STREET SMARTS

Taking On Starbucks

How independents can hold their ground.

Norm Brodsky is a veteran entrepreneur.

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If you've been following the saga of the aborted sale of my businesses, you know that I called the deal off at 3 p.m. on April 5, when I met with my senior managers and informed them it was dead. What I haven't told you is that the managers held another meeting right after mine. The subject: how to keep me out of their hair. The company's president, Louis Weiner, said that he knew how much they'd all enjoyed my absence for seven months, and that if they wanted me to stay away, they would have to continue operating the company as they had during that record-setting period. They vowed to do just that.

As a result, I now have even more time to spend outside the business. Among other things, I've been doing what I love, helping small entrepreneurs who come to me for advice. One is a former New York City firefighter named Brian Kelly. He first approached me when he was thinking about getting into the secure document destruction business (see "A Few Good Competitors," August 2002). Aside from the shredding company, Brian also has a coffee shop business, City Beans, with two stores in northern New Jersey, both located in office buildings. He opened the first in Newark in 1996, and it immediately attracted a following, turning cash-flow positive and profitable within the first month. He later added soup and sandwiches to his menu and did even better. About a year ago, however, Brian received the kind of news that can strike terror in the heart of any independent coffee shop operator: Starbucks was coming.

He learned the coffee giant was sniffing around when the manager of his shop called to say that two guys from Starbucks (NASDAQ:SBUX) had shown up with a tape measure and walked through City Beans taking measurements. At the time, Brian's lease was expiring, but he thought he had already come to terms on a new one. When the landlord told him that Starbucks was putting in a bid, Brian had the good sense to refuse to renegotiate. Apparently, however, Starbucks insisted on terms the landlord found less attractive, because Brian wound up getting the lease anyway, causing him to breathe a sigh of relief.

Then he heard that Starbucks was moving into a large, empty retail space on the other side of the office building. At first, he felt a stab of panic and a flash of anger at the landlord, but he soon found out that Starbucks was coming at the invitation not of the building management but of a Hilton (NYSE:HLT) hotel located in the building. The shop would be in the hotel lobby.

Brian had only recently begun to make money on his second coffee shop, in Jersey City, which was in a new office building. Barely 20 percent of the office space had been occupied when he'd opened the store, and it had struggled for a year or more. Along the way, Brian had taken on a considerable amount of debt. He could wind up in trouble if the Newark store went under, which to him suddenly seemed a real possibility. He'd heard all the horror stories about companies like his being crushed when forced to go head-to-head with a national chain. Starbucks in particular had a reputation for aggressive marketing. "I'm not sure what I should do--if anything," he said. "Maybe I should just sit back and wait."

Sitting back and waiting is what a lot of small companies do when a giant moves in. They hope for the best and then react when the giant starts squeezing their margins and taking away market share. By then, it's too late. The outcome can be different, however, if owners capitalize on the advantages small companies have when competing with a giant. For one thing, they can establish close, personal, one-on-one bonds with customers that large companies can't match. Small companies can also outmaneuver giants. That's especially important if they're competing against a retail chain with a cookie-cutter approach to managing its stores. The managers have a formula they have to follow, and they're not allowed to deviate from it. So you can do things that they won't be able to respond to for months, if ever. You can also prepare for their arrival by taking steps to emphasize what makes your store different--and special. That's what I suggested Brian do. "You need to be preemptive," I said. "When is this store supposed to open?" He said he'd heard it would be up and running in December, which gave him four months to make and execute a plan. "Let's talk about your strengths," I said. "What can you do that Starbucks can't do--aside from offering a reasonably priced cup of coffee?"

Brian reminded me that City Beans was about to celebrate its 10th anniversary and had plans to do promotions thanking its customers. It already had a customer loyalty program--buy 11 cups, get one free--using magnetic cards that allowed it to track sales automatically and even offer electronic credits. To receive a card, customers gave City Beans some information about themselves, including their e-mail addresses. Brian thought that he and his partner, Jim Toscano, could expand the program and use the e-mail addresses to market directly to customers.

