Two years ago, Sebastian Simsch started noticing large groups of people crowding into his independent coffee shop in Seattle. As they nosed around, some of the visitors made notes in folders labelled ‘Observation’. “I thought it was funny,” he says. But then he discovered that they were all employees of one of his biggest competitors, Starbucks, and the third time they came in he told them: “If you want to buy something, that’s great. But just to look – that’s not cool.”

Not long afterwards, a couple of the city’s Starbucks branches closed down. Builder’s fences went up, with signs that read: “Your neighbourhood coffee shop is getting a makeover.” And in due course those cafés reopened. Only now they served coffee a new way – dripping slowly through paper filters – as well as beer and wine. They promised evenings of music and poetry. The fittings looked inexpensive, roughed-up, and included discarded theatre seats. Nowhere was the name Starbucks visible.

Make no mistake: these were Starbucks cafés. But they’d been ‘de-branded’, to look homely, independent and ‘authentic’ instead of homogenous and bland. And high time too, you might think. Because as one customer put it in a comment on a blog: “The old Starbucks seems ‘bloated’, ‘suburban’, and ‘irrelevant’ these days – a haunting reminder of flush times now gone.”

It may seem hard to believe, but 2011 marks the company’s 40th anniversary. In the course of four decades the company has changed enormously. When Starbucks was founded, in 1971, it didn’t serve drinks. Customers came in, bought some beans, and left. Nobody hung around. Starbucks became the place we know today only after Howard Schultz joined as director of operations and marketing and – on a trip to Milan – was blown away by the theatrical ethos of baristas, the neighbourhood feel of the cafés and the sheer number of them. He decided to turn his bean retailer into something similar.

It took a while for his partners to let him. It’s hard to imagine now that opening coffee shops could be particularly risky – but this was before the appearance of Friends, the long-running and hugely successful American sitcom substantially set in one. Only after Schultz bought out the others did Starbucks become the place he imagined – a comforting refuge with a sense of community, a third place for people to congregate beyond work or the home, with a layout that could accommodate both fast service and quiet moments. Like in Milan, Starbucks’ baristas (an Italian word that Starbucks drove into everyday English use) became familiar with regular customers, learning their names and their favourite drinks.

The effect on customers’ daily routine was genuinely transformative. “When Starbucks arrived, it had an air of quality and excitement and novelty,” says Peter Backman, managing director of the British restaurant analysts Horizons. “It gave us somewhere that was clean where you could go and relax on the high street. And that was a major thing.”

As if to mark the company’s milestone birthday, Starbucks recently opened a branch in Milan, its spiritual birthplace. And Schultz is publishing a book (his second). “The world has

Clockwise from above: CEO Howard Schultz; the original Starbucks in Pike Place, Seattle; and the company’s distinctive advertising

changed in ways I couldn’t have imagined,” he explained recently. What he didn’t say, but will perhaps investigate in the book, is that the world has changed, in many ways, because of Starbucks.

The company has changed the way businesses operate, and not only in its own sector. It became a significant presence in the record and publishing industries. Having familiarised us with the idea of a space somewhere between play and work, it brought something similar into bookshops, airports and hotels. It’s arguable that Starbucks provided the inspiration for places such as The Hub network, which currently has locations in 12 cities on four continents. Hubs describe themselves as innovative spaces for meeting, working and relaxing – something between a serviced office and a members club – with coffee and other sustenance available at a counter.

And Starbucks’ endorsement of what might be called caring capitalism encouraged others to follow suit. As long ago as 1990, when Douglas Coupland immortalised “low-pay, low-prestige, low-dignity, low-benefit” service-sector work as “McJobs” in his novel Generation X, Starbucks was methodically seeking to attract and retain enthusiastic staff. Even before it became profitable, Schultz offered healthcare even to part-time workers and unmarried spouses.

