market disruption

Starbucks: Ripe for Disruption, or Already Disrupted?

I suspect most people have heard by now of the kerfuffle about an internal memo, leaked through a popular Starbucks fan blogsite and ultimately covered by BusinessWeek, The Wall Street Journal, Forbes, CNN, etc., which was penned by the founder and chairman of Starbucks, Howard Schultz. Certainly the blogosphere is a-buzz with the come-to-Jesus nature of Schultz's personal revelation that Starbucks may have lost its mystique. I counted hundreds of blog postings - right up there with Britney Spears haircut and Anna Nicole Smith in popularity.

The memo itself was an interesting document that raises eyebrows and questions: although addressed to the president and other senior execs, was it always intended to be leaked via social media, into the mainstream press and back to the blogosphere?  It has certainly created a lot of passionate commentary and free advertising for Starbucks.

Was it really intended to tell the public that Starbucks knows that people are complaining and that the competitive sands are shifting? Was it a message to investors that the company needs to slow growth and fix the experience to save the brand and that it's going to cost a bundle?

Or was it just the confessions of a founder and Chairman, purging feelings of guilt about a loss of soul, and a plea to executives for salvation? (Which, incidentally made Starbucks look good while rallying those who are still passionate about the brand experience to Starbucks' defense?)

No matter which of these it was, it was a brilliant document, but it may be too little too late.

Too Little, Too Latte? Starbucks is the World's Pre-eminent Coffee Brand: How Can it Be So?

It really depends on whether the executives realize that disruption is afoot, and that there's much more going on here than the diminution of brand experience. To properly address this question, and explain why disruption is the real problem, it helps to go back to the beginning, and define the innovation that led to Starbucks becoming a household name approaching 15,000 stores around the world.

What problem did Starbucks solve for its customers?

Anyone who travelled in Europe BS (Before Starbucks) would have marvelled at the quality and variety of coffee, and the cafe culture there. Especially in places like Italy and France.

The coffees were strong, but fresh, well-prepared and a perfect complement to a day of sitting on a sidewalk under an umbrella people-watching, or to end a perfect meal, or a delightful jolt to start the day with a pain chocolat or even just toast and eggs. You would have wondered how everywhere you went, coffee could taste so strong, yet be so delicious and universally good.

On this side of the pond (outside of your favorite Little Italy restaurant), it was almost impossible to get a decent cup of coffee, and especially to get a strong cup that was drinkable. I remember wondering after every trip why it was that good coffee on our side of the pond was an oxymoron whilst on their side, it was impossible to get a bad one.

It wasn't just that most (North) American coffees were made from Robusta versus the superior Arabica beans. It also had to do with poor roasting, poor quality control, and the fact that we got used to crappy coffee during the second world war when everything was rationed and/or watered down.

By the 50s, everything was about speed and automation, and so we made matters worse by going from percolated to instant to freeze dried to Coffee-Mate powdered creamer (another oxymoron). We drank it by the gallon, rotting our stomachs, taste buds and brains in the process.

It was purely about the caffeine and the speed. (Wonder why we never distilled out the caffeine and dispensed it straight via injection?). Yes, in a few big cities, you could find that rare place that would serve a great European-style coffee, and sometimes even with a bit of the ambiance, but that was so small a percentage of consumption that it barely qualified as an exception to the rule.

The story is apocryphal, and published on Starbucks website, and in Schultz's book, about how Schultz felt exactly this way on visits to Milano, and decided that it was time Americans got to upgrade their coffee experience. And, not just create a better cup of coffee, but the same smell and feel and cultured experience and ambiance that you felt in a great Italian coffee bar. That was the beginning of Starbucks as we know it.

We'd been upgrading the experience for ourselves, as much as we could with drip coffee becoming more the norm in the 70s and 80s versus instant, but the vast majority of Americans had never had a quality cup of coffee nor enjoyed the sensuality of the European coffee culture. So, when Starbucks hit Seattle, we were ready for something different.

So What About Disruption?

