Starbucks (with Howard Schultz)

all right, we're rolling, we're rolling. we get to see how you guys do this, it's.

kind of usually a pump-up music. we can do that. I saw your turntable. that's beautiful. what do you want to hear now?

welcome to season 14, episode 5 of acquired the podcast about great companies and the stories and playbooks behind them. I'm Ben Gilbert, I'm David Rosenthal and we are your hosts. seven years ago, David and I did an episode on the Starbucks IPO just the IPO. that episode was a mere one hour and 24 minutes, and Starbucks is a 90 billion dollar institution in our world that deserves the full acquired treatment. who, what were we thinking?

incredible one of the very, very small number of food and beverage establishments that has scaled to the entire world. yeah, most of those types of.

concepts do not work in different countries and continents, but Starbucks is different. today they're in over 80 countries with 39,000 stores across the world. they're even huge in China, a country that didn't consume very much coffee until Starbucks arrived. they are a bank scale financial institution as well. at any given time.

announcement for you. yes, save the date if you love acquired. you are going to want to be physically in the city of San Francisco on Tuesday, September 10th, 2024.

and we can't say much you know about every detail of it just yet, but it will be the biggest thing that acquired has ever done. it'll be in partnership with our good friends at JP Morgan payments. so mark your calendars now, save the date and if you want to be first to know details, you can sign up at acquired dot FM, slash SF, or click the link in the show notes speaking of JP Morgan.

payments. just like how we say, every company has a story, every company story is powered by payments and JP Morgan payments is a part of so many companies journeys from seed to IPO and beyond, and if you want more from David and I, you.

should check out our second show, ACQ 2, where we interview founders, investors and experts, often as deeper dives in topics that we covered on the main show. recent episodes have been awesome, with the CEO and the founder of synopsis of starfish space further exploring the space industry, and we've got some great stuff and payments coming up next too. we do all right. so with that, this show is not investment advice. David and I may have investments in the companies that we discuss, and this show is for informational and entertainment purposes.

there. this is what I know. there were three founders Jerry Baldwin, Zev Siegel and Gordon Belker and the story that was told to me is that one or both of them were going to school in California, in the Bay Area, and they became enamored with Pete's coffee company, which Alfred Pete yeah, Alfred Pete was, you know, more than anyone else in the history of coffee in America was the true pioneer. he brought specialty coffee, Arabica coffee to Northern California, and Jerry Baldwin and Zev became so interested and intrigued with what Pete's was doing and, given the fact that they were from Seattle, decided they would try and bring Starbucks coffee in the form of Starbucks to Seattle Washington. now what is not known is that when Starbucks opened in the Pike Place market in 1971, they were using Pete's coffee.

see what was going on. Was Starbucks buying it for use in? They were selling.

it in their store now. but here's the thing. Because this was a consumer device. Yeah, yeah, but you have to remember Starbucks coffee company, from 1971 until around 85-86, only sold pounds of coffee. there was no beverage.

in 1982 as a head of marketing. So when you and Sherry arrive here, like what was the coffee landscape? I mean there were these three soon-to-be-four Starbucks beans stores here in Seattle. Alfred Peet was down in the Bay Area. but what was coffee culture?

was, it was De Minimis. There was another coffee company, which was Seattle's Best Coffee, which was another retailer that was kind of at the same size and scale at Starbucks, both equal at the same time. But you couldn't even get a New York Times in Seattle in 1982, 83.. It was not no good food to speak of, and Starbucks was a true pioneer where they were educating customer after customer about what good coffee tastes like. And the pipe place market gave them an interesting vehicle because of the tourists, and so Starbucks actually started establishing a mail-order business as a result of all the people who were coming into Seattle.

they would buy a bag, and then they would fill out some kind of information and say I'd like to, I'd like to have this mailed to me. Because I don't have anything like it in my city.

Yeah, that's what happened. And because coffee has a shelf life of basically a week to ten days and we didn't have a vacuum bag at that time, we were shipping small amounts. Because, to Jerry Baldwin's credit, he had such a fastidious point of view about quality and freshness. And I think that had a huge impact on me.

But this couldn't have been like a great business. You're shipping small amounts, the logistics costs, you know the scale. This was a small business, but

the equity of the brand even back then was much larger than the size of the business. And the opportunity that I saw, even when we had four or five stores, was well beyond Portland, Oregon. And I was always kind of pushing we could do so much more, and then the whole thing blew up for me when I went to Italy in 83..

Okay, so before the Italy trip I just want to really contextualize coffee in America. I think coffee had been declining since like 1940.. It's still part of the American culture, but it's not that it's on the way out, but there's nothing new or interesting except for this little segment of specialty coffee.

which was tiny. And I think what you've just described, the reason for that is that coffee was terrible. It was instant coffee, stale coffee, and primarily robusta beans, which is the low-grade coffee that Starbucks was never involved in. Walk us through the two types of beans. There's mainly two types of agricultural coffee grown for commercial use.

our research is that the robusta market really developed, as you say, with the instant coffee market, and that was kind of a product of World War II, right? It was like, hey, we got to get the troops this product to survive, and so we just need a lot of beans and we need to ground them up and create this instant product. I believe Maxwell House was involved in inventing. Yeah, you're.

