The Success & Failure of Starbucks’ Service Innovation

Success vs. Failure in Innovation Case Study

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This report was written at Manchester Business School, Spring of 2018.

Introduction

Some innovation discourses have such intuitive appeal that their credibility is almost taken for granted. Success and failure of innovations is one such discourse. Although there has been numerous academic literature on the causes of success and failure of innovations since the 1940s, such as the infamous Betamax cassette, little attention has been given to the concept of success or failure. Business school case studies and other journals, almost without exception, seem to imply that success and failure are self-evident and rely on single measures such as the Queen’s Awards for Technology in order to attempt to attribute causality. However, for almost every academic study proving that an innovation is a failure, there is evidence proving otherwise. For instance, while many global businesses, such as Starbucks and McDonalds, have flopped in new markets, their innovations have not been total failures. In this report, I present cases where success or failure is multifaceted — meaning, a company might fail in meeting its accounting expectations for example, i.e. sales or profits, while also being successful in another dimension.

Starbucks’ rapid growth rate, between its Initial Public Offering(IPO) in 1992 to 2006, can confer success, but it has not been so entirely.

Starbucks opened its first coffee shop in downtown Seattle in the year 1971. Even though it did offer samples to customers, Starbucks didn’t start out selling coffee by the cup. In fact, its initial focus was selling whole ground coffee and whole bean, coffee machines and equipment. The company’s founders, three academics (Gordon Bowker, Zev Siegl, and jerry Baldwin), were coffee enthusiasts and had experience with selecting the best coffees, dark roasting techniques and creating exclusive blends. Coffee lovers were obsessed with the aroma, atmosphere and experience of enjoying superb coffee in their shop, which naturally paved the way for later success.

Starbucks’ early success is well described in a memo written in 2007 by Howard Schultz, the company’s former Chief Executive Officer (CEO) and current Executive Chairman, to the then CEO Jim Donald. In it, Schultz depicts how the company scaled its operations from a few hundred stores to over thirteen thousand stores. Overtime, Starbucks Corporation became a giant among the coffeehouse industry. And Schultz himself spearheaded a series of business decisions that, according to him in retrospect, have led to the commoditization of their brand. Prior to this realization however, Starbucks’ expansion was seen as a symbol of success — with news publications, such as CNN Money echoing headlines such as, “Starbucks beats analysts’ forecasts” (2004).

REPORT APPROACH: DEFINING ‘SUCCESS’ AND ‘FAILURE’

Before going headlong into asserting whether or not Starbucks’ products or services have been successful, its perhaps wise to define what we mean by ‘success’ or ‘failure’ in innovation. Surely, it would be counterintuitive to attribute causality without first defining the nature of ‘success’ or ‘failure.’ Its also worth noting, success and failure are relative. In fact, in isolation they are meaningless. Much depends on the circumstances in which we deem an innovation a success or failure. Ergo, for the purpose of this report, I’ve based my hypothesis on these two polar opposites by comparing the innovation against expectations, financial criteria, competition, and etc. In this context, the probability that these different criteria will yield different results is very likely.

To give insight into what exactly I mean, I would lay out two unique scenarios pertaining to Starbucks, of two different time periods and markets, and why I think these scenarios exemplify success or failure. The first scenario illustrates failure in Starbucks’ service innovation initiatives (i.e., expectations of customers), while having enormous success in sales and revenue. And the latter case reviews the company’s failure to crack the Australian market (competition and financial aspect) but also gaining new knowledge on entry market strategy. These selected cases are by no means comprehensive, but they should help illustrate what I mean.

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WHAT KIND OF SUCCESS?

In a world focused on getting bigger fast, it’s all too easy to overreach. Consider figure 1A, between 1997 and 2006, Starbucks grew very rapidly. By 2006, the company added 12,400 stores — opening new ones at a rate of six per day.In fact, that same year the international coffee monolith generated over $7.8 billion in sales (a 22 percent increase from its previous year), $894 million in operating profits, and a superlative 25 percent on Return on Equity (Starbucks FISCAL ANNUAL REPORT, 2006). Beating the coffeehouse market year after year, Starbucks’ success, even with its huge sales, seemed too good to be true.

What has enabled this construct, the company’s exponential growth, was in fact the management’s decision to grow, very quickly. In Schultz’s memo, he mentioned, one of those decisions was the company’s adoption of automatic expresso machines, which increased speed of service and efficiency. This, coupled with flavor-locked packaging, enabled them to sell fresh roasted coffee in North America and internationally. He also talked about the redesign of their stores. In order to gain efficiencies of scale and maintain a solid Return on Investment(ROI) on sales to investment ratios, they had to streamline their store design. Surely, these business decisions were right at the time, says Shultz. And without a doubt, they have brought immense success, financially, to Starbucks.