In part, he was motivated by personal sentiment. He’d seen his father work hard with little to show for it. But he was also convinced that hiring enthusiasts on good terms would have benefits for the company: happy workers contribute value, he would say, and stay in their jobs longer. He was right: while other fast-food retailers lost staff at rates as high as 400% a year, Starbucks’ turnover was a relatively low 65%. With the cost of replacing and retraining at around $3,000 each time, keeping people in employment with healthcare cover would pay for itself. For this insight, Schultz was invited to the White House to brief President Bill Clinton on his own healthcare proposals. For similar reasons, Schultz introduced a stock option for staff, who would no longer be called employees but “partners”. From now on, Starbucks would routinely appear in surveys of the best places to work or most admired companies.

Schultz also introduced a corporate mission and made it easy for those partners to point out, anonymously or not, when the management took a wrong course. He reviewed every submission. One early crisis, identified through this mechanism, highlighted a conflict between the company’s attachment to high-quality coffee and customer service: when customers started asking for no-fat milk, Schultz and others concluded that this would not taste as good as full fat. But customers were given what they wanted – and product quality was compromised.

Arguably the biggest change to Starbucks took place in 1992: it went public, gaining access to funds that would allow it to grow rapidly from 500 cafes to 17,000 in 49 countries. At this vast scale, plainly, Schultz would no longer be able to read all his partners’ ideas and feedback.

Following its float, Starbucks launched a dizzying range of new initiatives. It went into a joint venture with PepsiCo to make cold coffee drinks. (The first new product, Mazagran, a lightly flavored carbonated drink, was a failure; more successful was the bottled Frappucino.) And in 1995, Starbucks put its coffee into ice cream and even stout.

It opened stores in airports and bookshops (Barnes & Noble in the US; Borders in the UK). It opened in Wells Fargo banks, on university campuses and in hotel lobbies. In each sector, the effect was considerable. Andrew Sangster, editor of Hotel Analyst, says hotels learned a lot about style and atmosphere. “Hotels woke up to the fact that people don’t want to see them as stuffy people with silver salvers. Starbucks is a pioneer of that approach. Not a direct economic threat, but something to respect and steal ideas from.”

Some years after floating, a store manager who had worked in the music business discovered that hundreds of people had been asking to buy the music played in the café. So Starbucks started to sell music mixes through its Hear Music brand. No other coffee shop is known to have released music, certainly not as ambitiously as Starbucks did in 2007 after signing Paul McCartney to record new material for sale in its 13,500 retail outlets. It was a massively significant event but had nothing whatever to do with coffee. Another legendary artist signed that year was Joni Mitchell.

In 1997, Schultz set up a foundation to give money to community organisations, many of them identified by staff. Starbucks also went into partnership with the sportsman Magic Johnson to open branches in deprived urban areas. It struck Fairtrade deals with suppliers in developing countries and moved to reduce its own environmental impact. The idea in each case was to make the world a better place. Or, as cynics have it, to enhance the Starbucks brand.

As Starbucks got bigger, its initiatives attracted more cynicism. When it did the right thing, in response to public pressure – like ceasing to use milk from cows treated with hormones, or cutting corn syrup – it was not congratulated but criticised for not acting sooner. In some markets it became widely disliked. Communities signed petitions to keep Starbucks out, just as they might have done previously to keep out McDonald’s. Interestingly, McDonald’s had learned a lot from Starbucks, putting espresso machines on its front counters and borrowing the barista monicker.

In a much-quoted case study, John Quelch – a former dean of London Business School and now a professor of marketing at Harvard – wrote that Starbucks’ fundamental problem was its vast size, and that this stemmed from its public company status. “Starbucks is a mass brand attempting to command a premium price for an experience that is no longer special,” he wrote. Sooner or later, chasing quarterly earnings growth targets undermined the brand, Quelch argued. In particular, the company brought out a wide range of new products to broaden its appeal – and in the process, hurt the integrity of the brand for coffee purists and created so much work for baristas that they were no longer able to engage with customers.

“None of this need have happened if Starbucks had stayed private and grown at a more controlled pace,” he added. “To continue to be a premium- priced brand while trading as a public company is very challenging.”

