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Copyright © 2003 Thunderbird, The American Graduate School of International Management. All rights reserved.This case was prepared by Professors Michael Moffett and Kannan Ramaswamy for the purpose of classroom discussiononly, and not to indicate either effective or ineffective management. This case draws upon information presented in“Planet Starbucks (A)” by the same authors.

Planet Starbucks (B):Caffeinating the World

Ten years ago, we had 125 stores and 2000 employees. [Today,] we have 60,000 people workingin 28 markets outside North America, serving approximately 20 million customers a week. Ourcore customer is coming in about 18 times a month. With the majority of adults around theworld drinking two cups of coffee a day and with Starbucks having less than 7% share of totalcoffee consumption in the U.S. and less than 1% worldwide, these are the early days for thegrowth and development of the company. We’ve got a model that has been well tested frommarket to market.

Q&A With Starbucks’ Howard SchultzBusinessWeek Online, September 9, 2002

Peter Maslen, President of Starbucks International, had just returned from Greece where the companyhad opened its first café in downtown Athens. He had logged thousands of miles over the past few yearsshuttling from country to country extending the boundaries of the Starbucks empire. In anticipation ofstagnating growth in North America, the company had embarked on a global expansion strategy withthe objective of becoming “a great, enduring company with the most recognized and respected brand in theworld.”

Starting with Japan in 1995, the company had blazed through several key markets in Asia andEurope. The company looked to move into more of the emerging world, including Latin America.While much of the developed world had been conquered—or at least attacked—new growth potentialhad shifted to the less-developed regions. Although the company had already established beachheads inseveral emerging markets, many believed that the infrastructure and disposable income in these regionswould present forbidding obstacles for Starbucks’ expansion strategies. As Peter Maslen sipped his cupof steaming espresso, his mind wandered to the challenges his company faced in global markets. Did itmake sense for Starbucks to continue expanding globally at such a breakneck pace? Would the firm beable to meet the market’s insatiable appetite for earnings growth with its ventures into European andemerging markets?

History

Starbucks was founded in Seattle by Gerald Baldwin, Gordon Bowker and Ziev Siegl in 1971 as agourmet coffee bean roaster and distributor. In 1982 Howard Schultz joined the company as a memberof their marketing team. After a visit to Italy for a trade show, Schultz urged the partners to consideropening espresso bars in conjunction with their coffee sales. In 1984 Starbucks opened its first espressobar in a small corner of the company’s downtown Seattle Starbucks store, to rave reviews. AlthoughSchultz urged the company to expand the espresso bar line, the controlling partners, now Baldwin andBowker, were unwilling to enter what they considered the fast food business, wishing to focus on thecoffee roasting niche market.

April 28, 2003

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Howard Schultz then left Starbucks, and with the financial backing of his former partners, openedIl Giornale in 1985, an espresso bar that sold coffee and assorted coffee beverages made exclusively withStarbucks’ beans. Two years later, Schultz bought the former Seattle Starbucks company, six stores androasting plant, for $3.8 million from Baldwin (who wished to focus on managing Peet’s Coffee) andBowker (who wished to cash out of the business). Schultz now was in control of Starbucks, and withnew investors, began building a global business which reached sales of $3.28 billion by 2002 and wasacclaimed one of the top 100 growing global brands.

The Starbucks Experience

Howard Schultz’s dream was to take the concept of the Milan espresso bar to every corner of every cityblock in the world. Captivated by the sense of community and neighborliness that he had seen in thecafes in Milan, Schultz wanted to transplant a similar ambience into each Starbucks store. This desireoriginated in the very first coffee experience that Schultz had in Milan. While attending a housewaresshow in the city of over a thousand cafes, Schultz was quite impressed by the way in which the baristas(coffee brewers) prepared a cup of espresso. It was pure theater to see a barista move effortlessly as heground the beans, pulled the espresso, and steamed the milk, seemingly at the same time and all thewhile carrying on a conversation with the customer. It was precisely this experience that Schultz wantedto bring to each of the Starbucks cafes. He envisioned each café as a gathering place for neighbors andfriends or a place of quiet contemplation and perhaps even a neighborhood office for the work a daycustomer who might stop by to catch up on work and a steaming espresso at the same time. TheStarbucks café was indeed a destination. The Starbucks Experience had been designed to be pleasant,uplifting and diverse.1 Experience and ambience were central to the Starbucks strategy. As Schultzobserved,

We certainly don’t ignore the product, but it is something we always knew we had and a lot ofothers didn’t. But we built the business through experience, not through the product.

“Schultz’ Caffeinated Crusade,” Brandweek, July 5, 1999

I tried to build an environment and a place that could provide our customers with an oasis, a“Third place” away from home or work, that would exceed their expectations.

M. Pendergrast, “The Starbucks Experience Going Global,”Tea and Coffee Trade Journal, Vol. 174, Issue 2, Feb. 20, 2002

The cafés exuded a sense of chic and featured comfortable seating, sometimes even sofas, a selec-tion of leading newspapers and magazines including Starbucks’ own in-house weekly, and the strongaroma of rich coffee wafting through. In addition to a broad selection of coffee and Italian style espres-sos, the cafes offered several blends of special teas, localized pastries, and coffee brewing equipment. Thestores themselves were designed to be bold and striking in their color palettes, often using primarycolors. The ambience of the cafes was accentuated by piping selected music to complement the atmo-sphere of warmth and comfort. Employees were trained to not only provide advice on coffee selectionand appropriateness to potential customer needs, but to engage the customer.

