StockTalk:
TMF Interview With Starbucks CEO Howard Schultz
With Yi-Hsin Chang (TMF Puck)
and Brian Graney (TMF Panic)

September 3, 1998

Hello and welcome to Howard Schultz, chairman and CEO of Seattle-based Starbucks Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SBUX)") else Response.Write("(Nasdaq: SBUX)") end if %>. Since going public in 1992, this premium coffeehouse operator has grown earnings per share at a 34% annualized rate, compared to 22% for the S&P 500.

TMF: Thank you for joining us, Mr. Schultz.

Schultz: My pleasure. Thank you very much for having me.

TMF: You know we are going to ask this at some point in time, so let's get it right out of the way. Your same-store sales numbers have fallen a little bit from their historical growth rate in recent months. We just wanted to know if you can explain what caused the slide, and how is management fixing the problem?

Schultz: Let's begin by saying that we've had, I think, since going public in June of 1992, 76 consecutive months of positive [comparable]-store sales, which is a record, I think, that any retailer, any merchant would like to have. In many ways, Starbucks has been kind of a prisoner of its own success because our comps have been so strong over the years. We gave guidance to the Street that we would have mid-single-digit comps for the fiscal year ending September 30, and that's exactly where we'll end up.

There have always been monthly anomalies up and down, and you know we're at 2% in July and 3% in August. I really don't think it's something to be seriously concerned about, although there are some Wall Street analysts who are very, very fixated on comp-store sales, and as a result of that, I think sometimes the Street overreacts. I will say that, with regard to our company, I've always believed that comp-store sales were not as important to us as it has been to traditional retailers for two very, very important reasons.

One, over the last five years, because Starbucks has continued to open up one new store every single day, we have self-cannibalized over 30% of our stores each year, building market share rather than focusing on store comps, doing everything we can to satisfy our customer. The second thing is we continue to develop new channels of distribution that over time have the potential to both serve new customers and again cannibalize existing stores.

So, I think when people really do the analysis, Starbucks is building market share and serving new customers. The most important factor for me when I look at the retail growth of each store has not been comp-store sales but more significantly what has been the comp-store transaction traffic. Since December of 1997, each and every month leading up to today we've been up between 3% and 4%, which is a record that really is almost an ideal number for us, which means new customers are coming in the door, which is instrumental to the company.

"Starbucks has continued to open up one new store every single day, we have self-cannibalized over 30% of our stores each year, building market share rather than focusing on store comps."

TMF: You mentioned Starbucks' rapid growth. I don't know if you've seen this mock press release that's been floating around the Internet, but it jokes that Starbucks has just opened another branch in a Starbucks restroom. (Laughter.) Just wondering, what are your plans going forward, and do you think that Starbucks is near a saturation point?

Schultz: I have seen that [press release]. Let me try and kind of piece together what the strategy of the company is and why I think in some ways that also has been misunderstood. First off, in 1987 Starbucks ended the year with 11 stores and 100 employees. We'll end fiscal 1998 at the end of September with over 1,900 stores and almost 30,000 employees. There are 7 million customers a week going through our stores, and I believe we have the highest degree of loyalty/frequency of any retailer in America, where the average Starbucks customer is coming in 18 times a month.

Now having said that, one of the great ironies of the success of our company is, despite our success going from $15 million in '87 to over $1 billion this year, we have less than 10% of the market share of coffee consumption in America. So, we believe that we are still in the infant stages of the growth, the development, and the number of new retail stores that we're going to put, not only in North America, but around the world.

I think we have demonstrated that a company can get big and stay small by maintaining its intimacy with both its people and its customers, and maintain the most important aspect of building the brand and that is trust in the customer, the trademark, the experience, and the quality of the things that we do, primarily coffee.

TMF: Have you learned anything from the past expansions that you'll apply toward the new expansions?

Schultz: Certainly, I think we're a much more mature company today than we were five to ten years ago, and I think that we've really been able to leverage the infrastructure of our real-estate department, our marketing, and our merchandising to really build quality stores in neighborhoods and communities where people really are embracing Starbucks.

I think the most impressive thing about what we have done over the last couple of years, aside from the development of the store base in North America, is we've now opened stores throughout Asia -- Japan, Singapore, the Philippines, Thailand, and many new countries are coming -- and with no exception, every single country that we've opened up stores without a dollar of advertising has embraced Starbucks. The acquisition in the U.K. gives us a tremendous springboard now. We've said publicly that we will open up incrementally 500 new stores in Europe and 500 new stores in Asia by the end of 2003. So the most significant thing that we have learned is that the growth, the development, and the scale of what we're building is that we are committed to executing a global strategy in which Starbucks is going to be the most respected and recognized brand of coffee around the world.

