Full Steam Ahead : Starbucks Is Hot to Grow, Even as Coffee Market Cools

Raul Jordan would drive a mile for Starbucks coffee. The coffee brewing at the Pasadena brokerage where he works is cheap but undrinkable, he says. So he slips out when he can to a nearby Starbucks, where he plunks down $1.15 for a cup of joe.

“I’m a coffee drinker,” says Jordan, a regular at the trendy cafe. “This is the best coffee in town.”

Starbucks Corp. is looking for a few more customers like Jordan--say, a few million more. Undeterred by an overall slide in coffee consumption, the Seattle-based coffee roaster is steaming ahead with plans to triple the number of coffee shops it operates, to 2,000, in the next five years.

To meet that ambitious goal, Starbucks must somehow win over those hard-core coffee drinkers who have managed to survive this far into the ‘90s without a daily caffe latte.

“A lot of the early discoverers [of specialty coffee] have done it,” said consultant Tom Pirko of Bevmark Inc. in New York. “The average person who likes coffee hot, strong and cheap has yet to be converted.”

Starbucks’ expansion comes as the $950-million specialty coffee business appears headed for a shakeout. Brothers Gourmet Coffees of Boca Raton, Fla., sold its Gloria Jeans chain to Second Cup, based in Canada. Baskin-Robbins sold its Caffe Classico stores back to its franchisees.

“The business has plateaued,” Pirko said.

To stay on top of the specialty coffee business, Starbucks needs to make inroads with the vast majority of coffee drinkers, who have been content to drink Maxwell House, Folger’s or Nescafe. According to the National Coffee Assn., a trade group, only 2.2% of Americans drink specialty coffee, although 47% identify themselves as coffee drinkers.

The company is taking steps to get the attention of potential converts to its brand. It is developing products with Pepsico and Dreyer’s Grand Ice Cream to get the Starbucks name into supermarkets.

Last week, Starbucks agreed to supply coffee to United Airlines, a move that will let the 75 million people who ride its planes annually sample the brand. Starbucks has a similar deal with Delta Air Lines’ Eastern Shuttle. Those moves follow agreements that put Starbucks outlets in Nordstrom department stores, some Barnes & Noble bookstores and 23 airports.

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The company “is trying to increase awareness of the trademark and convince people they are Starbucks drinkers,” Pirko said.

In doing so, the company is going against the trend. The National Coffee Assn. says the percentage of Americans drinking coffee dropped below 50% in 1995, hitting a 30-year low.

Those who are still drinking coffee are slurping less of it--1.7 cups a day, down from 1.9 in 1993. Analysts attribute the decline in part to higher prices and to competition from other beverages.

Nonetheless, few experts in the investment community are betting against Starbucks, in part because company management has proved its ability to handle growth, they say.

The company has grown to 675 stores from 17 in 1987 as it reinvented the coffee shop for the 1990s.

With its sleek black furniture and a sound system that plays jazz tunes, Starbucks emerged as yuppie destination, giving new meaning to the term coffee break.

Starbucks has seen its sales grow an average of 66% a year since 1989, totaling $248.5 million for 1994. Earnings have grown by 88% a year since 1990; the company had a loss in 1989. It expects to serve 3 million customers this year.

Its stock price is around $42, about 45 times per share earnings, putting it in a league with high-flying technology companies. Last month, the company sold debt securities to raise $150 million for the 275 new stores planned in 1996.

Analysts say that a secret to the company’s current success is they way it treats its work force of mostly part-time employees. They receive stock options equal to 10% of their annual salaries, and full health-care benefits. The benefits have helped keep Starbucks’ turnover rate at 60% per year, compared to 200% for fast-food restaurants.

The company holds quarterly forums that Chairman Howard Schultz likens to town meetings, during which employees can raise complaints or make suggestions. At a forum in Los Angeles two years ago, an employee suggested a cold, blended coffee beverage that became Frappacino, a drink that accounted for about 11% of Starbucks’ sales last summer.

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“They believe that if you treat the employee well, they will treat the customer well,” said Michael T. Moe, an analyst with Lehman Bros. in New York. “The challenge for them, as they grow larger, is to maintain the culture within the company.”

There are small signs of strain. On a busy night this summer, the Starbucks store in Manhattan’s theater district was cluttered with empty cups, crumpled napkins and coffee spills. At a store at the Phoenix airport recently, a line formed as two employees debated when to go on their breaks.

The company’s breakneck sales growth appears to be slowing. In October, Starbucks said sales grew by 6% from October, 1994, at stores open at least 13 months. Analysts said that 3% of the gain resulted from price increases that went into effect to cover higher coffee bean costs.

Mary C. Fleckenstein, an analyst with Ragen MacKenzie in Seattle, said Starbucks should be showing same-store growth of between 8% and 10% to maintain its pace. Same-store sales grew by 9% in 1994 and 19% in 1993.

Down the road, the company’s policy of staffing and operating its own shops could hurt it as the growth engine slows. Pepsico, which long pursued a strategy of owning its Pizza Hut restaurants, is turning to franchising in order to reduce overhead at a time of sluggish growth.

But Schultz said he is pleased with Starbucks’ performance. He said the company’s strategy of clustering outlets to dominate a market erodes sales at individual stores and hurts same-store comparisons.

Schultz believes franchising would be a mistake because Starbucks would lose a degree of control and the ability to respond to market trends quickly.

“Our growth is linked to our value system and our culture,” he said. “We will not make decisions to dilute the integrity of that.”

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So where is Starbucks headed, beyond the next five years? Schultz says Nike, the athletic shoe behemoth, “is one of the great models for Starbucks.”

Nike transformed sneakers into a specialty item that appealed to a mass market, despite high prices.

Schultz said that although Starbucks will “always be a specialty product,” it could find a place in the grocery store next to Folgers or Maxwell House. “The supermarket today is our primary competitor,” he said.

“It is a hard question to answer, but I would never say never.”

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No Mo’ Joe

A trend toward fewer coffee drinkers hasn’t slowed Starbucks’ expansion plans. Percentage of people in the United States who drink coffee:

1995: 47.4%

Source: National Coffee Assn.