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Solved by verified expert :9-504-016REV: JULY 10, 2006YOUNGME MOONJOHN QUELCHStarbucks: Delivering Customer ServiceIn late 2002, Christine Day, Starbucks’ senior vice president of administration in North America,sat in the seventh-floor conference room of Starbucks’ Seattle headquarters and reached for hersecond cup of toffee-nut latte. The handcrafted beverage—a buttery, toffee-nut flavored espressoconcoction topped with whipped cream and toffee sprinkles—had become a regular afternoonindulgence for Day ever since its introduction earlier that year.As she waited for her colleagues to join her, Day reflected on the company’s recent performance.While other retailers were still reeling from the post-9/11 recession, Starbucks was enjoying its 11thconsecutive year of 5% or higher comparable store sales growth, prompting its founder andchairman, Howard Schultz, to declare: “I think we’ve demonstrated that we are close to a recessionproof product.”1Day, however, was not feeling nearly as sanguine, in part because Starbucks’ most recent marketresearch had revealed some unexpected findings. “We’ve always taken great pride in our retailservice,” said Day, “but according to the data, we’re not always meeting our customers’ expectationsin the area of customer satisfaction.”As a result of these concerns, Day and her associates had come up with a plan to invest anadditional $40 million annually in the company’s 4,500 stores, which would allow each store to addthe equivalent of 20 hours of labor a week. “The idea is to improve speed-of-service and therebyincrease customer satisfaction,” said Day.In two days, Day was due to make a final recommendation to both Schultz and Orin Smith,Starbucks’ CEO, about whether the company should move forward with the plan. “The investmentis the EPS [earnings per share] equivalent of almost seven cents a share,” said Day. In preparation forher meeting with Schultz and Smith, Day had asked one of her associates to help her think throughthe implications of the plan. Day noted, “The real question is, do we believe what our customers aretelling us about what constitutes ‘excellent’ customer service? And if we deliver it, what will theimpact be on our sales and profitability?”1 Jake Batsell, “A Grande Decade for Starbucks,” The Seattle Times, June 26, 2002.________________________________________________________________________________________________________________Professors Youngme Moon and John Quelch prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are notintended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.Copyright © 2003 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may bereproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical,photocopying, recording, or otherwise—without the permission of Harvard Business School.This document is authorized for use only in Business/Lower Division Capstone – 01072016 by Kelsey Dunning, Harrison College from January 2016 to July 2016. 504-016Starbucks: Delivering Customer ServiceCompany BackgroundThe story of how Howard Schultz managed to transform a commodity into an upscale culturalphenomenon has become the stuff of legends. In 1971, three coffee fanatics—Gerald Baldwin,Gordon Bowker, and Ziev Siegl—opened a small coffee shop in Seattle’s Pike Place Market. The shopspecialized in selling whole arabica beans to a niche market of coffee purists.In 1982, Schultz joined the Starbucks marketing team; shortly thereafter, he traveled to Italy,where he became fascinated with Milan’s coffee culture, in particular, the role the neighborhoodespresso bars played in Italians’ everyday social lives. Upon his return, the inspired Schultzconvinced the company to set up an espresso bar in the corner of its only downtown Seattle shop. AsSchultz explained, the bar became the prototype for his long-term vision:The idea was to create a chain of coffeehouses that would become America’s “third place.”At the time, most Americans had two places in their lives—home and work. But I believedthat people needed another place, a place where they could go to relax and enjoy others, or justbe by themselves. I envisioned a place that would be separate from home or work, a place thatwould mean different things to different people.A few years later, Schultz got his chance when Starbucks’ founders agreed to sell him thecompany. As soon as Schultz took over, he immediately began opening new stores. The stores soldwhole beans and premium-priced coffee beverages by the cup and catered primarily to affluent, welleducated, white-collar patrons (skewed female) between the ages of 25 and 44. By 1992, the companyhad 140 such stores in the Northwest and Chicago and was successfully competing against othersmall-scale coffee chains such as Gloria Jean’s Coffee Bean and Barnie’s Coffee & Tea.That