Skip to main content
Publish date:

Starbucks a China Star

The coffeehouses are the cool place to be in Beijing.

BEIJING -- It's not exactly intuitive that a chain of high-end coffeehouses would make inroads among ardent tea drinkers. Yet


(SBUX) - Get Starbucks Corporation Report

already claims over 190 stores on mainland China, just seven years after opening its first outlet in Beijing. The reason may have as much to do with China's emerging class of social climbers as with the coffee itself.

In the U.S., Starbucks does a brisk takeout business, but customers in China spend long hours hanging out in the upscale stores where they can see and be seen.Starbucks is "a symbol of status and success that's become kind of an iconic brand. People use us to highlight their lifestyle," says Jinlong Wang, the Shanghai-based president of Starbucks Greater China. "I don't think anyone can compete with us in that respect."

Company founder and chairman Howard Schultz has frequently said he expects China to become the biggest market outside North America for the Seattle-based coffee chain.

In China's biggest cities, Starbucks stores have become a common fixture in office buildings. But they've also filled a niche as a key meeting place for affluent Chinese (and foreigners) outside work hours. On nights and weekends, outlets in malls or near department stores are often full of the trendy 20- and 30-somethings who can afford to shell out 29 yuan ($3.67) for a tall green tea frappuccino.

Starbucks estimates that 41% of its Chinese customers are between the ages of 19 and 25. Seventy-five percent are under age 35, Wang says.

By comparison, the average age of a Starbucks customer in the U.S. is now 42.

"There's a huge demographic advantage" in China, says Wang.

In giant first-tier cities such as Shanghai, Beijing and Guangzhou, Starbucks plans to expand into more neighborhoods in addition to commercial shopping and office areas. The coffee chain also has started opening stores in a handful of the less affluent, so-called second-tier cities such as Dalian and Qingdao.

For now, with sales of less than 10% of Starbucks' 2005 revenue of $6.4 billion, China doesn't yet rank among the company's top three international markets (currently Japan, Canada and the U.K.).

TheStreet Recommends

Starbucks' "China story is exciting, but will likely not be a significant contributor to the company's 20%-plus total revenue growth over the next few years," writes UBS analyst David Palmer in a recent note. Still, China could "become a meaningful growth driver in the next decade as unit deployment there could approach 500 or more units per year, and as unit growth in the U.S. slows," he adds.

It's also not clear whether the mainland stores are making a profit. "I suspect people walk around thinking they're making very good money here because they see lots of stores, but they never tell you how much money they're making," says Paul French, an analyst for the retail and consumer market research firm Access Asia.

Indeed, customer habits in China pose some potential challenges.

At Starbucks' U.S. stores, a big proportion of revenue is from the more profitable takeout business, but customers in China tend to prefer drinking and eating in-store, says Shaun Rein, managing director of Shangai-based China Market Research Group. "They might sit for four or five hours and milk one coffee."

The usage pattern is something Schultz acknowledged on the company's fourth-quarter 2005 earnings call last November: "In the afternoon and evening we have been very surprised, almost stunned, to see how the Chinese customer is using Starbucks stores as an extension of their home and office," he said. "In many ways it's because the Starbucks stores are bigger than where people live. The commuting distances are very long."

Schultz cast this development as favorable to Starbucks, adding: "Because of this, the Chinese people are coming to Starbucks in waves that we did not anticipate" compared with earlier overseas markets such as the U.K. and Japan.

Still, competition is on the rise in China, with U.S. chain The Coffee Bean & Tea Leaf, Hong Kong's Pacific Coffee and the Philippines' Figaro coffee stores all having entered the mainland market.

Rein believes Starbucks could be handicapped by its relatively small selection of food offerings, because many Chinese are still getting used to the taste of coffee, and some of the newer chains, such as The Coffee Bean, offer more options beyond coffee drinks.

In areas such as Shanghai, teahouses are a more common (and also more traditional) alternative to coffeehouses. They're cheaper than Starbucks, they also sell beer and soft drinks, and they're happy to let customers smoke -- unlike Starbucks, says French.

However it fares, China has become strategically important enough to Starbucks that the company cited potential stumbles there among the risk factors in its 2005 annual report. Those risks include deterioration in U.S.-China relations, legal uncertainties and intellectual-property ripoffs. (Earlier this year, Starbucks won a lawsuit against a Shanghai coffee company that was using the Chinese version of Starbucks' name and a similar logo).

Starbucks has refused to say how many stores it plans to open in China. But in October, CEO Jim Donald said the company has raised its long-term store target to 40,000 locations around the world, up from its earlier goal of 30,000.

About 10,000 of those new stores will be in Asia. And with China being billed as the next big market for Starbucks, expect it to get a lot easier to find a cup of coffee in the Middle Kingdom.