Market Research Reveals a Service Gap at Starbucks Retail Stores In 2002, Starbucks was a high-growth company, successfully implementing ambitious retail expansion and product innovation in spite of the economic downturn. However, despite uninterrupted growth, recent market research suggested that everything was not going according to plan for the company. Starbucks built its empire on a foundation of customer service, but data collected in 2002 suggested that its consumer base did not feel a high level of satisfaction at Starbucks stores.
Christine Day, a Starbucks senior VP, was concerned by data which showed that service performance in their retail stores was not meeting customer expectations. Specifically, Day believed that speed of service was a key factor in customer satisfaction and proposed a $40M investment in labor hours to serve customers with-in three minutes (from back of the line to drink in hand). Most importantly, the market research findings called into question one of Starbucks key value propositions – service or “customer intimacy”.
Without a cohesive marketing department, Starbucks overlooked an alarming “service gap” – customer satisfaction did not reflect the brand strategy Starbucks believed they were executing. It is clear that improving customer satisfaction at Starbucks retail stores is a critical issue and closely tied to maintaining the company’s brand strategy. Day’s attention to market research was relevant to keep loyal customers coming back and timely for acquiring new customers. Our objective was to understand the impact of investments that improve customer satisfaction on Starbucks bottom line.
Key assumptions and calculations are explained below. II. Day’s Proposal After careful deliberation, we’ve concluded that the $40 million investment under Ms. Day’s proposed plan is not advisable. We support making an investment designed to improve customer satisfaction in general, but not under the terms of the stated plan. Our analytical framework started with a segmentation of the two customer bases, as outlined in the table below: New customersEstablished customers First visit0-1 years ago5+ years ago % of customers27%23% number of visits(monthly)(1)3. 97. 2 Average ticket per visit(1)$3. 0$4. 40 Annual revenue per customer$182$382 # of Customers Visits(2)252,780,750215,331,750 # of Unique Customers (3)5,401,2982,492,266 Note: (1) Number of ‘Newer customers’ refers to ‘Unsatisfied customer’ in exhibit 9 and number of ‘Established customers’ refers to ‘Highly satisfied customers’ in exhibit 9 (2) Derived from total number of customers in 2002 (daily customers per store*number of store*365) (3) # of customers visits / (monthly visit * 12) We focused on two customer segments, representing what we believe are the quintessential “new” and “established” customers.
Our new customers first visited Starbucks in the past year, and represent 27% of our customer base. Our established customers first visited Starbucks 5 or more years ago, and represent 23% of our customers. We believe that the $40 million investment would have a positive effect on the new customers overall, but based on our analysis of this customer segment’s preferences, particularly the fact that they are price sensitive, we are assuming only a 0. 5% increase in annual customer visits from this group.
Additionally, we have assumed that the investment strategy will backfire for the established customers, who we believe may feel rushed and a reduced sense of intimacy as a result of the increased emphasis on reduced wait time. Accordingly, we have assumed a 0. 3% decrease in annual customer visits for this customer segment based on the investment. New customers generated only $182 in annual revenue for Starbucks, while the established customers generated $382, so the loss of an established customer has a greater negative effect than the addition of a new customer has a positive one.
The following table outlines the impact to customer headcount and revenue generation from each customer segment: New customerEstablished customer Effect of strategyPositiveNegative Increase/decrease of Customers (%)0. 5%-0. 3% Increase/decrease of Customers (#)27,006-7,477 Increase/decrease in Revenue(1)$4,903,947($2,855,299) Note: 1) Based on stated annual revenue per customers*increase/decrease of customers Based on our assumptions, Starbucks generates $4,903,947 in additional revenue from the new customer segment, but loses $2,855,299 in revenue from the established customer segment.
The overall increase in annual revenue totals $2,048,648. We assumed this annual figure could be generated on an annual basis in perpetuity, and, assuming an opportunity cost of capital for Starbucks of 10%, we find the present value of this revenue stream to be $20,486,475. Once the $40 million investment is accounted for, the net present value of the investment is found to be a loss of $19,513,525. Accordingly, we believe the return on the proposed investment is grossly insufficient and cannot recommend making it. II. Suggested Alternative Marketing Strategy
We propose an alternative investment that we believe will result in both increased customer satisfaction and increased profits for Starbucks. This strategy was built using was using a 3C’s framework described in detail below. After careful analysis, we believe that an improvement in customer service ratings would be best achieved through a broader strategy of investment across labor and operational efficiencies. Customers Historically, Starbucks’ customers tended to be affluent, well-educated, white collar individuals, skewed female and between the ages of 25-44. 4% of these consumers viewed Starbucks favorably as of 2002. However, research performed in 2002 showed the customer base had evolved, with newer customers tending to be younger, less well-educated, and in lower income brackets. The company for the first time was faced with the challenge of catering to two distinct customer segments rather than a uniform customer base. Only 25% of these newer customers had an overall favorable opinion of Starbucks. They visited less frequently and weighted each component of Starbucks’ value proposition differently than the established customers.
