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Tuesday, July 19, 2005

Coffee and music create a potent mix at Starbucks

Tuesday, July 19, 2005
By Steven Gray and Ethan Smith, The Wall Street Journal

When Concord Records Inc. President Glen Barros was deciding whether to sign an Italian pop singer named Zucchero to a U.S. record deal this spring, his deliberations included an unusual consideration: Would Starbucks Corp. help finance and distribute the singer's next CD?

More than once, Mr. Barros says, he has consulted Starbucks executives when pondering a musical act -- effectively giving them final say on whether to sign an artist. "If they'll be our partner," he says, "we'll do it."

Starbucks, already the world's largest chain of coffee shops, has emerged as an improbably potent force in the music business, able to resurrect moribund careers, enrage music retailers, and now -- the company hopes -- create new stars. As the music industry's sales suffer from digital piracy and competition from DVDs and videogames, Starbucks has found success selling carefully selected music to its millions of loyal customers.

After receiving a commitment that Starbucks would help Concord license the album, "Zucchero & Co.," from its Italian distributor, Mr. Barros signed the artist. The 14-song album, which pairs the singer with a lineup of stars including Eric Clapton and Luciano Pavarotti, went on sale at thousands of Starbucks locations and other retail outlets this month.

Mr. Barros knows how powerful a boost from the coffee chain can be. Last summer, his independent jazz label joined with Starbucks to produce and distribute "Genius Loves Company," a collection of duets between the late Ray Charles and performers such as Norah Jones. Helped by the biographical film, "Ray," and attention about his death, the record sold nearly three million copies -- about a quarter at Starbucks stores -- and in February won eight Grammys. No new Ray Charles release in decades had come close to that sales level.

That performance grabbed the attention of a music industry that has seen sales sink by 13 percent since 2000. Almost overnight, fierce competition emerged to supply one of a handful of CDs sold at any given time at Starbucks. The latest albums by Coldplay and Carole King are now in Starbucks. Two discs by Bob Dylan are due in stores next month.

Most of the CDs Starbucks sells hit its shops at the same time that they reach traditional music outlets. The chain also offers some exclusives, such as an album by New York rock band Antigone Rising. The CD, which Starbucks co-produced with Warner Music Group Corp.'s Lava Records, has sold more than 70,000 copies -- a remarkable start for an unknown group with little radio support and a limited touring schedule. Selections from the band get heavy play at the chain's stores. One record-label executive calls Starbucks "the new cute girl that everyone wants to take to the dance."

The push into music is part of Starbucks Chairman Howard Schultz's broader ambitions to make its stores the "third place" in consumers' lives, after home and the office. As Mr. Schultz, 51 years old, sees it, music and other forms of entertainment help draw customers and, in turn, drive up sales of Starbucks's pricey coffee and food.

Starbucks offers high-speed Internet access at some stores. Last year, the company also opened a sprawling combination coffeehouse and music store, called Hear Music Coffeehouse, in Santa Monica, Calif. Customers can shop for prepackaged CDs or burn their own on "media bars" using Starbucks's 200,000-plus song library. The company plans to open similar stores in Miami and San Antonio, later this year.

Starbucks plans eventually to install media bars in most of its traditional coffee shops as well. Already, at 45 coffee shops in Seattle and Austin, Texas, customers can pay to burn CDs. The company also says it has heard from movie studios and television networks about someday setting up online video downloads.

In music, the company has been careful to cultivate what its executives call "the Starbucks Sound" -- an aesthetic that's recognizable, if difficult for even those executives to articulate. Music sold at Starbucks tends to appeal to the chain's mostly adult customers, and generally reflects a sensibility similar to that of National Public Radio stations like Los Angeles' influential KCRW: moderately eclectic, often jazzy, and never noisy enough to disrupt a quiet cup of coffee.

