Howard Schultz Has Something Left to Prove

June 8, 2017, 10:30 AM UTC

The longtime CEO of Starbucks has “stepped down” to become executive chairman. Now he’s leading the chain’s efforts to launch a higher-end coffee business. It may mean even more to him than it does to the company.

Every year, before Starbucks’ (SBUX) annual meeting, Howard Schultz goes to its original store at Seattle’s Pike Place Market to drink a doppio macchiato and reflect on how far the company has come in his more than 30 years there. The most recent annual gathering on March 22 was Schultz’s last during his second run as CEO. That gave the ritual added weight, and he planned a ceremonial moment to mark the occasion.

Schultz was scheduled to arrive at the store at 6:30 a.m., but he’s notorious for running early—“Howard time,” as a colleague calls it. Those playing some part knew to get there by 6:15 or risk missing him completely. One of those people was Kevin Johnson, Schultz’s chosen successor as CEO. That morning the two, both in shirt and tie, suit jackets doffed, spent a few minutes together amid the bags of beans. Schultz reminisced about the early days.

Then he formally presented Johnson with the key to the original store, a possession he said he had carried in his pocket for nearly 35 years. The two posed for a photo and by 6:22, with the sun yet to rise, both were gone. “Note to self: Don’t lose the key,” Johnson stage-whispered on his way out the door.

New CEO Johnson will lean on his tech experience to focus on Starbuck’s digital ordering.
New CEO Kevin Johnson will lean on his tech experience to focus on Starbucks’ digital ordering.PHOTOGRAPH BY BRIAN SMALE
Brian Smale for Fortune

The new CEO need not have worried, it turns out. “I have another key,” Schultz tells me a month and a half later in his office at the company’s Seattle headquarters.

Could there be a more apt metaphor? Handing over control of a company is always tricky—Schultz, 63, officially relinquished the CEO job on April 3—and doubly so when it involves a charismatic, longtime leader who all but founded the company.

In Schultz’s case, how does a notorious perfectionist who craves total control apply his perfectionism to the act of ceding control? That challenge is all the more fraught because his most notorious professional failure by far was his last attempt to leave as CEO, in 2000, a slow-boiling disaster that eventually concluded with his triumphant return. Schultz really, really, really wants to nail it this time. “I would say that, of the list of the most important things that a public CEO has to get right, succession is in the top three,” he says. “I did not get it right the first time around.”

For its part, Wall Street has made its position absolutely … contradictory: Starbucks must prepare a new generation of leadership!! And also, Howard, could you stay just a little longer?!?

None of that makes it easy for Johnson, 56. In addition to replacing a legend—as he has quipped, he has venti-sized shoes to fill—the new CEO is doing so at a time when Starbucks’ sales have turned from scalding to tepid. Same-store sales, a key metric, are still rising, but at the lowest pace since the financial crisis. The company has fallen short of analysts’ expectations on that measure for five consecutive quarters.

Despite that, Starbucks’ ambitions are audacious. The company recorded $21.3 billion in revenues last year, ranking it at 131 on the Fortune 500—and it’s projecting it will reach $35 billion in sales by 2021. To achieve that hoped-for 64% revenue explosion, Starbucks plans to open some 12,000 stores over the next five years, which would bring its total count to 37,000. The majority will be in China, a market the company thinks could be its biggest someday. Some 3,400 of the new stores will be in the U.S. (By comparison, Chipotle has about 2,300 in its entire system.)

Starbucks’ 2017 rank in the Fortune 500.

Beyond covering the planet with coffee bars, Starbucks has two main growth initiatives, which Johnson calls the “most critical things for the future of the company.” Johnson will be in charge of one of them: the continuing development of Starbucks’ digital and mobile operations. That’s a natural mission for him, given that he was an executive at Microsoft (MSFT) for many years and, later, CEO of telecom hardware maker Juniper Networks. Starbucks is already a leader in this realm, with 25% of orders now placed or paid digitally. Johnson’s task will be to expand and iron out the logistics so that a system made to facilitate speed and convenience doesn’t leave customers frustrated and cooling their heels.

