Starbucks awaits long recovery

Faced with increasingly fierce competition and price wars in the Chinese market, Starbucks has to re-examine its strategy in China. From insisting on not participating in price wars to focusing on store expansion, product innovation and membership system upgrades, Starbucks is taking a series of measures to cope with the current market challenges.

As a typical old American company that puts profit first, Starbucks has repeatedly stated: In a competitive environment with frequent promotions, we maintain a high degree of restraint and avoid price wars. Starbucks is waiting, waiting for the passage of time, and external disturbances such as price wars will gradually disappear.

Recently, Starbucks released its quarterly financial report. In the second quarter, the company had 7,306 stores in China, but its revenue fell by 10% year-on-year to US$730 million, and same-store sales also fell by 14% year-on-year.

This is certainly not a satisfactory result. Although Q2 2023 is the quarter with the best growth data after the epidemic, the number of stores increased by more than 800, but the revenue decreased.

Although Luckin's Q2 same-store sales also declined significantly, with total same-store sales down more than 20% year-on-year and single store revenue down 45%, this is related to Luckin's continued efforts to expand its store count, but also because of the opening of more stores, Luckin's single-quarter revenue hit a new high.

Due to their different models and positioning, it is difficult to compare Starbucks and Luckin Coffee on an equal footing. But the reality is that the difficult market environment Starbucks faces, dominated by price wars, is an objective reality.

As a high-customer-order, high-premium coffee culture brand with spatial attributes, Starbucks has undoubtedly been surrounded by low-priced coffees of 9.9, 8.8, and 6.6 yuan in the past period of time.

Starbucks Global CEO Laxman Narasimhan also mentioned that "over the past year, unprecedented store expansion (by Chinese peers) and large-scale price wars at the expense of same-store sales and profitability have also caused significant disruptions to the operating environment."

As Nasshan said in last quarter's earnings call, the coffee market is evolving and undergoing transformation, and it is still in the early stages and has not yet been fully stratified.

Starbucks' original plan may have been that when the coffee market was naturally stratified, whether it was occupying the top of the spindle-shaped high-priced coffee market, or like a funnel taking in educated, mature, and heavy coffee users, Starbucks would always be able to find its comfort zone in the corresponding consumer levels.

However, when mass coffee brands in the early coffee market rapidly expand their stores with an extremely low-price strategy, they are actually stirring the market with external forces. Stirring will produce shear force, disturbance force and centrifugal force, none of which is conducive to stratification.

As a typical old American company that puts profit first, Starbucks has repeatedly stated: In a competitive environment with frequent promotions, we maintain a high degree of restraint and avoid price wars. Starbucks is waiting, waiting for the passage of time, and these external disturbances will gradually disappear.

01 What does Starbucks care about besides price?

Giving up the price war strategy means that Starbucks will give up short-term income and pay more attention to other things. For example, Liu Wenjuan, co-CEO of Starbucks China, pointed out that the continuous month-on-month growth of key business data such as net income, store transaction volume, and profit margin is the current focus of Starbucks.

For reference, in terms of profit margin, Luckin's profit margin experienced a sharp decline and then a significant correction, and the operating profit margin of its own stores has not yet returned to normal levels. However, Starbucks China's operating profit margin has achieved double-digit growth for two consecutive quarters.

This proves that Starbucks is not doing nothing. Liu Wenjuan said that the three main tasks at present are the continuous innovation of Starbucks' high-end products and experience, the rhythmic store expansion plan, and the continuous investment in Starbucks partners.

Among them, the increase in the number of stores is the most visible. Starbucks is opening more stores in county-level cities. According to information revealed in the conference call, these stores usually perform well, recovering 70% of the investment in the first year, and the average cash profit margin exceeds 30%.

The information we have obtained shows that, at least in the lower-tier market shopping malls, Starbucks is still very positive about attracting investment. Whether in terms of brand status, store area, or the role of attracting customers to the malls and attracting other brands to enter, Starbucks can still obtain generous conditions from the malls that other domestic coffee brands cannot get.

Starbucks actually has its own understanding of product innovation. When Schultz visited China in the first half of the year, he mentioned that in his eyes, innovation must first be disruptive and disrupt the market. Under this idea, the extension of product lines, the introduction of new flavors, and even a change in size, even if customers give positive feedback, are not great innovations, but more of a responsibility. What he considers disruptive innovation is, for example, the olive oil coffee drink Oleato launched by Starbucks.

