1. Eric Perkunder Said,

   Poor Starbucks.

   I think even more profound than the question of whether or not they are 3rd Wave, is what they are showing the World about conventional business thinking itself. For years, Starbucks like many companies has had a strategy that states that they will grow earnings by 5% or more each year. To “meet or exceed” this goal (yet another mantra of our Business Age) more stores must come on line AND existing stores must sell that much more stuff at higher margins year after year, essentially over a long enough horizon of time grow sales and profits must grow to infinity.

   When you have 300 stores and add 100 or so each year these targets are pretty easy to accomplish–especially it seems if you are Starbucks. When you are small and have had a few good years, you can plot a line with the data that ends at the moon. But when you try to grow the earnings on a base of 15,000 stores by 5% a year you just can’t open enough locations to pull this off. And in Starbucks case their music and merchandise offerings simply can’t make their existing stores keep pumping out the results to the desired goal.

   Even hiring a Walmart guy to show the way just won’t help. In fact you can count on the fact that a Walmart guy is steeped in the “no limits to growth” ideology, so he is like bringing the CEO of Seagrams to an AA meeting. At some point endless growth like this besides being a debilitating addiction, becomes a virtual a mathematical impossibility.

   We have witnessed Starbucks struggling with this for several years. Remember the loads of cheesy merchandise and other products at the Starbucks store in Ballard last Christmas. Broadening the product offering with tired product is an attempt to shore up and achieve an unrealistic and misguided goals. And Starbucks has being trying this unsuccessfully for years. In the 1990’s they even tried to sell outdoor furniture on their website, presumably so you could stay home yet feel like you were at a Starbucks.

   Imagine a similar growth objective for a sports team. Take Howard’s old team, the Sonics. Imagine having the goal of incrementally taller players each year. Imagine setting that goal at 5% growth each year. In fifteen years time all seven foot players would have to be over 14 feet tall. It’s utterly absurd.

   So going back to Starbucks–the lesson here is that growth as a end in itself means the dilution of the brand from its core business (some might say expanding the offering to include more, but this is just dilution in different clothing, using other words). It also means with any degree of success, you will ultimately reach a mathematical limit, like the basketball players height, and growth will slow to more modest levels.

   It’s just a fact and Starbucks and every other corporation in America might as well get used to this right now (note to the Harvard Business School, you may be pumping out a generation of executives doomed to beat their heads against the concrete wall of limits to growth).

   Getting back to Starbucks. Publicly traded companies trade on future earnings. A company with a P/E ratio of 40 means that this company is valued at 40 times the current years earnings. The only way investors will pay this is if the company is able to grow earnings faster each year so it achieves these higher numbers in a shorter period of time. When a company like Starbucks shows that growth can not be maintained, the value of the company as reflected by its stock price shrinks to fit the new reality.

   In the case of Starbucks, the stock price shrunk by over 40% over the last year to reflect what the market sees as reasonable growth targets. P/E at Starbucks is now around 20. This means its stock is valued at around 20 years worth of current earnings. Publicly traded companies play by these rules, and men like Howard Schultz must live and die by them (from a business sense). In the casse of someone who owns five percent of the company, they see the value of their stake shrink by $300-400 million in a single year.

   However, this is the value of the company as reflected by its stock price. Starbucks, as a business entity, is still a remarkably strong company. It has very little debt and can open stores from free cash flow alone. It generates almost $1 billion in net income each year. Starbucks also employs hundreds of thousands of people to whom it gives health benefits even for part time workers as well as stock options and free coffee every week. On other levels, Starbucks has a composting program and has taken pains to use paper products that contain post consumer content, and prints most collateral materials using soy based, not oil based ink. These are all better choices for the environment than alternative choices made by some “competitors”.

   This company is not sick. . . or even doomed. Starbucks underlying numbers and actions reflect a robust and successful firm. Instead, the thinking that defines Starbucks and the future of Starbucks, the thinking behind conventional business modeling is sick, outdated and possibly misguided. Unfortunately, Starbucks has embraced this 1990’s thinking and has never updated. Its as if investors just want to hear the same old story and no one in management has the courage to come forward present a realistic outlook. There is a limit to growth–and the cost of ignoring this fact is worse product, less consumer love, and more bad merchandise that has nothing to do with what Starbucks is supposed to be all about–the COFFEE-loving customer!

   Fortunately for those of us who actually, truly LOVE coffee, there are real options. These are the companies that are built around the personal goals of owners and their like-minded staff for coffee quality, social responsibility, and customer focus with reasonably high levels of profitability and fun. These are the mainly privately held 3rd Wave roasters and retailers that dot the landscape.

   What I love about these small players is that so much of what they do, particularly around social responsibility in origin, is not a marketing ploy–its genuine concern. Their actions are driven by the authentic passions of the owners and their like-minded staff–not remote shareholders charting stock valuations. Usually when you talk to the ownership of these little players they are ready to define the limits of the growth that is acceptable to them. And they are not megalomaniacs about it–they know that once they reach a certain size, the soul of their companies simply disappears replaced by other priorities not related to the reason they started their companies to begin with. It is to these remarkable little companies and their motivations that the rest of the industry’s players, large and small, should take their lead.

   Come on Starbucks take a deep breath and talk to your shareholders about the truth. Oh yeah, and start paying dividends to your shareholders instead of opening stores. It’s that time now.

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