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Data from Statista, Figure1B, shows that between 2003 and 2008, Starbucks has more than doubled its revenue, from $4.1 billion to $10.4 billion. The important thing to note in this case is the transitory judgement — the point in time we are judging Starbucks’ economic output, i.e. 1997 to 2007 — when we say they have been successful. And also, we are judging from the company’s perspective, its managers and investors, by using financial notions such as ‘ROI.’ Ergo, Starbucks’ products were successful from those aspects.

TRUE SERVICE INNOVATION IS TRICKY

Starbucks have had both positive and negative impacts from its service innovation initiatives. But, what exactly is service innovation? Service innovation is translated as change in one dimension of a business, i.e. new technology, having an impact on other aspects of service, i.e. production processes (Den Hertog, 2000). The service innovation in Starbucks, during the Schultz era, would include their service process based on for example the adoption of the expresso machines, Flavor-Lock technology, streamline store design, and etc.

The key to successful service innovation lies in focusing the service solution on the customer. Surely, Starbucks failed to ask, “How is the customer doing?” while making those incremental improvements, such as using flavor-locked packaging, to their existing services. They overlooked the cause and effect of flavor-lock bags in their stores. This has resulted in the loss of aroma — perhaps the most powerful nonverbal signal once emitted in their stores — and also the loss of employees scooping fresh coffee from the bins and grinding it fresh in front of the customers, consequently stripping the store of tradition and their heritage.

FROM THE CONSUMER’S PERSPECTIVE

The longer-term impact of the service innovation implemented by the company, i.e. the flavor-locked packaging, has had a negative impact on Starbucks’ customer experience. Although, revenue continues to grow, the company has had some ‘failures’ in differentiating its products and services in the coffeehouse industry. For instance, the adoption of the automatic expresso machine, in order to increase productivity, has caused the coffee arbiter to lose the “romance” and theatre-atmosphere their previous La Marzocca machines once emitted in their stores. Although, this helped shorten the brewing time and reduced labor costs (less time to train new baristas), it distracted the company from its core competency — preserving superlative customer experience. In hindsight, one might argue, the need for economies of scale was justification for the rapid growth rate.

In an attempt to circumvent the issue of losing its competitive-edge, Starbucks, following the advice of Howard Schultz in the aforementioned memo, implemented numerous innovation strategies in revamping the company brand. And among them, they substituted old automatic espresso machines with Mastrena coffee-makers. Unlike the former, the later doesn’t block customers from seeing the “how its made” process. This retraction, created more opportunity for baristas to connect visually with customers. (Starbucks, 2008)

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Figure 1C shows the operating income of Starbucks, worldwide, between 2007 and 2017. In 2017, Starbucks’ operating income was approximately $4.13 billion, and their global revenue was $22.39 billion. (Statista, Revenue of Starbucks worldwide from 2003 to 2017).

Based on these findings, Starbucks has been relatively successful from the company level: i.e., investors; competency: it has also been successful in most markets; however, relative to past performance (from a customer experience perspective) their service innovation initiatives have produced negative results. Surely, the sophisticated, mobile-enabled consumer of today likes to feel extra special. She is even willing to spend £3.55 for a cup of latte — if its exclusive (London Toolkit, Starbucks Prices London 2017). However, if the product is ubiquitous (an undifferentiated good), it then becomes harder to convince her to pay exorbitant prices for that product. Consequently, the economics principle of “race to the bottom” will create sort of a gravitational pull towards a commodity price for that good.

However, Starbucks coffee prices remain high, which begs the question, “Is Starbucks the king of coffee advertising?” In fact, Figure 2A shows that Starbucks has been increasing advertising spending over the years. From 2011 to 2017, they’ve doubled their advertising initiatives from $141.4 million to $282.6 million, globally.

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Comparing Figure 2A to Figure 2B, we can observe that Starbucks has been shrinking its advertising campaigns in the US market, unlike its global push. The company seems to be pushing for the same “Starbucks on every corner” market domination outside the U.S. This is evident in their rapid shop openings in markets like China and Australia. Unlike China, Starbucks just can’t seem to crack the Australian market.

Starbucks’ failure in Australia

The coffeehouse industry in Australia, unlike many other countries, is not dominated by global coffeehouse chains such as Starbucks. Instead, its populated with a high volume of single-store, independent, coffee shops. Unlike its many successes elsewhere, Australia has proved to be quite a challenge for Starbucks. The same rapid expansion growth strategy that worked in the US failed in Australia when the coffeehouse giant tried to open eighty stores within a few months throughout the country in 2000.

