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China's growing taste for coffee gets expansion plans brewing

China, traditionally a nation of tea drinkers, has become home to a growing coffee culture that is driving expansion strategies for foreign brands while also fostering new domestic players.

Starbucks Corp. is aiming to triple its revenue and nearly double its store count in China to 6,000 in the next five years, a plan that calls for adding 600 net stores annually. Meanwhile, delivery-focused Chinese startup Luckin Coffee is emerging as a key market rival after launching early this year and recently raising US$200 million from investors including Singapore sovereign wealth fund GIC to support an aggressive pace of store openings.

Tim Hortons, the Canadian coffee chain owned by Restaurant Brands International Inc., also recently unveiled a plan to open more than 1,500 stores in China over the next decade. In late 2017, U.S.-based premium brand Peet's Coffee opened its first Chinese store location in Shanghai, while Whitbread PLC, owner of the British chain Costa Coffee, bought out its South China joint venture partner to gain full control of the market.

"Competition in the China coffee market is heating up, as we see an increasing number of new entrants, emerging brands and boutique coffee shops," Jinwen Xiang, an analyst with Chinese market research firm Forward Intelligence, told S&P Global Market Intelligence in an interview.

According to data provided by the research house, there were more than 100,000 coffee shops across China at 2017-end, compared with fewer than 16,000 in 2007. Starbucks dominated the Chinese market with more than 50% market share, followed by approximately 13% held by Taiwan-originated UBC Coffee and about 6% by McDonald's Corp.'s McCafé.

The remaining market share is split between several other brands operating in the country, which include Costa Coffee, Hong Kong-based Pacific Coffee, Chinese chain C.straits Café, and South Korean brands Caffé Bene and Hollys Coffee.

Forward Intelligence predicts that China's specialist coffee shop market will grow between 11% and 15% annually to post revenue of approximately 48 billion Chinese yuan by 2023, more than double the 21 billion yuan recorded in 2017.

Chinese consumers are just catching on to the caffeine craze, especially the younger population, which studied abroad, and a rising middle class that aspires to Western lifestyles, according to Tony Zhu, a food and beverage industry researcher at China Branding Research Institute.

"There is still massive room for the sector to grow — the average person in China now just consumes five to six cups per year," Zhu said in an interview. "Many from the rural areas are not familiar with coffee at all. Even those living in first-tier cities like Shanghai or Beijing drink only 20 cups per year on average." The researcher added that the figure stands at about 200 in Japan and South Korea, which were also tea-drinking nations but were exposed to Western influences earlier than China.

This environment has allowed for the rapid expansion of Luckin, which started trial operations only in January but as of July had opened 660 stores in 13 cities, Chinese-language news outlet Jiemian reported July 13, citing figures given by CEO Zhiya Qian during a press briefing.

Luckin is developing a foothold in the market by targeting China's tech-savvy consumers with a business model combining online and offline operations. Customers who want to purchase a Luckin beverage use the chain's app to find the closest store location, place an order for delivery or pickup, and make their payment.

"Such a self-ordering and cashless model not only saves labor costs and shortens in-store waiting time, but also effectively collects data about customer preferences, consumption frequency and hotspots, all of which could help with planning new store locations and product innovation," Xiang said.

Starbucks, in turn, is responding to Chinese preferences for app-based services to fend off local challenges. The company revealed during a July 26 earnings call that it plans to offer delivery in China starting in the fall. The service will reportedly be in collaboration with Chinese e-commerce giant Alibaba Group Holding Ltd., which owns food-delivery service Ele.me and previously partnered with the coffee chain to provide interactive features for the Starbucks Reserve Roastery flagship in Shanghai.

"Delivery as a whole is becoming a lifestyle ritual in China, and consumer behaviors are changing," Starbucks China CEO Belinda Wong said on the call.

However, Xiang does not believe Starbucks is in danger of losing its dominance in China. "For Starbucks, the birth of new brands will likely pose little threat in the short- to medium-term, as the market is still far from a saturation point," the analyst said.

Zhu also noted that foreign brands, particularly Starbucks, are the most trusted among Chinese consumers when it comes to coffee. Nestlé SA introduced the beverage to Chinese consumers in the 1980s with instant coffee products, while Starbucks nurtured fresh-brew drinkers in the 2000s.

Since opening its first Chinese store in 1999 in the China World Trade Center in Beijing, Starbucks has been expanding on the mainland by choosing prime locations with very high traffic, according to Zhu. "Backed by strong financial power, Starbucks has continued to outspend its smaller competitors on real estate, a strategy that further strengthens its visibility and branding," the researcher said.

Zhu predicted that Chinese consumers will get to choose from more new brands and coffee shop formats as the market continues to grow, but added: "It's unlikely for them to be able to challenge Starbucks' status, which is supported by its branding and culture. However, they will surely help diversify the market."

As of July 31, US$1 was equivalent to 6.81 Chinese yuan.