It became more challenging still against a backdrop of global financial meltdown. In the first three months of 2008, net income plummeted to 28% below the same period a year earlier. After eight years on the board as chairman, Schultz returned as chief executive – the latest in a line of high- profile ‘comeback CEOs’, of whom the best known and most successful is Apple’s Steve Jobs. (The best known but least successful was probably Enron’s Ken Lay.)

“We had to admit to ourselves and to the people of this company that we owned the mistakes that were made. Once we did, it was a powerful turning point”, Schultz told Harvard Business Review last July. “When I returned things were actually worse than I’d thought. We seemed to have become the poster child for excess. And all of a sudden we saw a seismic change in consumer behaviour.”

Schultz had replaced Jim Donald as CEO, but Jeff Sonnenfield of the Yale School of Management says the previous strategy of rapid expansion, which got Starbucks into trouble, was Schultz’s as much as it was Donald’s. Indeed, it is said that Donald was in Schultz’s office twice a day to check he was doing the right thing.

Be that as it may, the strategy had to change. In a memo to senior staff, subsequently made public, Schultz anatomised steps the company had taken that, in effect, watered down the “Starbucks experience”. He wrote: “Many of these decisions were probably right at the time, and on their own merit would not have created the dilution of the experience; but in this case, the sum is much greater and, unfortunately, much more damaging than the individual pieces.” Moves to use automatic espresso machines, and vacuum-packed coffee, removed what Schultz called the romance – the visual and aromatic experience. And designing stores to look similar, for sensible financial reasons, inadvertently lost their varied, neighbourhood feel. “All these effects have tested the loyalty of Starbucks customers.”

To re-energise staff and find a renewed focus on values, Schultz took 10,000 store managers to New Orleans to carry out work on houses, planting trees and an urban garden. He set also about pruning some of the previous years’ initiatives. He closed 600 coffee houses worldwide. He closed the Hear Music label. He pulled out of the partnership with Magic Johnson. And he ended a 22-year distribution deal with Kraft Foods Inc.

But it wasn’t just cuts and closures. More positively, Starbucks unveiled a brand of instant coffee called Via across the US, made with 100% natural roasted arabica coffee. Having sent out spies to independent coffee-shop rivals, it started to open its own de-branded branches, where the distressed, pre-used fittings happened to be both trendy and well-suited to a diminished budget for fit-outs. Later that year, Starbucks posted a 4% growth in sales and a 200% rise in profits, and 2010 proved even better. “We confronted these challenges by reaffirming our core values and reinventing our company from the bottom up,” said Schultz.

It seems clear that having shaved $600m off costs, Starbucks is looking to squeeze more money out of its US stores, rather than opening more. In 2010 it showed that this was possible – net revenues rose 9.5% thanks to 4% more traffic in coffee shops and a 3% increase in sales per customer. Looking ahead, could this be improved further? Schultz has emphasised selling food, but for three years food has accounted for less than 20% of sales. Clearly, increasing food sales could make stores even more productive.

It looks far likelier that bigger profits will come from overseas. Starbucks is expecting 80% of growth to take place outside the US, but with its biggest international markets supplied almost to American levels of density, analysts at Morgan Stanley say the company “will need to rely on less proven markets”.

One of these is Central America, which supplies 85% of Starbucks’ coffee beans. The company started selling its coffee in the region at the end of 2010 when it opened a store in San Salvador, the capital of El Salvador. Central Americans mostly drink instant coffee at the moment, but officials and competitors alike hope that Starbucks will help people acquire a taste for specialist fresh-brewed coffees.

In El Savador, the company is using a franchise model – something McDonald’s has done very successfully. Similarly, Starbucks used franchising to open in South Africa, just in time for the 2010 soccer World Cup. The company is also eager to crack the potentially lucrative Indian and Vietnamese markets.

