Starbucks Closes a Whole Latte Stores

While the Seattle-based coffee giant isn't anywhere close to going out of business, it's obviously going through a lot of pain while shuttering 600 of its stores this week. What caused their problems and what could (or should) they have done to stop them? Well, the all-knowing Sprizouse is here to offer a solution, so I'm glad you asked.

Let's examine the two biggest problems Starbucks is facing: First, in the current economic situation, people aren't willing to shell out the money for a Starbucks coffee and instead they go to Dunkin' Donuts (or Wawa or 7/11 or whatever). Second, Starbucks has had some customer service issues and a perceived commoditization of their product... both of these issues are a direct result of rapid expansion. I'll get to the expansion problems in a moment, but let's first examine the price issue.

Joe Coffee-Drinker's annual savings by switching to Dunkin' Donuts or Wawa are obviously miniscule. To prove it, I took a quick poll of the stores in my area to get the following prices for a large coffee:

Starbucks - $2.45

Dunkin Donuts - $2.10

Wawa - $1.49

And here are the prices for a large latte:

Starbucks - $4.05

Dunkin Donuts - $2.89

Wawa - doesn't carry lattes.

Assuming Joe Coffee-Drinker buys a large coffee every weekday morning at Starbucks but decides to switch to Dunkin to save himself some money, how much money will Joe Coffee-Drinker save? A whopping $87.50 annually (250 working days x $0.35). By going to Wawa, he'd save a little more ($250) while a switch from Starbucks' lattes to Dunkin's saves him $290 (assuming he drinks one latte every workday).

As you can see, the savings really are miniscule so why are people switching? Perceived costs! It's a marketing manager's dream. The current perception that Starbucks' coffees and lattes are expensive luxury items is hurting the business, but that perception was also the very thing that made Starbucks successful in the first place. Hmmmm... what to do? Well let me hold off on that for a minute, and take a look at Starbucks' other problem: growth.

Complaints about Starbucks' quality of service, the cleanliness of its stores and brewing skill of its associates began arising a few years ago. Most of this can be attributed to rapid growth. Starbucks prided themselves on high quality coffee offered in a great atmosphere with supreme customer service. All three of those selling points suffered when the company grow so rapidly that they couldn't keep the stores staffed with the type of employees they wanted -- unfortunately for Starbucks there are only so many Anthropology majors out there. Suddenly staffed with less talented, less committed workers the whole "Starbucks experience" suffered. The average brewing skill of the associates dropped, and the service level (and the quality of the lattes themselves) became rather uneven from store to store and employee to employee.

How could Starbucks have stopped all this? With controlled growth and a better overall growth strategy.

Middle grade products in nearly every retail industry are disappearing and dying. American consumers now either want the absolute cheapest item, or a high-priced, luxury item. The middle ground is where clothing retailers like The Gap and JC Penney tried to make a living (and where are they now?). If Starbucks had recognized this a few years ago, they could have seen that rapid growth presented not only a problem, but also a solution. Their growth should have included a "Starbucks Express" or "Starbucks Lite" or something along those lines. With a lock on the "Luxury Coffee" market and European Cafe atomosphere they should have expanded with tiny stores, staffed by one or two people, containing a very limited menu. In addition to solving the rapid-growth staffing problems, this new "discount" brand would have automatically sandwiched Dunkin' into the dreaded middle ground. And finally, smaller, cheaper stores would also not commoditize the main stores' coffees, service levels and atmosphere.

There's certainly a lot more that needs to be considered in promoting this kind of growth strategy: an examination about using the Starbucks name, for instance. Cheaper, smaller locations with a Starbucks label might still be associated with high prices... or a cheaper brand of service and coffee might damage the main brand's cachet. Either way, it would seem a sub-branding strategy is in order but those details could be worked out down the road.

In any case, since Starbucks isn't currently paying me to think about their problems and I haven't had a cup of coffee yet, I'm not going to offer up any more strategies here. What I will do is go get me some of that really yummy, really cheap Dunkin Donuts coffee and save myself hundreds of thousands of dollars in the process.