Brian also noted that he used a local coffee roaster. The coffee City Beans served was roasted every Thursday morning and delivered within 24 hours. As a result, he said, his coffee was fresher than Starbucks'. That would be worth promoting as well. At the same time, City Beans would be emphasizing its identity as a local business supporting other local businesses.

I pointed out that I happened to own, and be storing, several hundred Fire Department of New York lunch boxes left over from an earlier ill-fated venture (see "Learning From Mistakes," June 2003). They were taking up space in one of my warehouses. What if I gave them to Brian? He could use them in a promotion that told the City Beans story. Brian had known Jim since kindergarten. They'd grown up together and dreamed of starting their own business. Brian had joined the fire department, and Jim had become a professional drummer, but they hadn't given up their dream of becoming partners in a business. When coffee got hot, they decided to open City Beans as 50-50 partners, with Jim working inside and handling operations while Brian functioned as the CEO but continued to work as a fireman. (He retired from the department in June.) Finding a way to tell the story, I noted, would make the connection with customers that much more personal.

I had another suggestion. "No matter what you do," I told Brian, "Starbucks is going to take away a percentage of your business. It could be 5 percent, 10 percent, or 20 percent. Whatever it is, they're going to take it. So let's look for additional sources of income."

"We do a little catering when people come and ask us to do it," Brian responded. "Maybe we could do more."

"What are the gross margins like?" I asked.

"They're good."

"So that's a great idea. Why don't you put some real effort into signing up more catering customers. The extra money you make could help offset whatever you lose."

In the end, Brian and Jim decided to do all of the above. They would run a series of promotions to celebrate the 10th anniversary of City Beans, introducing a new one every few weeks. They would run specials on soup-and-sandwich combinations and generate a list of customers who wanted to receive daily e-mail announcements on the special of the day. They would expand the customer loyalty program and sign up as many new members as possible. When a new company moved into the office building, they would offer loyalty cards to all its employees, with a credit they could use to try City Beans for the first time. They also gave credits to existing members of the loyalty program in appreciation of their ongoing patronage. At Christmas, they sold the lunch boxes for the price of the sandwich inside and included a one-page history of the company. Meanwhile, they ramped up the catering business, taking advantage of contacts they already had at major corporations and big law firms throughout northern Jersey.

As it turned out, the Starbucks opening was delayed several months. When it did open, Brian saw a drop in sales. But many of his customers came back, and Brian talked to them about their experience at Starbucks. Some told him they'd been disappointed. The store had offered free iced coffee for a day, but the employees weren't as knowledgeable or as friendly as those at other Starbucks shops. Whatever anxiety Brian felt had melted away by the time he came to see me after competing directly with Starbucks for a couple of months. "You don't seem too worried," I said.

"I'm not," Brian said. "Our sales in the shop haven't dropped as much as I expected, and the additional catering business has made up the difference. I guess it also helps that it isn't a real Starbucks."

"What do you mean?" I asked.

"Well, it looks like a regular Starbucks, but I think it's actually a licensed operation. The people all wear Hilton name badges, and the service isn't up to Starbucks standards."

"That sounds like a bad move by Starbucks," I said. "They're cheapening the brand."

In any case, Brian isn't relaxing his guard. He and Jim are working on new signage for City Beans and looking for more effective ways to market their catering services. I wouldn't be surprised if the business picked up market share in the next year. It's almost enough to make you feel a little sorry for Starbucks. Well, not quite.

Norm Brodsky (brodsky13@aol.com) is a veteran entrepreneur whose six businesses include a three-time Inc. 500 company. His co-author is editor-at-large Bo Burlingham.

Last updated: Aug 1, 2007

NORM BRODSKY | Columnist

Street Smarts columnist and senior contributing editor Norm Brodsky is a veteran entrepreneur who has founded and expanded six businesses.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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