Starbucks: The Rule of Thirds

Howard Shultz is returning as Starbucks’ interim CEO for the third time, following the retirement of the firm’s last CEO, Kevin Johnson. 

The last time Shultz was summoned was in January 2008, when the economy was in the midst of the Great Recession and the firm was performing at its worst. 

The next 7 years were the best years, with the firm exhibiting constant growth. Kevin Johnson, who started in 2017, led a period of even faster growth (which was disrupted for some time by COVID) until recently, when the firm engaged in a hard unionization battle with its workers resulting in a deep sell-off of its stock. 

And the question is: Can Howard Schultz save Starbucks for the third time? 

The political side of labor relations is not my forte, so I will not discuss it. But I think there are multiple aspects, related to the way Starbucks operates, which are worth discussing.

In fact, I would argue that the unionization battle should signal (to Starbucks) the need for alignment between three important strategies:

• Competitive strategy 

• Operations strategy

• People's strategy

But in order to better understand the firm’s recent struggles, it’s useful to look at its overall journey, which I have broken down into three different eras.  

The “Third Place”

Let's go back to Starbucks’ origin, and in fact, let's start with its human resource strategy. For many years, the firm was a pioneer in how it treated its employees. It was one of the first firms to provide comprehensive health care coverage for all (both full and part-time), including coverage for domestic partners. In 2014, the firm started covering tuition, for eligible employees, to study toward a degree at ASU (limited to $5,250 for every calendar year). 

While many firms (such as Target and Amazon) now offer even more benefits, at the time, this was ground-breaking. 

And the question was always: Why?

It’s clear why firms do it now, especially with such a difficult job market, but why do it back then? One can claim all kinds of statements such as “people are our assets,” but long-time readers of this newsletter know that I don’t buy into that. There is always a deeper reason. 

One may say that the reason is employee retention, but let’s be honest, how hard was it to be a barista at Starbucks. Back then, the chain offered very few options: drip coffee and a slew of espresso drinks, none of which were well made. So why was it so important for Starbucks to retain its employees? 

The answer is that Starbucks was never about coffee. Starbucks always strived to be your “third place.” Not your home, not your office, but that third place you go to, to overpay for bad coffee.

I know…but I can’t help it. 

Starbucks wanted to be our neighborhood coffee shop, but at a scale. This required the firm to build customer loyalty, and in order to have repeat customers, the firm needed “repeat employees” who didn’t feel or seem to be working for a large chain. 

There is one particular process, unique to Starbucks, that accentuates this point: at the end of the ordering process, the barista asks you your name. This is clearly an inefficient step which creates both confusion and errors (after several years I adopted a Starbucks name, “David,” to avoid constantly grabbing the cup of coffee created for a more supreme being).

But the goal of asking for the name (among many other reasons, I assume) was to create the customer intimacy which is part of the coffee shop experience. 

Offering tuition rather than cash also ensured, beyond the tax benefits, that those working there were willing to spend money on education anyway, and thus were more likely to be more cultivated and, potentially, willing to strike a conversation with customers (which again is part of the coffee shop experience). 

This era was quite simple. The firm’s competitive strategy involved trying to become that “third place.” The firm’s operations followed a simple set of processes that ensured service intimacy by having an educated and coffee-interested, conversant workforce that ensured that level of service, even though the process was not fully efficient. The people’s (or HR) strategy necessary to support this service experience, was focused on employee retention through investing in those employees. 

The Lean Years

But over the years, Starbucks had to add more products as a way to grow. 

In 2010, Starbucks introduced its However-You-Want-It Frappuccino (which was actually introduced earlier but in a limited way). 

In, 2011 Starbucks allowed customers to bring their favorite brews home by launching the Starbucks K-Cup packs.

In 2012, Starbucks acquired Teavana and began selling tea while introducing the Starbucks Handcrafted Refreshers.

Evolution Fresh cold-pressed juices and smoothies entered Starbucks stores in 2016, after the company was acquired in 2011. 

In 2015, Starbucks launched its Cold Brew drinks, and following the success of its original Cold Brew, launched its Nitro Cold Brew in 2016.

And in 2017, the firm introduced the Pink Drink, which was the equivalent of Apple dropping the term “Computers” from its name. But the Instagramable product was a huge success. 

The goal was not to be an advertisement for Starbucks, but rather to emphasize the complexity creep the employees had to deal with. Every new product and every new version makes it harder to deliver consistent quality and a consistent experience. 

To deal with it, the firm had to embark on a long process of continuous improvement to help its employees. 

I call these the “Lean Years.” Under that initiative, the firm began utilizing tools from the Toyota production system:

“Pushing Starbucks’s drive is Scott Heydon, the company’s ‘vice president of lean thinking,’ and a student of the Toyota production system, where lean manufacturing got its start. He and a 10-person ‘lean team’ have been going from region to region armed with a stopwatch and a Mr. Potato Head toy that they challenge managers to put together and re-box in less than 45 seconds.”

