Why Starbucks is hitting the wall

July 2, 2008, 8:35 PM UTC

The news that Starbucks will close 600 stores and lay off as many as 12,000 employees is not only the news that Wall Street was waiting for. It is inevitable. One thing I’ve learned from my 24 years following retailers for Fortune is this: Every retailer that expands across the U.S. hits the wall on growth eventually. And every retail entrepreneur, no matter how talented, is eventually exposed as more romantic dreamer than disciplined operator.

All the greats have hit the wall. Bernie Marcus, who started Home Depot with Arthur Blank in 1978, used to have a wall—literally—outside his office that he called “The Wall of Shame.” Hanging there were framed press clippings about Home Depot—all stories that predicted that the home-improvement retailer’s go-go growth was approaching an end. One of my Fortune stories hung on that wall, and Marcus loved to say that I should be embarrassed to be there. Guess what? The skeptical journalists turned out to be right. In 2000, Bob Nardelli swooped into Home Depot from General Electric , then paid for the sins of the company’s over-expansion. Home Depot is still struggling under current CEO Frank Blake, and the stock is down 41% in the past year.

Investors in Wal-Mart saw growth stall as well. In 1996, four years after founder Sam Walton died, I wrote a story about Wal-Mart’s flat stock and the uncertain path to expansion. It took a major innovation, Wal-Mart’s supercenters, and a few missteps (like selling fashion-forward apparel) before Wal-Mart got its mojo back. Today, Wal-Mart, hitting the sweet spot of consumer demand by guaranteeing low prices, is the best performer on the Dow, up 19% in the past year. IBM and Chevron , the only other gainers, are up 14% and 17% respectively.

Meanwhile, other retailers suffer. Blockbuster yesterday announced that it was abandoning plans to acquire troubled Circuit City . Another sinking stock: Sears Holdings . As I told you last week, chairman Eddie Lampert admitted that he’s made mistakes managing this combination of Sears and Kmart. One of his errors was loading up on inventory ahead of the consumer-credit collapse. That’s a retail classic.

As for Starbucks, Howard Schultz, who built the company from a tiny Seattle-based chain, is now swimming in uncharted territory. After downplaying the threat of cannibalization for years, he now has to deal with the reality of it. It’s a complicated challenge. By removing breakfast items, among other products, to focus on Starbucks’ core proposition—the coffee experience—he’ll find it difficult to lift per-store sales. Meanwhile, McDonald’s , a standout performer throughout the downturn, is ramping up its beverage offerings. McDonald’s stock is up 13% during the past year. Starbucks is down 40% and at just below $16, it’s trading at its lowest level since 2003.

Management turnover compounds Starbucks’ problems. In January, Schultz fired his top operator, CEO Jim Donald. (See my recent interview with Donald and two other ex-CEOs in “Lessons of the Fall.”) And since he assumed the CEO role six months ago, Schultz has lost other key managers. One is former U.S. president Launi Skinner, who was considered a potential CEO successor and made Fortune’s Most Powerful Women to Watch list last year. Skinner just landed as president and COO at 1-800-Got-Junk, a hot little privately held outfit that calls itself the world’s largest junk removal service.

From $4 lattes to junk retrieval. Doesn’t that say something about the direction of the economy?

P.S. While Starbucks Chairman and CEO Howard Schultz clearly needs help on the operating side, he stands out for his enduring personal touch. Last January, right before he ousted then-CEO Jim Donald, he hugged him. And while Donald, who was an at-will employee of Starbucks, was due no exit package, Schultz and the board gave him a $1 million severance. By CEO standards, that’s a pittance—but still better than nothing. Click here to see Jim Donald talk about his last days at Starbucks.