Location, Location, Location

The company displayed remarkable business savvy in choosing its locations. It focused on spots thatprovided ready access to consumer foot traffic, typically in densely populated neighborhoods. Storeswere located in such a way to blanket a neighborhood and often several stores competed for patronageon the very same street. Starbucks had however been both admired and criticized for these market-swarming expansion techniques that were used to proliferate within defined market locales. This ap-proach to first-mover advantage in a market space gave Starbucks sufficient time to establish itself whileholding competitors at bay. The downside however was the cannibalization of revenues across stores

1 “Schultz’ Caffeinated Crusade,” Brandweek, July 5, 1999.

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located in close proximity to one another. Between 1995 and 1998 Starbucks had averaged $0.69million per store per year. Beginning in 1999, this revenue per store value had continuously declined,falling to $0.56 million per store in 2002.

The company had leveraged multiple channels to sell its coffees and related products. Its wareswere available through mini-Starbucks cafes located within grocery stores, at airports, on all UnitedAirlines flights, and in Barnes and Noble bookstores. Its roasted coffee beans, and ice cream productswere sold through both specialty and mass-market retail grocery chains. It entered several distributionagreements with well established companies such as Kraft Foods for distribution of coffee related prod-ucts. Despite these systematic attempts to proliferate through multiple channels and multiple locations,sales in North America had shown signs of slowing. It was against this backdrop that Starbucks startedlooking East.

The World Market For Coffee

Coffee was the second most widely traded commodity in the world behind crude oil. Despite this prideof place amongst commodities, most of the world’s coffee was grown in small farms encompassing justa few acres. Like most commodity products, the prices for green beans (unroasted coffee) fluctuateswildly with changes in demand and supply which in turn is driven by growing conditions. Latin America,Central America, East Africa, and parts of Indonesia and Vietnam were the leading coffee growingregions. The price of coffee in 2002 reached record lows of $0.42 per pound for robusta grade, thelowest price in a century. The robusta grade was considered an inferior grade of coffee with a fairly highlevel of bitterness. The arabica grade was the premium coffee and commanded a price premium—typically about $0.20 per pound—over robusta. Arabica was much more aromatic and full flavored andpreferred by coffee connoisseurs worldwide. Starbucks exclusively used arabica beans in its cafes.

The market for coffee was decidedly global. Most of the intermediate buyers were large transnationalpackaged foods companies. The top four firms—Nestlé (Switzerland), Kraft Foods (USA), Proctor &Gamble (USA), and Sara Lee (USA) collectively purchased roughly 50% of the coffee produced glo-bally. Given their product mix and development of new roasting techniques, many of these buyers wereable to make do with robusta grade. Buyers such as Starbucks, and its Italian competitor Illy, however,specialized in gourmet coffees which accounted for only about 10% of global coffee production.

The consumer market for coffee was quite concentrated: 20% of the world’s population accountedfor 65% of global consumption. Exhibit 1 provides an overview of the structure of the global coffeemarket in the year 2000. The Swedes clearly had the highest per capita consumption in the world,quaffing 1097 cups per year, while the Chinese averaged per capita consumption of less than one cup.Yet, there were only a little more than eight million Swedes, and there were over a billion Chinese.

The coffee market was subdivided between retail sales (instant coffee and roasted and groundcoffees purchased in supermarkets for home consumption) and out-of-home coffee purchase and con-sumption (the coffee cafés like Starbucks). The differences in consumer preferences across countrieswere dramatic. For example although the Swedes and Swiss were the top two consuming populations,instant coffee was extremely unpopular with the Swedes, making up only 9% of retail sales, while a full35% of all retail coffee purchases by the Swiss was for instant coffee. The extremes in retail sales pur-chases and consumption were the Italians, 96% of all retail purchases being roasted and ground to 4%instant, and the Philippines, where 100% of retail purchases were for instant coffee. Only Japan and theUnited States to date had any real markets in ready to drink products (like Starbucks’ Frappucinoproduct).

The second major distinction, and the one of most immediate interest to Starbucks, was thepropensity of some national populations to consume their coffee outside the home. Out of home coffeeconsumption was the highest in absolute consumption (average cups consumed per capita per year) inSwitzerland, Spain, Sweden, and France. Many of the emerging markets, countries like Mexico, Chile,

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Russia, and Thailand, demonstrated extremely low levels of out of home coffee consumption, posing asignificant challenge to the Starbucks business model.

Much to the dismay of coffee marketers, consumption in the developed world was declining withthe markets migrating to the developing countries. It was estimated that the sophisticates (people con-suming one or more cups of coffee a day) accounted for 65% of total coffee consumption but theyrepresented only 17% of the world’s population.2 In contrast the beginners (people consuming one cupor less per week) accounted for 57% of the world’s population but only 2% of coffee consumed. Al-though it would make sense to target beginners with the hope of turning them into sophisticates, thechallenges were formidable. Much of this population lived in countries that had not developed a tastefor gourmet specialty coffee.

Key Competitors

Although the traditional mass market coffee segment was dominated by the major transnationals, thefreshly brewed coffee market and specialty coffees represented a far more fragmented domain withseveral companies operating a variety of local, regional and sometimes international chains. In additionto the ubiquitous Starbucks, the more popular chains were Tully’s Coffee and Seattle’s Best Coffee (bothheadquartered in Seattle USA), The Coffee Bean and Tea Leaf Company (Los Angeles USA) and TimHortons (Canada). In addition to the national competitors there were several local and regional chainswithin national markets that enjoyed limited popularity such as Dutour (Japan), Trung Nguyen (Viet-nam), Costa Coffee (U.K.), Dome (Australia) and Barista (India). Many of these local favorites were

