A lot of people are wondering what Brian Niccol will do to fix Starbucks’ U.S. sales when he takes over as CEO and chairman next month. In reality, his biggest challenge may be half a world away.
The market for coffee in China has exploded recently, as locally-based concepts grow at rates almost inconceivable to those of us in the U.S. Those brands are cutting the price of their beverages in a bid to gain share, which is playing well as the economy there struggles.
The result: Western brands like Starbucks and Tim Hortons are struggling. Same-store sales at Starbucks in China plunged 14% last quarter, as customers visited the chain’s stores less often and spent less when they did.
Tims China, meanwhile, received a delisting notice from Nasdaq recently.
“We’ve continued to face more cautious consumer spending and intensified competition,” former Starbucks CEO Laxman Narasimhan told investors last month. “In the past year, unprecedented store expansion and a mass segment price war at the expense of comp and profitability have also caused significant disruptions to the operating environment.”
China now has more branded coffee shops than any other country on earth, according to World Coffee Portal, a phenomenon that happened almost literally overnight.
Luckin Coffee was founded in 2017, for instance, grew rapidly, went public in the U.S., was found to have faked earnings numbers, filed for bankruptcy, reorganized and resumed growing to become the country’s largest coffee concept last year. It has about 20,000 locations now after that ridiculous rollercoaster of a history.
Cotti Coffee, another Chinese chain launched by two former Luckin veterans, was founded in 2022 and already has 7,000 global locations, most of them in China.
By contrast, Starbucks added less than 800 stores in China last year.
Cotti Coffee has grown to 7,000 locations, mostly in China. | Photo courtesy of Cotti Coffee.
Those aren’t the only chains growing in China. Yum China created a brand of its own, KCoffee. The coffee is available in all KFC stores in the country. But it has started to roll out KCoffee Café locations next to KFC units. There are now 300 such locations in the country, up from 100 just in March. Yum China sold nearly 120 million cups of coffee last quarter.
All of this is giving Chinese coffee drinkers a jolt of choices. And it’s creating challenges for chains like Starbucks and Tim Hortons that had banked on strong growth in the market.
“What makes coffee the worst, I hate to say, is there’s no barrier to entry,” Joel Silverstein, a consultant who has worked with restaurant brands on overseas development, said on a recent episode of the Restaurant Business podcast A Deeper Dive. “If you’re selling supplies to somebody, they can put up a storefront and sell coffee cheap.”
That said, numbers from Luckin demonstrate the impact of this price war and store growth strategy.
Luckin, based in Beijing, increased revenues 35.5% in the second quarter, thanks to nearly 1,400 new locations. The company now averages nearly 70 million customers per month, up 62% from a year ago.
But same-store sales growth declined 21% in the quarter. And operating profits at the store level declined to 21.5% of sales, from 29.1% a year ago.
“They’re driving themselves into the ground,” Silverstein said. “They’re intensely competing with each other and no one’s making any money.”
The Chinese market, perhaps more than the U.S., may have attracted activist investors to Starbucks. The coffee chain owns its stores in China. But the market’s volatility and the growing local competition could force the company into some sort of alternative strategy there.
Starbucks said last month that it is exploring “strategic partnerships” to enhance its competitive position. But that was also before Narasimhan was replaced by Niccol. “Twenty five years ago, when Howard (Schultz, Starbucks former CEO) went to China, we created a specialty coffee industry from pretty much nowhere,” Narasimhan said. “We’ve been very entrepreneurial, and we’ve looked at various ways of making that happen.”
Silverstein believes that one of the problems is Starbucks’ growing focus on more takeout and delivery. In Asia, he said, consumers expect to sit down and enjoy a cup of coffee if they’re going to pay the type of premium prices Starbucks charges.
“If they’re going to take it away, it doesn’t make any sense [for] them to pay the same price, because they’re not renting a seat,” he said. When Starbucks arrived in the market, it undercut existing players that charged higher rates for more premium lounge experiences. But consumers still were able to sit and enjoy a coffee.
The other players are also intriguing to local consumers. “I just think Starbucks is getting old and the others are more interesting,” Silverstein said.
Another factor is the economy. China has struggled this year economically, much like the U.S., prompting consumers to cut back on their restaurant spending. “Consumer sentiment in China is quite weak,” McDonald’s CEO Chris Kempczinski told analysts last month. “You’re seeing both in our industry and across a broad range of consumer industries, the consumer being very, very much deal seeking.”
Each of the western brands remain committed to the China market. Restaurant Brands International, for instance, invested in Tims China, hoping it could grow faster there. Starbucks, meanwhile, argues that new locations there continue to generate a return, even if the company is rethinking its approach to the market.
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