Starbucks Stock: Not A Well-Conceived CEO Succession Plan (NASDAQ:SBUX)

Having just written an article on Starbucks (NASDAQ:SBUX), I had little expectation of writing another one so soon. However, my concerns about Starbucks CEO transition from Kevin Johnson to Howard Schultz have been exacerbated by the most recent statements in this Wall Street Journal article attributed to Schultz and the board of directors about the CEO succession process.

While it is clear that Schultz, as the “legendary founder” of Starbucks, has been responsible for much of its remarkable growth, their CEO succession process is of concern. Having Schultz on speed dial and counting on him to ride in and save the day is not strategic planning for CEO succession. One would expect Starbucks, like many excellent companies, would have a clear CEO succession plan in place, one that actually begins when a new CEO is named. Yet, when considering the departure of Kevin Johnson was not followed by a successor being named, it clearly does not have that plan in place. Rather, Howard Schultz returned and will remain interim CEO until an external search finds a new CEO…someone not currently working at Starbucks…an outsider!

This is no small matter, and any discussion of CEO succession must begin with understanding the board of directors and their role in corporate governance.

A Board of Directors and Corporate Governance

Common shareholders have limited ability to be involved in or directly influence the operations of a company. In truth, while technically owners, investors know little about the strategic nature of the business. However, as proxy representatives of shareholders, it is the role of the board members to operate in their best interests. Correspondingly, it is the board’s obligation to approve all decisions that might affect the long-term (strategic) performance of the corporation. That includes the approval of all strategies and all corporate funding necessary for business execution. This means the corporation is fundamentally governed by the board of directors, as it oversees top management on behalf of shareholders. In the many textbooks on strategy I have read (and sit on my bookshelves), all are clear that the effective involvement of the board in strategic management is positively related to corporate financial performance.

As such, among the biggest and more important challenges the board faces is CEO turnover.

According to a study by Korn Ferry, 84 percent of board directors believe in the importance of a CEO succession plan and their role in the careful selection of CEOs; viewing it as one of their most critical responsibilities because poor CEOs negatively impact the businesses they manage.

Good board governance requires awareness that 40 percent of new CEOs depart within 18 months of their appointment and 64 percent depart within four years (Kevin Johnson’s CEO tenure at Starbucks was slightly longer), so choosing the right person as CEO is of paramount importance.

Yet, data from a Stanford research initiative suggests many boards of directors are unprepared for engaging in the process of CEO development and succession. The study found only 51 percent of boards can identify their internal successor CEO and a surprising 39 percent say they have zero internal candidates; both points clearly indicating a failure by the boards to invest in leadership development. This failure is understandable considering that, according to that research, boards only average 2 hours per year on succession planning and only 50 percent of the boards say they know “well” the strengths/weaknesses of potential internal candidates!

Despite these dismal numbers, companies report 80 percent of all new CEOs are internal promotions, with those elevated to the position having spent an average of 22 years with the company. Relatedly, is important to remember that Johnson, after coming over from Microsoft (MSFT), spent 13 years with Starbucks and was COO before being elevated to CEO. So, he was at least grounded in the business and culture of Starbucks, even if coffee was not part of his management DNA. (puns intended)

When considering whether to hire a CEO from inside or outside the company, the research also shows that two-thirds of CEOs hired from within succeed (success based on a range of factors relevant to the specific company), versus only one-third of external CEOs. This is a compelling reason a company should have a CEO succession process in place, one that ensures internal talent is developed and it is the board of directors that should lead the process.

Overall, the emphasis on hiring CEOs from within stems from the belief that boards see it as the lower-risk route. “There are many studies that show better performance over time for companies that promote insiders to the CEO role,” according to Dr. Paul Winum, head of RHR International’s Board and CEO Services practice.

Winum also said inside succession often indicates a planned development process that occurs over years, with intentional grooming of select talent evidenced by developmental assignments that offer the people opportunities to manage a range of functions within the business, which usually yields a much better prepared CEO. Also, inside successors are often able to leverage their knowledge of the company, its culture and the organizational talent to build on past performance.