The second key area will fall to Schultz. As executive chairman, he’s leading Starbucks’ push to develop a higher-end brand and “experiential destinations” to entice people who have abandoned malls to stop by a store. That strategy involves a three-pronged attack consisting of (1) the Roastery, a handful of massive, ultraluxurious coffee palaces inspired in part by Charlie and the Chocolate Factory; (2) a new brand of rare and single-origin coffee beans called Reserve; and (3) a second line of boutiques—a notch above a regular Starbucks but not quite as over the top as the Roastery—also called Reserve. If all goes well, those options might even lure some self-styled purists who spend $16 for a cup of single-origin pour-over at an “artisanal” coffee emporium like Blue Bottle and wouldn’t deign to set foot inside a Starbucks.

There’s a tension there. Schultz wants to keep serving 90 million people a day, maintain the admiration of Wall Street—and be respected by the coffee community. He’s an aficionado, and this feels personal. It’s no coincidence that his drink of choice, the double macchiato—a traditional espresso “stained” with a dash of frothy milk—is downed more often by people standing at the bar of a café in Rome than in a typical Starbucks.

But his company achieved epic success not so much by emulating Italian coffee as by adapting it to American tastes, what one tiny rival derides as the “Big Gulp version of coffee and milk.” Schultz initially hesitated to sell frappuccinos, says Howard Behar, a Starbucks executive for 21 years. “It didn’t live up to his purist idea of coffee,” says Behar. Schultz has always asked one question, Behar says, since the beginning: How do we elevate the coffee? Now he’s making it his primary mission. All of which suggests he won’t be leaving anytime soon.

The first time Schultz stepped aside as CEO in 2000, the process started fairly smoothly. His successor, Orin Smith, was a company veteran who had served as CFO and COO at various times. Schultz knew and trusted him. Business was booming.

The circumstances changed five years later, after Smith retired. By then Jim Donald had taken over, and Schultz’s relationship with him became “complicated,” according to Schultz’s 2011 book Onward. Donald, a former Walmart (WMT) executive, was an outsider, and the two regularly disagreed on major hiring decisions. Schultz’s entrepreneur’s disease—his inability to detach from the company he had built—began to show itself. “I put the responsibility on myself,” he tells Fortune. “I don’t think I was prepared as I certainly am today to recognize the need to let go.”

Schultz returned as chief executive in 2008 as the business struggled, owing to a combination of a spiraling economy and what Schultz, in a famous leaked memo to Donald, called the “commoditization of the Starbucks experience.” Schultz, who had retained the chairman title, returned to the CEO job and was hailed for the turnaround and the stellar run that followed.

Those kinds of accolades are great for the ego but less so for succession plans. When Johnson was announced as CEO on Dec. 1, the company’s stock briefly dropped 12% in after-hours trading. “Investors are very focused on it,” says restaurant industry analyst John Zolidis. “They’re well aware of what happened the last time Howard Schultz stepped aside.”

Schultz is now walking a fine line, making it clear that Johnson is running the business but signaling that the big kahuna is never far away. “I say not only that he’s becoming the CEO of Starbucks, but I want you to know he is going to be the CEO,” Schultz said during his prepared remarks at the company’s investor day in December, preempting the likely question from analysts. “He’s got the last word. He is running the company.” All of Schultz’s direct reports except for two—Liz Muller, senior vice president of creative, global design, and innovation, and Cliff Burrows, president of the group overseeing the Roastery and Reserve—have shifted to Johnson.

Still, it takes time for everyone to adjust, and even Schultz’s attempts to be encouraging betrayed the faintest hint of the old lion patronizing his successor. Less than a month after Johnson officially became CEO, he hosted his first earnings call with analysts on April 27, and Schultz was on the line.

