Why the new Starbucks CEO is worth $18 billion

Starbucks boss Laxman Narasimhan was under pressure, facing unusual public criticism from former chief Howard Schultz and more recently a pair of activist investors. But his abrupt replacement with Chipotle Chief Executive Brian Niccol on Tuesday still surprised investors. It also delighted them, with the stock rising 22%, a gain of almost $18 billion.

Such rallies have become as common at Starbucks as baristas mangling customers’ names. When a flailing Jim Donald was replaced by Schultz himself in January 2008, the stock jumped 8% in response. And when the legendary boss came back for his third and (probably) final stint in 2022, replacing Kevin Johnson, the stock rallied 13% that week.

The even larger gain on Tuesday stems from a few differences. One is investors’ respect for Niccol: Chipotle stock dropped sharply on the news. But Schultz, who effectively created Starbucks as we know it and then came back twice to turn it around, arguably had even more credibility. The sharp rally also reflects how ill-suited Narasimhan, the first outsider to get the job, was to run the coffee chain.

Part of that was his awkward, public-facing persona, exemplified by a trainwreck of an interview with CNBC’s Jim Cramer where he came across like a McKinsey consultant (which he was for years). His cringeworthy turnaround plan, “Triple Shot Reinvention With Two Pumps," was soon followed by the worst quarter in the chain’s history and its largest single-day drop in market value.

There were signs from the start that Narasimhan was a strange choice. He joined from British consumer-goods company Reckitt Benckiser, not a retail or restaurant company. The memo announcing Narasimhan’s departure from Reckitt lauded his “successful rejuvenation of its strategy, execution and foundational capabilities," but he presided over a roughly 6% drop in the share price measured in dollars in a three-year stint at a company that sold Lysol during the pandemic.

Compared with that fat pitch, Starbucks was a tall order. On paper it seemed to be in fairly good shape when he took over just 16 months ago after an apprentice stint under Schultz. The chain’s problems were quietly mounting. One was the fact that it was nearing saturation in the U.S. while transforming itself to deal with rapidly rising wages for entry-level jobs. It was also fighting a unionization push.

The solution—more high-tech automation in making drinks and opting for convenience of drive-thrus and mobile ordering—made Starbucks less true to its roots as a “third place" to meet friends, savor a drink and mooch off of free Wi-Fi. Its leading digital loyalty program was and is a huge edge, but customers pinched by rising costs for necessities began to question why they were paying a premium for a takeaway beverage made by a machine not unlike one they could have in their kitchen.

The bigger problem, though, was intense and growing competition in a market it had all to itself for years. Starbucks was the first coffee chain in China in 1999 and Schultz, a sinophile, had identified it as the key to the chain’s future growth. He said Starbucks would open a store there every nine hours over a three-year span in the country.

As incredible as that sounds, China’s two leading coffee chains have, between them, opened a new outlet every hour on average in recent quarters. Just last year Luckin Coffee added as many stores as Starbucks had in its entire history in the country. Meanwhile, competing bubble-tea operators have been burning cash in a land grab. One local chain, in its offering prospectus, detailed how, among each of China’s top 10 shopping areas, there are about 50 tea shops in a 1-kilometer radius and 10 shops within each of China’s top 10 shopping malls. That chain, ChaPanda, which isn’t even the top one in the country, has more tea shops in China than Starbucks has cafes.

Irrational competition in China could force Starbucks to discount in the country, threatening the chain’s premium brand image. Or the company could stay the course. But shares in Starbucks already reflect more modest growth expectations there. Meanwhile Niccol, who joins from another quick-serve brand with a good digital strategy and relatively well-off customers, could be well-suited to tackling its less-severe problems in the U.S. and other developed markets. Margins on beverages are vastly superior to those on food, so a creative leader has more wiggle room.

Niccol will have to listen to activists’ ideas but, unlike his predecessor, investors should give him the benefit of the doubt.

Write to Spencer Jakab at Spencer.Jakab@wsj.com