exactly right. I mean it was just fuel and bitter, acidic, and yeah, and that's. I think World War II and the GI's were kind of the impetus for that kind of quality coffee or not quality coffee to exist and have any kind of run after the.

war. So you show up at Starbucks, you know, you know a little bit about the market because you've been a supplier of theirs, but you happen to be a pretty talented salesman from your time at Xerox. Yeah. And I want to make a tie here. Our previous episode was the Microsoft episode, or at least Microsoft volume one.

word processors were in the mid 70s. So my territory was 42nd to 48th Street, from 5th Avenue to the river, and I had to make 50 cold calls, physical cold calls a day. That was a job. The Xerox job taught me incredible amounts about not only selling but humility. Humility.

letter. And does it have a screen or has it a typewriter? No, it's a typewriter. No.

screen. It's like a typewriter with like a, with a little bit of cash, right? Yes.

Yes, exactly. Yeah. Mistakes for one line, right? Yeah. The job at Xerox at the time was like working for Google.

you quitting, well, Hammerplast, but you know, quitting what seemed like a stable of pretty good jobs. Yeah. To drive across the country to provincial little.

Seattle. I mean that's that's nuts. I knew after a couple of years, if I stayed at Xerox for a longer period of time, I was going to be locked in there. But I'll you the story that got me to realize I've got to get out of here. At the end of the year, the performance appraisal at Xerox was basically a scorecard from 1 to 5..

and I'm a 3.

entrepreneurs out there. I got a 3, and as soon as I got the 3, I swear at that moment I knew I've got to get out of here. And that's when I started putting myself in a position of meet other opportunities and, by and large, I was able to get the Hammerplast job, which was the general manager of the company which was based.

in Sweden, in the US. But I was a 3.. Do you think, having that background at Xerox, did that give you a piece of perspective that helped build Starvex?

to what it is today?

common with someone for your background, poor kid in the projects, coming from nothing, to get a great job, two great jobs and be wildly dissatisfied and not feel like I've made it, but rather know there's got to be something more than this. There's something deep inside you that caused you to be willing to take a.

risk. I was really insecure about not succeeding and I didn't view what I was doing as the success that I was not destined for, that sounds wrong, that.

I had the appetite for. All. right, so we're getting to the big risk. So the year takes over to 1983.. Yeah.

went to a trade show called Matcha. It's a big convention center and it's a giant houseware show with equipment and all kinds of stuff, and I I was staying at a relatively cheap hotel and walking distant to the convention center. I get out of the hotel, I'd never been to Italy before, and I am all of a sudden being intercepted with the physical manifestation of one coffee bar after another in the business that I'm supposed to be in. But it wasn't the business that Starbucks was in. and I walk in like a normal person that's never seen this before, and I am just like I'm in a black-and-white movie.

espresso. And there's nowhere else. No one in Seattle had it. Well Cafe Allegro.

had it and that was Dave Olson, and after a few months, or six months or so, Jerry said I don't want to repeat this. I don't want to do it. I don't want to be in the.

restaurant business. Yeah, what was the objection? Was it the stigma of the?

restaurant business? I mean I don't want to speak for Jerry. I have so much respect for him, but he didn't think it was clean. He didn't like it. Now, between 83 and 85, Jerry Baldwin, because of his love of Peet's and his relation with Alfred Peet, had an opportunity for Starbucks to acquire Peet's Coffee Company, and they did.

financial trouble. And so really, at this point it was like their mentor was retiring, this person who was a steward of the industry. We're operating six points of retail distribution in Seattle for our beans. Why don't we just buy your effectively the same business, but in Northern California and keep them?

separate for now? Well, it's important to know that between the opening of the fourth and spring coffee bar inside of Starbucks. Starbucks number six. Yeah, and Jerry and Gordon saying we don't want to repeat this. I was so frustrated I said I'm gonna leave Starbucks.

down. So at this point you're in Italy, you're trying to get ideas and investors for what would become Il Dronali. For the first Il Dronali. And only Starbucks and a couple.

other people have committed. But I didn't have enough money. I still needed more money. And you were raising 1.6 million? About 1.6, 1.7 million.

America. Which is stupid, because you watched it happen. Like I ran this store for six.

months and like it was fine. Yeah, they didn't want to do it. So Lavazza and Faema, just get that on the record, turned me down.

needing the money to expand, just to pause on that for a minute, business-wise, obviously, coffee bars are a much better business long term than coffee beans. But probably more capital intensive, right? Eating, more staff. Yeah, more labor, yes.

But the stores weren't that expensive to open because they were small. Less than a thousand square feet. And we understood how to do it. And I was working as a barista with Dave Olson and other people to keep the costs down. We were behind the counter and I had no salary.

increasingly worse from a traditional perspective of leaving a high-quality job, moving across the country, then, just a couple years later, here you are not making any money again, while raising millions of dollars to try to start your.

own business. It gets worse. Sherry is six, seven months pregnant. She's working. Her parents visit Seattle.

have been over. And that would have been a very understandable response if Sherry had said, I wasn't going to say anything. But look at our situation objectively.

Putting ourselves in your father-in-law's shoes. How could you not feel that way, for?

your daughter and her impending family? Yeah. And her father was a great guy. And I understood, but I was embarrassed and humiliated. How could I not be?

I mean, I guess that's another dimension here, too. This was not 2024.. It's not like being an entrepreneur was a glorified profession here.

