A "Latte" of Changes in Store for Starbucks

By , Money Morning •

By Mike Caggeso
Associate Editor
Howard Schultz, founder and chairman of Starbucks Corp. (SBUX), could use a good, stiff drink.

Starbucks has been announcing major shakeups that affect nearly every element of operations this year as it copes with sliding sales, greater competition, and soaring coffee bean prices.

Since Jan. 1, Starbucks has:

  • Ousted CEO Jim Donald and replaced him with Schultz, who previous held the job from 1987 to 2000.
  • Assembled a new senior management team.
  • Tested $1 coffees and free refills in its home market of Seattle.
  • Announced 100 underperforming stores in the United States would close.
  • Cut its net number of planned locations by 350.
  • Halted sale of hot breakfast sandwiches.
  • Struck a deal with AT&T to provide Starbucks Card holders free Wi-Fi.
  • Tested a $2.50 premium coffee in Seattle.
  • Temporarily closed its near 10,000 U.S. locations to retrain its 135,000 baristas.
  • Named Cliff Burrows president of U.S. operations.
  • Announced 600 job cuts in various U.S. locations.

"Change will not happen overnight. It will evolve over time, but I ensure you a positive change will occur," Schultz said in a statement in January.

The frenetic pace of changes for the coffee company might not be quite "overnight," but that's still a lot of changes for less than three months.
And yet, there is much more in store.

Last week at Starbucks' annual shareholders meeting, Schultz outlined major "back to basics" changes that are aimed at regaining the Seattle-based premium brewer's stranglehold on the market. Among them:

  • Begin selling a new everyday brew, Pike Place Roast [named after Starbucks' first location at Seattle's famous Pike Place Market].
  • Brew smaller batches of coffee to be served in 30 minutes or less.
  • Phase in a new espresso machine, the Mastrena, made by Thermoplan AG.
  • Buy Coffee Equipment Co., maker of the industry-favorite Clover single-cup commercial brewer, and introduce the machines to many U.S. locations.
  • Give Starbucks Card holders more benefits, including a free beverage when they buy a pound of coffee.
  • Launch www.mystarbucksidea.com, a social networking site.

"By embracing our heritage, returning to our core - all things coffee - and our relentless commitment to innovation, we will reignite the emotional connection we have with our customers and transform the Starbucks experience," Schultz said in a statement.

Nipping at the Giant's Heels

Not too long ago, Starbucks was setting up franchises seemingly everywhere at a caffeinated pace. Pop culture paid close attention to the rising coffee dynasty - with spoofs in "Austin Powers: International Man of Mystery" and online satirical news site, The Onion, which joked that Starbucks was unveiling a new location in the restroom of an existing Starbucks.

But while Starbucks was riding its wave, a bevy of competitors were brewing plans to unseat the coffee king. Among them, Tim Hortons Inc. (THI), Mud Coffee, Caribou Coffee Co., Inc. (CBOU), Cosi, Inc. (COSI), Panera Bread Co. (PNRA), and Dunkin' Brands, Inc., whose Dunkin' Donuts chain is currently running a snarky commercial campaign that mocks the "Fritalian" language on Starbucks' menu offerings.

Also in that arena, the rise of egregiously caffeinated energy drinks supplanted a good portion of coffee drinkers - the ones that bypass the taste of coffee and just provide its intended head rush. In response, Starbucks is expanding its menu to include energy drinks.

So much for returning to "all things coffee."

However, its biggest competitor is fast-food kingpin McDonald's Corp. (MCD), whose recent facelift included an upgrade to premium blend coffee and iced coffees.

And more are coming, as beverages are one of three key areas of focus for 2008, McDonald's said in its 2007 Annual Report. After the company buys new beverage equipment and trains employees, customers can expect drinks such as smoothies, frappes and espressos using "McCafe Specialty Coffee" beans.

Rising Coffee Prices

Coffee prices have risen 23% in the past six months. In normal economic times, a coffee titan as big as Starbucks could blunt the pain.

But on top of that, the falling U.S. dollar means that coffee importers are getting fewer beans for their buck.

"There is nothing fundamentally that suggests coffee should be higher, but due to the volatility in the stock market, the prices have remained high because the dollar has been devaluating against other currencies," Jay Isais, coffee buyer for Los Angeles-based Coffee Bean & Tea Leaf, told the San Jose Mercury News.

Mix that with penny-pinched U.S. consumers, and you have the recipe that's played a large part in Starbucks' stock tailspin from its Oct. 2006 high of near $38.

Important to note, however, Starbucks' stock troubles began well before the credit crunch began crippling budgets and rising food costs stung retailers.

And that makes it hard for John Langston, a senior analyst at Hodges Capital Management, to drink Schultz's Kool-Aid. 

"I didn't really hear anything that blew my skirt up," he told Reuters.
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