Exhibit 1 Global Coffee Consumption, 2000

Retail Coffee SalesPer Capita Roasted Ready Out of Home

Consumption and to Out of as PercentCountry (cups/year) Instant Ground Drink Home of TotalSweden 1097 80 777 — 240 22%Switzerland 855 220 415 — 220 26%Germany 735 80 565 – 90 12%France 658 145 363 — 150 23%Spain 517 100 207 — 210 41%Italy 478 15 323 — 140 29%Brazil 463 30 298 — 135 29%Australia 459 305 24 — 130 28%Canada 438 108 155 — 175 40%United States 424 57 207 4 160 38%United Kingdom 424 290 24 — 110 26%Japan 360 125 55 45 150 42%Korea 286 166 5 — 115 40%South Africa 286 222 14 — 50 17%Mexico 181 125 26 — 30 17%Chile 159 137 2 — 20 13%Philippines 142 127 — — 15 11%Russia 129 110 9 — 10 8%Thailand 96 78 8 — 10 10%China 1 0.8 — — 0.2 20%

Source: Nestlé S.A.’s Nescafe Division, as quoted by Merril Lynch, May 20, 2002. Total annualper capita consumption is the sum of instant, roasted and ground, ready to drink, and out ofhome. Instant coffee is also frequently termed soluble.

2 Original data from Nestlé S.A., Nescafe Division, presented in Starbucks Corporation Reference Book, MerrillLynch, May 20, 2000.

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also eyeing the global market and some had selectively ventured abroad to set up cafés especially incountries such as Japan, China and the Southeast Asian region.

• Tully’s Coffee operated over 100 stores in the United States, primarily focused on the PacificNorthwest region. It had expanded internationally through licensing agreements and had setup Tully’s Coffee Japan. Tully’s Japan operated more than 40 stores largely in the Tokyo-Yokohama region. The company had also entered into franchising agreements with UeshimaCoffee Company to sell Tully’s products in Asia (outside Japan). Ueshima had a presence inSoutheastern China, Thailand, Singapore, Taiwan, Korea, Indonesia, Brazil and Paraguay.

• Tim Hortons, a subsidiary of the fast food chain Wendy’s, operated over 2100 stores in Canadaand 150 in the United States. The company’s strategy was to focus nearly exclusively on thesetwo markets. Much of its expansion effort was through franchised operations.

• Seattle’s Best Coffee was a subsidiary of AFC Enterprises, an Atlanta-based food company witha fairly large footprint in the fast food business. AFC also owned Torrefazione Italia, Cinnabon,Church’s Chicken, and Popeyes Chicken & Biscuits. Seatlles Best had expanded to Japan, thePhilippines, Saudi Arabia, the United Arab Emirates and Korea. Its largest presence outsidethe United States was in Japan where it operated 40 stores.

• The Coffee Bean and Tea Leaf Company, founded in Los Angeles, was engaged in significantinternational expansion both through its own network of stores as well as through franchiseagreements. It had a total of 104 cafés in Singapore, Malaysia, Taiwan, Korea, Israel, the UnitedArab Emirates, Brunei, Australia and Indonesia.

• Trung Nguyen, a Vietnamese chain of coffee stores, operated 400 outlets in that country. It hadfranchise operations in Singapore, Thailand, China, and Japan and was looking for franchiseesin the United States. The company was trying to cash in on its origins, promising to deliver aVietnamese experience to its patrons. Initial reports showed that the company’s cafés wereperforming well especially in the exotic blends.

Expanding the Starbucks Empire

Starbuck’s first foray into marketing coffees abroad began with operations in Vancouver Canada in1987. However until 1995, much of its marketing focus was limited to building dominance in the U.S.marketplace. Beginning with its entry into Japan in 1995, the company had opened close to 1,000locations in over 20 countries by 2002.

Mode of Entry

The rapid expansion overseas was built around joint ventures with local partners and rounded outthrough company owned stores. As illustrated by Exhibit 2, Starbucks international expansion wasachieved primarily through joint ventures and licensing agreements. The frequent use of the joint ven-ture form, however, was a bit misleading given the limited ownership held by Starbucks relative to itslocal partner. The exceptions were Australia (90% owned by Starbucks), South Korea (40% Starbucks),Thailand (97% Starbucks) and the United Kingdom (wholly owned as a result of the acquisition of alarge existing coffee chain followed by rapid expansion). Even in this short list, Thailand was a reluctantmajority ownership. In early 2002 Starbucks was forced to buy-out the interest of its local partner as aresult of financial difficulties experienced by the partner, preventing it from undertaking the rapidexpansion of stores per the joint venture agreement.

Given the reliance on joint ventures and licensing as the preferred modes of foreign expansion, thecompany set forth fundamental qualifications it expected of its potential partners. These criteria in-cluded financial solvency, knowledge of local market conditions, prior retail experience, and creative

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ability. Before entering a new country, the company conducted rigorous quantitative market studiesand extensive focus group interviews to get a pulse of the marketplace and potential. Despite the inten-sive process of market and partner selection, the company was constantly being courted for partnershipventures in many international cities.

Winning a partnership agreement, however, took much tenacity in addition to the desirable fi-nancial strengths. Markus Hofer was a prime example of this. He had campaigned tirelessly to gain aStarbucks franchise in Australia. After having been rebuffed by Howard Schultz once, he persisted bysending frequent reports about the coffee business in Australia, changing trends and opportunities inthe café markets, and the potential demand for gourmet coffees in the country. Schultz eventually hada change of heart and signed on with Hofer to set up operations in Sydney and Melbourne, appointinghim Managing Director of Australian operations. Hofer resigned his post in March 2002 when hedecided to cash-out of the Australian business and sell his share back to Starbucks as a result of thegenerally sluggish performance of Australian operations.3