In a business that he clearly did not understand. You know, a coffee store.

The other interesting thing to point out around this time is, for the people who were seeking high-risk business investments, you know, this is the late 80s. It's time to look at tech. Like, we're now 12 years into Microsoft, Apple's four years past the Macintosh. And you're trying to raise money for a coffee.

house chain. With names that people couldn't pronounce, and serving it in a.

paper cup. To go. That does not sound innovative to me. I don't know why I'm.

putting my risk capital into your.

in Vancouver. You could see it. What would people do after they bought the coffee? You said these are very small places. They would stand up, because the two.

stores didn't have seating. right away. They would stand up at the coffee bar at the window on Columbia Center. And it was at eight, nine o'clock in the morning, they were hanging out there. And then they afternoon, late morning, they were coming back.

Alright, so we're at the pivotal moment. Starbucks and Pete's gets into.

financial trouble. And the debt to equity was north of six to one for a company that was tiny.

And so did you hear from Jerry that the bid had been dropped?

We walk out and I say to Mr. Gates, what just happened? And he said, you're going to buy Starbucks coffee company and my son and I are going to help you. Wow. And we raised the money.

but that's the story. And Sam, I mean, for anyone who doesn't live in the Seattle area, his name is on buildings and community centers. I mean, this revered philanthropist, I actually don't know his business background. How did he become the Titan that he was?

He was involved in real estate and also in those auto stores.

How did you get him off the Il Giornale cap table? Like, wasn't he an investor?

He and his family were investors to the end until they got out. Oh, wow. Until they got out.

Wow. Looking back now, what do you think happened? Did he have any legitimate criticisms of you as running the company?

He had a henchman, who was his money guy, who figured out we could just take this company. and what do we need? Howard Schultz for? He's a young kid. And Sam had experience with retail, with those auto stores.

I see. So he could install some professional management from some other venture. Yeah.

Run the playbook.

Yeah. It would have been over. But the thing about Bill Gates is I saw him socially a hundred plus times. He never, ever said anything public about what he did. He never took credit for it.

So for listeners, Howard's told this elsewhere, but you spoke at the Microsoft CEO Summit, you've recounted the story to the Fortune 500 CEOs and Bill Gates III, Microsoft founder, comes up to you afterwards and says, yeah, who was the guy?

But Bill did not know the whole story. He didn't know any of it. He didn't know what his father had done for me. He's hearing it for the first time.

And this is, you know, 2015 or something. So Starbucks, like you would think...

No, he didn't know.

someone would want to tell their family, I played some significant role in this, but that's not the type of guy he was.

Bill Gates never told his soul what he did for me. Wow. Again, humility.

It's amazing.

Yeah.

And so were Bill Gates Sr. and Bill Gates III investors in that $3.8 million round?

Bill Sr. was, but I don't know if it was part of Bill or...

But yeah, Microsoft. Interesting. So I asked Sherry about this when I was preparing for the episode, and her recollection was it was something like one to two weeks before the three-month exclusivity for you was going to be up. And so you're basically like, this event happens, but now you need to come up with the money. And you have this unbelievably short period of time to do so.

But I had another angel who helped me by the name of Jack Rogers, who became a lifelong friend who passed away a couple years ago. He was part of an investor group, and he brought them along.

So the acquisition goes through.

Yeah. August of 87, we bought the six Starbucks stores. We had the three Ildren Ollies, and there were two stores under construction. So at the end of the calendar year, we had 11 stores and 100 employees in 1987..

All in the Northwest.

Yeah.

Meanwhile, the original Starbucks folks, they've now gone down to California.

They went to California.

When did Pete's open coffee bars?

Many, many years later.

Ah, so you weren't competing right away?

No, no.

But this is one of the great observations, David. Ildren Ollie buys the Starbucks stores, rebrands Ildren Ollie, Incorporated as the Starbucks Corporation. Yeah. And the original Starbucks had owned Pete's and now needs a new name, so it rebrands the company Pete's. So Pete's was actually Starbucks.

But you asked me a question earlier about what did the years at Xerox teach me? So the rejection I was going through, the Italians turned me down, people in the U.S. turned me down. Nobody would believe in the idea. It was like I was cold calling again at Xerox.

The other thing that is worth pointing out is

No debt. I want any debt again because of my childhood.

I was going to ask you, was that informed by what you had seen with the Starbucks situation or your childhood?

No, it was totally my childhood. My parents were always in debt. Bill collectors were always calling. And no, we never had any debt the entire time. Never.

This is probably a good point in time to talk about the business model a little bit. You've alluded to kind of a stigma, at least among potential investors, and the original Starbucks founders of, like the restaurant business. What did the economics of the coffee bar business look like when you bought the Starbucks stores?

So what did we buy? We had the stores, we had the brand name, and we had a roasting facility on Airport Way in Seattle. The ability to source and roast coffee and put that through the supply chain of a beverage gave us probably at the time, an 80% gross margin.

Yeah, that is not the quote unquote restaurant business that people are imagining.

And I could begin to see, even early on, the accretive nature of frequency. where I can see what was going on here is people were not coming for coffee in the morning anymore. They were starting. The morning rush was getting bigger, the need for more labor. And I could sense that the business that Starbucks was in was going to be significantly in the back and the beverage and the romance of the theater.