So, the involvement of the board matters in CEO succession and it necessitates an active not passive participation with the process. Yet, the few facts known about Kevin Johnson’s departure are disconcerting and, as it relates to a successor CEO, do not reflect well on either him or the board.

The Johnson Transition to Retirement

The obvious question to ask when a CEO leaves without a successor being named is – Did the person voluntarily retire or was he (Johnson) told his time was up? While a conundrum this article will not seek to solve, what we know is limited but problematic.

As discussed here, when Johnson took over in 2017, the early returns on his performance were mixed. As he moved into the next two years, Johnson did not seem as committed to the development of the Reserve Roasteries (a personal favorite of Schultz, who created the concept), but that is not to say he did not have an important business focus.

To his credit, as CEO Johnson streamlined parts of the business and focused on increasing efficiency, particularly to-go ordering through the company app. That approach boosted sales but, as noted here, some former executives said the company lost touch with its people-focused culture, a key element developed under Schultz. Workers noticed an increasing focus on speed metrics, including the average time to prepare an order. Some workers complained about increasing pressure and the lack of store staff to meet the customer demands for Starbucks’ ever-complex set of products.

However, Johnson soon found himself dealing with the COVID pandemic that no one could have predicted, with its impact on the business and its development profound.

What Johnson seems to have learned during the time of the pandemic was that, indeed, Starbucks was not the same business that his predecessor had created. It no longer was the “Third Place” where customers came to enjoy a hot expresso in its comfy cafe environment. It had become a place where people wanted their now predominately cold drinks fast. A place that sought to meet customer demands coming through the app and, when available, the drive-thru windows, which Johnson put a greater emphasis on in new store development. (Interestingly, Schultz had long been a critic of drive-thrus.)

The pandemic badly hurt Starbucks’s business, curbing sales and increasing expenses once cafes began reopening. While to-go sales helped Starbucks perform better than many competitors, the recovery has been bumpy and is the likely the breeding ground for the unionization effort that has taken root.

Regarding retirement and the need for a new CEO, Johnson said he had “signaled” (what that meant is not as clear as saying he “told”) the board in 2021 that he wanted to retire after the pandemic eased. The timing of his “signal” matters because in early 2021 Rosalind Brewer was COO, Johnson’s second in command. However, she left Starbucks in 2021 to become CEO of Walgreens Boots Alliance, Inc. (WBA) and, beyond being a logical successor to the CEO position, Starbucks had no immediate replacement for her, promoting two veteran executives and splitting her operational responsibilities. Again, putting into question Starbucks’ processes for planned CEO succession and executive development.

Whatever the perceived “signal” given by Johnson to the board, there was a failure on both sides for a responsible CEO succession. If Brewer was the CEO-in-waiting, Johnson should have made his decision to retire clearly known to the board when his direct report told him she was leaving. Then the board could have let Brewer know that she was on-deck and ask Johnson to work with her on a timeline for transition.

However, it is possible there is more to this story, which is often the case. Given timing, the decision to force Johnson out might not have been made until after Brewer departed. Also, Brewer might not have been the choice as successor to Johnson. But Starbucks board now says that CEO succession planning has been underway since knowing of Johnson’s “signal” in 2021 and the board has said it has found a strong slate of potential candidates, with help from the executive search firm Russell Reynolds Associates.

In what will be a first, Starbucks is looking to hire an external candidate as CEO.

Hiring an Internal v. External Candidate for CEO

A study by the Kelley School of Business at Indiana University and management consultants A.T. Kearney looked at Standard & Poor’s 500 companies that promoted CEOs exclusively from within their own ranks between 1988 and 2007, which included quality companies including Microsoft, Intel (INTC), United Technologies (UTX), NIKE (NKE), FedEx (FDX), Colgate-Palmolive (CL), McDonald’s (MCD) and Dow-DuPont (DD), among others.