We've learned that our domestic expansion not only is in the early stages but because coffee is consumed all over the world -- most adults in the free world drink two cups of coffee a day; we believe most of it is not very good -- that Starbucks has a unique opportunity to not only build a global brand but to have a retail presence around the world complemented by the beginning of a new growth vehicle for the company, and that's the new complementary channel of distribution of creating products and categories for the grocery stores as we develop our retail business. So, we're in a very unique position, I believe.

"One of the great ironies of the success of our company is, despite our success going from $15 million in 1987 to over $1 billion this year, we have less than 10% of the market share of coffee consumption in America."

I also believe that we will demonstrate and execute the fact that ubiquity is not something to back off of, but we can I think be able to execute elegance and style, build a bigger company at the same time maintain our values and our guiding principles by preserving those things that were very, very important to us when we were small and making sure that we do everything we can to embrace them as we get larger.

TMF: Up to now, you've been operating without any real nationwide competition. In the near future, a rival chain is bound to emerge. How will you ward off such competition without having to lower your prices?

Schultz: The truth of the matter is we've had very, very good competitors all over the country in local and retail markets as we've grown, and I think for any retailer those local and regional competitors tend to be as strong as any national competitor that might emerge. We are a company, I think, that practices great humility, and we don't want to be arrogant on any level, and if a competitor emerges we think we're very prepared because of the equity of the brand and the trust that people have in what we do.

But we're not in any way thinking that what we do is going to be accepted just because we do it. Success is something that is not an entitlement. It has to be earned. And I think that every great retailer that has emerged and has sustained has to reinvent and be committed to self-renewal, and that has been the hallmark of our company.

TMF: Two new developments at the company are the Starbucks magazine and also the Starbucks caf�s. I was wondering if you would talk a little bit about these two products and what they mean for the company in the future.

Schultz: Caf� Starbucks is what we believe to be an exciting new potential growth vehicle for the company. I can't talk too much about it because the first one has not opened yet. The first one will open in Seattle, I believe, on September 11. It's a very, very exciting product that we've worked on now for over a year -- extending the day part from early morning to late evening. It has a whole new component to it with the addition of prepared foods but most importantly a whole new line of proprietary beverages that links alcohol and coffee to produce the very best, unique taste of coffee, of course, that we've ever experienced. And we believe that it's going to be a big idea for the company and a big idea for our customers, but again not having served one customer yet, I don't want to go too far with that.

There have been rumors that I can't really comment on about Starbucks magazine. This is a company that continues to look for new ways to add value to our customers, be relevant to our customers. We're looking at a lot of things, but I can't comment on the magazine today.

TMF: Going back to the Caf� Starbucks, what type of food will you be serving, and will this be in a fast-food format or will it be a sit-down restaurant?

"We are committed to executing a global strategy in which Starbucks is going to be the most respected and recognized brand of coffee around the world."

Schultz: I've never viewed Starbucks either in our current formats or in the future to be anything close to being a fast-food business, so what we're going to try and do is really build the kind of environment that continues to be the third place for our customers between home and work and in this setting there will be prepared foods that will be more restaurant-like -- breakfast, lunch, and dinner, very unique foods, tremendous value, and, as I said earlier, a very significant evening-day part that we believe our customers want from Starbucks that is skewed towards new coffee cocktails linking liquor and coffee.

TMF: What are the main financial moving parts of the company that you think investors should focus on and keep track of? Is it same-store sales, cash flow, inventory, or possibly something else?

Schultz: I reiterate I do not think same-store sales is the primary criteria in which to judge Starbucks' financial performance. This is a company that for the first nine years of its life grew at over 50% compounded, will grow at over 30% this year, and we've given counsel to the Street that we will grow over 30% in 1999 and 35% EPS, but I think the driving success of the formula for Starbucks is our retail stores. We've been able, I think, to create very attractive unit economics in that business.

We now believe that we can leverage the equity of the brand into new products on the grocery shelf. We have the number one coffee ice cream in America. We have a bottled Frappuccino product in a joint venture with Pepsi that has 90% market share in the ready-to-drink coffee market. And now for the first time something we're very excited about is we're beginning to roll out on the West Coast and we'll execute a national strategy in 1999 -- Starbucks coffee in grocery stores all over the country.

The financial performance of the company is something we've always been proud of, and I think it's a strong record of growth and development and doing everything we can to really build long-term value for our shareholders. I will say that we tried over the years to link long-term value for our shareholders with creating long-term value for our people. In 1988-89, Starbucks became the first privately held company in America to provide equity in the form of stock options and comprehensive health care to part-time people. That has resulted in a very low attrition rate and very strong financial performance in our stores and has rewarded our shareholders with the kind of company and hopefully the kind of stock performance and comps that we would be very proud of as a stakeholder in our company.

TMF: And that is actually all the time that we have. Thank you so much, Mr. Schultz, for joining us today.

Schultz: Thank you very much. It went too quick.

TMF: (Laughter.) You'll have to come back.

Schultz: Okay. Thank you.

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