By Spencer Jakab
It turns out that selling foamy brown water at an 80% markup is really profitable.
Investors who have made about 300 times their money owning Starbucks shares over the past four decades weren't the only ones to notice, but even huge, otherwise-successful companies have often struggled to match its hyper-caffeinated magic. Google "coffee" and McDonald's and, instead of its McCafé espresso drinks, several results involve Stella Liebeck, the woman who famously sued the company for burns in her "pelvic region" after being served an excessively hot cup way back in 1992.
Others have fared better. Back in 2013, the chief financial officer of what was then called Dunkin' Donuts dubbed beverages "the holy grail of profitability." Dunkin' now has drinks as creative and habit-forming as those from its Seattle-based rival. Smaller North American chains such as Tim Hortons, Peet's, Dutch Bros and The Human Bean are growing quickly too.
But Starbucks still towers above them all. Americans tend to be tribal about their Pumpkin Spice Lattes, and the chain's digital prowess and efficiency reinforces that: Starbucks said recently that it has an incredible 31.4 million U.S. customers who have been active members of its Starbucks Rewards loyalty program in the past 90 days -- roughly one of every 10 Americans. Snagging a spot on customers' smartphones is a formidable competitive moat.
But that isn't enough for investors: Only developing markets, and China in particular, can create the sort of growth that justifies Starbucks' rich stock valuation. To get a sense of how crowded things have become in its home market, it has been 25 years since The Onion was able to get a chuckle out of the headline "New Starbucks Opens in Rest Room of Existing Starbucks." The chain has nearly 10 times as many North American stores today.
Most of the recent revenue growth at home has come from price increases. For the fourth time in the past five quarters, for example, Starbucks said its North American comparable-store transactions grew by just 1% from a year earlier. Its store count grew by just over 3%.
Three-time Chief Executive Howard Schultz, who resigned last week from Starbucks' board, placed great importance on China, heavily courting President Xi Jinping. Tellingly, his replacement will be former Alibaba executive Wei Zhang. Schultz's ambition to grow Starbucks' store count from today's 37,000 to 45,000 in 2025 and 55,000 by 2030 hinges on one day making China the chain's top market. It has about 6,500 there today and pledged last year that it will open one every nine hours on average over the next three years.
Some local competitors are putting even those ambitions to shame. Luckin Coffee, China's one-time answer to Starbucks, was brought to its knees financially after it admitted fabricating sales. It has had a dramatic recovery under new management. Three years ago it was neck-and-neck with Starbucks in terms of store count and heading lower. Now it has nearly 11,000.
Even more impressive, though perhaps deserving an asterisk, is Cotti Coffee, a China-based chain started just a year ago by Luckin's founders. It now claims more than 5,000 stores, which would make it the fifth-largest coffee brand globally. Between them Luckin and Cotti have opened a coffee shop every hour on average in the past year.
Starbucks opened its first store in tea-loving China in 1999 and the country had nearly 12,000 branded coffee shops by 2015, according to World Coffee Portal. The organization forecasts that number to have tripled by 2025, putting China on track to overtake the U.S. in a few years. Shanghai already has more coffee shops than any other city in the world.
American quick-serve eateries have stellar reputations in China, particularly in its wealthier cities. According to a survey released this summer by Bank of America, Starbucks remains the preferred choice in China's largest and most sophisticated urban areas. In smaller cities, though, Luckin wins for "perceived quality and value for money."
Plenty of other foreign chains are piling in, though. Peet's only entered China in 2018 and expects to open its 200th store there this year. And Tim Hortons' U.S.-listed, China-dedicated entity, Tims China, is becoming a force too. It had 700 stores in June with plans to expand to 1,000 this year and 2,740 by 2026.
Incredibly, Tims China already has nearly 15 million local loyalty members -- about half as many as Starbucks has in the U.S. Others have popular apps and programs too. Starbucks representatives wouldn't discuss Chinese digital competition beyond what has already been made public.
The most successful foreign fast-food player in the country, KFC and Pizza Hut parent Yum China, disclosed in a recent investor day that it has opened 95 high-end coffee shops through a joint venture with Italian espresso maker Lavazza. Another part of Yum's empire poses a far greater threat to Starbucks: Americans wouldn't think of going to KFC for their cappuccinos, but the chain is making a huge push in China.
"The only thing that smells better than my chicken is my coffee" is one of the Mandarin-speaking Colonel Sanders's advertising lines in China. That includes coffee sold through its 9,200 restaurants, third-party sales points and more than 200 stand-alone K-Coffee kiosks -- a number it says is "growing rapidly."
And then there is McDonald's, an afterthought for coffee in the U.S. but a serious competitor in China. World Coffee Portal says it had 2,500 McCafé locations in that country last year, some self-standing, and was planning 1,000 more this year.
Starbucks CEO Laxman Narasimhan saw the mug as half-full on a recent visit to the country, pointing out that Chinese people still only consume about 12 cups of coffee a year on average, compared with 380 in the U.S. But they won't all be drinking Starbucks.
Write to Spencer Jakab at Spencer.Jakab@wsj.com
(END) Dow Jones Newswires
September 22, 2023 05:30 ET (09:30 GMT)
Copyright (c) 2023 Dow Jones & Company, Inc.
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