February 23, 2022

Starbucks' Living System

Posted By:
John
Sviokla

How Starbucks discovered competitive advantage isn't a thing, but rather a living system, and how your organization can create its own.

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In our global study of over 1,000 self-made billionaires (See: The Self Made Billionaire Effect: How Extreme Producers Create Massive Value) we discovered that four out of five of them made their fortunes in mature markets like water, pizza, or even coffee.

How?

They win by creating not an invention, but a superior living business system with self reinforcing advantages.

Building a Coffee Empire

The earliest evidence of modern coffee drinking (e.g. roasted beans, ground, brewed) was in Yemen in the mid 15th century. Given the maturity of the coffee drinking market and the vast number of competitors of every stripe and size, how does Starbucks — started in 1971 and taken over by Howard Schultz in 1982 —become the biggest coffee shop in the world?

Schultz created a superior business system around his core insight that America, and then the world, wanted a latte. The key elements of that system are below and see Figure 1:

  • Efficient use of capital;
  • A superior talent strategy;
  • Behavioral economics on pricing;
  • Forward looking sourcing and roasting;
  • Aggressive acquisitions for segment dominance.

Early in the history of Starbucks their stores had a very small footprint, often as low as 300 square feet, which means that they could recoup their capital investment in six or even three months after opening.

Schultz was always concerned about being a superior employer and he was early to give his talent access to benefits — particularly health benefits, even for part time work. This approach allowed him to attract superior talent and when you are charging $3 or more for a cup of coffee you want good talent behind the counter. It also allowed him to tap into a talent pool which might not be willing to work at a fast food restaurant.

When you walk into a Starbucks there is not a small or large coffee to be found, but rather, a tall, venti and grande. This simple change makes it that much harder to make a comparison for my Starbucks drink and the cheaper version of a small, medium or large coffee down the street. This is a classical behavioral economics strategy — make it hard for people to do a direct comparison on key attributes when you want to charge a higher price. Make your product unique.

This idea of a competitive system rhymes with Jim Collin’s brilliant insight of the “Flywheel Effect” from his ever popular book Good to Great which states that there are actions which have inevitable outcomes in stages, which creates momentum. He goes even further saying that those businesses that are great, and those startups who success discover and execute on their flywheel.

I do think it’s a worthwhile exercise to think about what your flywheel is, but it’s also important to remember that the reality is that a firm is a living system. I say living because many businesses fail because they think they are machinies, not human entities living in human world. I say system because the interactions of the parts are not just linear — from step one to two, etc. — but often interact in more subtle ways. In the Starbucks example the interplay between great talent behind the counter and higher prices, and the notion of the “third place” between work and home all interact. Would you want to hang out in a coffee shop that had rude staff, even if you were served efficiently? Are you more likely to pay a high price for a cup of coffee if the staff is bright, cheery and personable?

One way to simplify the self examination is to ask yourself and your team: how healthy are the “hard” factors in our system? How healthy are the “soft” factors? Hard factors can be unit economics, quality of a service or production process, our access to market, etc. The soft factors are things like employee engagement, client trust, strength of our brand, etc.

Every executive needs to ask him or herself the following three questions:

  1. What is our living system?
  2. Is it healthy? How healthy are our “hard factors? Soft ones
  3. Does our living system deliver competitive advantage?
  4. If not, how do we design and improve our hard and soft factors?
  5. If we do have a living system that delivers advantage, how do anticipate the next cycle of customer needs — because they are always moving to the next level of desire.

Behind Great Companies Are Often Great Living Systems

Starbucks isn’t unique in their ability to build a better system.

  • Capital One built a flywheel using cheaper underwriting, which enabled better pricing and allowed them to reinvest in digital to gain an early advantage relative to legacy financial institutions.
  • Disney executed brilliantly on Walt’s original vision of a system, in which their films, theme parks and other elements all built on and reinforced each other.

Designing Your Business System

Most people think about innovation from a product perspective. But as Starbucks shows, it is possible to innovate on multiple areas of the business simultaneously. And when done correctly, these pieces reinforce and build on top of each other, creating a flywheel effect.

When embarking on an innovation or transformation initiative, it’s critical to evaluate your system business from a variety of lenses — hard and soft:

  • The product or service
  • The talent and staffing model
  • The production and operations process
  • The customer service experience
  • The brand and marketing engine
  • The approach to digital
  • The financial engineering
  • The employee engagement

Looking at each lens, challenge the status quo. Constantly ask yourself why you do things the way you do. Whether it’s possible to do it better or completely differently.

And as you do so, constantly refer back to the other parts of the system, looking for ways they can build upon each other.

Conclusion

My late departed friend and colleague Ted Leavitt, a legendary professor of Marketing at Harvard Business School has a book called the Marketing Imagination which has a chapter entitled: “Differentiation — of Anything”. Put another way, market maturity and lack of growth are not economic realities, they are only point of view problems. My research, as well as Jim Collin’s work both point to the fact that a flywheel or system are at the core of greatness. I like the idea of a living system — better than a flywheel — because I think it reflects the commercial reality better and gives a guide to executives to analyze, design and intervene in a way that can lead to true competitive advantage.

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