But like every other large Western company, it is pinning many of its hopes on China, where coffee sales climbed 9% in 2009 to RMB4.6bn (€520m), according to Euromonitor International. At the end of 2010, Starbucks had nearly 400 outlets on the mainland, with roughly the same number spread across Hong Kong, Macau and Taiwan. In November, Shultz said China would overtake Japan, which currently has around 900 outlets, to become Starbucks’ biggest market outside North America. Sales at its Chinese coffee shops have more than tripled since 2004, reaching RMB35m in 2009 and notching up a market share of 69.8%. “How fast they embrace change has really surprised us,” Schultz recently noted. “People were drinking black coffee when we got here [in 1999]. Now they are drinking Frappuccinos,”

Nevertheless, according to the World Bank, the average Chinese worker still earns only $5 a day, a quarter of which, says Euromonitor, is spent on food. Several analysts have been quick to point out that substantial profits may be a long time coming. And Starbucks will hardly be short of competition: Gourmet Master Co, which operates the popular 85C chain throughout the region, recently surged 138% on its first day of trading in Taipei after raising funds in an IPO to finance an expansion in China.

Starbucks isn’t just viewing China as a marketplace, though. Last November, it signed a deal with the government of Yunnan, a southern province steeped in thousands of years of tea production, to open its first coffee-bean farm in the country. China has been encouraging farmers to replace tea with coffee to bring in higher revenue and tax dollars. The Yunnan government plans to invest RMB3bn in the next decade to increase coffee production from 38,000 to 200,000 tons annually.

But the chain has grander plans than cultivating a beverage for Chinese palettes. Schultz says that Starbucks aims to “bring the distinctive Yunnan coffee taste” to the global marketplace. It’s anyone’s guess how customers, accustomed to more traditional varieties of coffee bean, will react – not to mention how Chinese working conditions will affect Starbucks’ liberal image. Already, Starbucks is stressing its promotion of responsible practices and is opening a coffee-farmer support centre in Yunnan – its first in Asia and third globally, after Costa Rica and Rwanda. That said, the company is no stranger to audacious plans.

And who knows, maybe one day the resulting brew – which “has a unique flavour and aroma of fruit and herbal spiciness”, according to Huang Jiaxiong, a researcher at the Yunnan Academy of Agricultural Sciences – will be as popular worldwide as the early-morning muffin. After 40 years of innovation, perhaps it’s wise to give Starbucks the benefit of the doubt.

...AND HOW IT CHANGED THE HIGH STREET

by Richard Lofthouse

A rainy November morning and we’re in London’s first ‘de-branded’ Starbucks, just south of Oxford Circus. Our table is a reconstructed industrial water tank. In one corner a guy in a suit sits yogi-like on a cushion, consulting his netbook. Across the room are a couple of 1970s chairs. But it’s not too grungy – this is not somewhere you’re going to ruin your chinos.

Our host is Starbucks UK’s ‘coffee ambassador’, Laurence Winch. “We start every meeting with a coffee tasting,” he says. Out comes a bag of seasonal blend, aged Sumatran beans. A timer bleeps. “Four minutes and 40 grams of coarsely ground coffee,” he says, plunging a cafetiere. Next we taste, slurp and sniff using professional tasting cups. “There is a bitter note,” proclaims Winch before correcting himself. “Bold. We don’t use the term bitter. It’s a bold note.”

The top barrista has touched upon the question that for four decades has engulfed the Starbucks brand like a Seattle fog. Is its coffee any good? Taste, of course, is subjective but the March 2007 issue of Consumer Reports called Starbucks coffee “strong, but burnt and bitter enough to make your eyes water instead of open”. It claimed the “cheapest and best” was McDonald’s Premium Roast.

Starbucks was credited as having reinvented coffee in the US by roasting beans and applying a pressurised brewing process for a European experience. American consumers had, since the 50s, favoured weak over-extracted stuff, content with the promise of free refills. In the early 80s, US coffee sales were declining.

Starbucks first began serving espresso-based beverages in 1984 in its sixth store. By 1988 it had 20 stores; by 1991 there were 100.

