Pour Your Heart Into It (32 page)

In June 1994, I awoke one morning to face the worst crisis in Starbucks’ history. It came without warning. It was no one’s fault, nothing we could have predicted, nothing we knew how to handle.

I had just set off on what I had intended to be my longest vacation in ten years. Sheri had suffered through a series of delayed or canceled vacations as I had become more and more preoccupied with growing the business. But I was finally convinced that Starbucks was in good hands and I could afford to take off a full two weeks. After four years as chief financial officer, Orin Smith had just assumed the responsibilities of president. Neither of us realized that he was about to be tested by fire.

I had rented a cottage on the beach in the Hamptons, not far from where Sheri and I had met, not far from where we were married. The kids would have a chance to spend some time with my mother, my sister Ronnie, my brother Michael and his family, and my other relatives in New York. Our cottage would be like a little island, a refuge in a place where no one knew us, where family and friends could come to visit without the daily demands of work and school. Sheri and the kids planned to stay for a month. I would spend the first two weeks with them, return to Seattle for two weeks, and then fly back to New York to pick them up.

The cottage was everything we had hoped for: a modest white shingle house with a big deck, only a hundred yards from the beach. The sun was shining brightly when we arrived, and the kids jumped into their swimsuits immediately. Sheri was smiling and humming as she got us settled in, the happiest I’d seen her in years. We passed the first two days setting the house up and exploring the town and the beach with the kids.

On our third morning there, Monday, June 27, I called the office to check in—a daily habit that, unfortunately, I’ve not yet been able to break. I had waited till 11
A.M.
so that I could reach Seattle at the start of the West Coast business day. I was standing in the kitchen when I punched in the number, wearing shorts and a loose shirt, looking out over a small backyard where the kids liked to play. I had just come in from shooting baskets with my son and still heard the sound of his dribbling outside.

I heard the note of alarm the instant that Georgette Essad, my assistant, recognized my voice.

“You need to talk to Orin and Dave immediately.”

“What’s wrong?” I asked.

“You just need to” was all she would tell me.

My stomach clenched as a fast montage of ugly possibilities raced through my imagination. I could tell something serious had happened.

My phone call was patched into a conference room, where Dave Olsen and Orin Smith were waiting for me.

“Howard,” Orin said, his normally calm voice pinched, “there’s been a severe frost in Brazil. Coffee prices are going crazy.”

Brazil?
Starbucks didn’t even buy any coffee from Brazil. Most Brazilian coffee ends up in cans.

But I understood the significance of that frost immediately. Brazil produces more than a quarter of the world’s coffee, and a serious shortfall there would send up prices for coffee everywhere. Because Starbucks buys only top-quality coffee, we normally pay a premium above the commodity price of coffee on the Coffee, Sugar & Cocoa Exchange in New York. The standard bellwether price for green coffee is the widely quoted C contract on that exchange, a composite price for green coffee, and when it goes up, our prices do, too.

That morning, Orin told me, the C contract was shooting straight up; it had just surged from $1.26 to $1.80 a pound, the highest price since 1986, and far above the 80-cent price we had counted on for the first four months of the year. In effect, one of our basic costs of business had doubled, and green coffee prices were still rising. Starbucks’ stock price began to drop.

The last time Brazil had had a serious frost, in 1975, coffee prices had soared as high as $3.40 a pound and stayed high for years. That legendary “black frost” had decimated much of Brazil’s crop. Back then, Starbucks had only three stores. Now, with 350 stores to supply, we had a huge exposure. What if the price doubled again?

Within five minutes I knew my vacation was over. I would have to take the next available flight to Seattle. Though they didn’t ask me to return, we all knew we had to be together to deal with the problem. It wasn’t right that Orin, in the first month of his new job, should have to resolve this on his own.

With that call, my whole life changed—not only for the summer but for the year that followed. In fact, it took two full years to finally work through the problems that hit us that day.

I hung up the phone and stood still for a second as the magnitude of the emergency hit me. I called for Sheri, who was in the next room, and she could hear the edge to my voice. When she came into the kitchen I could see, with a pang, that she was both filled with concern and bracing for disappointment.

“You’re not going to believe this,” I said to her. “I’ve got to go back to Seattle.”

S
HOULD
W
E
R
AISE
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UR
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RICES?

I got a flight early the next morning and was in my office at 12:30
P.M.
Orin had set up a meeting, so when I walked in I was immediately surrounded by the worried faces of Starbucks’ leadership. Our task was to respond to the worst crisis that had confronted us as a team. The fear and uncertainty of everyone in the room were almost tangible. I wanted to reassure them that we could handle this problem, but I was filled with doubts myself.

Seated around the conference table were the managers who represented every major area of responsibility: coffee buying, inventories, roasting, finance, planning, retail operations, mail order, and wholesale. First we needed to understand the breadth of the issues we were facing and the risks involved. The size and scale of Starbucks demanded unusual discipline and sensitivity to things that were not in our control.

Each person gave a status report—a term that in this case was really an oxymoron, since the situation was literally changing, from minute to minute, as coffee prices jumped.

Dave Olsen put the frost in a historical context for us. Ironically, for the past two years, he had been worrying that coffee prices were too low. In the late 1980s, coffee-producing countries in the International Coffee Organization had tried to prop up prices using an export quota system. But in July 1989, that agreement fell apart, and coffee prices dropped to historic lows. The world was awash in coffee as global production reached an all-time high, rising well above the level of consumption. By 1992, the C contract had drifted down to around 50 cents a pound, far below the cost of production.