“Kevin, congratulations on your first call. I think you did really well,” he said after the presentation of the company’s results, which had failed to meet analysts’ targets. Referring to Starbucks’ China CEO, ­Belinda Wong, Schultz added, “And, Belinda, coming from China in the middle of the night, I could not be more proud of you.”

Johnson ran the management discussion but left time for Schultz—who described himself as the “unscripted closer to summarize what’s been said”—to speak before executives took questions.

Schultz is adamant that this transition will be different from the last. For one thing, he says, Johnson isn’t an outsider. That’s technically true, but slightly misleading. Johnson, a company director since 2009, spent his career at Microsoft and other tech companies, then took an executive role as Starbucks’ chief operating officer and president in 2015, beginning when the last heir apparent, Troy Alstead, departed.

Some analysts question Johnson’s lack of retail chops, but Schultz has stressed the importance of his experience as a 34-year tech industry veteran. This increasingly critical digital business is not Schultz’s “primary skill,” he admits.

Fortune 500: Starbucks, Howard Schultz
Schultz at the Roastery in Seattle.PHOTOGRAPH BY BRIAN SMALE
Brian Smale

Schultz also had started to see not only the potential and importance of the Roastery and Reserve brands but the time investment they would require. “My schedule was not going to be compatible with running the company day to day,” he says. “And I had my own private moment of realizing I honestly believe that Kevin would be better suited to run the future of Starbucks than myself.”

Compared with Schultz, a double macchiato of an executive—he’s intense and caffeinated—Johnson comes across as a decaf vanilla latte. (He says he favors a triple macchiato.) Johnson is methodical in his responses—he’s data-driven, whereas Schultz tends to operate more on instinct—and hews to a standard CEO script. When I interviewed the duo together in Schultz’s office in May, Johnson gave a careful minute-and-a-half analysis of their differing leadership styles before Schultz jumped in. “Kevin is calmer, more patient,” Schultz says. “I was born restless.”

One of countless examples: Starbucks’ SVP Muller was on a trip to China when Schultz wanted her to fly back right away to look at the site he had found for the Seattle Roastery. He then called her while she was on vacation in South Africa to tell her they should open more.

More: Howard Schultz for President?

Starbucks had perhaps gotten too big for Schultz to run alone, given his exacting attention to detail. Years ago he became obsessed with the company’s breakfast sandwiches because he thought the odor of burning cheese—in particular cheddar—overwhelmed the coffee aromas in the store. While Donald was CEO, Schultz pushed unsuccessfully to remove all breakfast sandwiches from the menu. Then, when he returned as CEO, he again took up the issue, ultimately instituting a series of new procedures (including placing the cheese in a different part of the sandwich) to avoid burning it.

“If you’re a control freak and there’s 20,000 stores waiting for you to tell them what to do, it’s not going to work,” says Dave Olsen, a senior adviser to Starbucks. He recalls that in the days before speed dial, Schultz had some 50 to 70 store phone numbers memorized. “His passion, his intense drive, all of that could play out in that way when there were that many stores.”

Schultz’s quest for perfection, which may have been part of the problem during the last CEO handoff, just might help the transition this time around. One failed changeover could be chalked up to a fluke; two makes it look like Schultz’s problem. That’s not a mark that he wants on his record.

In 2009, as Starbucks’ turnaround was underway, Schultz jotted a few phrases on a Post-it: “the Willy Wonka of coffee,” “take customers on a magical carpet ride,” “totally immersive joyful customer experience,” “coffee at its peak.” Schultz let the idea percolate until 2012, when he found what he believed to be the perfect laboratory: a 15,000-square-foot onetime ­Volvo dealership on Pike Street in Seattle. Schultz had Muller, the company’s head of creative and design, come over to his house to watch Charlie and the Chocolate Factory with him.