same year, Schultz decided to take the company public. As he recalled, many Wall Streettypes were dubious about the idea: “They’d say, ‘You mean, you’re going to sell coffee for a dollar ina paper cup, with Italian names that no one in America can say? At a time in America when no one’sdrinking coffee? And I can get coffee at the local coffee shop or doughnut shop for 50 cents? Are youkidding me?’”2Ignoring the skeptics, Schultz forged ahead with the public offering, raising $25 million in theprocess. The proceeds allowed Starbucks to open more stores across the nation.By 2002, Schultz had unequivocally established Starbucks as the dominant specialty-coffee brandin North America. Sales had climbed at a compound annual growth rate (CAGR) of 40% since thecompany had gone public, and net earnings had risen at a CAGR of 50%. The company was nowserving 20 million unique customers in well over 5,000 stores around the globe and was opening onaverage three new stores a day. (See Exhibits 1–3 for company financials and store growth overtime.)What made Starbucks’ success even more impressive was that the company had spent almostnothing on advertising to achieve it. North American marketing primarily consisted of point-of-salematerials and local-store marketing and was far less than the industry average. (Most fast-foodchains had marketing budgets in the 3%–6% range.)For his part, Schultz remained as chairman and chief global strategist in control of the company,handing over day-to-day operations in 2002 to CEO Orin Smith, a Harvard MBA (1967) who hadjoined the company in 1990.2 Batsell.2This document is authorized for use only in Business/Lower Division Capstone – 01072016 by Kelsey Dunning, Harrison College from January 2016 to July 2016. Starbucks: Delivering Customer Service504-016The Starbucks Value PropositionStarbucks’ brand strategy was best captured by its “live coffee” mantra, a phrase that reflected theimportance the company attached to keeping the national coffee culture alive. From a retailperspective, this meant creating an “experience” around the consumption of coffee, an experiencethat people could weave into the fabric of their everyday lives.There were three components to this experiential branding strategy. The first component was thecoffee itself. Starbucks prided itself on offering what it believed to be the highest-quality coffee in theworld, sourced from the Africa, Central and South America, and Asia-Pacific regions. To enforce itsexacting coffee standards, Starbucks controlled as much of the supply chain as possible—it workeddirectly with growers in various countries of origin to purchase green coffee beans, it oversaw thecustom-roasting process for the company’s various blends and single-origin coffees, and it controlleddistribution to retail stores around the world.The second brand component was service, or what the company sometimes referred to as“customer intimacy.” “Our goal is to create an uplifting experience every time you walk through ourdoor,” explained Jim Alling, Starbucks’ senior vice president of North American retail. “Our mostloyal customers visit us as often as 18 times a month, so it could be something as simple asrecognizing you and knowing your drink or customizing your drink just the way you like it.”The third brand component was atmosphere. “People come for the coffee,” explained Day, “butthe ambience is what makes them want to stay.” For that reason, most Starbucks had seating areas toencourage lounging and layouts that were designed to provide an upscale yet inviting environmentfor those who wanted to linger. “What we have built has universal appeal,” remarked Schultz. “It’sbased on the human spirit, it’s based on a sense of community, the need for people to cometogether.”3Channels of DistributionAlmost all of Starbucks’ locations in North America were company-operated stores located inhigh-traffic, high-visibility settings such as retail centers, office buildings, and university campuses.4In addition to selling whole-bean coffees, these stores sold rich-brewed coffees, Italian-style espressodrinks, cold-blended beverages, and premium teas. Product mixes tended to vary depending on astore’s size and location, but most stores offered a variety of pastries, sodas, and juices, along withcoffee-related accessories and equipment, music CDs, games, and seasonal novelty items. (About 500stores even carried a selection of sandwiches and salads.)Beverages accounted for the largest percentage of sales in these stores (77%); this represented achange from 10 years earlier, when about half of store revenues had come from sales of whole-beancoffees. (See Exhibit 4 for retail sales mix by product type; see Exhibit 5 for a typical menu board andprice list.)Starbucks also sold coffee products through non-company-operated retail channels; these socalled “Specialty Operations” accounted for 15% of net revenues. About 27% of these revenues camefrom North American food-service accounts, that is, sales of whole-bean and ground coffees to hotels,airlines, restaurants, and the like. Another 18% came from domestic retail store licenses that, in3 Batsell.4 Starbucks had recently begun experimenting with drive-throughs. Less than 10% of its stores had drive-throughs, but inthese stores, the drive-throughs accounted for 50% of all business.3This document is authorized for use only in Business/Lower Division Capstone – 01072016 by Kelsey Dunning, Harrison College from January 2016 to July 2016. 