Starbucks' strategy adds stores by cupful

By Dina ElBoghdady
Washington Post

WASHINGTON — On one episode of "The Simpsons," Bart saunters into a mall to get his ear pierced, only to be rushed by the sale sclerk.

Workers put the finishing touches on a Starbucks coffee shop scheduled to open next weekend in San Juan, Puerto Rico. Associated Press

As Bart leaves, the distinctive white-on-green Starbucks logo hangs over the old store — and over every other storefront in the mall.

Just about everyone has felt like Bart at some point in the past decade. Consider Washington's hip Dupont Circle area, with four Starbucks stores in eight blocks. Each serves a customer who might not cross the circle just to grab a latte.

The effect is intentional, and the strategy behind it is as counterintuitive as it may be irritating.

Conventional wisdom dictates that a retailer that crams stores close to one another cannibalizes its own sales. Yet Starbucks embraced self-cannibalization as the fastest way to expand its business.

Coffee entrepreneur Howard Schultz, who built Starbucks into a global goliath, said that decision was made in the early 1990s, a few years after he purchased the small chain from its founders. The company was in what should have been a predicament: two stores across the street from each other in Vancouver, British Columbia.

The first, a tiny but top-performing shop, was in a building about to be closed for remodeling. Fearful of what might happen, Starbucks opened a larger store 30 yards away.

Not only did the two stores coexist, they thrived. Since then, Starbucks has replicated the model with similar results nationwide.

A new Starbucks location typically eats away at the business of the older one nearby — at first. Within a year, though, sales at the original store recover. Even if they don't, the company would rather have one store lose those sales to another Starbucks than to a competitor.

Deliberate cannibalization

Today, Starbucks has 4,479 locations in North America and 1,256 overseas. It continues to open three to four stores a day.

"We self-cannibalize at least a third of our stores every day," Schultz said in a recent interview.

The approach worked on several fronts. In the early days, when the Seattle-based coffee company had little advertising money, it used its storefronts as billboards and clustered them close together. The goals were to intercept consumers on their commute and build brand awareness through ubiquity. Now, the nearly $3 billion-a-year empire has inspired thousands of copycats.

It was by no means a revolution in retailing. Franchisees for Dunkin' Donuts saw a similar effect when they clustered stores in New England.

The tactic gave them more street exposure, allowed them to pool advertising dollars and drove traffic into their stores.

"The lesson learned by both Starbucks and Dunkin' Donuts is that a retailer can create demand where demand is latent," said Jim McKenna, president of McKenna Associates Corp., a retail real estate training firm in Milton, Mass. "They can increase the size of the pie."

Starbucks blasted open a new market by turning a basic commodity into an indulgent necessity for the 20 million customers it serves each week, creating an espresso bar culture nonexistent in this country only two decades ago.

American coffee consumption has increased steadily since 1995. More than 109 million people, about half of the adult population, drink coffee every day, and an additional 52 million (about 25 percent) drink it on occasion, the National Coffee Association of U.S.A. Inc. reported.

The biggest gains are among daily and occasional drinkers of "gourmet" coffee of the kind popularized by Starbucks. Those drinkers' ranks grew from 87 million people in 1997 to 150 million last year. Analysts and rivals say the chain has mastered real estate by picking spots populated with well-educated, well-paid and well-traveled consumers who appreciate a pricey cup of java.

Because of its "early mover" advantage, Starbucks owns almost half of the nation's 13,500 coffee bars, the Specialty Coffee Association of America estimates. The market's second-largest player, Diedrich Coffee Inc. of Irvine, Calif., owner of Gloria Jean's Coffees, lags with a mere 383 stores.

"Starbucks now commands so much 'disk space' in consumers' heads that it's extremely difficult to compete against them," said Nancy Koehn, a professor of business administration at Harvard Business School. "It built its brand through its storefronts, and that is a very powerful word of mouth."

No franchisees

In 1993, the company had its first East Coast spot, on Wisconsin Avenue NW in Washington. Back then, with 272 stores, Starbucks was already a tough lease negotiator, said Chris Weilminster, vice president of anchor-tenant leasing for Federal Realty Investment Trust, owner of 23 retail properties in the region.

The typical mall or strip-mall landlord collects a percentage of sales from a retail tenant in addition to a base rent, Weilminster said. Under the lease terms, the landlord usually bans the retailer from opening another store inside a certain radius. The idea is to keep the retailer from cannibalizing its own sales, thereby depressing the landlord's share.

Starbucks chose not to franchise, which meant staying away from territorial franchisees, who often want to limit new stores. It decided not to accept landlord restrictions either, believing demand for its coffee would exceed the capacity of any one store.

"We were willing to accept those terms because they were willing to pay higher rent," Weilminster said. "They would pay to avoid having those types of radius restrictions."

Those deals helped Starbucks lock in prime real estate, leaving upstart rivals at a disadvantage.

The company says it's nowhere close to saturation nationwide. In a recent call with stock analysts who closely follow the company's fortunes, Starbucks officials said only seven states have more than 100 Starbucks stores.

"These are still the early days of the company's growth," Schultz said in a later interview.

Hawai'i is one relatively new and growing market, with 30 Starbucks stores and three scheduled to open later this year.

Greg Meier, president of the local operator Coffee Partners Hawaii, said the company found demand so high at downtown Honolulu and Ward Centre locations that new stores a block away had to be opened.

"As the lines were getting long, customers were basically indicating that they wanted more convenient locations close by," he said.

Fueling that growth are Starbucks' impressive customer frequency counts. While consumers visit local shopping malls about 3.7 times a month and their local video store about twice, loyal Starbucks customers come in 18 times a month.

A key barometer used by capital markets to gauge a retailer's success are the sales at stores open more than a year, also known as same-store or comparable-store sales.

How many is too many?

The more stores a chain opens in a densely populated area, the more likely its same-store numbers will drop. Also, the business can suffer if the chain expands so rapidly that its service or the quality of its product slips, analysts said.

For example, Home Depot Inc. got slammed by shoppers for poor service as the chain grew larger. Its same-store sales were practically flat last quarter, Home Depot executives said.

Joanna Barsh, a director at consulting firm McKinsey & Co., tracked 400 publicly traded retailers from 1990 to 2000 and found that only 38 percent of those that were "stars" at the start retained that status 10 years later.

Those who clung to their status kept reinventing their services or products while watching for the next new shopping occasion.

Wal-Mart Stores Inc., for instance, added food to some of its discount stores and morphed into one of the nation's top five grocers, Barsh said.

Starbucks is striving to introduce new beverages that will attract more customers, of various ages, during different times of day. In just a decade, it has broadened its menu from 15 to 30 drinks. That's in addition to the bottled beverages and ice cream it sells in grocery stores.

How many stores are too many?

Starbucks doesn't seem to know and, for now, financial analysts don't seem to care.

"As long as the performance is there, the question won't be front and center," said Patrick Schumann, an analyst with Edward Jones.

Last month, Starbucks reported a 20 percent profit boost in the quarter ended June 30. It netted $56.2 million, compared with $46.8 million a year earlier.Same-store sales have fluctuated over the past decade. But they have remained positive for 120 months in a row, with an 8 percent year-over-year gain last quarter.

Investors got a solid 14.4 percent return on equity in 2001, comfortably above the 10.4 percent median for Fortune 500 companies that year. With that track record, Starbucks sees no reason to retrench. Its stores, about 5,700, should double in number by 2005. In the past quarter, it opened its first stores in Germany and Spain.