Starbucks opened the Roastery, its “coffee shrine,” in December 2014, and indeed it has some “chocolate factory” touches, albeit in a much more elegant setting. Tubes shoot coffee beans through stages of the roasting process before they land at the coffee bar. There you can order a micro-lot like Cape Verde Fogo Island or Rwanda Maraba, brewed using methods not available in a typical Starbucks: Chemex, pour-over, a high-tech Clover brewer, French press, siphon, or manual espresso (the regular stores use automatic machines). The Roastery is filled with copper and hand-stained, reclaimed wood.

The retail section sells items like thermoses that set your coffee to a selected temperature for $149.95, or a Miir McCall Cruiser bike designed exclusively for the Roastery, complete with a carrier for your cold-brew growler, for $1,499.95. Customers have spent accordingly. The average visitor spends about $20 at the Roastery, about four times the outlay at the typical Starbucks.

The Roastery achieves something that few regular Starbucks can accomplish: It attracts significant clientele during the afternoon and evening. At the Roastery, the majority of sales occur in the afternoon. (The company has tried in the past to boost later-day sales at regular Starbucks, by selling wine and beer at 400 locations as part of its “Evenings” program, which was supposed to launch in thousands of stores over time. The company says it “paused” the endeavor in many stores in January.)

The company plans to open 20 to 30 Roastery locations, with projects underway in New York, Chicago, Tokyo, and Shanghai. These sites will roast coffee for Starbucks’ premium Reserve brand, which will also be served in 1,000 Reserve stores—essentially mini-Roasteries that are twice the size of a typical Starbucks. The first will open inside the company’s headquarters in the fall, with the second planned for Chicago in 2018. Reserve stores are expected to generate $3 million in annual sales, twice that of the typical Starbucks. Eventually 20% of Starbucks will have a high-end Reserve bar. The company is also upping its food game for the Roastery and Reserve cafés with its investment in Italian luxury baker Princi.

Fortune 500: Starbucks, Reserve Bar, Chicago
Brewing coffee using a “siphon” at a Starbucks with a Reserve bar in Chicago.COURTESY OF STARBUCKS

These projects are designed to engage the customer: a tasting menu of coffee flights or the glow of the bright bulb under the siphon brewer. The company realizes it no longer can count on malls to attract shoppers who then wander into Starbucks. With millions of customers abandoning in-person shopping and flocking online, Starbucks needs to draw them on its own.

The Roastery and Reserve initiatives are also an attempt to head off rising competition from high-end coffee shops. Says Tim Calkins, a professor of marketing at Northwestern’s Kellogg School of Management: “Starbucks is going to have to figure out how you navigate a market that seems to be becoming a little bit more like beer—small crafty players merging and becoming a big force.”

There were many decades when restaurant coffee in the U.S. was almost universally watery and brackish. So when Starbucks stormed the nation beginning in the 1990s with its richer, darker roasts and its lattes, it was a coffee revolution. The offerings were exotic enough that when the New York Times reported on the company’s East Coast expansion in 1993 it felt the need to explain how to pronounce the word “latte.” (LAH-tay, for the record.) Before long, Starbucks was a global behemoth, with mass-scale products that earned it comparisons to ­McDonald’s in some quarters.

What’s known as the “Third Wave” of small coffee purveyors then emerged in recent years as a rejection of Starbucks and an embrace of the broader food movement that reveres ideals like purity, authenticity, and a know-your-farmer philosophy. If Starbucks is where you go for a Pumpkin Spice Latte, the Third Wave shops are where you go to get your single-origin brew (black, please, no sugar) from a specific region.

These newer and cooler chains like Stumptown and Blue Bottle may not be big enough to take market share, though some of them are consolidating and gaining substantial backing. Investment fund JAB Holding, for example, has rolled up a number of coffee companies, including Peet’s, which in turn has purchased Stumptown Coffee and a stake in Intelligentsia.