504-016Starbucks: Delivering Customer ServiceNorth America, were only granted when there was no other way to achieve access to desirable retailspace (e.g., in airports).The remaining 55% of specialty revenues came from a variety of sources, including internationallicensed stores, grocery stores and warehouse clubs (Kraft Foods handled marketing and distributionfor Starbucks in this channel), and online and mail-order sales. Starbucks also had a joint venturewith Pepsi-Cola to distribute bottled Frappuccino beverages in North America, as well as apartnership with Dreyer’s Grand Ice Cream to develop and distribute a line of premium ice creams.Day explained the company’s broad distribution strategy:Our philosophy is pretty straightforward—we want to reach customers where they work,travel, shop, and dine. In order to do this, we sometimes have to establish relationships withthird parties that share our values and commitment to quality. This is a particularly effectiveway to reach newcomers with our brand. It’s a lot less intimidating to buy Starbucks at agrocery store than it is to walk into one of our coffeehouses for the first time. In fact, about40% of our new coffeehouse customers have already tried the Starbucks brand before theywalk through our doors. Even something like ice cream has become an important trial vehiclefor us.Starbucks PartnersAll Starbucks employees were called “partners.” The company employed 60,000 partnersworldwide, about 50,000 in North America. Most were hourly-wage employees (called baristas) whoworked in Starbucks retail stores. Alling remarked, “From day one, Howard has made clear hisbelief that partner satisfaction leads to customer satisfaction. This belief is part of Howard’s DNA,and because it’s been pounded into each and every one of us, it’s become part of our DNA too.”The company had a generous policy of giving health insurance and stock options to even the mostentry-level partners, most of whom were between the ages of 17 and 23. Partly as a result of this,Starbucks’ partner satisfaction rate consistently hovered in the 80% to 90% range, well above theindustry norm,5 and the company had recently been ranked 47th in the Fortune magazine list of bestplaces to work, quite an accomplishment for a company with so many hourly-wage workers.In addition, Starbucks had one of the lowest employee turnover rates in the industry—just 70%,compared with fast-food industry averages as high as 300%. The rate was even lower for managers,and as Alling noted, the company was always looking for ways to bring turnover down further:“Whenever we have a problem store, we almost always find either an inexperienced store manager orinexperienced baristas. Manager stability is key—it not only decreases partner turnover, but it alsoenables the store to do a much better job of recognizing regular customers and providingpersonalized service. So our goal is to make the position a lifetime job.”To this end, the company encouraged promotion from within its own ranks. About 70% of thecompany’s store managers were ex-baristas, and about 60% of its district managers were ex-storemanagers. In fact, upon being hired, all senior executives had to train and succeed as baristas beforebeing allowed to assume their positions in corporate headquarters.5 Industrywide, employee satisfaction rates tended to be in the 50% to 60% range. Source: Starbucks, 2000.4This document is authorized for use only in Business/Lower Division Capstone – 01072016 by Kelsey Dunning, Harrison College from January 2016 to July 2016. Starbucks: Delivering Customer Service504-016Delivering on ServiceWhen a partner was hired to work in one of Starbucks’ North American retail stores, he or she hadto undergo two types of training. The first type focused on “hard skills” such as learning how to usethe cash register and learning how to mix drinks. Most Starbucks beverages were handcrafted, andto ensure product quality, there was a prespecified process associated with each drink. Making anespresso beverage, for example, required seven specific steps.The other type of training focused on “soft skills.” Alling explained:In our training manual, we explicitly teach partners to connect with