Small coffee, please

Can tiny-by-comparison chains exploit giant Starbucks’ troubles to their advantage? The diva on the specialty coffee stage has a cold and its very public sniffles are, in the opinion of many, opening doors for others to grab a bit of the spotlight.

While it might not seem obvious to the average Joe waiting in line for his morning half-caff quad extra-hot hazelnut latte, problems at Seattle-based Starbucks Corp. have begun to seriously impact the giant’s performance and spur it to take dramatic steps to try to right the ship. In January, Starbucks founder and chairman Howard Schultz reclaimed the CEO spot. He quickly began to refocus the company on its original core competency—premium specialty coffee—and steer it away from becoming a ubiquitous mass-marketer the likes of McDonald’s and Dunkin Donuts, both of which have launched specialty coffee programs. Schultz announced plans to close 100 underperforming U.S. stores, ended a license for 45 stores inside supermarkets, cut 220 corporate jobs, pulled warm breakfast sandwiches off the menu and even put the company’s entertainment division on the back burner.

Brewed coffee will again be scooped and freshly ground in Starbucks units. In many stores, that coffee will be prepared in $11,000 semi-automatic French press Clover machines, widely regarded as the best. Schultz was so smitten with the machines, in fact, that he bought the company that makes them. He’s also installing new “high-performance” Manestra espresso machines, has debuted a new “everyday” Pike Place Roast and launched a Web site (www.mystarbucksidea.com) where customers can submit business-improvement ideas. Next came the announcement that Starbucks would this summer unveil a new three-pronged cold beverage program. New introductions include energy drinks, to be sold through retail channels, smoothies and an as-yet unnamed Italian frozen blended beverage.

The flurry of activity gives analysts and competitors a lot to chew on, and opinions vary as to how impactful Schultz’s moves will be. In the short term, at least, many share the view of Chris Eilers. “Starbucks,” says the CEO of 97-unit Dunn Bros Coffee, “is spending a lot of money to tell people that its coffee is no longer as good as it should be.”

Turnarounds take time and Starbucks’ woes are exacerbated by the current latte-unfriendly economic environment. But Schultz’s quest to regain the company’s soul and its momentum has generated more buzz than bang for the buck. In late April, Starbucks shares hit a four-year low after warning that second-quarter and full-year profits would decline due to decreased traffic at U.S. stores. Its stock quickly dropped 10 percent to $15.99, a nearly 50 percent decline in value in a year. A week later, Starbucks confirmed that quarterly profits had indeed dropped to $108.7 million, 28 percent lower than the $150.8 million gain a year earlier. Schultz also dramatically lowered domestic store opening targets. More than 1,000 U.S. stores will open this year, but fewer than 400 a year are slated between 2009 and 2011.

While “big green” has seen its same-store sales drop by mid-single digits, David Tarantino, senior analyst at Robert W. Baird & Co. in Milwaukee, notes that smaller coffee-house companies saw sales strengthen in the first quarter of this year.

“We haven’t seen a lot of specific efforts to launch direct hits against Starbucks while it’s down,” Tarantino says. “But all of the independents and private chains we talk to say they’re using the current backdrop as a time to make sure they’re differentiated and elevating their game in terms of operational effectiveness and product offerings.”

Bob Goldin, executive vice president of Technomic, Inc., notes that independents and smaller coffee chains could benefit from a combination of Starbucks’ strategic stumbles, increasing customer burnout and growing competition from McDonald’s and Dunkin Donuts. “Starbucks has a lot of issues right now, but underlying them is the sense that the company in many ways has begun to lose its ‘cool factor,’” Goldin says. “In many consumers’ eyes, they’ve become another big cookie-cutter chain. And as competitive pressures intensify, consumers are learning that they can get a good cup of coffee almost anywhere.”

Independents and small chains are working hard to make sure they’re positioned to be top-of-mind when those consumers think about where else to stop for their coffee fix. Among them is Port City Java, a 60-unit chain out of Wilmington, North Carolina. Touting downturn-defying same-store sales increases for February, March and April of 2.5 percent, 4.5 percent and 5.3 percent, respectively, Port City is a specialty coffee concept where food is a real draw. CEO Don Reynolds says food accounts for 35 to 40 percent of total sales.

Direct hits the company has made against Starbucks include espresso drinks “made with one more shot than the other guy,” baked goods freshly finished in the stores and warm “Perfect Breakfast” sandwiches and wraps. The latter are recent additions promoted through a “Breakfast With That” program. In test since last summer, the program rolled out systemwide earlier this year.