Even the best, most successful restaurant. you could possibly imagine, how many times are their most loyal customers going to come there in a week?

Well, there was a time in the Northwest when we were really at our peak, where the average customer was coming 18 times a month. I should rephrase it. Maybe the most loyal was coming 18 times a month.

There's some magic to this idea that it's not a terribly expensive item. I think I saw some research that said that it's, you know, sub 1% of someone's household income and often far less than that. But it is repeat and it is high gross margin. And so when you say lightning in a bottle, there's a cultural lightning in a bottle, but there's also this like ridiculous business model, where the way it shows up is your stores, basically from this point forward, for all of Starbucks's life, you build a new store and the profits from that store would totally cover the costs within two years, and often a year and a half.

But I'll tell you the economic model that we applied to every single store we were opening. You know, by the way, I chose the first 500 locations myself. So I was in it in so many ways. But the economic model in Wall Street, when we went public in 92, now I'm just, when they heard the model, they said, well, we'd never seen a model like that. And the model basically was a sales to investment ratio of two to one.

So what does that mean, sales to investment ratio?

So if the sales were a million dollars, the investment was 500,000.

In year one of operation.

Yeah, yes. And the operating profit was north of 20%.

Wow.

So cash on cash return was.

So yeah, you get that two years or less payback. The retail world had never seen a model like this before. There was no physical storefront that could have this business model before this.

Early on, it became clear to us that customers were also starting to customize the beverage on their own. So we were just, barista was behind the counter and somebody would say, can you put something else in there? Yeah, what do you want? And then, so that just started, the average ticket started growing as a result of the customers personalizing and customizing their beverage.

And to be clear, the era of Starbucks we are in right now, you produce drip coffee and you produce espresso, and you can put that espresso in frothed milk. And that's basically your options. Like none of this, you know.

Yeah, exactly. But can I tell you a mistake I made?

Please. Please.

When Il Dronali was getting ready to open, the standard cup in the world was that terrible styrofoam cup that is used in diners in New York City. Remember that cup?

Yeah.

I put boiling water into that cup, five minutes later, the cup is starting to turn like a golden color because of the chemical.

That can't be good for your insides.

Or the taste of the cup. And so we had to find, we had to change the cup. This was such a smart move in retrospect, but we were just trying to figure out. Now, no one in America that is in the paper business had any kind of cup or lid that was compatible with what I was trying to do. In fact, they didn't understand it.

Right. Why go to the trouble of, you know, this perfected roast of these beautifully sourced arabica beans from all these farmers, if you're going to pour it into styrofoam?

Yeah. Okay.

Did people think you were a hippie? Like when you were telling these, like, are you an LSD or something?

I think they just dismissed me.

You got enough right. You don't need to get them all right.

No, I just, I missed it.

When, uh, the sizing. Grande, Venti.

Oh, that was, uh.

The hidden Trinta. Yeah.

Right. When did that start?

There was a brilliant, brilliant guy who was the architect of the name Starbucks. Named Terry Heckler in Seattle. And he's a fantastic design guy. And we're just sitting one day and I just talking about the importance of language. We got to get the language, right?

It was Venti, not an original.

Venti. We didn't have that size when we started. That was later on. Wow. Who would have thought somebody wanted to.

This is America.

So my one more question on this, writing the customer's name on the cup.

That didn't come from me. As the stores got busier and busier, the baristas were having a hard time. with whose cup is it? What are we going to do? And someone at Starbucks, I don't know who it was, started writing names on the cup, writing names.

And this is all, like, you know, to my mind, just starting to create this incredible flywheel, right? If you've got this 80% gross margin business, where the key lever is repeat loyal customer visits, you've got customization that is making customers more loyal and increasing your margin at the same time, because you can charge more for it. You've got the interpersonal relationship with the baristas. Sure. But also, even as you scale, I mean, the name on the cup, that's something that scales, even as thousands and thousands of people come into the store.

The intimacy with the customer and the barista became a very powerful component of the equity of the experience. And I've always thought in so many ways, Starbucks became the first experiential brand at scale. We didn't spend any money on marketing, zero. There was no money for marketing. And the cup, the iconic cup, became a badge of honor because people were doing something that was new and novel and walking in the street with it.

It's your free billboard.

Yeah.

That people are proud of.

Wow.

Well, listeners, this entire episode. so far, we have broadly been talking about the concept of customer experience with Howard, and we want to talk about another business that has been innovating on the customer experience, and that's JPMorgan Payments. When it comes to digital commerce, JPMorgan Payments is all about personalization and convenience, both for consumers and businesses.

Right.

So, on the consumer side, technology has completely changed expectations for shopping and commerce. Whether it's a sneaker drop or a coffee order, customers expect functionality like ordering in an app, but picking up in-store, getting real-time updates, and having our preferences and past orders synced and remembered.

Yep. And importantly, we expect our payments to be simple, no matter where or how we want to pay, which creates real challenges for the business on the other side of that. to create the magic. Even with super complex transactions like a marketplace website, where you aren't just buying from one single retailer, but a merchant on the other side of that platform. You can imagine there are plenty of technical and regulatory complexities to make that frictionless across different countries and currencies, but with great embedded finance and innovative commerce solutions, you can delight customers without really taking that all on yourself.

