The Big Gulp at Starbucks

By Barbara Kiviat / Seattle

Starbucks fancies itself a small company, which might ring a little odd, considering that the coffee giant is regularly parodied as being practically unavoidable. Well, the joke is only going to get funnier as the Seattle firm, with its shareholders clearly in mind, gets even bigger, selling more stuff, from hot food to hot music, in more places than ever before. Right now Big Green runs 12,440 locations worldwide, but the goal is 40,000, which would trump even McDonald's.

But McDonald's doesn't try to behave like a chain of boutiques, and that's where the tension inside Starbucks lies. "The battle within the company is making sure growth doesn't dilute our culture," says founder and chairman Howard Schultz. In the Starbucks ethos, the best authority is decentralized, and the best decisions are made store by store. The company stays clear of focus groups, acts on its instincts and doesn't open franchises for fear of losing control. Schultz decided to sell the New York Times, not USA Today, in stores because, he says, "it felt right." If he or another senior exec doesn't like a new drink concoction, it doesn't get sold. How's that for research?

In other large corporations, "We act like a small company" is one of the great empty slogans, but at Starbucks, executives tenaciously hold on to the idea that every store is like an independent coffeehouse. "You see the banter, the customers' knowing the people behind the counter," says CEO Jim Donald. "It's part of the reason they go." But Schultz and Donald are aware that it will be hard to keep the intimacy thing going. As Starbucks branches into more products (22 new drinks in two years, its own section of iTunes), spreads to more countries (from China to Brazil) and sees sales increase 22% a year, to nearly $8 billion annually, life is getting a lot more complex. And complexity is dangerous for any company.

You can see the resulting tension all over the place, even in your latte. Six years ago, Starbucks moved from manual to semiautomatic espresso machines. The quality was more consistent, but the real reason for the switch was that an employee needed 24 fewer seconds to draw an espresso--a double shot of productivity. "People struggled with it," says Silvia Peterson, director of store operations engineering. The new machine was at odds with the Starbuckian notion of a "handcrafted" beverage. An ice dispenser that would have eliminated time spent scooping was rejected as a step too far. "It was big and QSR-like," says Peterson--QSR being an abbreviation for quick-serve restaurant, as in fast food, anathema to Starbucks. "It was a lot of stainless steel."

Now the company is back to thinking about dispensing machines as it works through its biggest general operational problem: the length of time it takes to serve a customer. Starbucks aims to serve your drink in three minutes or less--any longer and people might bolt. Less than 60% of stores manage to hit that mark on average, which means that the company is missing millions in sales.

One solution might be an automated syrup dispenser, which for now sits in the Starbucks R&D lab but could speed up, among other things, the production of blender-made Frappuccinos. That goal was given fresh urgency in July when same-store sales for the month rose 4%, the slowest pace in nearly five years. The reason, said management: hot weather increased demand for cold drinks, and stores couldn't keep up. Customers saw long lines and kept on walking. It was a rare financial miss, and Starbucks' stock dropped 9% on the news (it's still up more than 20% for the year)--highlighting that in the debate between handcrafted and automated, what investors care most about is results.

For Starbucks management, the decision is more difficult. "As much as we want to meet people's desire to produce beverages quickly, we also realize that people want a smile with their drink, that they don't want to feel rushed," says Jim Alling, president of Starbucks Coffee US.

Striking a balance between efficiency and atmosphere is largely why it took 3 1/2 years to roll out ovens, the biggest thing to hit Starbucks since the blender's 1995 debut. Starbucks knew there was demand--witness the bags of food carried in--but creating a good-looking oven that could cook a range of items and contain the odor--lest a store not smell first and foremost of coffee--was a challenge. Even after some breakfast sandwiches were developed, entirely new deployment routines had to be created so that employees would not slow the line. "If our espresso-only or drip-only customers suffered," says Alling, "it wouldn't be worth doing."