Weighing in on Fannie & Freddie

WAIT, don't go! I promise this won't be boring! Okay, maybe it will be a little boring, but you also might learn a thing or two, so stick around and edumacate yourself, dammit!

First of all, let me start by saying that the most important lesson to take home from the Fannie Mae / Freddie Mac problems, is that in England 'fanny' is a slang term for the front bits of a woman, not the back bits. Did you know that? I didn't either! It gives me a whole new understanding of why the stupid Brits laughed so much when I said I was going to store stuff in my fanny pack. They laughed and laughed even though, according to them, I don't even have a fanny.

See? I told you... NOT boring!

Anyway, moving on... Congress is currently working toward passing legislation enabling emergency funds for Fannie and Freddie as well as control over both mortgage giants' executive salaries. Seems like a good move to some, a bad move to others. You wanna know why there's a divide on the issue? Well, if you'll be patient, shut up and listen, I'll tell you.

Economists have a favorite expression and that expression is: "We're not ineffectual nerds! We helped explain that when a lot of people want a product, it will cost more. That's useful right? RIGHT?"

Okay, so maybe that's not their favorite expression, but it's close. But their second favorite expression is "Moral Hazard" and that's the expression that's relevant to this post.

What's a Moral Hazard, you ask? Well it's a term for the risky behavior that results from having insurance. Personally I feel the term Moral Hazard should be renamed "Jerkwad Hazard", or if you want to be a little more politically correct, perhaps "Risk Hazard". But anyway, what Moral Hazard means, in a nutshell, is that if you were somehow insured against losing your money at a Blackjack table, you'd bet higher amounts, play riskier and not really care about the outcome. You would lose your risk aversion. This is what Moral Hazard means. Seems logical right?

Side Note: I've sometimes seen people try to apply Moral Hazard to Health Insurance which is patently ridiculous. Giving everyone free (or affordable) health coverage doesn't mean everyone's going to start going to the doctor. Moral Hazards only apply to things people ENJOY doing. And sitting around a hospital room or doctor's office with a bunch of other sickies and whining rugrats is something most people AVOID doing even when they have broken legs and ruptured spleens. Nobody likes going to the doctor, so Moral Hazard doesn't apply to health coverage. But people (and businesses) do rather enjoy making money, so Moral Hazard is a useful term to describe what happens when the Federal Government insures that a company or bank can't fail.

Now then, lest you think the government is completely and totally filled with morons (it is), let me tell you that The Fed DOES understand the Moral Hazard problem and tries to avoid creating it. They do this even though Wall Street itself is very "failure friendly"... most collapsed hedge funds and bankers end up working elsewhere or getting golden parachutes for their fantastic failures.

For example, the Fed stepped in when Bear Stearns collapsed with a plan that avoided the Moral Hazard issue. Bear was a huge bank with $300 billion in assets that would have caused a big ripple in the marketplace had it totally collapsed. So when The Fed encouraged JP Morgan to buy the beleaguered Investment Bank they also wanted to make sure Bear (and its shareholders) were virtually wiped out. JPMorgan initially wanted to offer $8 to $12 per share for Bear Stearns but The Fed lowered the offer to $2 to ensure Bear was significantly punished.

As you can see, even though The Fed stepped in to staunch the bleeding from Bear they also did what they could to avert the Moral Hazard problem. Now let's look at Fannie and Freddie: Bear might have been huge ($300 billion in assets is nothing to sneeze at), but Fannie and Freddie are super-mega-hyper-global-death-ray HUGE. The two of them control $5 TRILLION in mortgages! Almost half of all the mortgages in this country are backed by the two institutions. So if Bear's collapse was a big problem, then Fannie and Freddie's potential collapse is a fantastically craptastic problem!

Hoping to avert their collapses, Congress will finalize the legislation of emergency funds next week in the amount of $300 billion to help the companies, but in doing so it seems the Moral Hazard problem has risen its ugly head, right? The government is propping up Fannie and Freddie and guaranteeing they won't fail... which is the very definition of a Moral Hazard, the same situation The Fed wanted to avoid with Bear.