customers—toenthusiastically welcome them to the store, to establish eye contact, to smile, and to try toremember their names and orders if they’re regulars. We also encourage partners to createconversations with customers using questions that require more than a yes or no answer. Sofor example, “I noticed you were looking at the menu board—what types of beverages do youtypically enjoy?” is a good question for a partner to ask.Starbucks’ “Just Say Yes” policy empowered partners to provide the best service possible, even ifit required going beyond company rules. “This means that if a customer spills a drink and asks for arefill, we’ll give it to him,” said Day. “Or if a customer doesn’t have cash and wants to pay with acheck (which we aren’t supposed to accept), then we’ll give her a sample drink for free. The lastthing we want to do is win the argument and lose the customer.”Most barista turnover occurred within the first 90 days of employment; if a barista lasted beyondthat, there was a high probability that he or she would stay for three years or more. “Our trainingends up being a self-selection process,” Alling said. Indeed, the ability to balance hard and soft skillsrequired a particular type of person, and Alling believed the challenges had only grown over time:Back in the days when we sold mostly beans, every customer who walked in the door was acoffee connoisseur, and it was easy for baristas to engage in chitchat while ringing up a bag.Those days are long gone. Today, almost every customer orders a handcrafted beverage. Ifthe line is stretching out the door and everyone’s clamoring for their coffee fix, it’s not thateasy to strike up a conversation with a customer.The complexity of the barista’s job had also increased over time; making a venti tazoberry andcrème, for instance, required 10 different steps. “It used to be that a barista could make everyvariation of drink we offered in half a day,” Day observed. “Nowadays, given our productproliferation, it would take 16 days of eight-hour shifts. There are literally hundreds of combinationsof drinks in our portfolio.”This job complexity was compounded by the fact that almost half of Starbucks’ customerscustomized their drinks. According to Day, this created a tension between product quality andcustomer focus for Starbucks:On the one hand, we train baristas to make beverages to our preestablished qualitystandards—this means enforcing a consistent process that baristas can master. On the otherhand, if a customer comes in and wants it their way—extra vanilla, for instance—what shouldwe do? Our heaviest users are always the most demanding. Of course, every time wecustomize, we slow down the service for everyone else. We also put a lot of strain on ourbaristas, who are already dealing with an extraordinary number of sophisticated drinks.One obvious solution to the problem was to hire more baristas to share the workload; however,the company had been extremely reluctant to do this in recent years, particularly given the economic5This document is authorized for use only in Business/Lower Division Capstone – 01072016 by Kelsey Dunning, Harrison College from January 2016 to July 2016. 504-016Starbucks: Delivering Customer Servicedownturn. Labor was already the company’s largest expense item in North America (see Exhibit 3),and Starbucks stores tended to be located in urban areas with high wage rates. Instead, the companyhad focused on increasing barista efficiency by removing all non-value-added tasks, simplifying thebeverage production process, and tinkering with the facility design to eliminate bottlenecks.In addition, the company had recently begun installing automated espresso machines in its NorthAmerican cafés. The verismo machines, which decreased the number of steps required to make anespresso beverage, reduced waste, improved consistency, and had generated an overwhelminglypositive customer and barista response.Measuring Service PerformanceStarbucks tracked service performance using a variety of metrics, including monthly statusreports and self-reported checklists. The company’s most prominent measurement tool was amystery shopper program called the “Customer Snapshot.” Under this program, every store wasvisited by an anonymous mystery shopper three times a quarter. Upon completing the visit, theshopper would rate the store on four “Basic Service” criteria:•Service—Did the register partner verbally greet the customer? Did the barista and registerpartner make eye contact with the customer? Say thank you?•Cleanliness—Was the store clean? The counters? The tables? The restrooms?•Product quality—Was the order filled accurately? Was the temperature of the drink withinrange? Was the beverage properly presented?