Now, Starbucks Uses Its Bean

The java giant bets on more bricks and mocha, less Web

Howard Schultz has returned to earth. Last summer, analysts and investors concluded that the CEO of Starbucks Corp. was all but lost in cyberspace. Schultz and his management team were busily crafting a grand-scale Internet plan for Starbucks that would turn the coffee outfit's Web site into a "lifestyle portal" by partnering with gourmet food sellers and home-furnishings stores.

But while Schultz had his head in the cyberclouds, trouble was brewing at the bricks-and-mortar stores. Delayed store openings and lower-than-expected sales at existing outlets were putting a damper on earnings. Analysts' angst turned to alarm on June 30 during a conference call, when Schultz said that earnings per share would come in at 54 cents for the year instead of 60 cents as expected. After he spent most of the meeting talking up his Internet strategy, investors concluded Schultz was distracted by his online aspirations, and they told him so in a hurry. The next day, they sent the stock down an eye-popping 28%.

Schultz got the message, and seven months later, he's a born-again coffee-shop man. He plans to add 450 U.S. outlets this year to a base of 2,217, about level with last year's pace. He's stepping up overseas expansion. And while not totally abandoning the Internet, he will focus on pumping up store sales by stocking more sandwiches, gifts, and other noncoffee merchandise. "Our management team is 100% focused on growing our core business without distraction or dilution from any other initiative," says Schultz.

The shift in focus is already starting to pay off. On Jan. 27, the Seattle-based chain reported a better-than-expected 30% increase in earnings, to $34.7 million, for the fiscal first quarter. Sales at stores open at least a year grew by a healthy 7%. Investors, impressed with both the numbers and Schultz's new store-centric vision, have pushed Starbucks' stock price up about 30% since Jan. 1, to 32. And Schultz has promised more of the same for the year to come. "It's back to basics," he declares. "We've got a great opportunity to build the brand and grow."

TALKING TURKEY. One key to reaching that goal: lunch fare. Schultz is hoping that such items as $3.95 turkey sandwiches and $4.75 Greek pasta salads--made offsite and delivered to stores daily--will bring in a flow of customers after the morning coffee rush. He's planning to double the number of locations that sell the lunch menu to 400 this year. While so far stores with food each pull in a modest $50,000 to $100,000 extra in sales, experts believe the beefed-up menu will ultimately lure more beverage buying customers to the stores. "If it gets you to buy a $2 latte, then it's a good business for them," says Jerry Castellini, president of Chicago-based CastleArk Management, which owns about 750,000 Starbucks shares.

Schultz also plans to take the $2 latte into new territories. Armed with a $300 million capital spending budget for this year, Schultz will open stores primarily in the Midwest and Southeast in the U.S. While it may seem to dwellers on the East and West coasts that there's a Starbucks on every corner, plenty of communities in the U.S. are still waiting for their first shop. Company watchers say saturation is actually years away. "Until they have 7,000 stores, they don't have any problem growing," says Castellini. The company plans to add 100 locations in Asia and another 50 in Britain to its 300-plus international stores.

BOARD GAMES. Within the stores, consumers can look for a raft of new merchandise. Building on its reputation for cool in-store music, Starbucks has acquired privately held San Francisco-based music retailer Hear Music, a small chain known for its ample listening stations that let customers sample before they buy. That acquisition is supposed to help Starbucks improve its CD selection and presentation, which currently doesn't amount to much more than a small rack near the cash register. Schultz is even considering installing listening stations in some Starbucks stores.

Starbucks is also making an ambitious push into selling gifts and knickknacks. It kicked off the effort during the holiday season, promoting items such as $35 board games, $14 millennium-themed time capsules, and $25 stationery sets. Now, Starbucks aims to have new products, such as seasonal items pegged to Valentine's Day, every couple of months.

The merchandise changes are not risk-free. Schultz has already discovered that while he knows how to sell coffee to the masses, he knows far less about selling novelty wares. Over the holidays, for example, the stationery kits and time capsules didn't sell as well outside the big cities. No surprise, say some critics. "Once you achieve the size of Starbucks, it lets you do different things without jeopardizing the brand, but you can still get into trouble and get distracted doing that," says R.J. Selfridge, a vice-president at Starbucks rival Tully's Coffee Corp.

But Schultz maintains the mix will work. And so far, investors and analysts seem willing to give the new initiatives a try. "Strategically, it makes sense because they've got an enormous flow of customers," says Richard Fradin, an analyst at William Blair & Co. in Chicago.

For all his contrition over last year's stock debacle, Schultz hasn't abandoned the Net. Starbucks has a marketing pact with in Santa Monica, Calif., and another test program with wine seller Geerlings & Wade Inc., based in Canton, Mass. Hot links to Starbucks appear on both companies' sites. But the strategy is a far cry from last year's portal plans. The Net today "is a secondary or even tertiary business for us," says Schultz. Nudged by investors, Schultz woke up and smelled the coffee.