As Schultz Steps Down, What Can History Teach Starbucks Investors?

By Jeremy Bowman Markets Fool.com

Last week's news that Howard Schultz was stepping down asStarbucks(NASDAQ: SBUX) CEO rattled investors and surprised the business community.

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Starbucks shares were down more than 3% after hours as investors adjusted to the realization that Schultz, who had guided the company from a small Seattle chain in the 1980s to the 25,000-store behemoth it is day, would be relinquishing his leadership role.

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In a press release, Schultz said COO Kevin Johnson would move up to the CEO position, and Schultz would become executive chairman and direct the expansion of the Starbucks Reserve brand and the company's social impact initiatives.

Johnson has been on Starbucks' board since 2009, but in a management role only since last year. He came to Starbucks with a technology background, and lacks the retail/restaurant experience that might be expected of someone assuming the CEO chair of the second-biggest restaurant chain in the world. Investors would be right to wonder if Starbucks' success will continue without its visionary leader. In fact, last time Schultz stepped down, the chain ultimately faltered.

Deja vu

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Schultz first vacated the CEO chair in June 2000, passing the reins on to Orin Smith, who had served as an executive at the company since 1990 and as COO since 1994. Schultz left Smith with an exceedingly popular, fast-growing brand. Same-store sales had increased in March, the month before he announced his departure, by 10%. At the time Schultz left, the company had 2,500 stores in North America, and a few hundred abroad.Schultz said he hoped the company would open 20,000 stores over the next few years, and remained the chairman, saying he would focus on the global brand and development, building out international partnerships and channel development including making Starbucks products available in supermarkets.

Investors greeted that announcement by sending the stock down 28% over the next seven weeks; however, shares recovered under Smith, who proved to be a worthy steward of the coffee chain. Under his leadership, revenue increased from $2 billion in 2000 to $5 billion in 2004.Store count went from 3,500 at the end of 2000 to 8,569,and earnings per share increased from $0.24 to $0.95. Global comps increased by an average of 7.6% during those five years, and the stock more than tripled under his watch.

However, trouble started brewing when Smith retired in 2005, and Jim Donald, who had been the head of the company's North American unit, took over. Operating margin fell in each of Donald's two full years at the helm of the company, and U.S. comparable sales growth slowed from 11% in 2004 to 4% in 2007. The stock began cratering in 2006 and would lose more than 80% of its value from its peak to the bottom of the recession.

In aleaked memo in February 2007, Schultz questioned the commoditization of the brand, noting decisions like switching to automatic espresso machines, using flavor-locked packaging instead of bins that allow the coffee aroma to circulate through the store, and a"cookie-cutter" store design. The stock continued to flounder, and Schultz ultimately replaced Donald in January of 2008. He unveiled an ambitious turnaround plan that included closing hundreds of stores, retraining baristas, and undoing many of the aforementioned decisions to bring back the Starbucks experience. As a result, the stock has gained more than 1,000% since its recession-era bottom.

A test of leadership

On the recent call discussing Johnson's promotion, Johnson called Schultz one of the "iconic" business leaders of this era. Considering he built the coffee chain into an $80 billion company, Schultz seems deserving of such label.

Two qualities about Schultz stand out as making him and his company so successful. First, Schultz has a passion for his product and the customer experience that is hard to match. He regularly talks about the "theater" and "romance" of coffee, words that the everyday Java drinker probably doesn't associate with their caffeine buzz. That attitude was what inspired to him to build Starbucks from the ground up into a global empire, and it's allowed him to see the store through the customer's eyes, obsessing over things like eye contact with the barista and the aroma inside the store.

Second is his judgement and ability to see where the industry is going. Time and again, Schultz's instincts have proven accurate. He recognized that the Italian espresso bar concept could work in the U.S. He created a unique brand that offered Americans an affordable everyday luxury, and took that global. After leaving the company, he recognized the brand was losing its way and came in and turned it around. More recently, he developed Starbucks loyalty and mobile programs, making the company a clear leader in technology, and his creation of the Reserve Roasteries and brand also seems to be a canny move at premiumization and creating a brand halo.

It's unclear if Johnson possesses such talents. Schultz expressed full confidence in him, saying he was uniquely qualified for the job. Johnson served for five years as CEO ofJuniper Networks, and has worked side-by-side with Schultz since becoming COO last year.

Schultz is leaving Johnson with a well-oiled machine, as the company's comparable sales continue grow by mid-single digits and it has a number paths for future growth, including China, mobile, and the Reserve brand. But markets change, and in a few years things could get tougher. Starbucks will be challenged by rivals old and new, and consumer demands will change. The company needs a CEO with the instincts to sense such shifts and adapt. Only then will we know if Johnson is the right person for the job.

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Jeremy Bowman owns shares of Starbucks. The Motley Fool owns shares of and recommends Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.