Starbucks’ involvement in the operations of its cafes, licensed or joint ventures, varied only indegree. It was constantly in touch with café operators to keep abreast of the marketplace. Starbuckstrained the management teams of all cafes at its Seattle facilities for a full 13 weeks. This training was animportant part of the launch process because it helped the company imprint the values and meaning ofthe Starbucks experience on its new recruits. It was critical that the people who ran the front-endoperations of the company exude the Starbucks spirit. As Starbucks International VP Peter Maslen

Exhibit 2 Starbucks’ International Operations and Partnerships

Starbucks’ April 2002 eoy 2003Country Partner Agreement Ownership Stores StoresAustralia --------- majority-owned 90% 29 60Austria Bon appetit Group jv 19.5% 3 15China (Beijing) Mei Da Coffee Co license – 26 45China (Shanghai) Shanghai President Coffee Co jv 5% 25 45Germany KarstadtQuelle AG jv 19.5% 0 21Greece Marinopoulos Brothers SA jv 18% 0 5Hong Kong Maxim’s Caterers Limited jv 5% 25 70Indonesia PT Mitra Adiperkasa license – 0 5Israel Delek Development jv 19.5% 5 12Japan Sazaby Inc. jv-public 40% 357 570Malaysia Berjaya Coffee Co license – 23 30Mexico S.C. de Mexico, S.A. de C.V. jv 18% 0 5Middle East M.H. Alshaya Co. W.L.L. license – 65 98New Zealand Restaurant Brands Ltd. license – 32 42Philippines Rustan Coffee Corp. license – 42 57Puerto Rico MacNaughton Group jv 5% 0 6Singapore Bonvests Holdings Ltd. license – 29 35South Korea Shinsegae Department Store jv 50% 40 82Spain Grupo Vips & Europastry, SA jv 18% 2 13Switzerland Bon appetit Group jv 19.5% 7 20Taiwan President Coffee Co. jv 5% 91 137Thailand --------- majority-owned 97% 26 37United Kingdom --------- wholly owned 100% 297 470

System-wide 1,153 1,912Company-owned 358 572Licensed/JV 795 1,340

Source: Merrill Lynch, May 20, 2002, p. 19.

3 T. Liddle, “How to Become a Starbucks Millionaire, Cup by Cup,” Australia internet.com, February 7,2001; and “Bottom of the Harbour,” J. Rolfe, Sydney Telegraph, March 15, 2002.

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remarked, “Starbucks brand is built on passion, and you can easily feel the passion of our partners in any ofour international stores.4 Once the cafes were up and running, inspection teams from Starbucks weredispatched every two months to make sure that the operations met company expectations and stan-dards. This continuous involvement and training ensured that the Starbucks experience was indeedconsistent across locations.

The company standardized its menu of coffee offerings in most locations worldwide with somelocalization of its baked goods and pastries. The cafés were required to buy most of their coffee relatedsupplies through Starbucks, but they could make mutually acceptable local arrangements for procuringbaked goods. For example Starbucks’ Shanghai partner used an airline catering company and a bakerychain to buy pastries. The company’s standards were so exacting that Starbucks even insisted on ship-ping its own roasted coffee back to coffee growing countries where it had operations. Even in its mostrecent expansion into Latin America, the company would not source locally, although many of thecountries in the region were among the largest producers of coffee in the world and also frequently theoriginal source of much of Starbucks coffee.

The Economics of Global Expansion

A Starbucks joint venture or licensing agreement required the payment of an up-front licensing fee, aroyalty on sales after operations began and the purchase of all store furnishings and coffee-based mate-rials from Starbucks itself. These terms did appear to vary somewhat by location and market potential.For example it was reported that Delek Fuel, Starbucks’ Israeli partner, paid $250,000 in licensing feesand a 6% royalty, while P.T. Mitra Adiperkasa, the partner in Indonesia, reportedly paid a $2 millionlicensing fee up-front.

Although the company’s equity position in its joint ventures varied across a wide range, there wasa tendency to minimize its holdings and require the local partner to shoulder most of the capital cost.Even in the case of Japan, Starbucks first and largest international venture outside North America,Starbucks was guaranteed a 5.5% royalty on sales while its local partner earned only a 1.0% royalty,which then fell by 0.25% per year until reaching zero. Exhibit 3 provides a comparison of the coststructures of North American and International company-owned stores.

The Caffeine Crusade

Starbucks had ventured into Canada very early on but true international expansion of its café conceptwas started in 1995 with its entry into Japan, the second largest coffee importing country in the world.5

At that time Starbucks believed that it was not ready to move into Europe’s well established café scene.The company’s first focus was Asia.

Asia and the Far East

The decision was made to go to Asia first because we felt that the maturity of the coffee marketin Europe was very strong and was not going to change much over the years. The Asian marketwas in its developmental stage and we had an opportunity to position Starbucks as a leader ina new industry.“Expanding the Coffee Experience: Starbucks Keeps Sales Brewing with New Products,

Innovation, and Global Expansion,” Beverage Industry, October 1, 2002

4 M. Pendergrast, “The Starbucks Experience Going Global,” Tea and Coffee Trade Journal, Vol. 174, Issue2, February 20, 2002.5 According to the Coffee Research Institute, the 10 largest coffee importing countries for the decade of the1990s were the United States (25.6% of global imports), Germany (14.2%), Japan (7.7%), France (7.5%),Italy (6.3%), Spain (3.8%), Holland (3.4%), the United Kingdom (3.4%), Canada (2.8%), and Sweden(2.2%). Note that these are importation statistics, and not consumption. Source: www.coffeeresearch.org/market/importations, accessed 10/6/02.

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Japan. Much of Asia had a very strong tea culture that had been nurtured over centuries. Tea drinkingheld the pride of place in countries like Japan where elaborate rituals had been devised to both institu-tionalize the beverage and establish tea drinking as an inextricable way of life in those societies. Starbuckshowever set out to change these norms.