Yep. No matter how big or small your company is, you have to manage a complex technology ecosystem that now includes online payments, in-app payments, social payments, in-store payments, digital wallets, and much more in the future.

Oh yes. Like biometric payments, which, remarkably, research shows that will reach 3 billion users and $5.8 trillion in value globally by 2026.. That is insane.

Yep. And just like Howard pioneered many firsts in his industry, JP Morgan is doing the same with biometric payments. It's essentially a pay-by-face solution that allows you to complete transactions seamlessly and securely, removing the need for carrying a wallet or digging into your bag to pull out your phone.

Yeah. If any of you were at the Formula One race in Miami last month, you may have even seen JP Morgan's biometric payments powering the fast lane checkouts in the merch store. In last year's pilot, literally every single payment was processed in under one second.

Crazy. And for businesses, speed of payments is obviously great. to shorten lines. To quantify that, biometric payment solutions have shown to decrease checkout times by up to 35 seconds per transaction and increase purchase value by 4%, driving incremental revenue and maximizing profitability.

I can totally attest to this. as a customer. I basically only use tap to pay with my watch or phone everywhere I go now, which, you know, just felt like sci-fi a few years ago. But unsurprisingly, that capability for merchants to accept contactless payments is now also being powered by JP Morgan payments.

So, whether you want a full-stack, omni-channel service with biometric payments or streamlined online payments with the latest APIs, JP Morgan's commerce solutions work to drive your business forward with the foundation and security of a leading global bank and the innovation of a fintech.

The very best of both worlds. That is why we here at Acquired work with JP Morgan. You can check them out, jpmorgan.com slash acquired to learn more and discover more payment solutions powering growth for your business across every industry, from startups to the Fortune 500..

So in this era, I mean, you must just be getting more and more excited every day.

Oh, I was out of my mind.

So David Howard sent me, there's a 1988, I can't believe this was filmed, but a 1988 shareholder and employee meeting, where it's great. The whole thing's like an hour and a half. It's all there. And you are using all the same language that you use today. Back in 1988, we focus on our people.

That's what happened.

The pace of growth, approximately you just doubled stores year over, year over year. Was there some moment in 88, 89, 90, where you're just like looking around, realizing we must expand as fast as we possibly can, because this concept is the concept the world needs now. And if we don't pull out all the stops, someone else is going to do it.

There were regional competitors who were making noise about doing what we were aspiring to do. And I was very mindful because one of them was franchising. That was Gloria Jeans out of Chicago. And at one point, I think they had more stores than we did because of the franchising opportunity. And that's one of the reasons why I went to Chicago as well in 87, 88..

Because Chicago was the first market outside of Seattle and Vancouver, right? Yes. Even before LA.

And it didn't work right away. Howard Behar should be credited with so much of the cultural texture and the tapestry of the humanity of the company, said, I will go to Chicago and fix it. He went to Chicago and stayed in Chicago through the winter and recalibrated the mistakes we were making. And, of course, he and Oren were so instrumental into the loneliness that exists as an entrepreneur and their ability to help me build the company that you know today.

So I have in my script here, this is literally labeled the H2O era. And for anyone who was a partner at Starbucks, sort of knows what I'm talking about. And anybody else outside has no idea. But there's two Howards. There's Howard Schultz and Howard Behar.

No, he was the adult in the room. More than the numbers. He had the style. He was quiet. He was a gentleman.

And is it true that the three of you had dinner every Monday night for a decade?

More or less, that is true. Sometimes more than once, if we had a crisis or two, which generally we did, or we had a disagreement. There's a lot of creative conflict, especially between Howard and I. Because he had to operate what we were trying to do. And at times he thought we were growing too fast or ahead of the resources.

Hmm. Because he was basically training all these operators, the sort of management fleet of the company.

He was building the operating system for us to be able to open the store, design the stores, which more or less I had done, build them, operate them, train them, and create the system to handle the flow of customers. So his job was much harder than mine.

Speaking of system, what did your technology look like at this point?

Don't embarrass him.

No, we had, there was no, there was no technology. No.

Were you running like a Oracle system?

Not at that time, no. Wow. No.

We're talking paper?

It was mostly manual. Wow. Yeah.

I mean, eventually. when they did get point of sale terminals, they were DOS based all the way through, like 2008, right?

Yes, yes.

Like the iPhone was out and you guys had DOS based point of sale systems. Sounds right. But obviously technology was not the secret sauce.

I'm foreshadowing here of the future of the company. Yeah.

So let's take it forward from this 88,, 89, 90.

That's the big fight between Howard and I.

I don't think I realized it was a big fight.

I just felt in my bones. we had to go to LA. Why? And he said, we're not ready for LA. We're going to San Diego.

You went to play in the majors.

Yeah. So we had a meeting about it and it erupted, erupted into a bad scene.

I'm shocked.

We did go to LA and it was fine.

And your conviction of we have to go to LA, was that for?

The equity of the brand, I could see, I could envision the warm weather and everyone walking around with our cups and the media and the celebrities, and just the iconic way. And there was nothing in the market, nothing at all. that even appeared to be in the business that we were in. And anyone who was doing it was not doing it. well.

Was there an intentional strategy to create sort of a luxury brand out of Starbucks that, like the cool people, were carrying the Starbucks cup? It might be a little bit expensive, but you can afford it.

