Into the Black

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"Our goal here was to design a plan that would combat the attrition that is the greatest threat to a retail operation," says Schultz. "We've set up a vesting period of five years; it starts one year after the option is granted, then vests the employee at 20% every year. In addition, every employee receives a new stock-option award every year, and a new vesting period begins. The percentage of the grant is tied to the profitability of the company. It took us two years to design this."

To put the plan in place, Smith had to get an exemption from the Securities and Exchange Commission, the federal regulatory agency charged with monitoring corporate governance. Any company with more than 500 shareholders has to start reporting its financial performance publicly. That's costly and reveals information to competitors. Because Smith argued that employees would be receiving options, not shares, the rule was waived.

Before Starbucks went public, the original plan had been to let workers cash in their options based on a private valuation of the company by investment bankers. An employee stock ownership plan wasn't possible as long as Starbucks was private, and stock wasn't as much of an incentive as options were. Under ESOPs, workers have to buy the shares, but with options, there's a lengthy period until they can be exercised, one hopes at a very low price.

Though Starbucks is now public, Schultz says the basic offering can be duplicated by most any company, public or private. "For our plan to work in another company, there has to be some type of liquidity or cash-in potential," he says. "Now we're public, but a smaller private company would have to design an alternative structure, maybe backed by buy-sell agreements when employees retire or leave the company. But these aren't the kinds of obstacles that should get in the way of anyone who is considering setting up an option plan."

The first year that Bean Stock was offered, the company overshot its profit goal by 20%, and the board responded by nudging up the percentage of salaries for stock options to 12% from 10%. Schultz was so enthusiastic, he went so far as to give the first wave of workers who were offered options the same 30% discount on the price as the top company officers received. But the venture capitalists and shareholders on the board weren't going to let their stake be diluted without a challenge. "Increasing the shareholders substantially dilutes our interest," says Craig Foley, a director and a managing partner of Chancellor Capital Management Inc., in New York City, and the largest shareholder before the public offering. "We take that very seriously."

For months Orin Smith and his team crunched numbers to come up with a convincing argument for continuing the plan. He analyzed corporate studies, including some from Corey Rosen's group, the National Center for Employee Ownership, comparing productivity in companies where workers owned a stake with productivity in those where employees didn't. Most significant, Smith looked at what would be vested in four to five years and discovered that less than 3% of the entire company would be affected, based on the number of people and sales of the stores. "We could determine the number of shares offered per year, and applied turnover scenarios through year five," says Smith.

The most convincing case was built on how few people were leaving and how much easier it was to add topflight talent to the company. After a brief discussion, the board voted to keep the plan.

As Foley puts it: "We realize that if we can reinforce the culture and reduce the turnover in part-time employees, all shareholders will be better off. The grants are tied to overachieving. If you just come to work and do your job, that isn't as attractive as if you beat the numbers."

At Bean Stock's unveiling, Schultz recounted to his employees his memories of growing up in the Brooklyn projects, where his father "went from truck driver to cabbie to factory worker and never made more than $20,000 a year." When he died, said Schultz, the children took care of their mother. "I would have felt troubled if five years from now the wealth and success of Starbucks would affect only a few."

The way Schultz describes it, the stock options and the complete benefits package act as a glue that binds workers to the company, forging loyalty and, above all, encouraging attentive service to the customer. "It's reduced attrition," says Schultz. "And we've literally changed the level of communication. You can't imagine how excited our workers were when we started unveiling our new benefits package and explaining Bean Stock. All kinds of people started coming up with ways to save money and improve productivity. Now they're invested in our future. The future of Starbucks lies in increasing shareholder value -- and increasing employee value will increase shareholder value."

Additional reporting provided by Jill Andresky Fraser.

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