Fortune 500: Starbucks, Roastery, Seattle
A worker pours beans at the Roastery’s staging area. They’ll travel by tube to a roaster and then be cooled in the copper cask at rear.COURTESY OF STARBUCKS

But already, these smaller fry are moving consumers’ tastes and habits more upscale in the way Starbucks once did. For the first time in the history of its survey, the National Coffee Association found that more than half of the coffee consumers reported drinking in the past day was classified as gourmet.

So far, that’s not a real problem for Starbucks, which is included in the gourmet category, because there’s been enough growth to go around. But increasingly, dynamism is coming from offerings like cold-brew coffee and nitro (coffee infused with nitrogen), both of which have been popularized by the younger, small-batch operations. Starbucks has been forced to try to catch up. (One potential benefit of the Roastery: The shops are less regimented and can experiment. When the company realized it was serving 100 cups of nitro in the Roastery every day, it decided to roll the drink out to regular Starbucks.) “It’s at risk of losing the credentials of very premium coffee,” says Calkins. “Some would say it’s already lost a lot of its credentials.”

One indication that times have changed: The small shops fear Starbucks less than they once did. A decade or so ago they wouldn’t have dreamed of opening near a Starbucks, several independent founders told me. Now they believe they’re no longer competing for the same clientele.

Starbucks keeps a keen eye on the newbies. Todd Carmichael, a founder of La ­Colombe Coffee Roasters, says members of Starbucks’ R&D team have ordered cases of its canned draft latte. Starbucks even opened its own “stealth” Third Wave shops in Seattle. At its Roy Street store you can order a lavender cortado from a barista who’s wearing flannel rather than a green apron. The company has conducted research on “credibility cues”—a bit like taking a class on authenticity—and discovered that baristas with tattoos are thought to make better coffee.

And thus the Roastery, as appealing as it is, seems like a defensive move, one that is producing derision among the Third Wavers. “They looked at what every high-end coffee bar is doing and checked all the boxes,” says Tony Konecny, a longtime coffee guy who’s now running the coffee program at startup chain ­Locol. “The impression that I get is that it’s important for Howard to feel like they weren’t losing the high ground with all this revolution that’s happening in high-end coffee bars.”

Still, the force of Howard Schultz’s will should not be underestimated. Bryant Simon, a Temple University history professor who wrote a 2009 book called Everything but the Coffee: Learning About America From Starbucks, says Schultz’s resolve is one reason the company has been so successful. He is unwilling to believe that the company is no longer cutting-edge. Simon says Schultz was apoplectic when people compared Starbucks to McDonald’s. “That’s what keeps them from falling below the middle,” he says. “His own aspirational vision for the brand is enough to keep them there.” The Roastery and the Reserve brand, Simon thinks, “will satisfy in some ways for Schultz a yearning for doing something new and reinvigorating its legitimacy. Then someone in operations will come up with a new Unicorn”—the viral, color-changing neon frappuccino, which the company offered for a week in April. Smith calls this tension a “perfect Starbucks moment.” As he puts it, “It’s a battle that’s been going on at Starbucks for 15 years.”

When Johnson and Schultz are asked about it, Johnson responds by describing Starbucks’ core business as delivering a warm, welcoming experience that’s about coffee and people. The conversation moves on, but a few minutes later Schultz interjects and wants to go back to that point. “The Unicorn frappuccino was a phenomenon in the lexicon of Starbucks,” he says. “What we knew going in was that if we created a product that had the viral nature of being Instagrammable, that it would be accretive to the brand even though it was highly indulgent.” He goes on: “It was catalytic and accretive to the joyfulness of making people smile. And how could that be a bad thing? I think the long answer is that metaphorically, if we’re going to do things like that, we also have to make deposits in reaffirming our leadership position in all things that are in the essence of coffee. The discipline of that is in the art of the possible and the power of ‘and.’ And we’ve been good at that for a long time.”