Where Starbucks failed with warm breakfast sandwiches, Port City Java reports the program is successfully building sales. “It has been adding just over 5 percent to the top line,” Reynolds says. “If you look at our increase in same-store sales, it’s entirely due to the breakfast program. With a strong focus on food already in place, we were operationally and culturally positioned to make this work. We gave a lot of thought to developing foods that pair well with coffee, and we trained our staff heavily on the suggestive selling aspect so that asking, ‘Would you like breakfast with that?’ is second nature.”

Also on the Port City Java menu, strategically designed for all-day sales, are hot panini sandwiches, salads, fruit smoothies and desserts. The company also touts its Fairganic coffee line, selections that are both Certified Organic and Fair Trade.

At Minneapolis-based Dunn Bros, Chris Eilers and his team focus on marketing their differences from Starbucks and Caribou Coffee, also based in Minneapolis. “Our biggest distinction is our roasters. They’re in every store and add a lot to the experience and the quality of our product,” Eilers says.

“We roast every day and sell a lot of fresh-roasted beans that are hand-scooped and packaged to order by the pound. We focus almost exclusively on country of origin or single-estate beans versus blends, and typically have 20 to 25 varietals on hand. The beans are shipped green from our warehouse to franchisees for on-site roasting. And we don’t sell any beans that are more than three days old from time of roasting.”

Each Dunn Bros roaster, made by California-based Diedrich Coffee Roasters, costs $14,000 to $16,000, plus installation. “We know that Starbucks won’t start doing on-site roasting,” Eilers adds. “This is an enduring point of difference for us.”It all comes down to flavor, he
contends. “It’s like comparing packaged baked goods in the grocery store to fresh-baked products from the specialty bakery.”

Dunn Bros also distinguishes itself by offering primarily light, or full-city, roasts versus French roasts. “Ours don’t have that heavy, smoky, burnt flavor that many people associate with Starbucks,” Eilers says.

Eilers concedes that some of the strategic moves being made by Starbucks, especially the introduction of lighter Pike Place Roast, grinding beans in-store and using Clover machines for its drip program, could be cause for concern. But so far, he’s not worried. “My main concern is if we don’t take advantage of the opportunity they’re presenting to us,” he says. “They’re creating more awareness for the category. They did a lot of the initial ‘training’ of consumers but many of those consumers are now more sophisticated about coffee. They’re taking their training wheels off and looking for higher quality. That puts us in a good position.”

Dunn Bros plans to focus on improving employee training and in-store merchandising of the quality benefits of in-store roasting. “We often hear that even though people see the roaster and can smell the coffee, we’re not doing a good job of communicating through words and in-store visuals why that’s so important. That’s the first thing we’re working on.”

Caribou Coffee, No. 2 in the segment with 450 locations in 19 states and 2007 sales of $256 million, is following similar reasoning. The
company, which like Starbucks has seen sales slide the past year, has kicked off a major campaign designed to hammer home key points about its long-standing commitment to quality.

“Starbucks is trying to find themselves right now, but we’ve been ourselves all along. They’re going back to grinding beans in the stores. That’s something we’ve done all along,” says Lauren Mihajlov, director of brand development. “We roast in small batches and do cupping throughout the day. We throw away our brewed coffee after an hour so we’re sure it’s served at peak freshness. A lot of the things that they’re trying to institute or get back to are things that we’ve always done and taken for granted as a super-premium specialty coffee provider. We need to let people know that and get credit where credit is due.”

Caribou’s campaign, running under the tagline “Caribou Coffee, where the laws of nature apply,” runs throughout the summer in Minneapolis, Cleveland and Columbus, Ohio. It is unprecedented in scope for the company, Mihajlov says, and includes radio, print and digital billboards. “The key message is to communicate our commitment to quality—sourcing the finest beans and roasting, brewing and serving them in ways that don’t mask or adulterate their flavor, but bring out their very best.”

Another recent move made by Caribou, as well as by others in the segment looking to thwart Starbucks’ draw, is to offer no-strings, no-hassle free wi-fi access in its stores. Starbucks has until recently offered limited free wi-fi to paying customers and Starbucks card holders, and recently launched a partnership with AT&T to provide free wi-fi access in more than 7,000 U.S. locations to “qualifying AT&T high-speed Internet and wi-fi customers.”

Training and education—of staff and customers, alike—are a big deal at Gimme!, a seven-unit group of boutique espresso bars that tout the craft of espresso and the artisan side of coffee. Its units are in upstate New York and New York City.

