PoS Apr 2013 | The folly of chasing two rabbits

Last month I had written about risks associated with growth and why managers underestimate them.

Risk arises from complexity. I had cited how Nike has grown rapidly, and profitably over the last two decades by selecting initiatives that reduce the number of variables to one. Risk also results from trying to serve incompatible segments or markets. 

What happened at Starbucks

Activities of a company are the primary means of delivering value to customers. Incompatibility occurs when value chain is tinkered to serve different customer segments. Serving both with one configuration weakens value delivery to one or both. This is precisely what happened to Starbucks.

Obsession with growth led Starbucks to open more and more stores totalling nearly 17,000 by 2008. In many cities in US, they were so close by they started cannibalising each other.

Dilution of the Brand Experience

Conveniently located and easily accessible, the outlets began to attract takeaway customers who wanted a hot, reasonably good coffee, served quickly at an affordable price. They were different from the original target customers who savoured the coffee experience.

In order to serve both, Starbucks modified the value chain. To serve the takeaway customer the Company introduced flavour locked packaging, and new counter top coffee machines. The rich coffee aroma in the store and relationship between the coffee loving customer and the overworked barista began to wane. Commoditisation eroded value delivery and Starbucks found itself competing with the likes of McDonald.

Impact on share price

Between 2003 and 2007 Starbucks revenue grew from $4 billion to $9.41 billion. By 2008 annual growth rate fell from 20% to 10%. Revenue shrank 5.6% in FY 2009. Stock price tanked by 82% between November 2006 and November 2008 to $7.17. In the same period S&P index dropped 34%.

Starbucks was no longer the investor’s darling.

Back to the Basics

Returning as CEO in January 2008 Howard Schultz acknowledged the firm’s actions had led “…to the watering down of the Starbucks experience, and, what some might call the commoditization of our brand.”

He cut the number of stores by 1000,and costs by $600 million. More significantly, Starbucks went back to serving the original target customers. He retrained baristas to give customers the coffee experience, what was “the soul” of Starbucks. Coffee was being ground fresh again.

By FY 12 growth had returned. Revenue grew 14% over the previous year to $13.3 billion. Profitability had improved sharply, and stock price was hovering near $60 in March 2013.

Schultz brought about the dramatic turnaround by re-aligning the value chain to serve the preferred customer segment. He said, “The big issue I think was that growth is not a strategy, it is a tactic, and if growth becomes a strategy I don’t think it is an enduring one.”

The Starbucks case reiterates the folly of chasing incompatible segments or markets. What then must a company do to pursue attractive opportunities in incompatible segments?

The answer is simple: start a new company. Or, create an independent business unit that delivers superior value to target customers through a unique configuration of its value chain.

“If you chase two rabbits, you will lose them both.” – Native American saying.

V.N. Bhattacharya
Business & Corporate Strategy

Read What Highly Successful Companies Do.