You’d think that Dave and other coffee buyers would have been pleased with such low prices, but in fact, he was concerned about their negative consequences. Coffee growers around the world couldn’t afford to buy fertilizer and didn’t bother to prune, so in many regions coffee crops were weakening. Some farmers uprooted their coffee bushes and planted other crops, such as sugar cane. Although that cut world production back sharply, to well below the level of global consumption, the oversupply from earlier years kept prices relatively low for a time. By early 1994, the C contract had risen to only 80 cents, still low by historical standards.

Dave was actually relieved when prices began to rise in April 1994. He had traveled widely and worked for years to forge relationships with coffee growers and exporters, so he had seen firsthand the punishing effect low prices had had on them. More normal prices, he knew, were needed to ensure a continuous supply of quality coffee. In May, the market recovered, to a level above a dollar a pound.

During the time prices were low, Dave had, fortunately, locked in about a ten months’ supply of green coffee, through long-term contracts at fixed prices—more for some origin countries, less for others. Buying ahead was our normal strategy of protecting ourselves, the theory being that it was both necessary to ensure our inventories and a good investment for Starbucks’ capital. Long-term contracts also allowed us to lock in the more limited supplies of top-quality coffee. Overall, we were in a better position than many specialty coffee companies because we are vertically integrated: We buy and roast all the coffee we sell, rather than purchasing pre-roasted beans from independent roasters.

After the frost hit, I was relieved to hear we had so much inventory on hand. But what if green coffee prices kept rising? Should we buy more coffee now before they rose even further? Those weren’t decisions we could make that first day.

Over the next few days, the phones lit up as big shareholders, stock analysts, traders, and reporters called to find out how we were reacting. We had to make some decisions. Would we raise prices? If so, by how much and when? What impact might that have on sales?

The big three roasters, Nestlé, Kraft General Foods, and Procter & Gamble, increased prices immediately on their canned coffee. Between them, they control about 70 percent of the U.S. coffee market. With fewer months’ supply on hand and thinner profit margins, they had little choice. The price of Folgers jumped twice that week alone.

We decided not to raise retail prices right away. It wasn’t fair to our customers. We remembered how outraged everyone had felt when gasoline companies jacked up prices the minute oil prices rose, to reflect replacement costs, even though they had months of inventory on hand. We decided to wait and see what happened to green coffee prices.

Exactly two weeks after the first shock, we got a second. On July 11, another Monday, I woke up and heard the worst. Brazil had suffered another frost, this one even more bitter. Early estimates had suggested that the first frost had damaged 30 percent of Brazil’s crop; this one appeared to have destroyed another 10 percent, at least. Starbucks stock responded by dropping to a three-month low that day.

Within days, the green coffee price jumped to $2.74 a pound —more than 330 percent of the level just three months earlier. To me, it felt like it happened overnight. It was a body blow.

We held daily conferences, hushed and hurried. I don’t think most Starbucks people really understood the gravity of the situation and how fearful we were. Earnings had been growing more than 50 percent a year for four years, and Wall Street investors were counting on a continuing stream of profits in coming years. If we failed to meet their expectations, our stock price might drop so low we would have trouble raising funds for future expansion. Traders were now predicting coffee prices might reach $4. All the information we had at hand—about the 1975 frost, about depleted world coffee supplies, about lower production every-where—led us to believe those estimates could well be true.

The big three once again quickly raised their prices.

Inside the company, we debated intensely about whether and when to raise retail prices. Some board members urged caution, saying price hikes tended to be easy, short-term fixes that discouraged the hard work of lowering costs and improving efficiency. They thought it would put us at a competitive disadvantage. But with our main raw-material cost skyrocketing, we had to respond.

On July 13 we announced that we would increase prices by just under 10 percent on July 22. Although coffee drinks went up only 5 cents or 10 cents a cup, our whole-bean coffee prices rose by around $1.25 a pound, on an average price of about $8.50. How would our customers react? Our prices were already higher than supermarket coffees. Would our whole-bean coffee sales volume drop?

We consciously chose a different path than the oil companies and the big packaged goods companies. We did not raise our prices to cover current replacement costs, passing raw material price rises immediately on to the consumer. If we had, our prices would have gone up far more dramatically, as the canned supermarket coffees did. Instead, we tried to offset only our actual cost increases for fiscal year 1995.

During those days, my role was to provide the company with the leadership to instill confidence that we were going to get through this crisis intact. I also took the lead in communicating with the outside world about the problem. We had a lot of constituencies to deal with, not the least of which was Wall Street, where investors worried about the extent to which Starbucks was exposed. They were making bets on the short and long side. With Dave Olsen, I explained the situation to our partners, and then Orin and I discussed it with investors. We made frequent conference calls and left voice-mail updates nationwide, as well as posting signs in our stores, trying to keep people abreast of the situation.

What we tried to do with our customers was to honestly and directly explain that our costs had risen and we had no choice but to pass on a certain amount to them in order to continue to do business. We were fortunate in that the relationship we had built with our customers and most importantly with our partners gave us license to do what we needed to do. For the most part, they responded by being willing to pay higher prices for coffee they knew was best of class.

T
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ONG
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ERM
C
OST OF
S
HORT
-T
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ECISIONS

Behind the scenes, we had other tough decisions to make. Should we buy more coffee at current prices, lest they surge even higher? Or would $2.74 be the peak, and would it be better to wait and buy at lower levels? When the market was at 80 cents, we had dreamed of 70 cents and worried about $1. Now that the market was around $2.50, we dreamed of $2 and worried about $4.

The issue came to a head on one tense day in July, when we had to decide whether to commit to buying a substantial quantity—thousands of bags—of Colombian coffee. At these high levels, it was a multimillion-dollar decision, three times the amount of money we would have paid for the same coffee a few months earlier. The purchase could be either a wise hedge against even higher prices or a disastrous obligation incurred at the top of the market.