Music has played especially well at the company because of the generally young, affluent, iPod-toting customers that lap up its lattes. Adding to the allure, the company has created a cachet for its music by choosing to sell only a few carefully selected CDs at a time. Even though record executives fight to have their wares displayed in front of Starbucks cash registers, many say they wouldn't want to see Starbucks add racks and racks of CDs. "We don't want them to become a place we can dump anything into," says Phil Quartararo, president of EMI Group PLC's EMI Music Marketing unit.

The risk for the company is that its music ambitions drain money that could be plowed more profitably into coffee and other beverages that made the chain such a success in the first place. A broader risk is that Starbucks is perfectly attuned to this particular generation of customers but won't adapt to changing tastes and styles over the years.

Starbucks itself seems to be wrestling with how far it can go in the music business without diluting its coffee roots. This month, it began installing in most of its North American stores four-sided, rotating racks that can hold up to 20 different CDs. Ken Lombard, president of Starbucks's entertainment division, insists, "The customer won't go into the store and feel like they've walked into a music store."

It isn't clear how much money, if any, Starbucks makes from music. The company declines to publicly disclose revenue from CD sales, but says it's growing steadily. Restaurant-industry analyst John Glass of CIBC World Markets in Boston estimates that music will account for less than 2 percent of Starbucks's U.S. retail sales of $4.5 billion during fiscal year 2005. So far, Wall Street has generally been warm to the company's musical ambitions, largely because they help draw customers beyond peak morning hours.

Starbucks's journey into music began in the late 1980s, when the chain barely had 100 stores. (Today it has about 9,500 locations world-wide, with about 6,900 in the U.S.) Mr. Schultz recalls visiting a Starbucks in Seattle's University Village section, where the manager, Timothy Jones, played his own music. "He'd put on a record and watch how people reacted," Mr. Schultz recalls. "He'd ask them about it. He was literally playing DJ." Mr. Schultz says he eventually took the manager's suggestion that Starbucks sell music in its stores. Today, Mr. Jones is a Starbucks music executive managing compilations and programming.

In the mid-1990s, Starbucks began selling CDs, such as a compilation of Blue Note Records' jazz artists. By 1999, at the onset of Starbucks's growth spurt, executives began telling Mr. Schultz about Hear Music, a chain of five U.S. music stores based in the San Francisco Bay area.

Hear Music was run by Don MacKinnon, a young music wonk who had spent hours in his Williams College dorm room mixing tapes of his favorite songs. When it started in 1990, the company published a catalog of CD compilations of the favorite songs of artists like Rickie Lee Jones and Bonnie Raitt. That didn't catch on, so Mr. MacKinnon and his partners opened stores to sell compilation CDs in San Francisco, Chicago and other cities.

In 1999, Mr. Schultz, curious, flew to San Francisco to visit the Hear Music store there. After walking into the store, he recalls, "My imagination was racing a mile a minute." He watched customers thumbing through the banks of carefully organized compilation CDs and decided they were rediscovering music in the same way people had rediscovered coffee at Starbucks. "The fact that Hear Music had elevated its status from a record store to an editor was compelling," he says. Later that year, Starbucks bought Hear Music for $8 million.

Starbucks named Mr. MacKinnon, now 37, vice president of its Hear Music unit. He and nine of his Hear Music colleagues moved to Starbucks's headquarters in Seattle, where they continued developing compilation CDs and negotiating projects like the Ray Charles "Genius Loves Company" release.

As that project neared fruition, Starbucks's music business was getting big enough that Mr. Schultz thought he needed a business person to run it. Enter Mr. Lombard. Before joining Starbucks as president of its newly created entertainment division in May 2004, the former investment banker had been president of a company owned by basketball star Earvin "Magic" Johnson. That company developed retail projects featuring Starbucks outlets in largely black and Latino communities.

Mr. Lombard, 50, says Mr. Schultz told him to expand and broaden the music venture. The primary focus was to shift from producing compilations to selling global acts such as Tina Turner and Beck. "This was a start-up in every sense of the word," Mr. Lombard says.

