A Full-Bodied Talk with Mr. Starbucks

Chairman Howard Schultz discusses the java chain's biggest problem (health care), its philosophy, and its future strategy

Starbucks has said CEO Orrin Smith, 62, will retire next year, turning over the duties of chief barista to James Donald, 50. Though the Oct. 12 announcement took Wall Street somewhat by surprise, it's an orderly transition, as Donald was recruited two years ago from grocery chain Pathmark (PTMK )to eventually run the coffee retailer.

Whoever the CEO is, he's responsible for running Starbuck's rapidly growing operations, but the company's vision and culture are still derived from Chairman Howard Schultz. It was Schultz who took Starbucks (SBUX ) from a popular Seattle-based coffeeshop to a worldwide business and one of the most dominant consumer brands in North America -- and increasingly the world.

Schultz was born in 1952 and raised in a Brooklyn (N.Y.) housing project. A football scholarship to Northern Michigan University was his ticket out, and after graduating he worked a variety of jobs until becoming manager of U.S. operations for plastics company Hammarplast.

He began working for Starbucks in 1982 when he talked the founders into making him director of marketing and operations. It went public in 1992 with a market capitalization of $200 million. Today, it's worth nearly $19 billion.

Schultz recently talked to BusinessWeek about the big issues confronting Starbucks, including expansion, leveraging the Starbucks brand, the music and publishing businesses, and his biggest headache -- the soaring cost of employee health benefits. Edited excerpts of their conversation follow:

Q: What's the biggest challenge you face in terms of meeting your objectives for growth?


Without a doubt, it's health-care costs. We just had to raise our prices for the first time in four years. That is primarily because of the rising costs of health insurance and also dairy prices. Over the next two years, we will spend more for employee health-care costs than we will for coffee. That's quite a statement.

The companies that are doing the right thing by covering their employees are paying for the companies who don't do the right thing. Starbucks provides health insurance for all employees working 20 hours a week and up.

Q: Why do you do that? Clearly you are putting yourself at a competitive disadvantage.


The value and guiding principles of the company are linked to how I grew up, in the Canarsie section of Brooklyn. We were working-class and lived in federally subsidized housing. My dad never made more than $20,000 a year. I saw the fracturing of the American dream. My parents didn't have much -- and they didn't have much hope. We didn't have health insurance.

And I saw up close the plight of a working-class family. Building Starbucks has been very much about building a company my father never got a chance to work for. The cultural transformation took place when we were small and still losing money, and we decided to provide comprehensive health insurance for every employee, and later stock options for every employee. That was a first for part-time workers. About 65% of our employees, then and now, are part-time.

Early on, we decided we wanted to build a different kind of company. A company that made a profit, built shareholder value, but had a social conscience integrated back into the company. The challenge was could you do that and still make a profit?

Q: What's the upside to providing all that health care?


The result is that we probably have the lowest rate of attrition of any retailer in America. Managements of major retail businesses have used employee churn as a mechanism to keep wages low and health insurance out of the labor picture.

When you look at what companies say they do and what they really do, you have to be careful. Some companies that say they offer health care go out of their way to restrict part-timers' hours [so they won't be eligible for coverage]. And if they do qualify, they often can't afford the upfront premium. One of the largest companies in the country is famous for this.

Q: Is there any hope of health-care reform getting off the ground?


We have been to Washington and to health-care providers and to other leading businesspeople. Everyone I have talked to says it's a top three issue for them. We'll hold a summit at our headquarters in Seattle in the next 12 to 18 months. Former Senator Bill Bradley, who is on our board, is spearheading it. It's not to be political. It's just a matter of "let's try to have a dialogue and get at this problem."

Q: Most CEOs these days say health-care costs are out of control and imposing serious threats to their businesses. It appears that the Democratic Party is more anxious for reform than Republicans. Doesn't it seem ironic that most CEOs support the Republican Party?


I agree. But I won't go any further than that.

Q: You are not only in the coffee and food business, but the music business as well. How is that going, and how far can you go with it?


We use music to create mood in our stores. Customers began asking what we were playing, and if we could sell them what they were listening to. HearMusic [a music cataloger and retailer Starbucks bought in 1999] helped us go to the music industry to create compilation CDs that we sold.

Then, we went to artists and asked them about the music that most influenced their lives and careers, and we produced CDs of that work. Now, we have artists calling us, because they see our model and what we are doing as being something they can work with. We are now an alternate channel of distribution for music. Starbucks is a ray of hope for these artists.

Q: And how about the HearMusic format you have been pilot-testing in Santa Monica?


We saw the opportunity last year to combine our store traffic and the trust in our music business. The Santa Monica store is a prototype. [Customers] can sit in the store for eight hours and navigate the music and create their own CD. We will be in Miami next year. We're retrofitting 45 stores in Seattle and Austin this fall to be HearMusic stores. And we also just launched a satellite radio station. We are the first consumer-branded station of this kind.

Q: And now you have a book coming out?


This fall we're launching a holiday children's book [The Biggest Gift of All, by Lily Small] in a joint venture with Barnes & Noble (BKS ). It will be distributed only at Starbucks.... It's a start. We'll see how it goes.

Q: Where do you draw the line in how you expand the brand?


Everyone wants to license our name.... I went to a Green Bay Packers game in Green Bay, and I looked around and said I never want to see people wearing a Starbucks hat that looked like that what I was seeing.

There was a media executive who sat across the desk from me and said he was going to write me a check, and I could name the price, to put monitors inside all our stores to run his TV channel from 7 to 10 every morning. I pushed his check back and said we aren't going to do that. People come to Starbucks to get away from the noise, and we have to treat it like a sacred environment.

Edited by Patricia O'Connell

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