Hot breakfast sandwiches are a success in the handful of big cities they have reached so far, like Chicago and New York, where they add an average of $35,000 a year to the sales of each store--more than the $30,000 that comes from cold sandwiches and salads. Hot lunch sandwiches and quiche, now being tested, might someday draw a midday crowd--a real prospect for a company that currently sees 60% of its sales before 10 a.m. And while executives won't admit it, ovens also hedge against competitors like Dunkin' Donuts, McDonald's and Burger King, which have been stepping up the quality and variety of their coffees.

There's only so much stuff you can run through a 1,500-sq.-ft. retail store, although Starbucks has added everything from CDs to books to Scrabble sets. "You have to have new products. That's the retailer's dilemma," says John Glass, who covers Starbucks for CIBC World Markets. But every new item, whether edible or readable, increases the complexity of the organization, and complexity is a killer.

Mark Gottfredson, a partner at consultancy Bain & Co., studied that subject at 75 companies in 12 industries and found that as firms became more complicated, growth slowed. Companies lowest in complexity grew 1.7 times as fast as their average competitor, even when taking firm size into account. "Complexity creep is the most natural thing in the world, especially in retail," says Gottfredson. "The challenge is that while every one of those decisions seems to make sense, underneath you start building up enormous amounts of systemic cost."

Historically, Starbucks has done a great job at balancing new ideas with efficiency, says Frances Frei, a professor at Harvard business school who has studied the company. A classic example: the way it trains us to order in Starbucks jargon, grande this and half-caff that. Serving tens of thousands of possible drink combinations would be an operational nightmare were it not for a regimented logic to ordering, a marketing flourish that helps establish the atmosphere of an Italian cafe. "The fight in any company is [that] marketing wants more things for the customer and operations wants less," says Frei. "The thing that is so beautiful with coffee is that they did both."

But what happens when Starbucks introduces drive-throughs, which are at 58% of the stores it builds today? It took a decade for the company to put in its first drive-through because, says Schultz, "we wanted to ensure that once we did, we didn't take Starbucks down this road of fast-food mentality." Again the dreaded FF words. Next year Starbucks will open some 600 drive-throughs, many on busy highways--a huge departure from the store's original Main Street philosophy. Here's why: drive-throughs significantly boost a store's total sales.

How the homey in-store experience translates to a drive-through is another question. Executives try to explain, but the disconnect is so obvious that the Starbucks drive-through is lately being reinvented. Some changes boost efficiency (an order-confirmation screen reduces errors), but plenty of the redesign is aesthetic. Neatly landscaped hedges and big drawings of coffee pots funnel you through a chute that takes you round to the pickup window, which is broad and deep and designed to visually draw you into the store.

"There's more ambiance," says Donald. And it may not sound so bad, once you consider what Gerry Lopez, president of global consumer products calls "the smallest Starbucks store you ever saw"--a vending machine that will start dispensing lattes, mochas and hot cocoa in train stations and office complexes next year. The potential, says Donald, "is limitless."

Where does that leave the quintessential Starbucks experience--lounging around a cafe, sipping a French roast, surfing the Web? Ready for an upgrade of its own. Walk into the Northbrook, Ill., store, and you will see where Starbucks is headed. Bookcases line one wall, overflowing with espresso makers, French presses, coffee beans, thermoses and mugs. Next to a display case of food is a shelf full of CDs and DVDs. The space devoted to preparing drinks has been reduced by a quarter and re-engineered to conserve movement and space. Vertical shelves set into the wall help keep workers in one place as they reach for syrup bottles and tea bags. By the door are bins of coffee beans customers can touch and smell.

In the words of Levi Smith, who manages another next-generation prototype in Thornton, Colo., the new Starbucks evokes the concept of "coffee merchandiser." It is lively and crowded, with a lot going on at once. If you ask nicely, you can even get a cup of coffee.

With reporting by Rita Healy / Denver, Cynthia Martens / Chicago