Starbucks & Strategic Entropy

Guard Your Energy Vigilantly

Readers often ask me to write on current events at specific companies. I have done so occasionally, for example with the Bud Light and Jaguar advertising fiascos. But I only do it when the specific company situation illustrates a broader strategic point, which is the case with the goings-on currently at Starbucks. This Playing to Win/Practitioner Insights (PTW/PI) piece is called Starbucks & Strategic Entropy: Guard Your Energy Vigilantly. And as always, you can find all the previous PTW/PI here.

The Starbucks Story

Six months ago, Starbucks fired CEO Laxman Narasimhan, who had only been on the job for 18 months and had presided over a 33% decline in the stock price that reflected his inability to reinvigorate stagnating growth. The board replaced him with Brian Niccol who, after settling in, announced a 30% trimming of product line-up, and then more recently, firing 1,100 corporate staff.

I am very favorably disposed toward the trimming — for reasons I will discuss. But it is odd. The exact same thing happened in 2009. Leading up to that time, successive CEOs Orin Smith and Jim Donald dramatically expanded the product line-up found in Starbucks shops. The business went into the tank. Howard Schultz came back as CEO and dramatically cut both the product line-up and staffing — and returned Starbucks to profitable growth. (Good story on the turnaround here.)

For me, it begs the question: wouldn’t you have thought that an existential crisis only 16 years earlier would have built at least a little resilience against doing the same exact thing, getting into trouble the same way, and needing to perform the same streamlining? The definitive answer: nope!

The Strategic Entropy Challenge

Repeating exactly the same mistake is truly silly — in fact arguably fully irresponsible. There is no way it should have happened again a mere 16 years later. But the source of the mistake is a nearly universal business strategy problem: the diffusion of energy.

Thermodynamic processes are driven by concentration of energy. If you put energy into an enclosed space that keeps it concentrated, it will have great power. For example, if you light a match to gasoline in a tightly controlled space — e.g., dropping a lit match into your car’s gas tank — you will have a huge explosion on your hands. If the same gasoline is spread across the ground, you will have a fire, but no giant explosion.

Entropy is the process by which concentrated, organized energy becomes disordered and random. Rather than maintaining its power, the energy dissipates and becomes unavailable for use. And somewhat scarily, the second law of thermodynamics holds that entropy always increases with time.

Think of business as engaged in building concentrations of energy. Businesses invest in innovation, branding, distribution, etc. to build energy into an offering. If it is an innovative branded offering, it has lots of energy. Let’s take Tide Pods as an example. P&G invested billions in R&D and branding to create a very particular thing that both appeals to consumers and makes money for retailers. There is enormous energy in the vessel of Tide Pods — which is a manifestation of a set of Where-to-Play/How-to-Win (WTP/HTW) choices — a offering worth many billions of dollars in value.

But then imagine that a private equity guy took over Tide Pods and said: “Hey, we need to exploit this incredibly powerful thing. It is wildly underutilized.” And Mr. P/E launches a line of Tide Pods-branded washers and dryers, and clothes hangers, and clothes hampers, and so on. Given the energy inherent in Tide Pods, some consumers will give a Tide Pods-branded washer a try. And retailers may agree to shelve Tide Pods-branded clothes hangers and hampers.

But that will cause a transfer of energy out of the high-energy Tide Pods vessel to these other places — and that is entropy. There is, of course, an exception. If one of those products becomes a vessel as powerful as Tide Pods, it will generate its own energy. But that is the extreme exception, not the rule.

In Starbucks, coffee has always been and probably will always be the high-energy-intensity vessel of the company. Scones, egg bites, mugs, etc. will never be. But the energy produced by coffee pulling the customers into the stores and getting them to open their wallets (or more likely these days, their app) is transferred over to these things and as they proliferate, they can threaten to destroy the energy source.

Why is it that there is as powerful a force in business as there is in thermodynamics that causes entropy to seemingly always increase with time? I believe there are both defensive and offensive forces that push businesses toward damaging and/or deadly entropy.

The Defensive Force

The defensive force is the concern that we won’t be able to sell enough of our current offerings to meet our revenue goals. To assuage that concern about our weakness, we sell more stuff. For Starbucks that was more drinks, more food, more non-food merchandise — both in the lead up to 2009 and to 2025. For me, at least, it is a dizzying array. I can’t pay for what I really want without walking past a seemingly endless display of random stuff.

I have talked about this before in the PTW/PI series with Confident Companies Do Less. Fabulous confident companies like Vanguard or Southwest trust that they will grow because their core offerings are so compelling. And that conserves the energy that they created with their core offering rather than dissipating it.

Less confident companies say: “gee we have some space and/or capacity for added offerings that can garner us some sales that our existing offerings won’t.” There is some validity to that logic. There are almost certainly customers who will like those additional offerings. But these unconfident companies ignore (or don’t even imagine) the negative impact on their core energy. Starbucks didn’t take seriously how coffee drinkers would feel about a ‘coffee shop’ that smells like egg whites being microwaved or in which their coffee takes twice as long to be made because confused baristas are attempting to make myriad fringe drinks for the first time.