The study found that insider-only CEO companies outperformed other companies broadly in terms of profitability and growth. Moreover, not a single non-financial S&P 500 company with an externally recruited CEO generated 20-year performance numbers equal to or surpassing those of insider-only CEO companies. Further, internal candidates hired as CEOs at S&P 500 companies saw an average share price growth of 5.2 percent in their first six months compared to 2.5 percent for their externally hired counterparts.

While this may give Starbucks investors reasonable cause for concern, it is true that an external hire, with experience in different competitive landscapes and unburdened by a long history and tangled relationships within a company, can have an easier time driving major strategic changes. But what kind of change is “the thing.”

Outsiders do better when entering an environment in need of deep change. But is it really true that Starbucks needs deep change? If so, what issues might be of such a concern? (No Howard, unionization is not an “existential threat!”)

When reaching outside the organization for the next CEO, far too many boards and activist investors desperately try to land that outside superstar CEO. Often driven by preventable CEO succession crises, boards agree to bring people in who are often completely ill-equipped to run the businesses they’re supposed to rescue.

While there are many examples to offer, a prime example was the hiring of Ron Johnson by JC Penney (JCP) to be CEO. Johnson had phenomenal success as the executive behind the growth of the Apple (AAPL) stores and his rock star persona implied future success in turning around Penney’s struggling retail business. Except, he could not.

In fact, after the company reported a $985 million annual loss for the year on revenues that had declined 25 percent from the previous year to $13 billion, prompting a 50 percent decline in the stock price, Johnson was replaced. Ultimately, in 2020, Penney’s filed Chapter 11 Bankruptcy and closed 154 stores and, despite the restructuring, continues to struggle post-pandemic.

While other companies have tried to bring in a “superstar” CEO from the outside and stumbled (think Carly Fiorina at HP or Marissa Mayer at Yahoo), the bigger point of bringing in an outsider is that it is evidence the board of directors, its chairman, the current CEO, and the chief of human resources did not perform a key strategic responsibility of their jobs, ensuring the development of talent as part of a planned CEO succession.

Then there is the added concern that, for the first time Starbucks will be headed up by someone without “coffee in their veins.” Might that portend a problem with cultural fit? Possibly so. Then there is the question of industry. Will Starbucks select someone with a background in quick service restaurants? How about someone with experience in a union environment?

While it remains to be seen who will be chosen, I am certain the subject will be a major point of analysis in some future business school case.

The Landscape for a New CEO

On the positive side, CEO transitions are times when new performance expectations and goals can be established more easily. If properly understood and managed effectively, CEO transitions are a unique opportunity to reset a company’s rhythms to the requirements of the future. During such times, there is a basic willingness within the company to listen, learn, act, and defer judgment, as well as to give the new CEO the benefit of the doubt.

This is why planned CEO transitions, marked by a clear and identified succession, provide a sense of control and certainty. However, unplanned CEO transitions, without a successor named at the time of announcing the current CEO is departing, raise a great deal of uncertainty and are a cause of concern for employees.

That Schultz was named “interim CEO” to aid in what the company and board presented as a “planned transition” does not obscure the problem. There was a clear lack of a CEO succession process at Starbucks and that, as interim CEO, Schultz might be creating impediments to success for the new CEO, as the search process grinds on.

Interestingly enough, the day before Starbucks announced Schultz would return for his third tour, this time as “interim CEO,” an adviser told him he needed to listen more, and Schultz agreed, that person said. In his first week back, Schultz began a listening tour with employees, sitting down with workers in small groups to hear their thoughts on how the company should improve its workplaces. He even flew to Chicago to attend a memorial service for a barista who had died off-duty.

In meeting with U.S. store leaders, Schultz told them he is reviewing core parts of the company, from benefits to employees to the mission statement. He also wants to return more focus to the company’s Reserve Roastery business, a line of upscale stores that Johnson had curtailed.

Schultz has also “asked” some company veterans to leave to make room for “fresh blood.” In April, Starbucks said its chief human-resources officer, executive vice president of public affairs, and senior vice president of public policy would depart in May (they did), according to a message viewed by The Wall Street Journal. Two of those executives had worked for the company for more than 15 years.

