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Starbucks’ Long-term Investment in Leadership of the Chinese Coffee Shop Market

Jim Riley

13th June 2014

 How on earth is Starbucks making a success in China? China is a tea-drinking nation. In fact, China has the world's oldest and largest tea-drinking culture. Chinese people hate coffee – they say it tastes so bitter it is like tasting medicine.

But, look at the evidence. Starbucks has been in China for 13 years, with an initial presence in the major tier 1 cities Beijing, Shanghai and Guangzhou. Starbucks expects China to become its second-largest market by 2014 aiming to have 1,500 outlets throughout China by 2015. The number of staff employed by Starbucks in China is forecast to rise from 12,000 to 30,000.

According to the latest Euromonitor report, Starbucks has a 60 per cent share of China's emerging coffee house market, well above its closest competitor.

That sounds like a success story. So how has it done it?

Starbucks CEO Howard Schultz has always been cautious about investors and multinationals getting too excited about the opportunity in China. In a speech to investment analysts in 2013 he said:

"Every company that you're going to listen to and every company that you follow is going to talk about the opportunity in China, and the gold rush mentality that we've seen is going to be filled with great peril because there's going to be a lot of failures, there have been already."

"The growth in China over the next five, ten years will be obviously quite significant and the foundation that we have built is as strong as anywhere in the world in terms of the skill base of the team, the expertise, and the learning curve that we've gone through over the last 15 years."

What has Starbucks got right in China? Forbes Magazine columnist Helen Wang identified five key parts to their successful strategy:

(1) Think different - they recognised that China has a strong tea-drinking culture but believed that they could successfully introduce a Western coffee experience. In doing so they effectively had to create a new market - to persuade consumers to try coffee. Starbucks R&D centre based in Shanghai also responded to consumer reluctance to buy coffee by developing popular fruity drinks such as Strawberry Frappuccino and the Refresha line of juice beverages.

(2) Smart entry strategy - it initially used advertising and promotion to build brand awareness and visibility and then introduced beverages using popular local ingredients such as green tea. This helped customers develop a "taste" for Starbucks without being alienated by the traditional Starbucks product range. The promotional mix and store design and layout was intended to create a Starbucks experience, appealing to aspirational Chinese consumers (particularly the young). The business was helped by the high brand-awareness of Starbucks amongst Chinese consumers - when Starbucks arrives in a new location, plenty of potential customers already recognise the brand.

(3) Deliver on high quality - a feature of the brand reputation around the world; Starbuck's didn't compromise on quality.

(4) Work with local partners - Starbucks recognised that China is a hugely diverse country where consumer culture, disposable incomes and buying patterns vary enormously. They entered into three joint ventures to help expand into the north, east and south of China.

(5) Commit and invest for the long-term - Starbucks has seen its investment in China as a long-term project which requires long-term commitment. It takes time to recruit and train staff, educate the market and gain customer loyalty. Some evidence for this comes from staff turnover data. Annual staff turnover rates of 30% or higher are common in China, yet Starbucks is understood to have a much lower rate than that by offering good pay packages, work environments and structured career paths.

To the above list I would also suggest that the concept of localisation has also been an important part of the approach taken by Starbucks.

In his article in The Wall Street Journal, Laurie Burkitt explains how Starbucks has learned that Chinese customers value space and couches on which to relax in the afternoons. As a result, Starbucks stores are busiest in the late afternoon. Most Chinese visit Starbucks in pairs or groups so the stores must also be spacious enough to accommodate consumers who linger for hours.

So, rather than trying to force onto the Chinese market the same products and format that works in the UK and Europe, Starbucks has developed new products that appeal to local tastes and designed stores that support a dine-in experience.

In an interview with Marie Han Silloway (Starbucks Head of Marketing in China), the concept of localisation was explained further:

"One of the biggest mistakes companies make is they try to bring all their practices to China without any adaptation. Localisation means different things to different people. For us, it is about being very respectful to local culture and adapting."

Starbucks Pricing in China

Interestingly, what Starbucks has NOT done is compromise on price. The average coffee sold in China is far more expensive than in the US when compared to average disposable incomes. Might this premium pricing strategy work to Starbucks' advantage in China?

This pricing strategy was headline news in late 2013 when Starbucks received criticism from Chinese state media for its high prices:

Shaun Rein argues that carrying a Starbucks cup is seen as a status symbol. It is a way to demonstrate sophistication and the capability to afford a personal luxury for the up-and-coming middle class in China. This has enabled Starbucks outlets in China to become more profitable (in terms of profit margin) than the US. Rein quotes an operating profit margin of 34.6% for Starbucks China compared with 21.8% in the US.

Some have expressed concerns about Starbucks pricing in China. In this recent article in the WSJ, Laurie Burkitt argues that, as more Chinese travel overseas and shop online, many are hit with the realisation that back at home they’re paying far more a variety of ordinary goods—from shoes and infant formula to mobile phones and cars. One place where Chinese consumers pay significantly more than their wealthier Western counterparts is in the coffee shop. Burkitt provides an estimated break-down of the cost of a Starbucks grande latte in China, which costs nearly $1 more than in the US. Is this sustainable?

Starbucks might currently enjoy market leadership, but it will face intense competition over the next few years. Costa Coffee aims to have 500 outlets in China by 2016 and Hong Kong-based coffee chain Pacific Coffee has said its aim is to expand and overtake Starbucks in China. Pacific Coffee is owned by China Resource Enterprises, one of the largest retailers in China and a recent joint venture partner for Tesco’s stores there.

Let battle commence for the coffee consumer in China!

Further Research

These videos provide additional background research material on Starbucks and the Coffee Shop Market in China:

Jim Riley

Jim co-founded tutor2u alongside his twin brother Geoff! Jim is a well-known Business writer and presenter as well as being one of the UK's leading educational technology entrepreneurs.

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