But waitaminute, not so fast! There's a twist. Let's first examine why Bear Stearns collapsed:

As a bank, Bear had a bunch of principal and interest payments it needed to make it each month on outstanding debt. For argument's sake let's assume you had a mortgage with Bear and back in 2007, you missed a payment. No big deal for Bear right? They just dipped into the cash lying around from their other depositors and shareholders and paid off whoever they needed to pay off that month and then came after you with nasty letters and phone calls and damage to your credit. Now fast forward to March 2008. Depositors and shareholders at Bear start getting scared. They think the bank has a TON of risky mortgage securities on the books (they might have, but those securities might also have turned around if Bear could "stay at the table" long enough).

So the rumors about Bear's lack of liquidity start, everyone panics and fearing Bear's collapse, people start pulling their money out. If Bear didn't have a liquidity problem before the run, the panic definitely caused one. With depositors and investors pulling money out at an incredible rate Bear sits there facing a liquidity problem caused specifically by people afraid of Bear having a liquidity problem. With a lack of cash sitting around, what happens when you miss your mortgage payment to Bear then? Suddenly they have no cash to meet their own payment obligations and the result is a downward spiral of money caused by marketplace panic and little else.

Back to Fannie and Freddie... if the government nationalized both companies, investors and shareholders would be wiped out. Completely. So any rumors of nationalization would drive away investors and CAUSE the very same downward spiral of money that would lead to Fannie and Freddie's eventual collapse. Though the panic about "liquidity" would not be the same, the fact that shares would be worthless would cause everyone to sell -- which is pretty much exactly what happened when Fannie & Freddie's stock prices declined so badly a few weeks ago.

As Government Sponsored Entities, Fannie and Freddie actually have rules and regulations that forbid them from getting involved in the subprime mess, so most of the loans on their books are solid and not at risk for default. But some panicky Wall Streeter looked around, saw Bear and IndyMac failing and said, "Hey, waitaminute, Fannie and Freddie have to meet TRILLIONS of dollars in loan obligations. Bear and IndyMac had only a fraction of that and they both collapsed. I'm getting out!"

Those fears triggered a sell-off and left both institutions looking weak, but what else is there for Congress to do at this point? The issue is complex because rumors of nationalizing Fannie and Freddie would lead to their collapse, but propping them up would lead to the Moral Hazard problem.

Well let me be the first to say (in all my genius) that the main problem here is legislating "after the fact". A common theme running through this young and mostly pointless blog is that financial institutions are growing too large and many of the newer ones (hedge funds / private equity) are seriously under-regulated.

The government regulates the market share of everything else, so why not financial institutions? As banks, lenders and funds continue to grow, we're more and more likely to see problems like Fannie/Freddie with fewer and fewer answers. Thanks to derivatives, modern financial institutions are so interdependent on one another that when a big one collapses it sends ripples through the whole system. And ripples hurt. Even when banks and lenders are doing the right things (as the Bear and Fannie/Freddie cases illustrate), sometimes their failures become inevitable. Storing free cash underneath the mattress (or in a fanny bag... cue Brit laughter) for a rainy day doesn't help when you own every other house in the country and all the mattresses in the world can't store the reserves you need.

Steve Jobs is a Level-4

On December 31, 1992 Lee Iacocca stepped down as Chairman and CEO of Chrysler. It would be the last time the charismatic boss would walk the halls of the company's Detroit headquarters as the carmaker's leader.

Book tours, motivational speaking engagements and a $500,000 annual pension awaited him in retirement. Iacocca looked back on the fourteen years he'd helmed the company and smiled; he saved Chrysler from bankruptcy, helped it persevere through recessions and high gas prices and his marketing brilliance and tough-guy management style had not only helped the company survive, but thrive.

The industry landscape of the 1980s included shrinking market share and intense competition from Japanese imports. Such a landscape required a doggedly determined leader like Iacocca. He'd singlehandedly restored Chrysler to prominence with grit and a no-nonsense attitude and in the process became the first "rockstar" CEO.