Fortune came knocking on Starbucks’ door in the form of an unsolicited business inquiry from aJapanese group, Sazaby, which had been operating a chain, Afternoon Tea, and had a visible presence inthe important locales of Japan. Sazaby had 180 outlets and was engaged in a variety of products rangingfrom lifestyle furniture and clothing to tea and confections. While on a visit to the United States, thefounders of Sazaby became interested in the Starbucks concept and then approached Howard Schultz toexplore a joint venture in Japan. Starbucks and Sazaby constructed a very traditional equal partnership,each with a 50% equity interest.

The JV had opened its first store in Ginza in August 1996 and had immediately attracted a loyalfollowing. The customers were educated about various coffee blends and exposed to an environmentthat was remarkably similar to the Starbucks cafés in the United States. In time the local venture, withthe blessings of Starbucks, was introducing some variations that appealed to the local market, such asgreen tea frappucino, which were not available in the United States. The company instituted a no-smok-ing policy because it believed that cigarette smoke destroyed the natural aroma of coffee. It served itscoffees in paper cups thus going against the grain on most of the conventional wisdom that had beenpassed down about retailing in Japan. The blue chip consultants that Starbucks had hired prior toentering Japan unanimously concluded that a no-smoking policy combined with service in paper cupswould ring the death knell for Starbucks. However, within a few short weeks after entering Japan, it wasquite clear that the consultants were wrong on both counts. The no-smoking policy did not seem tohurt and the Japanese seemed quite comfortable sipping their coffees from paper cups.

Exhibit 3 Comparative Cost Structures of Starbucks’ Company-OwnedNorth American & International Stores, 2002

North American InternationalNet Revenues 100.0% 100.0%

Occupancy costs 10.7% 16.3%Roasted coffee:Green coffee 4.0% 4.0%Other (freight, shrink, etc.) 1.7% 2.4%Food 4.4% 7.2%Milk 3.9% 4.4%Retail media (newspapers, etc.) 3.0% 3.0%Other 10.8% 12.6%

Total Cost of Goods Sold (38.3%) (49.8%)Gross margin 61.7% 50.2%

Store ExpensesSalaries & benefits 27.7% 27.8%Regional overhead 4.3% 7.2%Advertising 0.8% 1.4%Operating supplies 2.5% 2.5%Other (taxes, pre-open, etc.) 4.2% 5.7%Total (39.5%) (44.6%)

EBITDA margin 22.2% 5.6%Depreciation & amortization (5.6%) (8.0%)

EBIT margin 16.6% - 2.4%

EBITDA = earnings before interest, taxes, depreciation and amortization.EBIT = earnings before interest and taxes.Source: “Starbucks Corp,” Merrill Lynch, May 20, 2002, pp. 26-29.

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Starbucks Japan priced its offerings much below the premier Japanese café chains such as GinzaRenoir which were billed as havens for the harried executive seeking peace and quiet. These cafés chargedroughly $7 for a coffee and the price entitled the customer to use its facilities for two hours. Manycustomers used the cafés for meetings as well. At the lower end of the spectrum were the low pricedchains which usually served robusta coffees below $2 per cup. Starbucks sought to build a new niche,promising to deliver the vaunted Starbucks experience at the nominal price of $2.50 per cup. The jointventure grew rapidly, reaching more than 250 stores nationwide by 2002 and was projected to operatemore than 500 stores by 2003. Although average Japanese store sizes were half that of the United States,they averaged nearly twice the sales.

The joint venture proved so successful that it undertook an initial public offering (IPO) in Octo-ber 2001, the only unit within Starbucks’ international network to be listed independently of the par-ent. Appendix B provides a comparison of Starbucks Japan with three major competitors at the time ofthe IPO.

Almost six years after we opened here [Japan], this is the best-performing market on a unit levelfor Starbucks in the world. It’s also the second largest in the world [after the U.S.]. When wecame here in August of 1996, we underestimated the size of the market just like we did inAmerica. So we’re sitting here today with approximately 360 stores, and we’re opening two newstores a week in Japan. We’ll have 500 stores by September 2003, heading toward 1,000.

“Q&A with Starbucks’ Howard Schultz,”BusinessWeek Online, September 9, 2002.

In the year following the initial public offering in Japan, the share price tumbled from a peak of$690 to $101 (U.S. dollar equivalents of Japanese yen share price). The company’s sales forecast hadbeen trimmed by 10%, and it had revised its earnings forecast downward from a profit of $7.9 millionto a loss of $4.2 million. The company blamed the misfortunes on a faltering economy while analystsbelieved that competition had a role as well.

Coffee chain competitors such as Dutour which had been content to sit on the sidelines and serverobusta coffees at low prices in the early years had now migrated upwards into the rarefied reaches ofarabica and higher margins. U.S.-based chains such as Peet’s and Seattle’s Best had entered Japan withfull vigor. Starbucks executives believed that the decline in same store sales was core to their strategy.Saturation of some market areas had led to cannibalization as expected and the competitive battlesbetween stores was playing out. ”Everyone realizes we cannot continue at this pace,” says Johanna Metzger,chief marketing guru at Starbucks Japan. “We’ve downshifted a bit.”6

Starbucks had reacted by instituting a wide range of cost cutting measures that included procuringsome supplies from Southeast Asia instead of from the United States. However many believed that thesemeasures were unlikely to make a significant dent. Many critics felt that nothing short of slowing downnew store openings could help Starbucks return to the black in Japan.