In 1995 there was one in every US city and a year later the first overseas branch opened, in Tokyo. By the turn of the millennium virtually everyone in the English-speaking world knew the diff erence between a cappuccino and a latte, and the idea of eating cake for breakfast, presented as a blueberry muffn, became the norm – as did asking for a “grande” or “venti” size instead of a medium or large.

As well as the marketing flourishes, Starbucks introduced an ethos alien to many consumers, particularly in Europe: the notion of customer choice – that they could have a skinny decaff soy latte with whipped cream if they so wished. Others were quick to run with the idea. Ian Semp founded Caffè Nero in the UK in 1987, selling it on a decade later; it now has more than 420 British stores and is expanding into Turkey and the UAE. Bobby Hashemi and his sister Sahar opened the first Coffee Republic in London in 1995 and over the next six years watched it grow rapidly into a listed PLC with 60 UK stores and a market capitalisation of £30m. (Under different management it fell from grace in 2009, briefly going into administration before a property firm bought it out.)

Back in the US, rivals included Caribou Coffee, established in Minneapolis in 1992 and now the owner of 500 stores in 16 states; and Gloria Jeans Coffees, which spawned a franchise operation that’s spread to more than 30 countries and done exceptionally well in Australia, where it has 480 stores. In Canada, Second Cup, which in 1975 was a shopping-mall kiosk, grew to encompass 340 cafes at home and another 50 abroad. Schultz even went off to found his own chain, Il Giornale, returning to buy Starbucks for $3.8m in 1987.

“Like Nike, Starbucks had entered a low-margin commodity business and transformed its product into a cultural symbol,” he reflected in his 1999 book Pour Your Heart Into It. In Starbucks’ case, by transforming a humble cup of Joe into a $4 status-bestowing purchase, it seduced the middle classes.

Starbucks even transformed the business model of Turin-based Lavazza, the world’s largest espresso company. It has launched several chains, including 150 Barista Coffee outlets in India, the 90-strong Caffe di Roma chain, particularly popular in Spain, and The Coffee Factory, which has 70 coffee shops in Mexico.

The gulf dividing the independent boutique with on-site roasting and the Starbucks model is as large as ever, although both sides generally concede that they need each other. Jonathan Money, founder of UK coff ee equipment supplier CLS, says: “You can’t be truly global and truly local at the same time. It’s irreconcilable. But by picking up on the indie theme Starbucks has done what capitalism does so well, which is to pump it out for the masses.”

Coffee consultant Hugh Gilmartin says a well-run coffee shop pockets only 5%-10% of the retail price of a cup of latte. Unless you are an indie store at the very apex of premium, it remains a scale business where serious profitability can accumulate only through having lots of faultlessly performing stores. Th at’s much more diffcult than it looks, especially when balancing rapid growth with a slow- to-make, labour-intensive beverage. Kenneth Lucciani, co-founder of Danish chain Baresso Coffee, recently told an industry conference that it took eight years to break even in a market where hourly wages run to €25 and a latte costs €6.

Market analyst Jeffrey Young estimates that of a cup of latte sold in the UK, 15% of the cost is the raw product; 20-25% is rent; 26-30% is wages and branding, and 10-15% goes to admin and wastage. This leaves an operating profit before depreciation and tax of 10%-30%. Spend too much on store design and opening, and you might never break even. There’s a reason why the successful indies inhabit the bad parts of town – they can afford the rent.

But what no one really expected was an onslaught from McDonald’s, which ditched the red-and-yellow arches for rainforest green and introduced Arne Jacobsen chairs. If that wasn’t enough, the same ‘Forever Young’ store redesign in 2006 included making a ‘premium’ play into coffee but without charging premium prices. McDonalds even offered free Wi-Fi, while fronting a marketing campaign in which posters proclaimed the $4 coffee as dumb.

