Starbucks Looks For New Friends In Choppy China Coffee Waters

Key Takeaways:

• Starbucks is considering bringing in partners to its China operation, as same-store sales in its second-largest market plunge during a bloody local coffee price war
• The coffee giant has faced multiple challenges in China, from severe restrictions during the pandemic to growing consumer caution and fierce competition.

By Xiao Lin

In rocky waters, you often need more than one paddle to steady your boat. That seems to be the case for Starbucks Corp. SBUX, as the world’s largest coffee chain explores potential partnerships in China, its second largest market after only the U.S.

In a statement to the media, the Seattle-based firm said it is working to find the best path back to growth in China, which includes exploring strategic partnerships — moves aimed at navigating increasing challenges in a country that was once its fastest growing market. Such partnerships, often with local companies, were initially the norm for most restaurant operators when they started to enter the unfamiliar Chinese market in the 1990s.

“We are fully committed to our business and partners, and to growing in China,” Starbucks said in a statement to numerous media, after Bloomberg reported last Thursday the company had informally gauged interest from prospective investors, including local private equity firms. “We are working to find the best path to growth, which includes exploring strategic partnerships.”

In addition to global private equity, Starbucks might also consider a sale of part of its China operation to Chinese conglomerates or other local companies with experience in the industry, the Bloomberg report said.

Starbucks’ shares edged up slightly after its announcement last Thursday. The stock is roughly flat over the past 12 months, and still trades at an elevated price-to-earnings (P/E) ratio of 31 – ahead of a 25 for McDonald’s MCD and 21 for Yum China YUMC, operator of KFC and Pizza Hut restaurants in China.

When Starbucks opened its first store in Beijing in 1999, it found itself not only facing a more regulated environment than it was used to, but also the equally big challenge of selling to a tea-drinking culture where Nestlé instant coffee defined most people’s understanding of its signature product. It formed a series of joint ventures with local partners to better find its way in the market, but later bought all of them out.

Fast forward to the present, where, with over 7,500 stores, the company is now grappling with more frugal consumers and intense competition from local rivals, prompting it to consider a return to partnerships to weather difficult times. Such partners not only offer more resources, but can also help spread the risk of owning such a large operation worth billions of dollars.

If Starbucks’ China U-turn sounds familiar, it’s because it’s not the first major foreign chain to change tack midway through its China story. In 2017, after nearly three decades in the country, McDonald’s (MCD.N) sold a majority 52% stake in its China and Hong Kong operations to a consortium led by state-owned conglomerate Citic and American investment firm Carlyle CG, after sales started declining and a food scandal dragged down its global sales.

Coffee Greenfield

When Starbucks opened its first store in Beijing’s Guomao area 25 years ago, it did so through a joint venture with Beijing Mei Da Coffee Co. out of necessity, since wholly owned foreign restaurants weren’t allowed at that time. The store offered cappuccinos for about 19 yuan, or $2.60, which was about 5% of the monthly average per capita income at that time. It later established two more joint ventures: one with Maxim’s to run stores in Hong Kong and South China’s Guangdong province, and another with Taiwan’s Uni-President to run stores in Shanghai and nearby regions.

In late 2004, China started allowing foreign restaurant operators to wholly own their local businesses as part of its commitments after joining the World Trade Organization in 2001. Starbucks started acquiring stakes from its local partners, and by 2017 it obtained full control of its entire China operation.

Starbucks had nearly 3,000 stores across China by the end of that year and was opening a new store every 15 hours to serve an increasingly affluent and status-conscious middle class. Its revenue in the China and Asia Pacific region increased by 10% in 2017, following 23% growth the previous year.

Things went well for the next two years, with Starbucks’ net revenue in China increasing by 38% in 2018 and 19% in 2019, when the country officially became its second largest market. After a difficult year in 2020 when many of its stores were forced to close at the start of the pandemic, Starbucks came roaring back in China in 2021 with 42% revenue growth as the country was able to bring its Covid outbreaks under control.

But things have gotten tough over the last two years, both in China and worldwide. The company’s global same-store sales declined 7% in its latest quarter through September, dragged down by a 14% decline in its China operation.

China contributed about 9% of Starbucks’ total revenues of $36.2 billion in the 12 months through September. In the company’s latest earnings call, newly installed CEO Brian R. Niccol told investors he needed to spend more time in China to understand the challenges.

Struggling Sector

Starbucks and the catering sector certainly aren’t the only ones in China facing difficulty, as a stream of regulatory crackdowns on various sectors over the last few years and a slowing economy that’s hurting consumer sentiment take their toll on businesses across the board.

But the food and beverage industry has taken one of the harder hits, following an initial boom in dining out after China reopened in early 2023. More than 1 million restaurants reportedly closed in the first six months of 2024, according to media reports, citing business registry searches.

The coffee sector is taking a harder hit than many of its catering peers as the aggressive Luckin LKNCY and Cotti Coffee engage in a price war by selling much of their premium coffee for just 9.9 yuan, or about $1.40, per cup. Others joining in the coffee war include Yum China with its KCOFFEE sold at its main KFC chain and in adjacent stores. Even e-commerce is getting involved with premium instant coffees like Saturnbird, which are primarily sold on platforms like Alibaba’s Taobao at even lower prices.

While the average monthly income in China is now more than 50 times higher than in 1999, a cup of Starbucks cappuccino priced at about 30 yuan can still seem expensive to consumers when they can buy Luckin or Cotti for just a third of the cost. That reality is becoming increasingly clear as consumers become more frugal in the current economic climate.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.