•Speed of service—How long did the customer have to wait? The company’s goal was toserve a customer within three minutes, from back-of-the-line to drink-in-hand. Thisbenchmark was based on market research which indicated that the three-minute standard wasa key component in how current Starbucks customers defined “excellent service.”In addition to Basic Service, stores were also rated on “Legendary Service,” which was defined as“behavior that created a memorable experience for a customer, that inspired a customer to returnoften and tell a friend.” Legendary Service scores were based on secret shopper observations ofservice attributes such as partners initiating conversations with customers, partners recognizingcustomers by name or drink order, and partners being responsive to service problems.During 2002, the company’s Customer Snapshot scores had increased across all stores (seeExhibit 7), leading Day to comment, “The Snapshot is not a perfect measurement tool, but we believeit does a good job of measuring trends over the course of a quarter. In order for a store to do well onthe Snapshot, it needs to have sustainable processes in place that create a well-established pattern ofdoing things right so that it gets ‘caught’ doing things right.”CompetitionIn the United States, Starbucks competed against a variety of small-scale specialty coffee chains,most of which were regionally concentrated. Each tried to differentiate itself from Starbucks in adifferent way. For example, Minneapolis-based Caribou Coffee, which operated more than 200 storesin nine states, differentiated itself on store environment. Rather than offer an upscale, pseudoEuropean atmosphere, its strategy was to simulate the look and feel of an Alaskan lodge, with knotty6This document is authorized for use only in Business/Lower Division Capstone – 01072016 by Kelsey Dunning, Harrison College from January 2016 to July 2016. Starbucks: Delivering Customer Service504-016pine cabinetry, fireplaces, and soft seating. Another example was California-based Peet’s Coffee &Tea, which operated about 70 stores in five states. More than 60% of Peet’s revenues came from thesale of whole beans. Peet’s strategy was to build a super-premium brand by offering the freshestcoffee on the market. One of the ways it delivered on this promise was by “roasting to order,” that is,by hand roasting small batches of coffee at its California plant and making sure that all of its coffeeshipped within 24 hours of roasting.Starbucks also competed against thousands of independent specialty coffee shops. Some of theseindependent coffee shops offered a wide range of food and beverages, including beer, wine, andliquor; others offered satellite televisions or Internet-connected computers. Still others differentiatedthemselves by delivering highly personalized service to an eclectic clientele.Finally, Starbucks competed against donut and bagel chains such as Dunkin Donuts, whichoperated over 3,700 stores in 38 states. Dunkin Donuts attributed half of its sales to coffee and inrecent years had begun offering flavored coffee and noncoffee alternatives, such as Dunkaccino (acoffee and chocolate combination available with various toppings) and Vanilla Chai (a combinationof tea, vanilla, honey, and spices).Caffeinating the WorldThe company’s overall objective was to establish Starbucks as the “most recognized and respectedbrand in the world.”6 This ambitious goal required an aggressive growth strategy, and in 2002, thetwo biggest drivers of company growth were retail expansion and product innovation.Retail ExpansionStarbucks already owned close to one-third of America’s coffee bars, more than its next fivebiggest competitors combined. (By comparison, the U.S.’s second-largest player, Diedrich Coffee,operated fewer than 400 stores.) However, the company had plans to open 525 company-operatedand 225 licensed North American stores in 2003, and Schultz believed that there was no reason NorthAmerica could not eventually expand to at least 10,000 stores. As he put it, “These are still the earlydays of the company’s growth."7The company’s optimistic growth plans were based on a number of considerations:•First, coffee consumption was on the rise in the United States, following years of decline.More than 109 million people (about half of the U.S. population) now drank coffee every day,and an additional 52 million drank it on occasion. The market’s biggest growth appeared tobe among drinkers of specialty coffee,8 and it was estimated that about one-third of all U.S.coffee consumption took place outside of the home, in places such as offices, restaurants, andcoffee shops. (See Exhibit 6.)6 Starbucks 2002 Annual Report.7 Dina ElBoghdady, “Pouring It On: The Starbucks Strategy? Locations, Locations, Locations,” The Washington Post, August 25,2002.8 National Coffee Association.7This document is authorized for use only in Business/Lower Division Capstone – 01072016 by Kelsey Dunning, Harrison College from January…