No, there was no, I can never remember a discussion about segmentation of the brand, because we wanted Starbucks to be accessible to all. You'd have a CEO of a company and the person behind them was a blue collar truck driver, because everyone could afford the affordable luxury of Starbucks at the time.

When you say affordable luxury, what about it was luxury?

The quality of the coffee, the experience, and what it felt like to walk around with that cup. at the time. It was a badge. It was like you were in the know.

Yeah.

It wasn't a badge of luxury. It was just like something new.

So it became a trope for decades. now that it's, oh, it's a $6 latte or an $8 latte. Where does that come from? In your mind, is Starbucks premium priced? Is there actually a?

I think the pricing of Starbucks was directly linked to the economic model that I alluded to earlier and the rising costs of labor, rent, and the fiduciary responsibility that we all felt to achieving the promise we had to our shareholders. Now we're talking about as a public company. There certainly was a fair amount of discussion all the time about the sensitivity of the price points. And I think in later years, maybe in the last couple of years, given the consumer inflationary time, I think it's become a bit of a problem. And certainly I've always said, as Starbucks was growing, that the ubiquity of Starbucks was an enemy to the company.

Can you tell us about the people? This is such a huge pillar to our minds of building Starbucks.

Again, we started this conversation talking about childhood. I really want to build a different kind of company. And how do I do that? in a way that provides respect and dignity? Because I was so imprinted with how my father felt disrespected, devalued, and kind of vilified as a uneducated, blue-collar veteran, working in a series of jobs that he just never made and living through the dysfunction of a poor family, always under pressure with money.

I mean, the health care for part-time workers.

So then health care, I think, 25 years before the Affordable Care Act, what we did was company for health insurers. And that also, I grew up in a family with no health insurance.

Do you want the stats on that initial employee stock grant?

I'd love to hear it.

So the program was called Beanstalk, listeners.

Another great name.

Howard was alluding to. Amazing name. So in 1988, the health benefits roll out even to part-time employees, including gay couples in domestic partnerships. I believe the first of its kind. That was a 33-store company.

Yeah. A lawyer, I think Scott Greenberg at the time, came to me and said, we can't do this unless we get approval from the SEC because we were over 500 shareholders.

So we've studied lots of amazing companies on this show who have lots and lots of different business models. One thing that just kept striking us as we were preparing for Starbucks are the similarities to your neighbor here in the Northwest in Costco.

Costco, right.

And how you treat your people specifically.

That's not by accident.

Both from a it's-the-right-thing-to-do perspective and the amazing business model benefit of the retaining employees. It's so expensive to train a new employee. It's not expensive to keep an existing employee. So you can just pay people more. if you keep them for longer.

Do you know the answer to that?

I actually don't. No, we don't know the answer.

I assume the answer to this, but I don't know it.

First, Jeff Brotman invested in Starbucks in the round to buy Starbucks.

No way!

Yeah, in that 87 round. That's when I met Jeff for the first time. Jeff became a board member of the early imprinting of Starbucks. And clearly a mentor, mentor of mine. And then he introduced me to Jim Senegal.

You sold beans.

We sold beans. In Costco.

Yes. And that brand awareness of I buy Starbucks beans at home meant that that group of people went to the stores more often.

We introduced thousands of beverage customers to Costco through the beans. Wow. So Jeff and Jim were instrumental in so many things and were so kind to me as a young kid. And then we went nationwide with Costco.

So this is a thing that I think many people don't realize. now that Starbucks is ubiquitous. We sort of forget about this time when it wasn't and where people had to find some way to experience Starbucks. You know, you only get a few stores in each of these cities. You're only in a few cities, but there are ways to scale brand awareness.

Yeah. If you thought the Costco revolt was high, you can imagine when I said, we have an opportunity for United Airlines. People thought that was absolutely blasphemy. Don't do that. And again, the exposure and the opportunity to surprise and delight customers in places that they've never had anything close to good coffee, all these things, when you consider we didn't spend a dollar, a dollar of marketing dollars ever.

Right.

And we were then going back to our core business in new channels of distribution.

It's like. the ultimate goal is to capture those margin dollars from selling cups of coffees in the stores that you operate. But there's all these other things that you can do that actually might spit off some profit dollars. But at the very least, it's a breakeven way to do customer acquisition and brand building in the rest of the world.

I don't know what our cost of customer acquisition was back then, but it was low.

Well, you weren't spending any money on marketing.

United Airlines was paying you for coffee, I assume. I don't know exactly how that went down. But yeah, I have to assume that Barnes & Noble was basically the same thing.

Barnes & Noble was a different deal. I met Len Riggio, the founder of Barnes & Noble, very interesting guy, very smart guy, great merchant. And we just started talking. He was from Brooklyn. I was from Brooklyn.

We have a fun piece of trivia that you may know, related to Costco. Do you know where Jeff Bezos and Jim Senegal met for the first time?

It sounds like in a Costco.

Not in a Costco. In the Starbucks, in the Barnes & Noble in Bellevue.

Did not know that.

And that led to so many things, Amazon Prime among them.

Yeah, did not know that. And I still am friendly with Jim Senegal today.

I mean, your companies rhyme in so many ways. That's not surprising at all. I want to talk a little bit, before we get to the IPO here, about what the strategy was when you expanded market by market. Did you try to sprinkle a few stores in and see? Did you try to move into a market with force and be the dominant coffeehouse chain in that city?

