Storytelling In The News: #99

Reverse credibility gap: Starbucks' investors unflappable

March 25, 2004

The Wall Street Journal this morning discusses an interesting storytelling phenomenon: the reverse credibility gap. A credibility gap occurs when the person is telling a positive story and the listeners read a negative story into it. A reverse credibility gap occurs when the person is handing out bad news, and the listeners read a positive story into. A reverse credibilty gap is very rare, but it's very nice thing to have. Warren Buffett has it. The late Sam Walton had it. And now Starbucks.

Thus when a top executive warns investors that his company won't be able to sustain its rate of growth, the result is usually a stock selloff. But on February 25 when Howard Schultz, chairman of Starbucks Corp., announced that the world's largest chain of coffee shops couldn't keep getting larger at rates as fast as 32% there was no sell-off. The stock price wobbled momentarily and then stabilized at its current level.

The faith in Starbucks isn't because the stock is undervalued. In recent days, the price-to-earnings ratio of Starbucks stock has flirted with 50, making it one of the most expensive stocks on Wall Street. By comparison, McDonald's Corp. shares yesterday had a price-to-earnings ratio of 24. Wal-Mart Stores Inc. was 28.

Rather, the market reaction -- or lack of reaction -- suggests a reverse credibility gap. This type of gap reflects no suspicion, no sense among investors that the executive is trying to fool them or gin up a quick bump in the stock; instead, there's a sense that this executive is too hard on himself and his company, and that therefore his self-effacement isn't entirely credible.

In the case of Starbucks, the stubborn faith of investors is attributable not so much to Mr. Schultz as to the company's long record of surprisingly good performances. From the outset, skepticism about this company ran deep, and for good reason: Coffee shops had been around forever. Coffee itself was everywhere, often for free. Why would hordes of people pay premium prices for it?

Concern persisted even after Starbucks showed there was a strong market for gourmet coffee shops.

Some investors sold for a quick profit. After all, just because a market existed for gourmet coffee shops didn't mean Starbucks had any lock on it: Imitators were popping up everywhere.

Others hung on and were rewarded when Starbucks trounced the competition. No other national competitors materialized. The stock continued rising.

The ability of the coffee retailer to achieve growth that surprises even its admirers is clear from the circumstances that led this month to Mr. Schultz's warning. Although the company is on the record as saying it expects revenue to grow as much as 20%, last month Starbucks posted a sales gain of 32% over the previous February.

Can Starbucks continue to give pleasant surprises? Surely there must be a limit to the demand for gourmet coffee? To continue to grow more rapidly, Starbucks almost certainly will need to figure out a way to sell more goods out of its existing stores. Robert F. Buchanan of A.G. Edwards & Sons recommends taking a lesson from Wal-Mart, which improved sales by widening aisles and expanding checkout lanes. Most Starbucks have long lines.By speeding up its lines, the coffee-shop chain might be able to grow even more aggressively - and maintain its amazing reverse credibility gap.

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