In fact, they had to close a about 60 stores for they weren’t as lucrative as they’d expected. The company reportedly accrued losses of at least $143 million since they opened for business in Australia. (Starbucks, Australian expansion 2016) There are currently just 23 Starbucks coffee shops in Australia. The reason Starbucks’ market entry strategy failed has been because independent shops, laneway espresso bars, already had a well-established position in the Australian coffeehouse industry. These laneway espresso bars have succeeded in building durable first-mover advantages and have been dominating their industry, since its infancy. They offer the “intimacy, personalization, and familiarity of a suburban boutique café” (Patterson, Scott and Uncles, 200: 43), leaving the consumers no need to switch to disruptors such as Starbucks.

Besides offering high-quality coffee and highly-trained baristas, many laneway espresso shops have also been known to offer high quality food offerings in addition to a hospitable atmosphere. Such high quality was what made Starbucks popular in the US., i.e. the aroma emitted in their stores, which formed the basis of their company tradition and heritage.

Starbucks’ Australian market quest hasn’t been a total failure, however. In an interview with news.com.au, Starbucks Australia’s CEO Chris Garlick mentioned they’ve decided to shift their focus to cities like Sydney, closer to tourist attractions. This has helped them reposition their entry to market strategy. In fact, the chain’s new cafes, far from being ubiquitous, would be centered in a limited number of locations, says Garlick. “Our growth strategy is centered around our customers preferences and where they want us to be, which includes shopping centers and high traffic tourist locations,” he said. The positive aspect to draw from this scenario is the new knowledge Starbucks has gained from this experience. Surely, the company would conduct better market feasibility studies in its next international expansion endeavors.

Conclusion

Scaling a service business, while trying to stay competitive, is a difficult task. Very often, even the best of managers fail to meet expectations. Expectations from shareholders, customers and the general public — these are all factors that sway the success or failure of most innovations in a company. Surely, Starbucks has had enormous success over the last two decades, growing at a rapid rate and establishing itself as an arbiter in the coffeehouse industry. However, their success, i.e., accessibility, has been threatening to cannibalize their customer experience. In this report, we’ve seen from different transitory judgements, i.e., different points in time of Starbucks’ product life cycle, how judging from what or whose viewpoint can affect the outcome of how successful we think an innovation has been over time.

In the first case, Starbucks’ product and service innovations exemplify financial success from the company’s point of view in the early 2000s, i.e. its managers and investors (relying on financial notions such as ‘profits’). However, these same innovations brought about failure in the company’s customer experience in the long run, i.e. post the 2008 Financial Crisis– judging from the customer’s perspective.

Conversely, in the second case, reviewing the company’s failure to crack the Australian market (taking on over $143million in losses) revealed that the management of the company has learned new knowledge about branding and have since updated their market entry strategy. Consequently, they’re becoming successful in rebranding themselves in Australia and beyond. These analysis, conveyed in this report, are by no means comprehensive, but they illustrate the benefits of defining the concept of success and failure when attempting to attribute causality in innovation market strategy.

References

1. Starbucks Corporation. FISCAL 2006 ANNUAL REPORT. California Management Review, pp.4–13.

2. Australasian Marketing Journal (2010). How the local competition defeated a global brand: The case of Starbucks: Paul G. Patterson *, Jane Scott, Mark D. Uncles

3. Oregon Business News. As Howard Schultz Steps Back, an Era Ends for Starbucks. [Online] Available at: http://www.oregonlive.com/business/index.ssf/2017/03/as_howard_schultz_steps_awa y_a.html

[Accessed 20 04 2018].

4. Shostack, G. L., 1984. Designing services that deliver. Harvard Business Review, 62(1), pp. 133–139.

5. Statista. Revenue of Starbucks Worldwide from 2003 to 2017 (in billion U.S. dollars). [Online] Available at: https://www.statista.com/statistics/266466/net-revenue-of-the-starbucks- corporation-worldwide/

[Accessed 19 04 2018].

6. Starbucks dot com. Starbucks Company Timeline [Online] Available at: https://www.starbucks.com/about-us/company-information/starbucks-company-timeline [Accessed 14 04 2018].

7. News.com.au. Starbucks Australian expansion 2016: Will it succeed second time? [Online] Available at: http://www.news.com.au/finance/business/retail/starbucks-coffee-is- quietly-expanding-in-australia-after-humiliating-retreat-eight-years-ago/news- story/b7f136c4d78f24aaa600a3822b1e31b4

[Accessed 22 04 2018]

Investor, Graduate student @ Manchester Business School, learning to code in JavaScript & Python. Site: www.msawo.com

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