Tully’s Coffee Corporation

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Tully’s Coffee Corporation

3100 Airport Way South
Seattle, Washington 98134
U.S.A.
Telephone: (206) 233-2070
Toll Free: (800) 968-8559
Fax: (206) 233-2077
Web site: http://www.tullys.com

Private Company
Incorporated: 1992
Employees: 1,000
Sales: $51.5 million (2002)
NAIC: 722213 Snack and Nonalcoholic Beverage Bars; 312111 Soft Drink Manufacturing; 445299 All Other Specialty Food Stores

Founded in 1992, Tully’s Coffee Corporation is the third largest company-owned specialty coffee retailer in the United States. Tully’s Coffee currently has 101 locations in Washington, Oregon, California, Idaho, and the Pacific Rim. Its wholesale division provides Tully’s whole bean coffee, related products, and supplies to domestic supermarkets, food services, restaurants, office coffee services, and institutions, as well as to customers through Tully’s mail order and Internet sales. The company’s international division sells Tully’s coffee, related products, and supplies to foreign licensees.

Early 1990s: New Barista on the Block

Tom Tully O’Keefe—head barista, founder, and chairman of Tully’s Coffee Corporation—founded the company in 1992 with an initial investment of more than $1 million. O’Keefe first began thinking about opening a gourmet coffee business in 1991, when, as president and chief executive officer of O’Keefe Development Corporation—a real estate development and investment firm he’d founded in 1986—he helped Starbucks and other coffee companies find retail sites for their coffee shops.

Known for his fun loving, but extremely competitive nature, O’Keefe was puzzled by the fact that no company had stepped forward to challenge Starbucks. “Nobody was competing with Starbucks,” he said in the Seattle Post Intelligencer in 1999. “It didn’t make sense to me. There were a lot of mom-and-pop operations. There were a lot of franchises. But nobody was competing with Starbucks’profile.” He decided that he would. O’Keefe named his new company Tully’s, using the middle name he shared with his Greek uncle, Tully, a man in his seventies who lived in New Hampshire.

From the start, Tully’s aimed to offer a European café culture experience, selling custom-roasted whole bean coffees, specialty coffee beverages, pastries, and, in some locations, magazines and newspapers. Its coffee houses were modeled after Starbucks but featured warmer interiors and targeted customers who wanted to spend time lingering over their espresso. In later years, select stores featured electrical outlets for computers, fireplaces, shoeshine stands, outdoor seating, and a “strictly business” section with local and national newspapers. Tully’s further differentiated itself from Starbucks by its lighter roast and by investing its marketing dollars directly in the community instead of advertising. Tully’s became and has remained a regular supporter of Northwest AIDS Foundation, DARE, Juvenile Diabetes Foundation, and the Pacific Northwest Ballet.

The company grew at a steady pace. By late 1994, Tully’s had close to ten retail outlet stores in the Seattle area ranging in size from 800 to 1,500 square feet and had added Italian-style “Tullini” sandwiches to its offerings. It was also the official coffee of the Seattle Space Needle restaurant. In January 1994, O’Keefe raised another $1 million through a private placement—the first of many—bringing in 35 shareholders and diminishing his share of the company to slightly more than 70 percent. The money raised went toward leasing new corporate headquarters and a roasting plant where Tully’s began roasting its own coffee blends. The new roasting plant and corporate offices, which opened in January 1995, had previously been those of Starbucks Coffee Co.

Mid- to Late 1990s: Aggressive Expansion

According to a 1995 Restaurant Business article, the United States was in the midst of a coffee café boom by the mid-1990s. The impetus for this trend emanated from San Francisco, Portland, and Seattle. The National Coffee Association, quoted in Restaurant Business, attributed the dramatic increase in the number of coffee houses nationally—from 564 in 1993 to 2,273 in 1994—to an increased interest in coffee among younger as well as older people. As the market for coffee grew, the number of players in the coffee business grew, although with the rapid expansion, smaller companies soon disappeared in corporate mergers and acquisitions.