Mr. MacKinnon continued as Starbucks's musical guru, "talking to the labels, and making sure that there wasn't an opportunity out there that we'd miss," Mr. Lombard says. Mr. Lombard beefed up his entertainment staff, which since his arrival has tripled to about 60.

Today, the fan of the late rapper Notorious B.I.G. and the late singer Sam Cooke presides over meetings of the company's "editorial selection team," a group of nearly 20 executives responsible for sifting through mounds of CDs from aspiring artists.

Choosing the music isn't easy, partly because Starbucks's customer base is ever-widening, reflecting an increasingly young, multiethnic, transclass mix. Five years ago, about 3 percent of Starbucks customers were between the ages of 18 and 24, 16 percent were people of color, 78 percent had college degrees, and overall they had an average annual income of $81,000. Today, however, about 13 percent of the company's customers are between 18 and 24, 37 percent are people of color, 56 percent are college graduates, and they earn on average $55,000 a year.

Starbucks struck gold with relatively safe artists such as Norah Jones. But it has occasionally ventured beyond its traditional sound. The company sold about 38,000 copies of edgy rocker Beck's latest CD, "Guero," over a six-week period this spring.

When Starbucks carries an album, its stores often account for 20 percent to 30 percent of the record's weekly sales, and sometimes as much as 50 percent, Starbucks and music executives say. EMI Group's Mr. Quartararo says every time one of his company's releases has been sold at Starbucks, the coffee chain has been among the top four retailers selling it.

The highest sales percentages often are for CDs by relative unknowns who aren't selling many records overall. In some weeks, the chain was responsible for almost 50 percent of newcomer Amos Lee's total sales, but only 6 percent of the 1.5 million U.S. sales of Coldplay's new "X&Y."

Record companies like doing business with the chain because its stores don't return unsold merchandise, as traditional retailers do. Dealing with returns is costly and logistically cumbersome, and can make for unpredictable accounting, since revenue evaporates with each returned CD. Starbucks says it shifts unsold CDs to other stores or keeps them in a warehouse if it thinks they can be sold at a later date.

For that reason, as well as the scale of its operation, Starbucks often receives favorable wholesale pricing terms. In some cases, Starbucks pays the record company half the suggested retail price, which can mean the equivalent of $3 less than the wholesale price.

In a sales environment in which retailers from Amazon to Target routinely discount CDs, Starbucks often charges customers close to and in some instances more than the full retail price. For instance, Beck's "Guero" album carried a list price of $13.98, while Starbucks sold it for $15.95. But Starbucks customers, who spend an average of $4 per visit to the store on drinks and food, have proved themselves willing to pay full freight for a CD.

Earlier this year, some music retailers were incensed that Starbucks was given a six-week window beginning last month to exclusively sell the new acoustic version of Alanis Morissette's best-selling record, "Jagged Little Pill." In Ms. Morissette's native Canada, the country's largest music retailer, HMV Group PLC, pulled her other discs from store shelves in protest.

Humphrey Kadaner, president of HMV North America, says in an email interview that the action was "a means of conveying our sincere disappointment with Alanis's decision, given we at HMV had supported her well before she became a star. ..." Ms. Morissette says she looks forward to continuing a "mutually gratifying relationship with traditional retail outlets" and she'll "also continue to come up with other new and creative ways to share my music."

Tuned In

Starbucks has emerged as a growing force in the music industry. Some recent retail offerings:

ARTIST: Alanis Morissette
ALBUM: Jagged Little Pill Acoustic
ON SALE: June 13, 2005
TOTAL UNITS SOLD: 147,400(1)

ARTIST: Coldplay
ON SALE: June 7, 2005
TOTAL UNITS SOLD: 1.5 million

ARTIST: Dave Matthews Band
ALBUM: Stand Up
ON SALE: May 10, 2005

ARTIST: Ray Charles
ALBUM: Genius Loves Company
ON SALE: Sept. 1, 2004
(1) Non-Starbucks sales data not yet available
Sources: Starbucks; Nielsen SoundScan