Disruption theory says that products or services evolve incrementally to better meet the needs of the most demanding customers, but eventually overshoot the needs of most consumers. In this process, the incumbents that dominate the existing market build processes and operational efficiencies that enable them to maximize profitability and continually introduce new "sustaining innovations".

In the short term, these series of decisions that improve processes and efficiency are seen as good management, delivering better profits. In the long term, however, they create the opportunity for a disruptive innovator to enter the scene.

At the time when Starbucks began, the big coffee suppliers had enormously overshot the needs of their customers for a cheap, fast cup of coffee. Yet, each "innovation" they introduced kept on making the product either cheaper or faster to prepare, stripping the product of the original reasons we became addicted to it - its flavor first and foremost, but also its ability to facilitate social interaction, savor a great meal, sit and relax, etc.

So Starbucks was a disruptive innovator. It brought flavor, a friendly social setting (the "third place"), quality, plus the consistency that only a chain can do. They brought back the smells, the sensuality, and introduced to Americans a "European experience" -- and, what Schultz has described as the sense of theater.

But isn't disruptive innovation "low-end"? How does a $5 cuppa disrupt?


But, you might be saying, Starbucks introduced a high-end innovation -- disruptive innovations typically are aimed at the low-end markets and low-end needs.  Well, you'd be right, usually, but the question is: what needs were low-end, or more accurately underserved?

The characteristic that initially made Starbucks a small niche disruption was the speed. The big producers were optimized for speed above all else, not flavor and certainly not the organic pleasure of a gathering place with great smells where you hang out with your friends.

The characteristic of Starbucks' innovation that was just good enough for the original niche of coffee culture appreciators was the speed.  They were happy to sacrifice the speed of picking up a pot of coffee off the Bunn burner (ironic that they called these things burners, because that's what they did/do to most pots left longer than 5 minutes) and pouring it straight to the cup and from there to the lips, in order to drink something they truly enjoyed, and to experience the coffee bar ambiance.

Initially, potential competitors to Starbucks ignored them because the market wasn't big enough for Dunkin Donuts or McDonalds to care about. To them, Starbucks coffee drinkers were aficionados -- a tiny specialized segment that had nothing to do with the mainstream, who they perceived still mostly wanted speed.

This ignorance is typical (and logical) to mainstream vendors who aim to maximize profit by serving the largest market as efficiently as possible. It also allowed Starbucks to "fly under the radar" for a long time -- over 20 years of strong growth -- allowing them to build their market unimpeded by real competition.

Yes, there are smaller chain coffee brands, like Caribou and Peets, etc., but their presence serves to expand the market for all specialty coffee vendors, and benefits the leader, i.e. Starbucks, disproportionately. But, Starbuck has become mainstream, and they can no longer hide -- they are officially perceived as a real threat to the foodservice business of other big companies.

But Starbucks is the leader and still growing. Are you seriously saying they might be "disrupted"? By who, and how?

As noted, disruption can take a long time to play out, and the seeds are sown long before the heavy damage is done.

As Starbucks has grown, they have focused on operational efficiencies to grow faster and more profitably. Efficiencies such as automatic espresso machines, flavor-sealed packaging (which eliminates the great smell of a real coffee shop), and expanding merchandise options ("would you like some fries with that doppio mocha latte half-caf with low fat milk?") to extract every last penny of same-store sales growth.

In the process, they have incrementally sacrificed seemingly small parts of the experience -- the smell, the theater, the ambiance (who wants a line snaking around the tables while you're trying to relax or have a conversation over a cuppa?), the service quality (rapid growth almost always comes with higher turnover and poorer training -- by now, we've all experienced the surly baristas who won't go the extra mile, but still make too many mistakes), etc.

The endgame: they've reduced themselves to serving a pretty-good-but-not-outstanding cup of coffee, too slowly and at too high a price. And, more importantly, they've overshot the needs of their customers, and are ripe for disruption.

