Middle-Market Woes Inspire Starbucks's Bet on Luxury Coffee

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About 25 years ago, Starbucks Corp. decided to become a public company on the bold idea that customers across the country would pay more than $1 for a cup of coffee.

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Now, Starbucks is betting people will pay as much as $1 an ounce.

Howard Schultz, who built Starbucks into a global brand with more than 25,000 shops, said last week that he was planning to step down as chief executive to work on a project within Starbucks to build high-end coffee shops charging as much as $12 for 12 ounces of coffee.

Starbucks plans to open 20 to 30 giant Starbucks Reserve Roastery and Tasting Room outlets -- where rare, exotic coffee grown in small batches will be roasted on site and prepared using a variety of brewing methods -- as well as up to 1,000 smaller stores under the Starbucks Reserve brand.

"We've seen so-called 'indies' selling cups of coffee for a lot more than we're charging and creating an interesting buzz," Mr. Schultz said last week in an interview.

Some experts say the company's plan to create a subbrand of luxury coffee shops aimed at the affluent is a good strategic move, given consumers' growing interest in better-quality coffee. They also point to a shrinking middle class with less discretionary spending power, which threatens demand for traditional Starbucks coffee.

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In addition to coffee, the new stores will offer craft cocktails, informed by a new generation of high-end "mixology" bars and trendy watering holes that strive for a speakeasy atmosphere. Mr. Schultz said Starbucks executives studied such bars clandestinely.

Starbucks has missed sales targets in its largest market -- the U.S. -- for four straight quarters, which it attributes to economic uncertainty, and has promised to return to its historic same-store sales growth rate of 5%.

Mr. Schultz said the company's plans for going upmarket took root three years ago when he noticed that consumers were significantly curtailing their visits to malls in favor of online shopping. He said Starbucks, which relies heavily on traffic from mall shoppers, needed to find a way to give people a luxurious experience worth leaving their homes.

Erich Joachimsthaler, chief executive of brand-strategy consulting firm Vivaldi, likens what is happening in the coffee business to what has happened in the beer industry, which has been hurt by the rise of craft breweries. "They never protected themselves on the high end," he said of beer companies. "I think Starbucks sees that the middle is slowing down."

It isn't just wealthy consumers who might be willing to pay more for coffee marketed as a more gourmet product.

Millennials are a big force in the better-coffee movement, as they seek out quality products with a story behind them. Between 2008 and 2016, the percentage of 18- to 24-year-olds who said they had bought a gourmet coffee beverage the day before rose to 36% from 13%, while the share of 25- to 39-year-olds who did so rose to 41% from 19%, according to the National Coffee Association.

Consumers also have shown a willingness to pay lot more for such products. The average retail price that certain specialty roasters charge for lots of coffee that included growers' names was an average of $9.95 higher per pound than those that didn't, according to research group Transparent Trade Coffee.

Andrew Hetzel, a consultant on coffee policy and international trade, said there is growing demand world-wide for higher-quality coffee. Citing data from various coffee trade groups, he said global consumption of specialty coffee is growing at 7% to 8% annually, compared with 1% to 2% for all coffee.

Starbucks created the high-end coffee category but the landscape has changed drastically in recent years. Starbucks now finds itself in the middle of the market, with independent coffee shops and larger companies such as Blue Bottle Coffee Co. serving an ever more discerning customer while McDonald's Corp., Dunkin' Brands Group Inc.'s Dunkin' Donuts chain and convenience stores are offering coffee and espresso drinks on the cheap.

"In coffee you have to pick a path," said Credit Suisse analyst Jason West.

Still, the only proof of the new Starbucks concept is the Seattle Roastery, a store it opened two years ago. Sales there are up 24% from a year ago and the average check is four times that of a traditional Starbucks.

Brooke de Boutray, managing director and portfolio manager at Seattle investment firm Zevenbergen Capital, said the questions being asked now -- whether the Roastery model can be replicated and whether people will really shell out $6 to $12 for coffee -- are the same ones people asked when Starbucks went public in 1992 and its coffees ranged in price from 65 cents for drip coffee to $2.85 for espresso beverages. "We talked to our clients in pension funds and they said 'Who in their right mind would spend $2 on a cup of coffee?' " she said.

Write to Julie Jargon at julie.jargon@wsj.com