Last week's article about America Online's (NYSE: AOL) success despite poor customer satisfaction ratings drew a strong response from AOL fans and foes alike. Fools on the Rule Breaker Companies discussion board made a number of good points to help explain the phenomenon. Most notably, I overlooked that first-time Web and computer users think AOL is easy to use. Whether that's actually true or is a perception created by AOL's spectacular marketing team ("So easy to use, no wonder it's number one!") is moot -- people think it's easy, so they sign up. It's hard to move, so they stay.
Tomorrow's article will address AOL further. Let me say that my intention last week was not to bury AOL, but to praise it. I'm not a fan of its product, but I greatly admire its business acumen. AOL saw an enormous business opportunity, figured out how to exploit it, and executed splendidly. Look up "great business" in the dictionary, and you'll find that definition. You won't see, "It has the best product." There are plenty of examples of lousy businesses with great products and vice versa.
It is wonderful, though, when great businesses and great products harmonize. Today I want to discuss one such business, Rule Breaker Starbucks (Nasdaq: SBUX). We don't write about Starbucks very much, which is a bit odd considering that it has been the Rule Breaker portfolio's best-performing stock by far this year. ('Course, that's no great trick this year -- have you seen the bloodbath in the numbers? Volatility, thy name is Rule Breaker.)
One reason we don't comment on Starbucks is that nothing much happens at the company, except that it maintains its strong business momentum. While the big story in Starbucks' year-end earnings announcement on November 16 was that it was writing down losses from its Internet investments, the more important point was that it recorded 9% same-store sales growth for the year. In the last two months, Starbucks' comps have reached 12% and 11%, respectively.
Those figures are just astounding. They out-do the average 6.4% comps Starbucks realized in the previous five years. They're all the more remarkable because Starbucks has been building its new stores for the last couple of years in markets that already had Starbucks locations (thereby cannibalizing a certain amount of its own sales) and in markets with low population density. Nevertheless, the company sees ever more customers spending ever more money on each visit.
On the other hand, Starbucks has paid quite substantially to build up its company-operated stores. Capital expenditures have consumed most of its operating cash flow over the years. As long as Starbucks can continue to produce excellent comps -- the consistency of which the Street loves -- its tireless expansion will lead to higher profits.
The day will come, however, when comps slow down and even slip into negative territory. When that happens, many of the investors who have assigned Starbucks its high multiple (currently about 63 times trailing 12-month pro forma net income) will make for the exits. In any given short-term period, Starbucks the stock could take a big hit.
Over the long-term, however, Starbucks the business will survive and probably thrive. A downturn in comps won't undo the job that Starbucks has done building a worldwide brand. It has set a new standard in the retail industry for ubiquity. There is a Starbucks just about everywhere you go: every mall, every airport, every block in the big city -- maybe even twice or three times a block. It's in virtually every Barnes & Noble (NYSE: BKS) bookstore. It is also in virtually every grocery store, in the form of whole beans, ice cream, or little cafï¿½s.
Here's the really beautiful thing about that ubiquity: Except for the independent, company-operated stores, Starbucks doesn't pay for most of it. Those airport kiosks and Barnes & Noble outlets? Free. In fact, in most cases it gets paid for equipment, training, store design, coffee, etc. -- and it collects royalties and licensing fees. Starbucks sells ingredients to the joint venture that makes bottled Frappuccinos and Starbucks Ice Cream. The joint ventures with PepsiCo (NYSE: PEP) and Dreyer's Grand Ice Cream (Nasdaq: DRYR) shoulder all the expenses.
That's really an ideal situation. Kudos to the business development teams that established so many different partnerships. The company has firmly established its brand as a promise of high-quality coffee products, to the point that its partners will pay just to use its name. It produces millions of customer "impressions" without costing the company a cent. That's the dream of every commercial brand.
But, the real credit goes to the foundation of the brand: quality coffee and great service. I don't know of any customer satisfaction surveys that rate Starbucks against other major coffee retailers (like... um... Gloria Jean's?), but in continental Europe, where Starbucks has no stores, people know Starbucks and want to buy its drinks. Its reputation precedes it.
I know that I love Starbucks coffee. I think it's consistently the best coffee I can find. The key word there, the one that probably brings more customers back than anything else, is consistently. You know what you'll get at Starbucks. You don't know whether The Blue Moose Cafï¿½ across the street will serve you great coffee or lousy coffee.
(Actually, I'd rather go to The Blue Moose, a great coffee shop in Morgantown, West Virginia, even if I might not like its coffee as well. A new experience is surely more important than one Grande Americano in a thousand. Again, though, I think I'm atypical on this point.)
Starbucks has built a brand that conveys not just a product but an experience. That, almost exclusively, is what has made this company into a Rule Breaker. The stronger the brand becomes, the more profitable the business will become through licensing opportunities. The more profitable the business, the better Starbucks will withstand the eventual downturn in comps. Brand is the moat around its business.
Excite@Home -- NOT a well branded business
Excite@Home (Nasdaq: ATHM) said yesterday that it has canceled plans to form a joint international venture with chello broadband, a division of UnitedGlobalCom (Nasdaq: UCOMA). The venture, which was to be called Excite Chello, might have been a decent idea, though the IPO of the new company surely wasn't going to raise much cash in this market. The whole thing probably wouldn't have mattered much anyway.
I get a laugh out of the cancellation nonetheless. It's just one more in a long line of failed plans Excite@Home has devised to -- for lack of a better term -- "unlock value in the company." When I wrote my parody of the letter to shareholders that announced the Excite Chello notion, I put these words into George Bell's mouth: "We really mean it this time. It's not like that Excite spin-off thing we used to talk about."
Well, not surprisingly, it is like the Excite spin-off thing. Someone call me when this company gets a clue.
--Brian Lund, TMF Tardior to @Home, which cold-calls him repeatedly but refuses to offer him service.