Last weekend Version 2.0 of the iPhone hit shelves and sold 3 million units in three days. Apple's stock is currently trading at $172, down a smidge from its high of $188 when the 3G version of the phone was first announced. However, $172 is still a far cry from the company's $7 price when Steve Jobs reassumed the CEO position ten years ago.

Most of Apple's success during the last eight years is directly attributable to their enigmatic leader's demanding style, marketing genius, micromanagement and charisma. Nothing at Apple escapes Jobs' watchful eyes and no product is released if it doesn't meet his exacting standards; entire projects have actually been scrapped during final stages because Jobs didn't approve. The iCEO micromanages everything at Apple, from products to company communications (the PR department releases nothing without explicit approval). Every press release and piece of marketing literature passes his desk first, and Jobs has instilled his tight-lipped discipline into all his employees.

Apple's growth under Jobs' stewardship has inspired a Wired article and recent book by Leander Kahney, who celebrates the iBoss' abrasive, in-your-face management. Jobs has indeed shunned the 'wisdom of crowds' approach favored by other techies like Google and Microsoft. He's flown in the face of conventional management doctrine by not treating Apple's employees as keys to the company's success but rather as slaves to his directives and whims. Kahney, the News Editor at Wired, defends Jobs' egomaniacal, S.O.B. personality by glorifying Apple's current success. He likens the low-growth prospects currently surrounding many Silicon Valley firms to the mid-1950's industrial landscape, and contends a leader like Jobs is practically required for a company to survive in such a world.

The problem with all of this is that Kahney stands awfully close to the line that separates journalist from Fan-Boy. He's written three books about Jobs and Apple (so far), created the Cult of Mac blog, and at one time was thought to be a fake version of Jobs, secretly leaking Apple information to the public through cultofmac.com. Even if we subtract the obvious reverence Kahney holds for Jobs, there would still be the likelihood of proximity biased reporting. I'm not condemning Kahney for all this, after all he's not the only person worshipping "rockstar" Steve Jobs nor is he alone in granting jerks wide allowances for their performance. What I am trying to do is draw attention to what should be a painfully obvious parallel... that Jobs is basically Iacocca Version 2.0.

Okay, so what's wrong with that? Well, what happened to Chrysler after Iacocca left? It tanked. Miserably. Iacocca's massive ego limited his instruction and management to the people in the company. When he departed, everyone there had been used to doing their job to "please Lee". He never consulted his subordinates on decisions or taught them to think for themselves. He treated them like slaves to his whims instead of keys to the company's success. Does any of this sound familiar? Does it sound like Jobs? Well it should.

I believe Wall Street (and the rest of the world) fully expects Apple to collapse once Jobs departs. In fact, Jim Collins' masterful and diligently researched 2001 book, Good to Great pretty much proved it will. Collins is what Jobs would call a Level-4 Leader: an egotistical, micromanager who can take a company to great heights singlehandedly but then leaves it to crumble after his departure (this crumbling feeds the ego, since it proves the company can't survive without its leader). Collins' book showed that for a company to have long-term, sustained success it needs what he has termed a Level-5 Leader. These CEO's and Presidents are highly motivated, but also fair, encouraging and nice. Their underlying drive and motivations are not the same as the Level-4 Leaders'. They don't want to make themselves look great, they want to make the company itself great.

As a society we nearly always excuse an S.O.B. personality in light of success. But what Collins proves is that being an a-hole isn't an intrinsic part of that formula. In fact, it's usually antithetical to it and only the most charismatic and talented people can make a company flourish for even a small period of time whilst being jerks. The basic point here is that thousands of companies have been successful with nice leaders and managers, and if it can be done with nice-guy attitudes, then it SHOULD be done with nice-guy attitudes. Too many things in the business world are beyond the control of any leader or manager at every level to guarantee success, so the guarantee should be that they'll be fair and nice.

Don't make the mistake here that Collins or I are claiming fairness and nicety are the keys to success... motivation, intelligence and hard work come first. But "a-hole" is not a part of the formula anywhere and everyone should remember that.