“Starbucks’ model is to take out the training element and make it so their personnel pool can efficiently produce consistent quality beverages,” says Kevin Cuddeback, CEO of the Ithaca, New York-based company. “Our model is to cultivate baristas and inculcate them with the notion of coffee as a craft.”

Instead of the now-ubiquitous super-automatic push-button equipment, Gimme! uses manual grinders to grind beans just before its espresso shots are pulled. Grounds are hand tamped and baristas monitor the shots as they’re coming out of the machines. The company follows steaming and milk texturing techniques perfected and advanced by espresso guru David Schomer, owner of Seattle’s Espresso Vivace Roasteria and author of “Espresso Coffee: Professional Techniques.”

"It’s all about the preparation techniques, about using the equipment properly to produce what we know are and what our customers tell us are paradigm-shifting beverages,” Cuddeback says. New baristas go through a 40-hour training session, and education for all staffers is ongoing. Weekly group cuppings, at which employees sample and discuss coffees, are particularly effective, he says.

Gimme! also uses its Web site extensively to educate customers on the fine points of the small-batch, boutique coffees it sells at its stores and online, on the language of espresso and how its various drinks are made. And it focuses heavily on teaching customers how to brew great coffee at home. It even makes its professional Barista 1.0 training manual available for sale to customers— as a downloadable PDF for $19.95 or in paperback form for $29.95.

“We’ve tried to make it so that when someone comes into our stores or places an online order for our boutique coffee beans that we’ve traveled the world to source, carefully selected and expertly roasted, they have the information needed to avoid turning that pound of fine coffee into something like coffee from a can,” Cuddeback says. “Part of our mission is to share what we know and get people into the ritualistic side of coffee. The more they know, the more they can become their own taste assessors instead of relying on marketing to tell them what’s a great cup of coffee.”

Gimme!’s penchant for education, he admits, is self-serving, too. “Starbucks is certainly a formidable strategic adversary, but it will come down to what ends up in the cup. If educated consumers are evaluating what’s in the cup, then we don’t have a problem.”

Just as Gimme! is establishing itself as a boutique New York coffee concept, The Coffee Bean & Tea Leaf is a long-standing independent icon in southern California. That’s in part for its focus on coffee quality and its extensive tea program, which comprises roughly 15 percent of sales. “It’s also for its laid-back LA vibe,” says president Melvin Elias.

Now with 210 U.S. units and another 400-plus operated in 19 other countries by area developer franchisees, that vibe is decidedly un-Starbucks. “We’re the favorite local alternative,” Elias says. “We’re cool, we’re fun, we’re friendly, we’re eclectic and we buy the top 1 percent of coffee and tea in the world in terms of quality. We were pioneers in creating menu items like Ice Blended drinks, which in the summer can comprise up to 40 percent of sales, and chai tea lattes, which we introduced in the 1990s. Unlike Starbucks, our stores are destination and lifestyle oriented versus commuter oriented. You’ll typically find us in more upscale neighborhoods and many of our stores have nice patios and outdoor fireplaces. We’ve cultivated an environment that has a great California feel and that people like to relax in.”

Elias says his company is watching specialty coffee market dynamics in general and Starbucks’ recent moves in particular. While Starbucks appears to be focusing on product—releasing a new blend, improving its coffee-making equipment, grinding beans in the stores, etc.—Coffee Bean & Tea Leaf is countering with an intensified focus on people and culture. “We’re confident our product is good, and we’re making no compromises there,” he says. “So we’re focused squarely on people, both our team members and our customers, to make sure that we’re continuing to cultivate a distinctive culture.”

One recent move along those lines was to ditch “trade dress” uniforms, letting team members dress in comfortable clothes that reflect their own style, as long as it’s not inappropriate. “We trust and respect people and we feel that when we send that message out to our team they will treat customers with the same positive relationships. We believe we’ll get much more mileage out of simple strategies like this than trying to find the next great coffee machine or launch a new blend.”

The company maintains a decentralized management style and fosters a sense of ownership among team members. “We don’t have the ubiquity that Starbucks does, so we have to give people a reason to drive by four of their units to get to ours and to come back. That’s our strategy, and it rests on the GMs and the team members in their local stores, not on dictates from corporate management and consultants.”

Elias maintains that while Starbucks is currently struggling, the specialty coffee niche as a whole is far from mature and holds plenty of room for growth for everyone, especially quality-oriented chains and independents.


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