Starbucks Tunes In to Digital Music


By Stanley Holmes

Here's a deal: Sip on a mocha latte while using headphones to listen to any of 250,000 songs you call up on a computer. Then order the ones you like -- burned on your own CD -- to go. Who's the dealer? Starbucks (SBUX).

On Mar. 16, the Seattle coffee giant unveiled an in-store music service allowing customers to do just that, using Hewlett-Packard (HPQ) tablet computers to make their choices. The first musical Starbucks opens in Santa Monica, Calif., and the service will expand into 2,500 stores over the next two years. "This is not a test," says Starbucks Chairman Howard Schultz. "We're going for it."

Known for taking innovative risks, this is Starbucks' boldest attempt to redefine "the Starbucks experience" since it pushed overseas in the mid '90s. Company execs say the effort is aimed at capitalizing on the forces revamping the music-retailing industry, where advances in digital-music technology push customers onto the Internet and traditional brick-and-mortar record stores struggle to survive.

"BIG IDEA." With 30 million weekly customers who go to Starbucks not just for its many beverages but also for its ability to create an attractive lifestyle brand around upscale coffee culture, execs think they see a huge market for selling music. "We have a unique opportunity to leverage the trust people have in the brand," Schultz says. And for the folks making the music? "The artists don't want to go to Wal-Mart (WMT)," Schultz says.

While he won't discuss revenue projections, he sees the move as a "big idea" with "much bigger impact than we've had to date." The coffee chain already has licensing agreements with most of the major record labels that will give it the ability to offer everything from Britney Spears and The Polyphonic Spree to Yo-Yo Ma and Ray Charles.

If Schultz is right, the ramifications could be huge. Starbucks thinks the service will significantly add to its $4.1 billion in annual revenue while enhancing its brand. For the music industry, still reeling from digital piracy and sharply declining sales of CDs, Starbucks could make shopping for music both legit and fun again. "There's no question in our minds that this is the future of music distribution," says Hal Gaba, who co-owns Concord Records with producer Norman Lear. "It's a significant enhancement of the iTunes experience," he adds, referring to Apple's wildly popular music download service.

TECH CHALLENGES. Several music retailers are planning a similar setup, so Starbucks won't have the field to itself forever. And its baristas will have to be trained in new skills. "Your typical barista may be great at making espresso but is not in a position to fix the broken CD burner," says Josh Bernoff, a digital-music analyst for Forrester Research. And with Starbucks offering more than 250,000 digital tracks, Bernoff wants to know "how do you find what you are looking for?"

Other technological challenges loom. Ultimately, CDs will be a thing of the past, so Starbucks will have to keep a wary eye on its digital competitors such as Apple's iTunes and Music Match. Legal electronic downloads and subscriptions accounted for $300 million in revenue last year, according to Bernoff's research, and that business is expected to just keep growing. Starbucks will likely have to make additional investments to keep up with the changing technology of music downloading.

The transition to all-things digital is still at least 5 to 10 years off, however. Starbucks foresees its music-customer base centered among middle-age javaholics, many of whom don't even go to music stores, let alone download songs. Prices will be comparable to Apple's (AAPL) iTunes service: $6.99 for five songs, the minimum purchase. Albums will cost $12.95. To appeal to a younger set, Starbucks will ultimately offer wireless downloads to laptops or portable players.

UNLOCKING A NEED. Starbucks execs also tout this as an opportunity to introduce people to new and more obscure music and artists. At the very least, being able to listen or buy music in a Starbucks café could enhance the core business and keep customers coming back. "The time it takes you to order a latte, you could have any CD burned on demand for you," says Don MacKinnon, vice-president for music and entertainment for Starbucks. "That's truly transformative and unlocks for so many people a need that's not being served -- making it easier to learn about music, easier to get it, and easier to create your own compilations."

Starbucks has been quietly preparing for an entry into the music business for more than a decade. It has had modest but growing success with its "artist's choice" albums and other compilations that showcase musicians that appeal to its core customers. Five years ago, Starbucks bought HearMusic, a small group of West Coast record stores founded by McKinnon and staffed by music aficionados. HearMusic was the first to offer CD listening stations in the early '90s.

Based on his experience with HearMusic, MacKinnon believes people want a place they trust to help them discover and choose new music. With partner HP supplying the high-powered CD burners, the special printers for the CD covers, the tablet PCs, the digital storage, and the army of servers, Starbucks figures it's taking the best of the digital world into the coffee shop. Says MacKinnon: "This is training wheels for digital."

CAPTIVE AUDIENCE. Music execs love the idea. "They're creating another way to recommend music to people and target a specific music buyer, bridging the gap between the digital and the physical," says Jimmy Iovine, chairman of Universal Music Group's Interscope, Geffen, and A&M labels. "Starbucks isn't just adding music to their stores. They're adding culture to the stores. They're enhancing the customer experience."

Although seven music retailers are planning a similar in-store setup under a new online company called Echo, they face an uphill battle to convince shoppers to return to their record stores. Starbucks doesn't have to worry about that. Schultz's bet is that music will make Starbucks, as singer Norah Jones might say, a place that feels like home. Holmes covers Starbucks from BusinessWeek's Seattle bureau


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