Tully’s had revenues of almost $2 million annually by the mid-1990s. By 1996, its number of stores had increased to 22, and same store sales increases were roughly 15 percent higher than the year before. The company still modeled many of its choices after market groundbreaker Starbucks, often opening stores adjacent to the market leader. According to O’Keefe in a 1996 Puget Sound Business Journal article, “Wherever Starbucks is, we want to be right across the street.”

Starting in 1997, Tully’s formulated an aggressive growth strategy combined with a desire to move into regional markets outside the Pacific Northwest. It also began to sell its coffee overseas: In February, its coffee debuted in Shanghai at an upscale grocery; in August, it opened a store in Tokyo; and in November, it opened three stores in Beijing, becoming the first gourmet coffee retailer to sell in China. The company founded Tully’s Coffee Japan Co. as an entirely separate venture in May 1998. By end of 2001, Tully’s Coffee Japan had 34 outlets and had become the exclusive wholesaler of Tully’s products in Japan.

Also in 1998, Tully’s bought Spinelli Coffee Co. of California for $8 million. The acquisition brought with it stores in the Bay Area, Singapore, and Taiwan, which Tully’s rebranded, as well as a direct connection to coffee growers. With the acquisition, Tully’s stores numbered more than 50. The company began selling its beans in supermarket chains owned by Brown & Cole in October 1998.

Yet the company that boasted of doubling its size annually had yet to turn a profit. There were losses of $2.5 million on sales of $5.4 million for fiscal year 1997. By fiscal year 1998, sales had increased to about $9 million, and by 1999 to $20 million. However, losses continued to climb—from $3.8 million in 1998 to $6.5 million in 1999.

Although Tully’s had replaced Starbucks as the “official coffee” of the Mariners, agreeing to pay somewhere between $1 and $2 million to become the only coffee served at Safeco Field ballpark in 1998, Tully’s was still far behind Starbucks and the number two national coffee chain, Diedrich Coffee, in both earnings and sales. Another private placement in 1999 brought in more millions, and the company continued to open stores at a fast clip as well as renovating its new headquarters in the old Rainier Brewery. Beginning in 1999, Tully’s moved into Europe, signing its first licensing agreement in Scandinavia. By the middle of 2000, there were 114 Tully’s internationally (compared to Starbucks’3,215), and attention was on the company’s expansion in San Francisco’s East Bay. In 2000, Tully’s formed a joint venture, called Tully’s Coffee Europe, with Belgium-based Seattle Coffee Factory to rebrand that company’s Stockholm retail outlets as Tully’s.

Back home, Tully’s formed a partnership with Home Grocer.com to sell bagged beans for delivery to online shoppers. It partnered with Briazz to offer sandwiches and salads at its downtown Seattle stores and became the official coffee of the San Francisco Giants at Pac Bell Field. The company also turned attention to its wholesale business both home and abroad. However, despite these efforts, Tully’s continued to operate in the red, losing $8 million in 2000.

In part, this deficit was due to Tully’s six-month store opening binge. A new Tully’s opened every six days in 2000 as the number of employees increased dramatically from 400 to 1,300. In late 2000, the company purchased Portland’s Marsee Bakery chain and five stores from Coffee Station in Los Angeles. When, by 2001, its expansion came to an end, it was leaking cash even as its sales grew. It had exhausted its bank credit line and had to turn to its board for emergency funds to keep growing. Losses for fiscal year 2001 were $25 million on sales of $42 million.

2001-02: Two New Management Teams

At this point, O’Keefe recognized that he no longer had the expertise needed to manage a company of more than 100 stores. To prepare Tully’s for its long-awaited initial public offering, the company brought in its first president and chief operating officer and later chief executive, Jamie Colbourne. Colbourne, who came from Coca Cola and 7-Up Canada, took over Tully’s day-to-day operations in February 2001.