Darwin, Freud and Morons

*** This Post Bumped Up From Previous Comments ***

Olivia Judson, Evolutionary Biologist and resident hottie contributor on the NY Times website recently wrote a piece calling for the retirement of the word "Darwinism". Judson feels evolutionary biology as a discipline has advanced and changed so much since Darwin's time that although he's a giant in the field and casts a shadow over everything, perhaps it's time to think about evolution without mentioning his name.

I commented on the article and said I thought it could be worse: I believed the progenitor of her field (Darwin) has largely had his theories proved correct while the progenitor of psychology (Freud) has had many of his theories proved wrong. Sigmund Freud created pyschology and psychoanalysis and for that, he should be celebrated (and indeed he is). Until Freud, nobody thought about the underlying motivations behind a person's actions. But Freud took a mis-step by believing all human behavior was the robotic byproduct of sexual urges. He then shoehorned many of the results of his psychoanalysis into that theory. Freud believed virtue was an illusion (everything we do, we do to impress others for the hope of sex), curing psychological problems an impossibility and happiness nearly unattainable. But Freud's name hangs over psychology as much as Darwin's hangs over evolutionary biology.

So what did my comment earn me? Mostly a bunch of angry replies and threatening emails that people were going to find me and shove a stapler up my nose. Well not really, I'm kidding... they mostly just called me a moron and left the stapler part out, but that doesn't mean I wasn't offended. The term 'moron' may be an accurate assessment of my intellectual capacity, but it doesn't mean I like hearing it, dammit!

I've read some Freud, but by no means consider myself an expert on the man or his work; hence the "Renaissance Man" name of my blog. I know enough about everything to sustain an argument, but not enough to offer new insight or an expert opinion and rarely do I feel the need to be correct. A quick perusal of my blog should prove that: I'm willing to fire off under-educated opinions about everything from Romantic Poetry to Investment Banking's correlation to Book Publishing, to the reasons why white people hate Michael Vick (yes I just linked to my own blog).

All this being said, however, I am willing to listen to other people's arguments (even when they call me a moron) because if I'm wrong (and there IS a 0.001% chance of that in this case), then I'd like to be corrected. Why? Because once I'm right I can spew opinionated commentary from a 'correct' position, and as everybody knows, intellectual bullying is waaaay more fun when you actually know what you're talking about.

So enlighten me, if you want, Freudian truthers. Why wasn't the man a total idiot?

What Are We Going To Drink?

Earth shattering news today in America's heartland: Budweiser is no longer an American beer! The calamity! The horror! I can't stop using exclamation points!

The backlash against Anheuser-Busch's sale to InBev, a Belgian company, has already begun. Jordan Moore, a 21-year-old concrete worker in St. Louis helps illustrate the outrage being felt across America -- Mr Moore, interviewed by the Wall Street Journal while enjoying a few cold ones on his lunch break (apparently something every red-blooded American who operates heavy machinery has a God-given right to do), had this to say:

"I'll tell you one thing, if Budweiser is made by a different country, I don't drink Budweiser anymore. I'll go back to Wild Turkey."

Wild Turkey is, of course, owned by French Company Pernod Ricard. But Moore's intelligent and intentional use of sarcasm here brings up an incredibly valid point. The man sees America's culture and soul being ripped apart by foreign companies and terrorists and wonders why the rest of us don't see it. What are we to do now that the King Of Beers is owned by a country whose greatest contributions to the world are Jean Claude Van-Damme and The Smurfs? Where's Chuck Norris and Charlie Brown when you need 'em? Surely those two bastions of American culture would help draw attention to how far we've slipped.

Guess we have to roll up our sleeves the old-fashioned way and boldy venture forth, soldiering on in the face of this adversity, to search for some U-S-of-A alcohol we CAN drink. Surely there's a Red White & Blue beverage out there we can use to inebriate ourselves. There's got to be a patriotic beer that can help us forget Osama Bin Laden is running for President and, if elected, will take away our right to worship God's son (Dale Jr.) every Sunday, force us to remain sober at work and not only legalize gay marriage but make it mandatory.