China: Storming the Forbidden City. After years of studied disinterest, China opened its doors toforeign companies and Starbucks ventured in to test the waters. Given the ingrained Chinese disposi-tion toward tea, Starbucks had entered in a measured way, first testing its coffee in major restaurants andhotels in Beijing before setting up cafés. It first negotiated a licensing agreement with Beijing Mei-Da,a wholesale distributor for Starbucks since 1995 in the city of Beijing. When it opened a café within thewalls of the Forbidden City, many of the traditionalists gasped at the seeming capitalist assault on thebastion of Chinese culture. The Palace of Heavenly Purity was after all the original residence of Chineseemperors and still the symbolic center of much of Chinese culture. Cultural criticism aside, the café wasa success.

6 “Is Japan Losing Its Taste for Latte Already? Losses Climb as Starbucks Japan’s Growth Grinds Down,”BusinessWeek Online, December 2, 2002.

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By early 2002 the company was operating 25 stores in Beijing. Although many Chinese consum-ers traditionally believed coffee to be foul tasting and bitter, many were now acquiring a taste for whatthey considered a luxury beverage. Heartened by the success in Beijing, Starbucks entered a joint ven-ture with Shanghai President Coffee, the operator of Starbucks cafés in Taiwan, to enter the Shanghaimarket. Starbucks added Maxim’s Caterers as a partner at the same time, entering the Hong Kongmarket.

It was widely believed that sales growth in Shanghai would outstrip Beijing in the near term. Inthe two years that the company operated in Shanghai, it increased the number of outlets there to 21.The company had adopted some novel ways of breaking down consumer resistance to coffee, includingeducational activities focused on potential customers. Starbucks’ Shanghai partner trained a staff of 300people who aggressively went out into the market to introduce the public to the intricacies of coffee.The successful launch of a Starbucks café directly across from one of the oldest tea houses in the countryin Yu Gardens, (one of Shanghai’s premier historical sites) was testimony to its remarkable market entryefforts.

Although many market experts predicted that Starbucks’ consumers in China would be predomi-nantly Western expatriates, the first two years of operations saw a consumer base of roughly 70% localChinese. This was somewhat surprising to some as the ambience in the Chinese cafés, the menu offer-ings, and the prices were extremely similar to outlets in the United States. A cup of coffee was pricedbetween $2.50 and $3.50, an exorbitant amount in a country where per capita monthly income wasonly $84.

Riding on the coattails of Starbucks’ success, many local entrepreneurs were opening competingcoffee chains. In Shanghai for example, new entrants included Discovery Café, Mr. Coffee, and U-LikeCoffee, all hoping to garner a share of the coffee-smitten Chinese. While these were relatively smalloperations, they tried hard to duplicate the environment and offerings of Starbucks. Many of them werefaithful copies of the Starbucks cafés, right down to the décor, magazine racks, tables, and coffees. Amanager at U-Like, Mr. Lu Yimin remarked “Our coffee is better than Starbucks. Our coffee shop looks likeStarbucks but in terms of service, they can’t match us… at Starbucks you always have to queue at the counter.”7

Europe: The Coffee Bastion

We know that Europe has a long coffee tradition, so it’s with humility and respect that we comeback to Europe.

Peter Maslen, Tea & Coffee Trade Journal, February 2002

If the company succeeds in establishing a major foothold in Europe, it will indeed be the U.S.equivalent of carrying coals to Newcastle.

BBC News, September 1998

The café culture of Europe had been widely institutionalized over several generations. Many among theolder generation had a favorite café right in their neighborhoods that they patronized. Loyalties, it wasbelieved were hard to change. It was, after all, Milan which had first inspired Howard Schultz. Ameri-can coffee had never earned a respectable reputation in Europe. Italy, for example, already had over120,000 cafés, an astounding level of saturation at one café per 475 inhabitants. Even in Seattle, a citythat Starbucks rated as “saturated” the number stood at one café per 9400 people.

Starbucks launched its European expansion with the acquisition of Seattle Coffee Company, aU.K. retailer with a chain of 64 cafés located in prime spots throughout the country in 1998. Althoughthe U.K. market was in many ways very different from Continental Europe, the company was happily

7 “Wake Up and Smell the Copy!” B. McIntyre, http://www.chinanow.com/english/shanghai/city/features/coffee.html.

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relieved by the initial success of the British cafés. Still the company saw entry onto the Continent as avery serious challenge. Its initial foray onto the Continent was via a flagship café in Zurich in 2001. ToPeter Maslen’s relief, long lines of people were waiting to get in even before the store opened on a coldMarch morning. Growing from strength to strength, the company proceeded to open chains of cafés inAustria, and Germany, seemingly flanking France and Italy for the ultimate assault.

The obstacles to an entry into Italy and France were formidable. For example in Trieste, Italy,home of the world famous Illy brand of coffee, Ricardo Illy, the Mayor of Trieste and Vice President atIllycaffe had organized café owners from Italy, Austria, Hungary, the Czech Republic and Germany intoan association to preserve and protect the storied café culture from foreign influence.8 Some believedthat the price of espresso could also pose a problem for Starbucks. The average price of a cup of coffeeat the local neighborhood cafés of Europe was about $0.30, while Starbucks charged closer to $2.00.There was also the problem of entrenched competition from the up-market cafés in many Europeancities. Much like Japan where there was a well established pecking order for cafés, the elegant cafésskimmed the top of the market with old world charm and ambience while the neighborhood cafésresonated with the locals who stopped by for local gossip, peace and quiet, along with a strong shot ofespresso. Starbucks would have to pick its spot in the pecking order to be recognized.

In Italy, I don’t think people feel the need to go to a place like Starbucks to sip coffee for hours,still less to buy take-away cappuccinos in paper cups.

Alberto Bottalico, Founder of the Slow Food Movement

Common wisdom would be that it has to fail—that it would not, could not, catch on withAustrians because we have the best coffee in the world. When McDonalds arrived, everybodysaid, “Who’s going to eat those stupid hamburgers when we have our wienerschnitzel and sau-sage stands?”