With all the “noise” being made about Schultz meeting with employees to get a better feel for the company, as the WSJ article reported, Schultz actually said he has not met with Johnson!

Wait, what?

With all the macro-environmental dynamics at play, failing to meet with the previous CEO (Johnson) makes no sense from a strategic management perspective. If Schultz can find the time to meet with a range of employees having various but narrow organizational perspectives, how can he justify not meeting with the one person responsible for overseeing it all…the big strategic picture?

Whether Johnson’s retirement was amicable or not and even if his perspective is contrary to that of Schultz, his assessment would be an invaluable source of information against which to balance inquiry, assess the potential solutions and, yes, aid in the selection of a new CEO.

However, based on how Schultz came back and rushed into the unionization effort, arguing that Starbucks was at cultural odds with unionization, I am left with the inference that Schultz thinks unionization would not have taken hold if Johnson had managed it better. This is not a small point.

With more than 230k employees working in Starbucks U.S. stores and the unionization movement gaining traction nationally, previous statements by Schultz indicate he may well view unionization as a personal affront.

In “Pour Your Heart into It,” the book Schultz wrote about building Starbucks into a global coffee company, he said: “I was convinced that under my leadership, employees would come to realize that I would listen to their concerns. If they had faith in me and my motives, they wouldn’t need a union.”

Yet, it remains there are issues in the stores, with customers ordering highly customized drinks from a complex menu, with low staffing levels that leave Starbucks store employees feeling overwhelmed. This is no small impetus for unionization, irrespective of the Schultz claims.

Final Thoughts

In all fairness, following a business icon is not for the faint of heart. Whether founders or revolutionary figures, it is not something done easily. A look at effective CEO leadership gives evidence of the problem that even well-made CEO succession plans do not always lead to a chosen one’s success upon transition. Missteps by internal successors were obvious with CEO transitions at IBM (IBM), Coke (KO), General Electric (GE), Johnson & Johnson (JNJ), Procter & Gamble (PG), and McDonald’s.

What is and should be a concern for Starbucks shareholders is that the lack of CEO succession has meant that Schultz, as interim CEO, has been able to make changes in the executive ranks that are normally left for the incoming CEO. Moreover, whatever the impetus, Starbucks general counsel, appointed by Johnson, departed on the second day of Schultz’s new tenure.

Schultz also brought back longtime confidants in advisory roles, including former Starbucks communications chief Vivek Varma and Cliff Burrows, who led past efforts such as the development of Starbucks’ upscale Reserve Roastery stores. Schultz also hired a new senior executive specializing in worker relations, Frank Britt, to act as the company’s chief strategy officer. The timing of these changes, problematic as they might be for the incoming CEO, should only have been made with the support of the board of directors.

An outsider considering the position of CEO at Starbucks might see these actions as obstacles to success. Let’s be honest, who wants to leave a good job and assume a new but potentially impaired CEO role, with the concern that it might be short-lived?

Why might it be short lived?

Among the things that any new CEOs will do – outsider or insider – is select key people and staff they feel will best support their efforts and improve their likelihood of success.

This usually involves the new CEO meeting one-on-one with those who would be direct reports, and even meeting with the direct reports of the direct reports. The purpose is to get a feel for the skills the people possess and how they might help address the challenges the new CEO believes lie ahead for the company. This is important and necessary, as those currently sitting in C-Suite roles will have their own agendas, career aspirations and, perhaps, some animus for not having been chosen as CEO.

An outsider CEO at Starbucks will have enough challenges to begin with. But to have a “legendary founder” who will remain on the board of directors (and history suggests is ready to assume the CEO role when asked) and has chosen new people to assume C-Suite positions that the new CEO will be expected to inherit, are notable concerns for any candidate sourced outside Starbucks.

It also raises salient questions for all Starbucks stakeholders: Can a new CEO brought in from outside the company succeed under the circumstances? How much time does the outsider have to achieve success? What does success look like? And, because succession planning should start at the beginning of a new CEO’s tenure, what is the board of directors doing to ensure a better, more planned CEO succession for the future?