Well, how about Milwaukee's Best? Heck, it's got one of America's lower 48 states right there in its name. Milwaukee, home to Green Bay and Minnesota. What could be more American than that? Waitaminute!!! Milwaukee's Best is owned by a South African company? Well nuts to that, "South Africa" is practically another way of saying "South Terrorist", guess we'll have to find something else. How 'bout Miller Lite then? Same guys? Are you serious? Dagnabbit!

Coors? They merged with them Molson Canadian kooks? They're out then. Sam Adams? Don't even say it, that's a blue state beer, you've lost your mind if you think I'll drink that.

Jim Beam, Jack Daniels? Yeah? Really, they're still American? Finally! Well then if you'll excuse me, I'm gonna go get drunk on Jack and Cokes before I go back to work. Hey waiter, tall Jack and Coke, heavy on the Jack! I'd also like the filet and frites... oops, I mean Steak and Freedom Fries. USA! USA!

Predictions & Bank Failures (redux)

For the most part, my professors in B-School have all been quite liberal (even though it's business school). Which shows that being a faculty member in university academia is a better predictor of political leaning than the subject that faculty member teaches. However, my Derivatives class is the first I've had so far with a conservative professor (he announced his political beliefs in the first class). It's been strange listening to him rant about how the government has never done anything good, how it shouldn't be involved in America's capital markets and shouldn't regulate businesses at all. He even spent five minutes the other day ranting on Sarbanes-Oxley and calling it a bad thing. Weird. Anyway... Mr. Ultra-Conservative Derivatives Professor loves Jim Cramer and Cramer's site, TheStreet.com. Personally I don't think Cramer's a genius, but he's also not a bad guy. In fact his overall investment strategy is solid, if you realize there are heavy initial "qualifiers" to his Mad Money picks. Unbeknownst to the average viewer, Cramer feels it's difficult-to-impossible to beat the market index and therefore 80% of your money should be invested in 401k's, IRA's, and index funds (mutual funds comprised of blue chip stocks from the S&P 500). When Cramer talks about "Mad Money" what he's actually talking about is the 20% of investment capital you're willing to gamble and lose. Cramer's stock picks have done very well, but time is the great equalizer of Wall Street prognosticators, so long-term we'll have to see whether "Mad Money" actually knows what he's talking about. The point of all this is that I don't usually visit TheStreet, but since Finance Prof talks about it so much I've spent the past few weeks checking out the site for class discussions. The site obviously has a heavy reliance on Cramer for material, so to diversify the site's content the editors hired Lenny Dykstra (old Mets / Phillies outfielder) to write articles and make picks as well. "Nails" has performed decently with his investment advice so TheStreet's editors kept running with a good thing and hired Tim Brown (retired Oakland Raiders WR) to write a column. Now, I'm not against ex-professional athletes spouting investment opinions, they're just not the first group that comes to mind when I contemplate bond markets and interest rate swaps. Come to think of it, they're also not the second group... or third... or fourth or fifth or sixth. Actually, considering recent research showing 60% of ex-NBA players go broke after leaving the league, and the laundry list of bankrupt ex-athletes, I'd put my interest in ex-pro athletes' financial advice somewhere between the two crazy guys outside my Wawa who think I'm the President and freshly poured cement. Unfortunately, Brown doesn't do much to help the cause by writing an article comparing Intel's short-term prospects to the Raiders' short-term prospects and claiming both look good! Sheesh. I'm left not only quetioning Brown's skill as an investment analyst, but as a football analyst as well. Like I mentioned in a previous blog post, predicting the market is nearly impossible but with the sliding demand for computers, razor-thin margins in chip sales, and Intel's current lack of diversification, it would seem Brown's Intel prediction is on shaky ground to begin with... and I don't know where to begin dissecting the Raiders' abysmal short term prospects. Their egotistical primadonna quarterback who hasn't done a single thing in the NFL? The $86.3 trillion they've got tied up between McFadden and Russell? Javon Walker? Al Davis? Yuck. Just yuck. Moving on... another interesting news item surfaced today related to the post I wrote about market predictions and bank failures. According to the FDIC, Indymac's collapse this week looks like it will be the 2nd largest bank failure of all time. Which is not a good thing, but like I said, as banks consolidate and get bigger, bank failures are only going to get bigger too.