Colbourne brought Tully’s rapid expansion to a halt. His first move, focusing on profitability over expansion, was to land a major licensing deal with Japan-based Ueshima Coffee Co. Ltd., making it the exclusive Tully’s supplier for all of Asia except Japan. This helped resolve the company’s immediate cash crisis. In place of O’Keefe’s vision of a Tully’s across the street from every Starbuck’s, Colbourne substituted the idea of Tully’s becoming a niche player. “We need to be a little more selective in our store sites,” he was quoted in a 2001 Portland Business Journal article. “I want to make sure we’ve got the business right first.” Colbourne also focused on expanding the company’s wholesale business beginning in March 2001.

Company Perspectives:

Since we opened our first store in 1992, Tully’s has provided a coffee experience that customers eagerly savor and enjoy. Our goal is to continuously build upon the quality of our products, customer service, and store ambience, and to extend that experience to customers outside of stores.

However, in July 2001, Colbourne suddenly resigned, citing differences with the board of directors and saying that the company’s finances were in worse shape than he’d been told. Marc Evanger became interim president and chief executive of Tully’s and continued to implement Colbourne’s profitability plan. Evanger closed some U.S. stores and all stores in Sweden, stopped offering sandwiches and salads in some locations, and cut corporate employees almost 20 percent. He continued to put expansion plans on hold while increasing the company’s wholesale and grocery business. Through the remainder of 2001 and into 2002, the emphasis on the company’s wholesale business continued, and by January 2002 Tuyll’s had signed on four supermarkets: Rosauers Supermarkets, Albertson’s, Safeway, and Quality Food Centers in the Pacific Northwest. By the middle of 2002, Tully’s coffee was selling in 650 grocery stores.

Despite Tully’s losses in 2001, it closed the year debt free because of the cash it received from Ueshima Coffee and Tully’s Coffee Japan. Tully’s Coffee Japan turned a profit of $758,000 on sales of $8.6 million in 2001, and in fiscal 2002 brought in nearly $2 million to the company. In fiscal 2002, Tully’s lost $11.2 million on increased revenues of $51.5 million, despite the fact that sales fell 6 percent at established stores.

Tony Gioia, former president of Southwest Supermarkets and before that of Baskin-Robbins, as well as co-founder of Wolfgang Puck Food, assumed the roles of chief executive officer and president of Tully’s in June 2002. To pit Tully’s against its competition and prepare it for going public, Gioia focused attention on improving the company’s financial performance and strengthening its market position, saving costs and increasing sales at its 103 stores.

With $700,000 left in cash in late 2002, Gioia hired an investment firm to pursue additional short-term and long-term financing for Tully’s. Yet he insisted that he had not “lost one minute of sleep over our cash position” in a 2002 Puget Sound Business Journal article. “We decided it was important to focus on our existing assets and make them generate more cash flow for the company.” It was also important to continue to expand Tully’s international licensees.

Gioia had high hopes for the company’s new gourmet, soft-serve ice creams, free samples of which were bringing in new customers. With the introduction of the ice cream, as a separate item and as a part of a drink, Tully’s was finally moving in a direction entirely different than Starbuck’s. Despite the fact that same store sales were down 6 percent in 2002 and the company continued to close stores, management firmly believed that strong revenue growth and slower increases in expenses would pay off for Tully’s in the end.

Principal Competitors

Diedrich Coffee, Inc.; Starbucks Corporation.

Key Dates:

1992:: Tom Tully O’Keefe founds Tully’s Coffee Corporation in Seattle.
1994:: Tully’s holds its first of many private placements.
1995:: The company opens a new roasting plant and corporate offices.
1997:: Tully’s begins to sell its coffee overseas.
1998:: The company founds Tully’s Coffee Japan Co. as an entirely separate venture and buys Spinelli Coffee Co.
2001:: Jamie Colbourne becomes president and chief executive officer.
2002:: Tony Gioia becomes president and chief executive officer.