Well, Boston's an anomaly because of the acquisition. But Bihar was so strident in not expanding to multiple markets at once. And he was 100% right. And so we went to Chicago, went to LA, and we stayed there for quite a while. Went to Portland.

You went to D.

Went to D.

Like a lot of the good real estate was taken by the Coffee Connection, right? Yeah.

And so George and I never saw eye-to-eye, but it was clear that if we came to Boston in a significant way, we were going to impact his business. And I think, to his credit, he was willing to sell. So Coffee Connection was the first acquisition. And we had to tread very lightly after the acquisition because of the loyalty and be careful with the name and solicit George's help and advice. And also, we needed him to kind of validate for us what we were trying to do.

Well, it seemed like, I think the numbers are, it was a little bit after IPO in 94, $23 million. They had 23 locations and they were doing $16 million a year in revenue. So if you just look at the purchase...

I think it was one-time sales.

Or maybe a little over one-time sales. And the original Starbucks, ironically enough, was exactly at one-time sales, right? That's what you bought it from the founders, for. If they had the lock on all the best real estate and they had burned all the capital figuring out what stores we should be in, what stores we shouldn't be in, and then you just get to move into that market for one-time sales, 1.5, whatever it is, with all that already figured out, that's pretty amazing.

It probably seemed high at the time, though.

I'm sure it did. Well, isn't that the thing about valuations? It always seemed like in the good old days, everything was undervalued. Yeah. Okay, let's talk about the IPO.

I think there was so much about being a public company that meant something to me personally, that it validated the company, it validated me, my own shame and security as a kid. So I was a driving force all along. Certainly the year before with Beanstalk is an indication what I was planning. If Beanstalk was turned down, I would have waited. That had to be done.

And what was the revenue at the time?

I don't remember exactly. I know what the market cap was the day we went public.

I think you ended up doing 93 million that year, but the year before it was 50 million or something like that. Companies went public when they were smaller back then, but you were a small cap IPO.

Yeah, we were. And we got turned down by Goldman Sachs, you know that?

I did not know that.

I couldn't believe it. I wanted Goldman Sachs. They were the patina on the prospectus to have Goldman Sachs.

It would be a very Starbucks thing for Goldman Sachs to be the elite left.

Well, Blankfine, I had a good friend who was a senior partner there, who's since passed away. I thought I had it locked. I mean, it was just so many things about it, New York, everything. And they said, no, you're too small.

Well, the thing that Dan Levitin told us years ago, when we did an episode on the Starbucks IPO, was that you were really only considering smaller banks because it was going to be a smaller IPO.

Well, I was considering it because of Goldman Sachs, because they told you you had no choice. I had no choice. And Brotman at the time was not a big fan of Wertham Schroeder, which was Dan Levitin's thing. And so Alex Brown became the lead. But I also, you know, I had my own ego attached to this.

I was looking up. I was trying to figure out, you know, your public comps. at the time. I think there were zero publicly traded coffee companies, not bean companies, not retailers, not coffeehouse chains. I mean, truly unheard of.

You have a huge investor education problem, right?

Yeah, I think we had to take them through everything. We had the product there. You know, we served coffee. I, you know, gave them the whole show. We had a short video that was probably in black and white.

Fascinating. I mean, I go there and eat many, many meals sitting in your store.

Yeah, well.

But as we've been talking about, I mean, the economics, you were a store.

We were a store. We were a retail store.

So, Howard, I'm going to take us through the IPO. You know, you're the first publicly traded coffee company. You do end up doing $93 million in revenue that year. Do you remember the exact price?

Yes, we went out at $17, and the price was $21.

Can you imagine today a $250 million market cap company going public? And people considering that a success. I mean, this is a great.

At the time.

For your employees, how crazy is that? What, 12, 18 months before? Yeah. I guess 12 months before. It's six bucks a share.

They tripled their money.

Yeah. Fantastic. And that was when you started calling them partners, right? When they became. 91..

As soon as Beanstalk was instituted, everyone was a partner.

And is that when you did the lowercase? When titles all became lowercase?

No, everyone was lowercase from the beginning. Oh. Out of respect. Everyone's lowercase.

Listeners, when you look up a Starbucks employee on LinkedIn, it always looks like, is that a typo? And then you realize there's a pattern. All employees always put lowercase titles. So another interesting thing about the, I was reading the S1 last night. The management team, inclusive of you, owned 18%.

Not intentionally. No.

Okay. Not a strategy.

No, that was not a strategy.

Interesting. So then, from there, you opened in Washington DC, on the East Coast. I think that the reason you picked DC was because your mail order business was strong there. So you sort of had proprietary data to know that that was going to be a good coffee city.

I don't know how you found that out, but that's accurate.

In 1995, you crossed 500 stores. You had just bought the Coffee Connection, as we talked about, in Boston. And they had one asset that was perhaps much more valuable than any of the real estate or any of the sales that you would generate from there. They owned the trademark on the word Frappuccino.

And I'm so smart that I looked at that Frappuccino with disdain. Really? I didn't like the name. I didn't like the beverage. I didn't think it was appropriate for Starbucks.

