Managerial Econ the Company That Is Going

Managerial Econ

The company that is going to be discussed in this analysis is Starbucks. Starbucks is in the quick service restaurant business, with a focus on the coffeeshop industry. The outlets are a combination of company-owned stores and franchises, most of the latter being overseas. There is an agency problem in the way that some of these franchise businesses are structure. Starbucks, in going overseas, frequently utilizes local partners to run franchises.

Organizational architecture involves three main considerations: the assignment of decision rights, the reward system and the performance-evaluation system (Brickely et al., 2009). At Starbucks, there is a dual architecture for foreign franchises, especially in the countries were foreign franchises compete directly against store-owned franchises. In such situations, the decision rights are primarily with the company, and the franchisee has its decision rights subordinated. The reward system is based on store performance. The rewards range from more territory rights being awarded to financial incentives. The performance-evaluation system is based on metrics like profit, revenue and market share. In addition, there are cost control metrics involved, and customer service/reputational metrics.

2. Agency problems arise when "one party in a relationship is expected to act in another's best interests" (Investopedia, 2012). One agency problem that sometimes arises exists when Starbucks competes in a market in which it has sold franchise rights (Layne & Sloan, 2010). The franchisees have an expectation that they will be able to enjoy exclusivity in a region or area in exchange for their efforts in running the stores. What happens, however, is that sometimes they find themselves in competition with other businesses within the Starbucks family. Sometimes, these are company-owned stores that encroach on the franchisee's territory. Other times, these conflicts arise when Starbucks markets its other products nearby. For example, if Starbucks has a franchise-owned outlet in a large Asian shopping mall, and then it sells its packaged coffee to a hotel adjacent to that mall, the store risks losing customers from that hotel who otherwise would seek out Starbucks coffee.

What is causing the problem is a business model that creates two distinct types of stakeholders operating in the same market. The franchisees are seeking to maximize the value from their assets, and they must contend with a wide range of competition. They do not need to compete with the same company that is licensing its brand to them. Worse, because Starbucks undertakes periodic evaluations of the performance of its franchisees, the franchisee might find itself subject to negative performance due to competition from Starbucks, and then be penalized for that negative performance. If the franchisee feels the need to compete with the company, it could damage the company's results. The potential for cannibalization in markets where franchisees compete with company-owned lines of business creates an agency problem because both entities are incentivized to pursue the same customers.

This problem might be better controlled in two ways. The first is to eliminate the problem by buying back franchise rights, so that all the company's business is company-owned. A second solution is to ensure that franchisees have some say in the in-house competition that they have to deal with. There may be times when other Starbucks businesses are more complementary than competitive, but for the most part franchisees still have an incentive to resent this competition. Either Starbucks could curtail such activities, or extend franchise rights to all Starbucks branded business in the region. Either of those approaches would satisfy the agency problem.

3. From a job design perspective, one of the keys to resolving this agency problem lies in decision rights. At present, these are very much centralized at Starbucks head office, or at least the regional head office. The franchisees are primarily only empowered to make decisions that affect their own businesses. If they had more control over the totality of the company decisions that would affect their business the agency problem would no longer exist.

The organizational structure of the firm should be oriented towards a geographic structure. Right now, the company largely operates on a product basis. Subordinate to the product focus are the geographic regions. The product focus includes a split between company-owned stores and those owned by franchisees. The existing structure therefore creates a natural separation between the two groups at the heart of the agency problem. A geographic structure would provide some sort of mechanism to make decisions on a national level. This would allow for more input from franchisees into the company's decisions in the region. With more input, the franchisees would be in a better position to ensure that the agency problem and cannibalization were eliminated.

The reason that the organization structure is the way it is, presumably, is for managerial simplicity. There are distinct differences between the different types of business that Starbucks operates, such that a retail store is very different from grocery and institutional businesses. In addition, the company's level of involvement is quite different between stores that are franchised and those stores that are company owned. If Starbucks rearranged the organization to place everything under a geographic banner, it would need to find ways for the people involved in the different business lines to focus on their tasks. This could be made more difficult because the individuals making decisions at the higher levels would have less familiarity with those businesses. However, multi-product strategies within a given country would be far more cohesive that is currently the case, to the benefit of all product lines.

4. The compensation package at Starbucks for executives is based on a "total pay" philosophy. The company's 2012 Proxy Statement outlines this. The Board's Compensation Committee sets out the compensation for the company based on the following objectives: attract and retain top talent, pay for performance and be true to our values. The executive compensation program in particular consists of the base salary, an annual incentive bonus in cash, long-term incentive compensation (usually stock options), discretionary bonuses and awards (cash, options, or other), executive benefits, deferred compensation (401 K), and general partner benefits.

Based on these compensation types, executives at Starbucks earned between $2.3 million last year, and $16.3 million for CEO Schultz. All received bonuses that were above the bonus target, because the firm performed above expectations. They all received long-term incentive above target for the same reason, that the company performed above expectations.

I believe that in general this not an effective package. The reason is that the total compensation does not truly provide incentive to Starbucks management. The executives receive very high levels of pay and bonuses if they meet their expectations. While they do earn more for exceeding expectations, their compensation is high enough as it is. Basically, they are rewarded with generous bonuses for what amounts to mediocre performance (achieving expectations). That does not create any particular incentive to excel. In order that an executive has incentive to push the company further, that bonus cannot be something that is an entitlement.