To speed up coffee service in order to sell everything else too, they installed automatic machines. Automatic machines can be more consistent, especially for inexperienced operators, but they also reduce the flavor and the authenticity of the experience, and show competitors how they too can produce a cup just as good as Starbucks (i.e. open themselves to commoditization). This was an unnecessary and ill-advised "innovation". 

Customers didn't ask for it, would probably agree that they didn't need it, and in general would feel that they are getting less for their money. Do I really need a bacon and egg (McMuffin) breakfast with my espresso?

Again, the more I overlap with my competition, the more I illustrate to them how to compete with me.  And now I smell eggs cooking, not coffee beans and fresh espresso.  Not wise.

Most fanatical customers who still are, were more fanatical 10 years ago, so what have these innovations added?

In becoming ubiquitous, the mystique is demystified, the coffee which was the central feature has become a means to sell myriad other food items and irrelevant merchandise (t-shirts anyone?), and the taste and smell and comfort have all been diminished. Yet, the high price remains. And, therein lie the seeds for potential disruption.

Because now, wanting a good cup of coffee has become mainstream, and Starbucks has become focused on speed (but not really), and efficiency, and foodservice, and add-on sales and rapid growth, they now face a new reality.

It's easy to add a pretty good cup of coffee to the menu. Especially for companies like McDonalds and Dunkin Donuts who already served coffee.  All they have to do is add middle-of-the-road or better automatic machines to their operation, and they're almost as good.

But, they excel at real speed and efficiency, and are optimized to process customers in seconds or at most a minute or two, whereas Starbucks will never get that fast without redesigning every store and adding a lot more baristas. Moreover, they are value-oriented -- i.e. cheap. For McDonalds, $1.25 for coffee is an improvement in margin, but for Starbucks, it's impossible to go that low.

So, if I can get something almost as good for 1/3 the price, is that 'good enough'? Heck, even the the local QuikTrip service stations can create a relatively decent cup of coffee or espresso now.

And, more than commoditization, Starbucks' real problem now is that the competition is 'good enough' to be disruptive and undermine their business. But here's the real conundrum Starbucks faces. It will be almost impossible to go back.

Replacing the automatic machines with better quality semi-automatic or manual, and fresh ground and hand-tamped shots means throwing out a lot of expensive machines. It means they will go a bit slower for each coffee, which also means they'll need more people and more space for brewing. And, they'll need to increase their training expense enormously.

It will be hard to explain to investors why all the superfluous merchandise needs to come out of the stores, and why same-store sales will likely decrease. It will be even harder to recognize that for the mainstream coffee consumer, a $1.25 cup of coffee is good enough, even if I can't quite bring myself to visit McDonalds, and so there will be increasing downward pressure on price.

And, if they don't want to compete on price, then they probably already have too many stores, because the average consumer won't continue to spend a premium price for a commodity that is only marginally better than the competition.

Coffee Customization at Its Finest

Coffee art from danyrolux on Vimeo.

To Schultz's credit, he recognizes that all is not well. And, he's recognizing it at a time of apparent strength. Starbucks just announced another record year where revenue grew 23%, 1177 new stores were added, and same-store sales increased 6% over the previous year (although the rate of increase is slowing, these are still impressive numbers for a $6.7B company.

If he can convince his executives and board and investors that a strategic overhaul is required to address the looming disruption, then he may well be able to avert it, but it isn't as simple now as returning to the good old days of better quality machines, better service, less merchandise, whole beans scooped out of bins rather than prepackaged in flavor-sealed bags, more uniqueness in each store, etc. They will need a plan designed specifically to address the disruption Starbucks faces from new competitors, or else the disruptor will become the disruptee.

Acknowledging that the market has changed irrevocably, and is now attracting disruptive 'good enough' solutions for quality coffee, but at a lower price and faster pace, what would you do to re-energize Starbucks and fend off a loss of leadership position in the coming years?

Links for coffee fans

Koffee Korner - coffee history and culture - the science of coffee
Wikipedia - coffee history
Wikipedia (2) - all about coffee
Starbucks Gossip - blog that broke the story

There is a follow up article to this post here: Has Starbucks gone far enough?