Only 15% of this market segment felt that Starbucks was designed for people like them, and only 30% considered Starbucks to be a trusted brand. The segment also exhibited more sensitivity to price, with only 8% feeling that Starbucks coffee was worth paying a premium for as compared to 32% of the established customers. This newer market segment had large profit potential based on the sheer population of the segment, particularly if Starbucks could successfully convert a portion of these generally “indifferent” or “unsatisfied” customers to “highly satisfied” customers.
In 2002, 62% of Starbucks’ total transactions came from 21% of the customers – the “highly satisfied” segment, so Starbucks was highly incented to make the newer customers feel as valued as the established customers did. Company Starbucks built their brand based on a fundamental strategic mantra referred to internally by the phrase “live coffee. ” This approach to the coffee culture was highly differentiated in the US, and elevated the appreciation of the coffee culture to levels more in line with those of European countries.
There are three components of Starbucks’ experiential branding – (1) the quality of the coffee, (2) the intimate customer interaction with the Starbucks partners and (3) the ambience of the coffeehouses themselves. The entire Starbucks experience was designed to be warm and welcoming to consumers. Every strategic decision Starbucks made was designed to deliver on the three components of its value proposition. Starbucks sourced the highest quality coffee beans, invested significant time and money into creating innovative products and handcrafted beverages to consumers’ customized needs to ensure high quality coffee products.
Starbucks encouraged its partners to remember customers’ orders and create friendly dialogue with the customers to create intimacy, and sought to optimize operations and eliminated non-value added components of the baristas functions to help them deliver the beverage products to the customers in the shortest wait times possible. The overall size of the specialty coffee market grew from $5. 67bn to $6. 67bn from 2000 to 2002, representing 31% of the $21. 5bn US retail coffee market in 2002. Over this period, Starbuck’s total share of this market segment grew from $2. bn to $2. 8bn, and we assume that Starbucks not only appropriated significant market share, but also played a key role in increasing the overall size of the market. With overall operating margins of 9. 4% , Starbucks ability to monetize its value proposition was unquestioned, and it had significant room for growth, as evidenced by its projected 2005 market share of $4. 5bn. Competitors Starbucks competed with three different competitor types – (1) small-scale specialty coffee chains, (2) independent specialty coffee shops and (3) donut and bagel chains.
Each competitor type sought to differentiate themselves from Starbucks by emphasizing one of Starbucks’ three components of value. Small-scale specialty chains tended to be regional, and would cater to the personalities of their regions or emphasize super-premium coffee quality. The independent specialty coffee shop segment was highly fragmented, with individual competitors differentiating themselves based on myriad factors from food and drink variety to personalized service to specific personality-types.
The donut and bagel shops followed Starbucks into the specialty coffee market, mimicking Starbucks innovations and offering lower priced beverages in an attempt to appropriate market share. As the previous analysis shows, the net present value of investing in labor hours is negative and thus we believe Starbucks should consider an alternative strategy. Since customers categorized as “highly satisfied” visit Starbucks more often, spend more per visit and have a longer average customer life, they represent the largest customer segment of revenue generation.
And, since established customers earn more money and are more likely to be highly satisfied, we believe that Starbucks should pursue a strategy focused on improving the aspects that established customers care about such as ambiance, customization, quality and service. We have outlined an alternate strategy that focuses investment within the following three areas: automation, ambiance, and coffee quality. These three areas are closely aligned with Starbucks’ brand strategy and present significant opportunity to increase sales by improving the overall experience for established customers.
Under this new strategy, Starbucks will invest $10 million in each of the three areas listed above ($30 million total). Additionally, we believe that this new strategy will have a positive impact on the new customers as well as there is some overlap in the values of both new and established customers. Based on our projections, we believe that this investment will increase the number of established customers who are highly satisfied with their Starbucks experience by 34,066, and thus generate $8,681,989 of increased year 1 revenue and a positive NPV of $26,819,889 on the investment. Effect of new strategy] New strategy:Automation$10 million Better ambience$10 million Coffee quality$10 million Total$30 million New customerEstablished customer Effect of strategyPositivepositive Increase/decrease of customers0. 4%0. 5% Increase/decrease of customers(#)21,60512,461 Revenue increase/decrease3,923,1574,758,832 * Total revenue change:8,681,989 * PV of revenue:86,819,889 * NPV of investment:26,819,889