but certainly serving customers whom Starbucks would call its own. And he is demonstrating the fallacy, as Schultz insisted a dozen years ago — and to which others in his pantheon such as Apple and Tesla will attest — that the masses always gravitate to fast and cheap. They want to feel personally attended to, to discern a craft in motion, and to feel connected to something larger than themselves. The genius of Schultz’s comeback was understanding that a third place that smells like an airplane kitchen were none of those things. Vigilante’s message a dozen years later is that these basics have not changed since.
Judging by how it performed during the Great Recession, Starbucks is historically more sensitive to economic slowdowns than most other fast casual dining chains. In an April 13 note to clients, Wedbush’s Setyan said Starbucks sales dropped for eight straight quarters around the crash — from the fourth quarter of 2007 to the third quarter of 2009. Faced with a financial choice, strapped coffee drinkers did not give up their java but traded down temporarily to less-expensive brands, like Dunkin’ and McDonalds. When the crisis was over, they returned to Starbucks in large numbers.
Though the current crash differs in origins, Setyan thinks that coffee drinkers are trading down once again, and he forecasts that Starbucks will recover its pre-Covid revenue in the second half of 2021 or in 2022. But a number of observers think this turnaround will take longer. Even when restaurants re-open in the U.S. and elsewhere, they predict that coffee sales will return to pre-Covid levels only by 2024.
Starbucks, on the line for $1.25 billion in rent over the next year at its approximately 16,000 company-operated stores and other real estate around the world, demanded a year of reduced rent from landlords across the country in May.
One can imagine a brisk Starbucks restoration in China, which has recovered far more quickly from the pandemic and where the third-place culture is much less entrenched. And indeed as of May, the company’s Chinese sales were down there just 21%. But the U.S. rebound will be harder. As long as the country’s Covid-19 response is chaotic, and there is no widely available therapy or vaccine, Starbucks will lack a runway to recovery resembling the pizza and burger joints. In an announcement Monday, Google became the first big company to decide to keep its employees home for another year — through next July — and not bring them back as planned in January. And Reuters reported that 25 of the country’s largest companies are reducing the size of their offices, presuming that many of their employees will continue to work from home. If suburban and urban downtowns remain largely closed, and sitting in a Starbucks is prohibited, a full comeback for the chain doesn’t seem possible. Reflecting this reality, Starbucks, on the line for $1.25 billion in rent over the next year at its approximately 16,000 company-operated stores and other real estate around the world, demanded a year of reduced rent from landlords across the country in May.
In 2008, Schultz worried that Starbucks would collapse. This time, with its access to cash and long-won ranks of loyal customers, Starbucks does not seem exposed like that. But neither does a sudden surge to business as usual seem likely. Until then, the company’s share price seems vulnerable to double-digit swings, like the 13% plunge that it, along with many other companies, suffered the week of June 8. It means it might be time to consider an artful short.
In Starbucks’ SEC filings in April, the company said it’s not actually getting rid of the third place, but only adding convenience for those who want to grab and go. Customers will now have more choice. “No matter the format,” the company said, “we know that the Starbucks ‘third place’ experience occurs from the moment a customer envisions their daily Starbucks experience to wherever they enjoy that Starbucks beverage.”
Many Starbucks customers may sincerely want to just sit in their car in the drive thru lane. Maybe many would be fine if Starbucks was reduced to nothing more than an app and a vending machine?
Analysts say Starbucks is smart to embrace the trend to quick and convenient. A key Starbucks advantage, they say, is its loyalty program, which operates through its app. Eric Gonzales, an analyst with KeyBanc, said 44% of the company’s business comes from loyalty program members and that mobile ordering is 18% of transactions. It is a similar strategy to Chipotle’s, a pandemic winner whose digital sales were up 216% last quarter, leaving overall sales down just 9.8%. “They’re evolving with the times, just like every other restaurant or retailer,” said Setyan, the Wedbush analyst. “Anyone who thought the soul of shopping would always require a customer to touch and feel and try on the clothing 10 years ago is now at bankruptcy’s doorstep.”
It is perhaps right that the typical Starbucks customer has changed since the early days of coffee culture and is no longer attached like glue to a memory of a place where he or she could find their more creative, imaginative, or reflective self. Where they might encounter a big thought, delight at some surprising sight, while lounging in a big comfortable chair with unlimited Wifi (though, not everyone, it seems, has been afforded that luxury). Many Starbucks customers may sincerely want to just sit in their car in the drive thru lane. Maybe many would be fine if Starbucks was reduced to nothing more than an app and a vending machine?
But it seems like a muddled message to convey, something like Apple offloading the iPhone, Amazon relinquishing fast shipping, or Tesla discontinuing the Model S. I have the feeling that none would do any of those things because it would be like ripping off their right arm, and leave their customers in utter mystification. Their share price could crash. As a sign of potential trouble, Starbucks said today that membership in its loyalty club shrank by 5% over the last quarter, to 16.3 million people.
If Starbucks is going to revive itself as the center of coffee culture, it needs to figure out how to react to the very real possibility that the office core will not return at scale. If the company were channeling Schultz, it might decide that the central answer to what ails it is not a commodity drive thru and grab and go, though they can be part of it. Instead, Starbucks needs to wholly reimagine the third place. Until then, there is plenty of time to bet on several cycles of wild swings in the company’s share price.
Reviewed By This Is Article About New Starbucks Earnings Show the Coronavirus Has Made a Dent was posted on have 5 stars rating.