At the other end of the market, swanky small chains emerged that behaved in strictly local jurisdictions. One was Australian-inspired UK outfit Taylor Street Baristas; another was Cafe Ritazza within global travel giant SSP Group. Elsewhere it wasn’t just Joe and the Juice and Baresso in Denmark, but local me- too operations in cities such as Cairo, where a local entrepreneur set up Cilantro. As the air got thinner and the economic boom evaporated, Starbucks, recalls Schultz, “was being squeezed to the middle”. Instant coffee and 50-cent servings followed, but analysts began to worry about a Dell-style race to the bottom.

Since 2007 Schultz has not only closed around 1,000 underperforming stores and begun to de-brand some, but reinvented the ‘third space’ by launching last year a proprietary digital network offering customers free access to otherwise paywalled content such as The Wall Street Journal. At the same time, Starbucks is still discovering coffee-drinking pockets of Latin America and North Africa, where emerging middle classes are thirsty for modern surroundings, decent service and branded products. And, of course, tea-drinking China is Starbucks’ biggest play, since the company believes it can mould the tastes of the young there.

In the artfully distressed surroundings of the 2011 Starbucks, it seems like an impossibly complex path to a blended coffee that tastes as it always has – bold to some and bitter to others. Nevertheless, the company appears be doing something right. For the 14 weeks to 3 October, it delivered record sales, up 17.2% to $2.8bn. Although coffee gourmets may snort, Starbucks is still seen as good value; stores are clean and bright. With so many extras freely available, the Starbucks experience seems pretty palatable.

PERCOLATED WISDOM

Five lessons from Starbucks that can be applied to any business

Service, service, service
Broaden your choice and widen your smiles. It’s hard to believe that once upon a time nobody ordered 20 fluid ounces of toffee soy latte with whipped cream at 8am.

Consistently innovate
Folks are willing to pay a hefty premium if they’re extracting other values from the brand, from Wi-Fi to sympathetic lighting. The trick is to make sure new products and services are what customers want and that they’ll reinforce the value offered by your core brand. Team up with knowledgeable partners whenever you can.

Listen to your customers
Starbucks has never taken customer loyalty for granted. The online portal enabling customers to suggest improvements, products and pricing is actually responded to by senior executives and acted upon, with public timetables.

Don’t be afraid to do a U-turn
From Howard Schultz’s Lazarus-like return, to pulling the plug on Hear Music, business models can change without sacrificing values. Adapt with the times.

Do good
A pioneer in the area of corporate responsibility, Starbucks broke the mould in the fast-food industry by offering healthcare benefits and stock even to part-time workers. It forges partnerships with coffee growers around the world that are designed to give growers a fair price for their beans – often higher than the so-called Fairtrade price – and to promote sound environmental practices. Showing you care should now be a cornerstone of any business plan.

BEAN THERE, DONE THAT

1971

Starbucks opens first store in Seattle’s Pike Place Market.

1982

Howard Schultz joins as director of retail operations and marketing.

1983

Schultz travels to Italy, where he’s impressed with Milan’s espresso bars.

1984

Schultz convinces Starbucks to test the concept in Seattle, where its first caff è latte is served.

1987

Starbucks opens its first stores outside of the Seattle area in Chicago and Vancouver.

1988

Offers full health benefits to full- and part-time employees.

1991

Becomes the first privately owned US company to off er stock options to part-time employees

1992

Completes IPO, with common stock being traded on the Nasdaq under the symbol ‘SBUX’.

1996

Joins with Pepsi Cola to sell bottled Frappuccino. Opens first store outside of North America in Japan.

1997

Establishes The Starbucks Foundation, benefiting local communities.

1998

Acquires Tazo, a tea company based in Portland, Oregon.

1999

Partners with Conservation International to promote responsible coffee-growing.

2001

Introduces coff ee- sourcing guidelines in partnership with Conservation International.

2002

Enters into licensing agreements to sell Fairtrade Certified coffee wherever it does business.

2004

Opens first Starbucks Farmer Support Center in San Jose, Costa Rica.

2009

Launches Via Ready Brew coff ee. Becomes the largest buyer of Fairtrade Certified coffee.