It is the bane of once-great companies — whether Sears Roebuck, IBM, GM, GE, Citigroup, or AT&T (not to be confused with Southwest Bell Corporation which bought AT&T for a song and renamed itself AT&T). All were on a long-term vector of doing more stuff — not less — when they dropped out of the Dow Jones 30 index. And my view is that all believed that they needed it for growth.

That is defensively driven entropy — doing more stuff for growth and inadvertently dissipating the energy of the strong core.

The Offensive Force

The offensive force is the belief that if we can do it, we should do it — and since there are so many things that we can do, we will end up doing a lot of things. Just as I continue to see many manifestations of the defensive force, I see plenty of the offensive force as well.

It often manifests itself in driving entropy from backward integration. It goes something like this: “Supplier x sells us this input and takes a profit mark-up on it. We could supply ourselves and internalize the profit.” It is not a problem when it involves internally creating some minor input. But it is when it is gigantic — like (the new post-SBC) AT&T backward integrating into content production and distribution with the absolutely disastrous, entropy-accelerating purchase of Time Warner.

I recently worked with a company that had a huge competitive advantage in its business, featuring an extremely tightly defined WTP that enabled it to pursue a truly advantaged HTW. It was smoking its competition with its WTP/HTW choice. But it had decided several years ago that it could backward integrate in a major multi-billion-dollar way. It was sensible. It could be rationalized as a broadening of its WTP to enhance its HTW. But it was only one of the ways that could have generated the HTW enhancement that it desired. And the consequence has been a huge drain on capital, which has constrained its ability to invest in growing the core WTP/HTW. It was able to do it, but should it have?

Because you can do something is a dreadful reason for doing that thing. Any broadening of WTP — whether more offerings, more customers, more geographies, more vertical integration (forward or backward) — should only happen if it strengthens HTW; that is, if it increases the intensity of the energy. If it has a neutral effect on HTW, it shouldn’t be done. Tie doesn’t go to the runner. That is because it will spread the energy, which accelerates entropy. If it decreases the power of HTW, it shouldn’t be given a millisecond of consideration. Steve Jobs understood this in spades. When he returned to Apple, he famously hacked and slashed his way through energy-dissipating offerings in order to build energy in the remaining core.

It is a challenge at every company, even the great ones like P&G, where executives have to fight against what is called ‘SKUs for news.’ (For non-aficionados of consumer-packaged goods, that is a stock-keeping unit, or individual variant.) A new SKU creates news for both the consumer and the retailer — and hence can have a positive impact on sales.

P&G’s Head & Shoulders is the most powerful brand in anti-dandruff shampoos globally by a wide margin. But can we be confident that the addition of Head & Shoulders Apple Cider Vinegar 2-in-1 Shampoo and Conditioner to the brand line-up increases the energy of Head & Shoulders? Or even maintains it? Or Head & Shoulders Apple Cider Vinegar Rinse? Or Head & Shoulders Ginger 2-in-1 Shampoo and Conditioner? Maybe, but maybe not.

If you don’t worry at all about the energy of the base brand, these are all nice, newsy additions. But that is not the question a strategist should be asking.

Practitioner Insights

The lesson here, to quote Canadian music legend Joni Mitchell, is “Don’t it always seem to go that you don’t know what you got ’til it’s gone?” When you enjoy the energy of an awesome WTP/HTW combination, it can so easily be taken completely for granted. It feels like the natural order of things. It may make you feel like doing other things will feel as easy and natural. Doing more things might feel natural because growth is slowing and doing more things holds the promise of reinvigorating growth. Or it might just feel like it is likely to succeed and therefore should be done.

But those logics ignore the pervasive threat of entropy on the core energy of the business. And the pervasive threat requires eternal vigilance — without it, entropy is inevitable.

It reminds me, sadly, about my experience on the board of a foundation for fourteen years. It had a billion-dollar endowment, which makes a board imagine that it can do anything. No. That means $50 million/year of spending. For the big social problems that this foundation wished to solve, that was (sadly) a modest amount. But we developed a tight WTP/HTW that enabled us to punch far above our weight — and win both high respect and awards in the foundation world, and make a real difference in the world.

However, the success brought in new directors who wanted to do new stuff. None of the stuff was stupid, but all of it generated entropy. The random new things simply sapped the concentrated energy of the core WTP/HTW. In due course, I wearied of fighting a rear-guard battle to protect our energy and left the board.

Of course, this doesn’t mean that you can’t/shouldn’t do new things — get into new markets. The question with broadening your WTP always has to be: does the broadening clearly strengthen our HTW? If it doesn’t: don’t do it! That is an absolute rule. It is a law as fundamental as the second law of thermodynamics. The only way to fight entropy is to treat your energy as if it is something you won’t know what you got ’til it’s gone.