Stefan Janny of Profil of Austria, as quoted in“Starbucks Jolts Europe’s Coffeehouses,”The Seattle Times, May 19, 2002

Latin America: Taking It to the Growers. Entry into the emerging economies of Latin America was aproposition quite similar to expansion in Western Europe. The main difference, however, was thatmany of these economies were the ones that were growing coffee. Technically Starbucks had opened itsfirst Latin American coffee shop in Puerto Rico in August 2002, but for all intents and purposes, theLatin American experience had started in Miami several years before. Miami was well known for itsvibrant Latin culture with a strong leaning toward the Cuban coffee influence that predated the rest ofthe United States by at least five decades. Neighborhood cafés that had originated in Latin neighbor-hoods around Calle Ocho and Sweetwater had spread like wildfire engulfing the entire city. In manyways Miami possessed a much more sophisticated taste for coffee compared to its new rival, Seattle.Miami’s Cuban population had brought their centuries-old coffee tradition with them. The Cubanneighborhoods of Miami were complex networks of walk-up kiosks, neighborhood cafés, push carts,and take-aways. Many of these venues had become institutionalized over time. They were places inwhich members of the community gathered to discuss the news, politics and sports of the day. Manycritics did not believe Starbucks could ever fill this role.

As could be expected, Starbucks coffees were not getting good reviews from dyed-in-the-woolcoffee fanatics here. Having become accustomed to a fairly strong, thick, and sweet potion known ascafé cubano, one local proffered a review, “Starbucks—that’s water.” There was also bound to be somereverse competition from established Latin American players who wanted a piece of the U.S. market.An association of 274,000 Colombian growers, the Colombian Coffee Growers’ Federation, planned toopen a chain of cafés in Miami shortly under the Juan Valdez label. Juan Valdez, a prototype fictionalcoffee grower, had been widely promoted in the U.S. for decades as a symbol for good quality Colom-bian coffee.

8 M. Prendergast, “Starbucks Goes to Europe... With Humility and Respect,” The Wall Street Journal, April9, 2002.

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Starbucks insisted on holding prices at U.S.–like levels throughout its stores worldwide, and LatinAmerica would be no different. However, the price disparity between the local brew and the one thatStarbucks offered was fairly steep, sometimes even four times as expensive. But would this high pricework in markets where disposable income was not high by any standard? Expansion in Latin Americawould take Starbucks into the heart of coffee-growing country. Even here Starbucks planned to sourcecentrally and have the coffee transported to its roasting facilities in the U.S. before shipping roastedbeans back to the Latin American stores.

In countries where there is a culture of espresso, like Venezuela, Brazil and Argentina, Starbuckswon’t have any sort of success. There is no room for mediocrity.

Jean Paul Coupal, Owner of Arabica Coffee franchise in Venezuela,K. Diagle. Associate Press Newswires, August 29, 2002

The Road Ahead

Starbucks was in a race for growth. It had always believed that the first mover advantage was a criticalingredient in its success. Staking new territory first meant that it could soon populate and perhapssaturate the markets with its cafés, creating insurmountable barriers to competitive entry. It had almostunflinchingly cannibalized its own sales through saturated store locations in the U.S. and appeared tobe doing the same in other markets.

There were rumors that Starbucks was looking at India as its next major market entry. AlthoughIndia was a logical next step in the implementation of Peter Maslen’s international growth strategy, itpresented challenges larger than those seen even in China. Monthly per capita income in India was ascant $24 compared to China’s $84. Furthermore Starbucks was sure to face competition from relativelywell-capitalized Indian coffee chains that had already established roughly 200 cafés in major cities. Thefront runner, Barista, had opened 100 cafés in India’s major cities in a span of only two years.9

Barista presented another competitive challenge, international expansion. Late in 2001 the com-pany had concluded an agreement with the House of Tatas, a powerful Indian conglomerate, to expandcafes into foreign markets. The objective was to move into eastern Europe ahead of Starbucks. Theventure had already established a roasting facility in Venice, and plans were being finalized for entry intoSoutheast Asia and the Middle East.10 With a distinct focus on the emerging economies, the companywould be able to bring its homegrown knowledge to bear. Barista believed that its strategy would reso-nate very well with emerging markets which had a set of environmental, economic and social conditionsthat were quite similar to India. Barista had fitted its cafés with imported Italian furniture, vivid andvibrant colors and an ambience that rivaled that of Starbucks—but at a lower price. Most of its coffeeswere priced under a dollar.

Since the company had addressed many of the larger developed markets, attention would inevita-bly have to turn to the emerging economies. What markets should they enter next? Would it make sensefor them to shore up their leading positions in the markets they were already in before launching furtherexpansionary moves? With much of the low hanging fruit already gone, it was now time for Starbucksto spell out a clear strategy of market selection and development that would continue to deliver superiorperformance into the future. Many wondered whether Starbucks was up to the challenge.

9 B. Kurian, “Barista to Float Coffee Retailing Venture,” Business Line, September 30, 2001.10 Managing in emerging markets could also be politically charged. Howard Schultz had learned this lessonthe hard way, when he had voiced strong support for the Israeli cause and denounced the Palestinian position.Starbucks cafés in the Middle East were instantly confronted with an Arab boycott. The result was an Israelipartner who wanted out.

