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Starbucks' genius blends community, caffeine
The company knows that emotion, not logic, powers the decision to pay $3.22 for a double-tall latte, extra hot with a shot of sugar-free vanilla.
By Jon D. Markman
Starbucks is aptly named, for this company truly stars at sipping bucks from our wallets. The one force in America that can unify the aspirations of slackers, suits and soccer moms, its shares have grown more than 1,500% in the last 10 years. Perhaps more important for the future, Starbucks (SBUX, news, msgs) is symbolic of the end of a generational culture clash.
Now it looks like Starbucks is getting ready to take its unique brand of caffeine capitalism farther into the world, as the company announced at its annual meeting last week a plan to open 1,500 new stores globally and boost total revenue by 20%. Perhaps the beans have addled my brain, because I think that the company's campaign to turn coffee into community -- while fully at odds with common sense much of the time -- will continue to work. Like few other companies in the world, Starbucks is adept at manipulating its customers' emotional weaknesses to generate cash.
Consider my own non-rational behavior. At home, it costs me 40 cents to enjoy a big dose of caffeine in the morning. I put four tablespoons of a $10 bag of Starbucks coffee in a French press, pour in hot water, and, in a few minutes, I have three cups of joe. After the first cup, the coffee may not be so great or hot, but it's drinkable. And the price is right.
Sucking two cups in the early morning, however, never prevents me from striding into one of the three Starbucks shops in my downtown Seattle building when I get to work. I'm greeted there warmly by several regular employees who know my drink -- a double-tall, extra-hot latte with a single pump of sugar-free vanilla. They then swipe my Starbucks smart card (Athens Olympics edition). A few minutes later, I am sipping a $3.22 drink in the elevator en route to my 43rd floor office.
Now you can already see that several things in this scenario make no sense, and therein lies the beauty of the Starbucks business model. To wit:- Why would I want a third cup of coffee in the morning?
- Why would I pay eight times more for it than for the first two?
- Why would I pay for it with a card that gives the company the right to earn interest on my money?
The third place of American life
First, I want a third cup in large part because, like many others, I am a sucker for the ritualistic experience of what founder Howard Schultz has termed the "third place" of American life. It's a place without the stresses of the home or the office, a neutral ground where there are always "friends" behind the counter. In our largely impersonal, digital and ethereal world, returning to the homey confines of one's own Starbucks, staffed with people who care enough to remember something about us, provides a primal human connection. | Genius loves company | Most people don't know it, but Starbucks has its own record label.
Click here to find out how the company helped make Ray Charles' last album a huge success. |
If Starbucks were just selling water, or a blast of air, we would still want to start or take a break from our day there. It's the white-collar equivalent of the tavern next to the auto plant, where Frankie behind the counter hits us with a shot of Wild Turkey and a Bud draft on sight. A company that can create the illusion of compassion with high standards of hiring and staff training is starting off on the right foot at earning a high rate of return.
A ridiculous premium for heating milk
Second, the cost of this third cup is ridiculous. Yet, despite being a value buyer in virtually every other part of my life, I pay without complaint. How crazy is it? Well, if you break down the components it becomes clear that you are paying a vast premium for the heating of your milk -- but not the milk itself. The main ingredient is a double shot of espresso, and that costs $1.85. My Starbucks doesn't charge for a single pump of vanilla, so that's free. And at the sugar-and-napkins counter, you can pour all the milk into your cup that you like. So that's free, too.
The $1.37 premium is therefore just for the labor of steaming the milk, which takes about 20 seconds. If a barista can do three steamed milks in a minute and keep up that pace all day, then she's earning Starbucks around $246 an hour just by steaming milk. Discount that by a third, and the company is still getting $175 an hour for steaming my milk. And that goes a long way to explaining why the company's profit margins come in around 11.5% pretax.
We pay this enormous premium for milk heating in part because it creates a consistently high-quality drink. Also, a lust for status emblems is an obnoxious burden that we carry around in our collective cerebral cortex. One reason given for the compunction among women to paint their fingernails, for instance, is that it provides a non-verbal message to others that they don't do physical labor. It's the same reason that businesspeople shake hands upon meeting, showing each other, in a subliminal gesture, that neither bears the calluses of hard labor (or a weapon). Ladies with red nails and sword-free men with soft hands thus bear identification to others that they are members of the same tribal caste.
Since it's fairly obvious that all the people riding the elevator in a downtown skyscraper are not day laborers, it seems that we then unconsciously take another step by holding an expensive white cup in our hands as a status symbol. In addition to being an effective drug-delivery system for the electric buzz of caffeine, a cup of Starbucks beams out a little message that we are wealthy enough not to care about overspending for coffee.
Here's another reason why Starbucks has maintained its margin of success in the stock market with consistent margins and virtually no mass-media advertising: It never, ever discounts. Free samples? Yes. Half-off cappuccinos? No. Unlike McDonald's (MCD, news, msgs), which focuses on increasing store traffic -- and, thus, transactional volume -- through heavy promotions like "dollar" menus and "value" meals, Starbucks never cuts prices. And after all, how could it? Its marketers understand that customers consider the green-emblemed cup an affordable luxury that has virtually no substitute in most cities. Discounting would imperil that key value.
Starbucks card means money is no problem
Third, we allow Starbucks the right to earn interest on the $10-to-$50 value of our smart cards to satisfy a need for convenience -- and to offer another symbol of caste. On one level, flashing a card instead of cash shows that you are a regular, that you're in the club. On another, it offers a way to exhibit a sense that coins and dollar bills are trifles. We don't readily see the cost of this behavior, but Starbucks collects millions of dollars on the float of the money it receives on the smart cards -- which, by the way, are also considered collectibles.
Now factor in the recent addition of Frappuccinos -- essentially, milkshakes -- to the menu, and you can see that the company has found a way to bring young people into the fold. With easy chairs, nice lighting and an addictive product that doesn't kill you, Starbucks has replaced 7/11s and pubs as gathering places for teens, 20-somethings and office workers -- a cultural hat trick that is unparalleled in restaurant history.
David Garzian, a sociology professor at the University of Pennsylvania, says that the academic view that this behavior runs against our economic self-interest is wrong-headed. For the middle class and its aspirants, he says, consumer habits like a regular visit to Starbucks help build identities that satisfy a yearning that is in our psychological self-interest.
Companies that help people plug into the zeitgeist or spirit of their times are going to be more successful than ones -- like bad grocery chain Winn-Dixie Stores (WIN, news, msgs), or cattle-car airlines like Delta Air Lines (DAL, news, msgs) -- that turn a blind eye to such deeply human appetites.
Starbucks shares are down nearly 22% since Dec. 29 on growth concerns, but look for them to recover over the next couple of months and lead the pack again by year-end.
Fine Print
To learn more about Starbucks, visit the company's Web site. . . To learn more about David Grazian, check out his "Sociology of Media and Popular Culture" syllabus.
Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jon.markman@gmail.com; put COMMENT in the subject line. At the time of publication, he held positions in the following stocks mentioned in this column: Starbucks.
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