The innovation of experience is mainly reflected in the expansion and upgrading of the membership system. For Starbucks, which wants to cut into the layered cake of coffee consumption, it is very important to serve its limited base well, whether it is to attract new customers or to increase the consumption frequency of the core group. This also confirms the relationship between stock consumption and membership improvement mentioned in the discussion of membership economics in "Narrowcast".

In June this year, Starbucks launched the biggest upgrade to its membership system, the Starbucks Rewards Club, since the epidemic, adding the Diamond Star membership level for the first time, rewarding loyal fans with exclusive gifts and services, and also adding a star redemption mechanism and various star gameplay.

With these changes, Starbucks' membership sales share continued to maintain historical highs, the number of active members reached a new high, and the consumption frequency of high-level members also increased.

We can also see that there are some Starbucks coupons on group buying platforms, which are basically based on membership. This also helps Starbucks continue to expand its membership and activity. After all, the latter is an indicator in the 2025 strategic vision proposed by Starbucks China at the end of 2022.

The 2025 vision covers all aspects, including net income, operating profit, number of stores, sales of Star Delivery services, compound annual growth rate of e-commerce business, ready-to-drink coffee and coffee service points, new jobs, registered members and active members, investment in sustainable development projects, and investment in digital technology innovation centers. It is a detailed long-term plan.

This reflects Starbucks' long-term optimism about the Chinese market, which has been emphasized many times. As early as 2016, Schultz said that China would become Starbucks' largest market. The latest timetable given is 2022, and the earliest time to surpass the United States and achieve this goal will be 2025, the same year that the vision plan was released.

02 What can Starbucks improve on?

Some people also say that Starbucks is also secretly lowering its prices, and that its coffee can be purchased at lower prices on various takeout and group-buying platforms. But it is hard to say whether this is to participate in a price war or to become more localized. After all, the coffee delivery service was one of the important reasons for Luckin’s rise to fame.

To be honest, Starbucks China's average same-store customer spending has been declining almost every quarter since 2021. Some of this is due to the epidemic, and some is not, but it is not mainly caused by its secret price cuts. Even in early 2022, Starbucks raised prices to cope with profit squeezes caused by inflation and labor market problems related to the epidemic.

Therefore, if we must give a reasonable reason for the price reduction from an external perspective, it is more reasonable to say that it is not participating in a price war, but rather following the consumer trend of paying more attention to cost performance, just like freshly brewed tea. After all, even if the price is reduced further, it is still more than 20 yuan, and the core customer groups of Starbucks and Luckin are not the same.

In summary, facing up to short-term difficulties and maintaining long-term optimism and patience are Starbucks’ core attitude towards the current Chinese market.

At the Global Consumer and Retail Conference at the end of last year, Nasshan mentioned that Starbucks' recovery in China may be only half of what was expected. Although the speed is slower than expected, the long-term trend is still very obvious as China's economy recovers and steadily moves towards normalization. "Once you see that we are working hard to overcome the challenges, I think you will find that our business is very strong in the long run."

Regarding some future actions, Nasham also mentioned in the conference call that he sees higher growth and profit opportunities in China and is building the next generation of Starbucks based on high-end brands with a more digital, innovative and localized business. He is also exploring early-stage strategic partnerships and working hard for the next 25 years in China (I say this because this year marks the 25th anniversary of Starbucks' entry into China) and longer.

Nashan did not clarify where the strategic partnership exploration in the early stage came from. The market speculated that this might be Starbucks reconsidering opening up franchises in the Chinese market.

In 2017, Starbucks decided to buy back the shares of the joint venture from Uni-President Group, so that all Starbucks stores in mainland China would resume direct operation. At that time, the market believed that this was to unify the pace, concentrate efforts to cope with market competition and increase investment in China.

The advantage of franchising is that it can quickly expand the scale and further reduce operating costs. If Starbucks wants to complete the layout of 9,000 stores faster and obtain better profit figures, it may be possible to open up franchising again.

But the possibility is limited, or it is not urgent. After all, the plan of 9,000 stores was put forward in 2022, and in May last year, when the newly appointed Nashan visited China for the first time, his attitude was still to insist on direct operation and not consider franchising.

Although Starbucks operates nearly 40,000 stores worldwide with half franchise and half direct operation, its excellent management level has always been one of its core capabilities.

How the Chinese business will operate will ultimately require comprehensive consideration of many factors.

"Our actions (in China) are having an impact. Leading business and operational indicators are moving in the right direction. This financial statement may not fully reflect the current changes, but the road to improvement will be long," said Nashan.

But at least, as an evergreen company that has experienced all kinds of ups and downs, Starbucks can afford to wait for the long recovery.

Author | Xiao Chao (Suzhou)

Producer | Shao Lele (Shanghai)