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Appendix A Retail Coffee Consumption and Population by Potential Market

EUROPE2001 Avg Monthly Retail Coffee Consumption Y-o-Y* CAGR*

Population Earnings (thousands of tons) 97-01 97-01Country (millions) (US$) 1999 2000 2001 (%) (%)Austria 8.1 2,016 31.0 30.6 30.3 -10.9 -2.8Belgium 10.3 2,267 31.9 30.4 30.7 -12.7 -3.3Czech Republic 10.28 364 26.0 27.1 28.4 31.0 7.0Finland 5.2 1,962 30.2 28.4 31.3 7.1 1.7France 59.2 2,011 192.6 191.8 190.2 -1.8 -0.5Germany 81.9 2,108 350.6 352.0 353.0 3.2 0.8Greece 10.5 1,453 20.9 21.1 21.4 5.3 1.3Hungary 10.1 364 14.1 14.5 14.7 58.4 12.2Italy 57.8 2,396 160.0 165.1 168.4 6.3 1.5Norway 4.5 2,919 28.4 29.2 29.8 10.9 2.6Poland 38.7 418 85.3 85.4 85.6 4.9 1.2Russia 145.0 105 46.7 53.0 61.3 22.5 5.2Spain 39.5 1,486 65.6 70.6 71.3 1.2 0.3Sweden 8.9 2,145 58.9 54.8 57.2 -12.8 -3.4Switzerland 7.2 4,056 38.7 39.5 40.3 -0.2 -0.1United Kingdom 59.5 2,223 48.3 48.2 48.2 -7.6 -1.9

ASIA & AUSTRALIA2001 Avg Monthly Retail Coffee Consumption Y-o-Y CAGR

Population Earnings (thousands of tons) 97-01 97-01Country (millions) (US$) 1999 2000 2001 (%) (%)Australia 19.2 1,541 18.2 18.3 18.6 8.6 2.1China 1,281.8 84 3.3 3.7 4.2 37.9 7.8Hong Kong 7.1 1,410 2.5 2.6 2.6 13.9 3.3India 1,017.4 24 8.8 9.2 9.7 -1.1 -0.3Indonesia 212.3 32 47.4 52.6 58.8 52.0 11.2Japan 127.0 3,529 94.8 96.0 99.5 11.8 2.8Malaysia 22.6 803 8.7 10.4 12.5 89.8 17.4Philippines 77.3 126 21.3 21.8 22.6 36.6 8.1Singapore 3.3 1,715 2.0 2.1 2.1 5.6 1.4South Korea 47.6 1,611 24.6 25.9 27.0 14.4 3.4Taiwan 22.4 1,620 4.0 4.3 4.6 9.0 2.2Thailand 61.7 180 6.5 6.7 7.2 42.4 8.2Vietnam 81.0 59 9.6 10.6 11.7 48.6 10.4

*Y-o-Y growth 97-01: Year-over-year growth rate for the 1997-2001 period (2001/1997-1).CAGR 97-01: Cumulative average annual geometric growth rate for the 1997-2001 period.Source: Euromonitor—Global Market Information Database.

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Appendix A Retail Coffee Consumption and Population by Potential Market (continued)

MIDDLE EAST2001 Avg Monthly Retail Coffee Consumption Y-o-Y* CAGR*

Population Earnings (thousands of tons) 97-01 97-01Country (millions) (US$) 1999 2000 2001 (%) (%)Egypt 63.6 405 4.2 4.2 4.1 39.7 8.7Israel 6.3 1,640 19.3 19.1 18.8 9.2 2.2Saudi Arabia 21.9 1,974 12.0 12.4 13.0 26.3 6.0

AMERICAS2001 Avg Monthly Retail Coffee Consumption Y-o-Y CAGR

Population Earnings (thousands of tons) 97-01 97-01Country (millions) (US$) 1999 2000 2001 (%) (%)Argentina 37.3 740 27.0 27.0 27.0 -5.9 -1.5Brazil 168.9 413 540.7 561.6 569.2 34.9 7.8Canada 30.8 2,096 41.1 44.6 47.2 3.6 0.9Chile 15.3 379 4.3 4.2 4.2 7.0 1.7Colombia 39.5 388 42.2 41.3 41.0 46.6 10.0Mexico 100.4 281 32.4 33.3 34.4 66.4 13.6United States 276.6 2,154 641.2 648.2 694.2 8.1 2.0Venezuela 24.6 367 27.9 28.2 28.4 50.4 10.7

*Y-o-Y growth 97-01: Year-over-year growth rate for the 1997-2001 period (2001/1997-1).CAGR 97-01: Cumulative average annual geometric growth rate for the 1997-2001 period.Source: Euromonitor—Global Market Information Database.

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Appendix B Starbucks Coffee Japan & Competitors, October 2001

Starbucks Tully’s Doutor GinzaCoffee Coffee Coffee Renoir

Number of stores 227 23 766 121Directly operated 227 19 158 121Franchises 0 4 892 0

Number of openings (closings) 110 (0) 15 (0) 100 (18) 1 (6)Average purchase per customer ¥500 ¥400-450 ¥300-350 naAnnual sales (million ¥) ¥180-200 ¥60-80 ¥100-120 naCapital expenditure (million ¥) ¥70-80 ¥20-35 ¥80-130 na

Percent of Sales Comparison (%)Sales 100.0 100.0 100.0 100.0Cost of goods sold 28.8 36.9 49.8 10.4

Gross profit 71.2 63.1 50.2 89.6

Labor 25.4 18.5 15.9 39.1Rents 11.1 13.0 9.0 30.2Royalties 6.5 0.0 0.0 0.0Other 18.3 18.3 12.6 17.6

Total SG&A 61.3 49.8 37.5 86.9

EBITDA 9.9 13.3 12.7 - 0.3Depreciation 4.5 5.4 2.9 2.6

Operating profit 5.4 7.9 9.8 - 2.9Taxes 0.5 2.7 4.7 ----

Net income 4.9 5.2 5.1 - 2.9

na = not availableEBITDA = earnings before interest, taxes, depreciation, and amortizationSource: Starbucks Coffee Japan, Daiwa Securities, October 15, 2001, p. 7-8.