Milan, the financial and design hub of Italy, plays a central role in the Starbucks creation story. Schultz was working as head of marketing for the company in 1983 when he traveled to Italy for a trade show and discovered the city’s espresso bars. The concept—a place where coffee was the main event—barely existed at the time in the U.S. Starbucks, with its four stores, was primarily a coffee roaster. Schultz went home and pitched to his bosses the idea of re-creating the company in the image of the Milanese coffee bars. They didn’t bite, so Schultz left to start his own—Il Giornale, named after Milan’s daily newspaper. When Starbucks went on the market in 1987, Schultz pulled together $3.8 million from investors and bought it.

Bringing Italian coffee culture to the U.S. was not enough for Schultz; he always dreamed of bringing Starbucks to Italy. As early as 1998 he had it in his sights, telling The New Yorker that to open in the country would be “to climb Mount Everest.” At the time he said it would be at least a year before he made his move. In the end it was closer to 20. The company announced in February that its first location in Italy will be a Roastery in Milan’s old central post office building. It’s scheduled to open in 2018, to be followed by regular Starbucks branches.

Starbucks has conquered most of Europe, but the delay in entering Italy is partly a reaction to the country’s unique coffee culture. Italians drink most of their coffee in the form of espresso—a quick shot that just coats the mouth—while standing at the bar in one of the country’s 150,000 cafés. ­Andrea Illy, president of the Italian company that bears his family’s name, says that in Italy coffee is consumed as a tiny concentrate, not a hot beverage. “It’s something you drink for physiological properties,” he says. “It doesn’t feed you. It’s an elixir.”

If you want to give yourself away as a tourist, order a cappuccino in the afternoon. “You’re not supposed to drink milk after lunch,” says Paola Bay, a fashion industry veteran who is advising Starbucks on the Roastery here. “That would be madness.”

Bay, a Milan native who now lives in London, takes me to a few of the city’s coffee bars, including Marchesi and Cova. As a sign of how important they are culturally, the Prada Group and LVMH recently invested in the brands. Bay thinks Starbucks will do well in Milan, that the Milanese will order frappuccinos and other novelties exported from the U.S. that they can’t get at an Italian coffee bar.

This is the strange full circle of Starbucks opening in Italy: The company found inspiration in Milan, Americanized it, and is now bringing its Americanized version back to the city. Schultz had “a deep passion for that intimate Italian coffee shop, that authentic experience,” says Christine Day, an early company executive who stayed for two decades, “but the challenge of growth led the company to become known for the innovation of new products, not the Italian coffee shop.” In short, if it were possible to memorialize a person with an eternal cup of coffee on his tombstone, Schultz would no doubt request a macchiato. But history will likely assign him a frappuccino.

The Roastery and Reserve: An Introduction

To combat artisanal coffee startups, Starbucks is launching two new lines of retail stores and a new brand of premium beans. The first will be massive, ultraluxurious palaces called the Roastery; the second—smaller versions of the Roastery—will be called Reserve. (A Reserve-branded bar will also be added to some existing Starbucks.) Finally, the premium beans will also be branded Reserve.

  • 20 to 30: The number of projected ­Roastery locations. The first, and so far, only, opened in Seattle in December 2014.
  • 15,000 square feet: The size of the first Roastery. The one planned for Chicago will be nearly three times as large as that.
  • $20: The average a visitor spends at the Roastery, vs. $5 at a typical Starbucks.
  • 1,000: The number of Reserve stores the company is projecting. They will be twice the size of a typical Starbucks.
  • $3 million: The expected annual sales of a Reserve store, twice that of the typical Starbucks store.
  • 20%: The percentage of Starbucks’ stores that will eventually include a “Reserve” bar with higher-priced options.

A version of this article appears in the June 15, 2017 issue of Fortune. We’ve included affiliate links in this article. Click here to learn what those are.

Read More

Great ResignationInflationSupply ChainsLeadership