Putting myself in your shoes back then. Now, Starbucks and Frappuccino, it's like a synonym. It's like you can't disentangle them. But yeah, it's very different than coffee.

Completely different. A blended cold drink. That was the first cold drink we've ever introduced. It was not a coffee-forward beverage. When we introduced it in Southern California, it went crazy.

So what changed your mind to greenlight it?

I didn't have a choice. I mean, Coffee Connection had it. Then we had it in Boston. People wanted it. And I just went along.

And you ended up reformulating it, right? It wasn't exactly what the store...

The store manager in Santa Monica reformatted it. And she was on it. I think Howard Behar loved it. People in California loved it. There's a fantastic story about Frappuccino because of what we did with it.

Was that your first bottled drink in retail?

Yeah. So I went to Atlanta and Pepsi in the same day.

Atlanta being Coke.

I went to Coke. I went to Pepsi in the same day. The Coke meeting lasted less than 30 minutes. I can't remember who I met with. They dismissed me.

And this is 95-ish?

Mid-90s.

500 stores, your public company.

But on the East Coast, Starbucks wasn't really well known. So I went to Pepsi in Purchase, New York, met Roger Enrico, the iconic CEO, and Craig Weatherup, the president of Pepsi. They loved the idea. And we started talking about this. Subsequently, Craig Weatherup and I, on a napkin, I swear, shook hands and created a multi-billion dollar business for Pepsi and Starbucks and a 50-50 JV and bottled Frappuccino.

How did you find yourself at Coke and Pepsi pitching a bottled beverage?

And was there an internal revolt? Because I could imagine people saying, this is a bridge too far.

I don't think people knew what I was even doing. I mean, I think maybe a few people, I just had the thought, we got to put this in a bottle. We have to put this in a bottle.

And this product, if I'm remembering right, was so successful. The instant that it hit store shelves, you had to pull it all off because you needed to create new manufacturing processes and spin up new factories in order to make enough to actually satisfy demand.

Basically correct. And we also, early on, had a recall where they found glass in the bottle. And Pepsi, to its credit, took all the blame for that and fixed it. From minute one, the power of Starbucks and bottled Frappuccino and doing something we had never known. It was no bottled coffee, let alone.

I mean, I'm just thinking about between the cups, but then United Airlines and Costco and the CPG products, there's got to have been like 50 billion Starbucks logos printed.

I'm sure that was maybe more.

I'm sure I could estimate it better.

You can see where the size of the equity of the brand was much bigger than the size of the company. Much bigger. Right.

Because at this point, you were like 800 stores.

Then something else happened. And that is we wake up one day and someone says, Starbucks is in a movie. And we said, what movie? You've got mail.

That wasn't coordinated?

First of all, Starbucks never paid for placement. Someone must have approved it. I knew nothing about it. And then someone said, you've got to see this movie. Starbucks.

Did you know that it was like the good old days? where you're like, this is just like...

We were so in the mud. It was so in it that we didn't have time to look up. And we were just running so fast, so hard. When you're growing at this pace, it's almost virtually impossible to catch the growth in terms of the infrastructure. And so you're constantly back and forth, trying to create that fragile balance between the seductive nature and the intoxication of growth and success and the foundation necessary to support it and not falling too far behind where you lose it.

Putting a bow on Frappuccino, the year after it launched in 1996, Frappuccinos were 7% of revenue, which I can attest to. Maybe freshman year of high school, I had my first tall mocha Frappuccino with whipped cream and a little chocolate drizzle on top. And now here I am drinking, what are we drinking here?

You're drinking coffee from India.

Yeah. And it's so good. No cream, no sugar, no this. And so the Frappuccino began my journey to the good stuff. So that's the Frappuccino story.

Okay. And there's a couple of things about this. I started taking a couple of trips to Europe and Asia just to get a sense of what the opportunity would be and how would we do it. I quickly wrote off Europe because coffee was there. I didn't think we could possibly enter as an American company.

This would be like a American luxury leather goods company coming in and competing with Hermes.

Yeah, not going to happen. And so we said, we just took it off the map. And then we narrowed our focus very quickly on Japan. Japan had a couple of thousand coffee stores named Dotour. You walk in there and it was smoke-filled, mostly men, dark, but they were successful.

Aren't there some consultants you could possibly pay to help this?

And so we hired a consultant who came back with a big book, presented it to the board. I had a preview and it basically was, this is a non-starter. You can't possibly succeed there. And in the meeting, I could feel my blood just boiling because with every statement, it was getting worse. The economics won't work.

It's like they've never met you.

And more intentional. And so we kept thinking about this. And then one day, we get a handwritten letter from a Japanese company.

High-risk, high-reward.

I'm so nervous. At 6am, we get in the car, it's so hot. The tie around my neck, it feels like a noose. We're driving up to the store in Naginza. It's like 200 people online.

Why were there people lined up around the block? Why did it work so well instantly? Was it a strong coffee culture?

No, it was the iconic reputation and anticipation of something that they had convinced themselves was unique, proprietary, not in Tokyo, not in Japan, that they wanted to have. By the way, the research, that cup was all over Tokyo. in months. Everyone was walking around with that cup.

This is nine years after you bought the six stores. It has turned into this icon. In all the events we just covered, Starbucks has already become Starbucks. It is already this globally desirable brand there by 1996..

Honestly, I haven't thought about it in that way.