The Long Tail of Market Disruption

. . . in which we examine how marketing professionals and creators of all types of products and services can use this upside-down view of the world to market more effectively.

The Long Tail According to Chris Anderson

Quickly summarized, the 'Long Tail' refers to the shape of a curve which has a concentration of high values for a small number of occurrences, and tails off to much lower values (approaches zero) for the vast majority of occurrences. The long tail is the part of the graph that is continuously approaching zero.

In Chris's writing, he examines the long tail of sales for all the products in a given category that were not 'bestsellers', or 'hits', or 'blockbusters', but rather catered to a much smaller niche audience.

Traditional views of the world see business as a "winner-take-all" venture, where the top two or three products represent 80 to 90 percent of all sales.

Or where Tiger Woods' income is more than twice Phil Mickelson's, and Phil's is more than twice the next highest. And together, they earn more than the rest of the PGA tour combined.

We have become acclimatized to thinking there is nothing beyond number 1 and number 2.

Chris Anderson coined the term Long Tail a couple of years ago in an article he wrote as editor of Wired Magazine. He has expanded his discussion of the Long Tail into a whole book which is now published, and rapidly ascending the NY Times bestseller list (ironically, it is not a 'Long Tail' book, but a very solid 'Head'). 

Although it has been called the Long Tail theory, much of what Chris has observed is not really theoretical at all, but plainly evident. There is no disputing the shape of sales data curves, nor can we dispute that the internet has introduced a new dynamic to sales of anything that can be digitized (and therefore has a low-cost footprint for storage and distribution).

What Anderson points out is that through most of the past century, and especially since the advent of broadcast media, we have tended towards a one-size-fits-all kind of mass marketing that emphasizes only the winners, or the head of the curve, and ignores the tail. Yet there are vast numbers of tiny niche products which in total represent much larger markets or unit sales than the hits.

The new order

The book is primarily about how the internet changes the economic equation for the the tail of the curve and enables niche products to find their audience efficiently (or vice versa). It focuses on digital and digitizable media and entertainment products - books, CDs, DVDs, film, music where the examples are most obvious because they are all information products.

Amazon, eBay, Netflix and iTunes have demonstrated amply that with "unlimited shelf space" and near zero-cost accessibility to niche products, huge revenues can be generated from what we used to think of as marginal (loser) products. But we knew that -- all of us have idiosyncratic preferences and things that we buy on foreign vacations because you can't get them here.

These internet stores just prove what was already obvious -- if you had access to things you like at a reasonable price, you will buy them, no matter how few other people do the same.

The bigger questions for me concern the niches rather than their aggregation. Internet retailers can generate hit-sized sales volumes from the aggregation of very large number of products selling in relatively small quantities -- their economics aren't so different from the old model, except that more products are in the channel. But that same model doesn't necessarily apply to the producers of small volume niche products.

What incentives do they have to fill the niche channels and how do they market effectively to make money at this game? Does thinking about things this way imply anything different for the marketer of a bona fide hit, mass market product or those products that are in 3rd through 10th place - the great middle mass market?

Are there existing markets we can learn from that have always been about selling the long tail?

These are questions that Anderson largely leaves unanswered, and an area of huge opportunity for businesses that understand we are going through a disruptive realignment of how companies create products and relate to customers.

What corporate America is only beginning to wake up to is that this realignment changes everything. The iconic companies of the industrial revolution must adapt or die.

This is also true of the vast army of traditionally-oriented marketing agencies supporting them that still have blinders on as well.

In my view, we are only beginning to see the upending of long held beliefs about "the right way" to market products. The next few installments of my blog will focus on these long tail marketing issues.

If you haven't already visited, Chris has an excellent Long Tail blog with links to many other sites discussing Long Tail implications. And, just so that we recognize that the hype the Long Tail is getting doesn't mean that's the only point of view, here's another way of looking at it The Shape of the Tail.