In that process, employees were encouraged to come up with their own solutions, and indeed, each store adopted many small changes to accommodate its own store layout and customer purchasing patterns. For example: 

“At a busy downtown Chicago Starbucks, store manager Ryan Dobbertin says bins of beans are kept on top of the counter so the baristas don't have to bend over; bins are color-coded, so they can find a particular roast without having to pause and read the label. They also use different colored tape to quickly differentiate between pitchers of soy, nonfat or low-fat milk.”

The change did create some stress at the firm, questioning whether adopting practices from a production-line firm was the right approach for a service-oriented firm, but the resulting improvements, and the employees’ involvement, were key. 

To summarize this era, Starbucks is still that “third place,” but with an updated and expanded menu. It’s no longer about quality (it was never about quality, but now it’s even less so). The operations strategy necessary to sustain this model is that of lean operations, and the HR strategy should still focus on workers, since they are the ones driving the process innovation. 

The Tech Years

As I mentioned above, in 2017, Kevin Johnson became the firm’s CEO. During his time, aside from a dip amid the COVID-19 pandemic, the coffee chain’s sales had been steadily increasing every year, with the firm achieving a record sales of $29.1 billion in 2021(up from $22.4 billion in 2017).

And during his tenure, multiple trends persisted. 

The firm experienced more online orders with nearly 25% of all orders being placed through apps, rather than in person. 

And this was not only through the Starbucks app but rather through third-party platforms. In 2020, Starbucks signed an exclusive agreement with UberEats, all while experiencing over 200% growth YOY through such services, maintaining a dominant market share on coffee purchases through these apps: 

All this, while orders and products were becoming even more complex. 

But these trends have had multiple implications:

The store has become less important and with it, the “human” side of the worker has become less important. The importance of speed has increased, since it's much more noticeable in online orders, and there is also much more technology involved in integrating the coffee making, ordering process, and delivery. All of this, while being led by a CEO that is much more data-driven.

I have already written about the tensions between learning by doing and learning before doing on empowering employees, so it shouldn’t come as a surprise that employees started complaining. 

“Baristas have filed more than 100 Unfair Labor Practice charges with the National Labor Relations Board (NLRB) against the coffee giant amid their efforts to unionize. This week, Starbucks filed two charges against Workers United, the labor organization backing baristas, as tensions escalate.”

All of this, along with rising costs (inflation and supply chain issues), challenges in its Chinese and Russian markets due to war and COVID-related closures, have brought Howard Schultz back. 

In this era, Starbucks is facing two important issues:

First, they have employees that feel that they are no longer a priority, and indeed they are not. Second, this is no longer the “third place.” 

Starbucks now needs employees that can execute a complex set of orders, at speed and precision, to customers who are either sitting at home or picking up their drinks on the go. Seems more akin to a production line than to a local coffee shop. 

The firm has also lost its step when it comes to its market performance. If it’s about speed and variety, how do you compete with Dunkin' on one side, and better coffee places on the other? 

On the S&P, the firm isn’t doing much better. 

Dunkin' may no longer be a public firm, but looking at the two firms’ performance until Dunkin' became private, no big difference is revealed (if anything, it shows a slight advantage for Dunkin'):

So this is an example where operational changes (technology) and customer behavior changes (mobile and delivery) are forcing the firm to rethink its strategy, and with it, the role of its people.

What’s Next?

I am not sure there is an easy place for Starbucks to go with its labor relations.

I don’t think it’s wise for the firm to continue this fight against its baristas’ interest to unionize. Just like REI, the firm’s customers lean left, and indeed, only 4% reported that they will not go to Starbucks if the employees unionize. 

But the firm also needs to embrace the fact that given the current store layout (and even its Amazon-Go collaboration), it is not ready to fully enter the world of online orders just yet. 

When I teach in SF, my need for caffeine increases so I have to order coffee on campus (and sometimes even at the hotel). Starbucks is the fastest and most reliable option (even if not the best coffee), and they also have a store near the hotel. But whenever I visit, it’s absolutely empty. As a result, it gives out a vibe of a sad place and not the warm and familiar “third place” that the firm aims for.

In my opinion, Starbucks should think about operating a set of cloud kitchens in areas with extensive online orders. It should also consider creating dedicated stores (or allocate part of the existing stores) for online orders, and invest in the rest of the stores in a way that will make them appealing again. 

But the question is, can the firm continue charging the high premium it does for its online orders? At this stage, the brand extension allows them to do so, but I am not sure this is fully sustainable in a world led by platforms. 

Howard Schultz is already discussing reinvesting in its workers, but in this day and age, that would mean a significant cost increase, and since it’s not fully aligned with the firm’s competitive advantage, the market is responding negatively. 

In other words, what worked at the beginning of the century is no longer enough. The question is whether the firm can reinvent itself. But to do so, it needs a new identity (or competitive strategy). It needs to align its operations with it. The big question is: what will the people’s role be in this new strategy?