Why Starbucks is struggling in China: High prices, competition

Starbucks opened its first store in mainland China in Beijing in 1999.

Shanghai was also chosen as the location of the second Starbucks Reserve Roastery, after Seattle.

In mid-August, Starbucks named Chipotle CEO Brian Niccol as its new boss in a sudden management shakeup. One of its key priorities could be to transform its China business.

Declining sales

Starbucks’ comparable store sales in China have been incredibly volatile over the past five years.

Comparable sales are determined by two components: the number of orders placed and the average order size.

In previous years, sales were massively affected by China’s strict zero-covid policy. But in recent months they have been hit by cautious consumer spending and increased competition, then-CEO Laxman Narasimhan told investors in July.

“Unprecedented store expansion and a price war across mass segments at the expense of compensation and profitability also caused significant disruption to the operating environment,” he said.

Comparable store sales have been negative for the past two quarters. In the most recent quarter to June 30, both the number of comparable transactions and the average ticket size were down 7% year-on-year. The average ticket size has steadily declined over the past two years.

In particular, fewer casual customers visited in the afternoon and evening, Narasimhan told investors in April.

Increased competition

The rapid growth of China’s coffee shop sector means there is simply “too much competition,” Sherri He, who heads the China unit of consulting firm Kearney, told Business Insider.

She said it is Starbucks’ “number one challenge” in China.

Narasimhan told investors in April that there was “fierce competition among value players” in China.

Luckin Coffee, Starbucks’ biggest rival in China, has nearly three times as many stores as Starbucks in the country after a monumental increase in units. Luckin was only founded in 2017, but has more than 20,000 cafes, the vast majority of which are in China.

Luckin has a much wider presence across China than Starbucks, including in smaller cities, analysts said. Nearly a quarter of Starbucks’ Chinese stores are in Beijing and Shanghai, and the vast majority of its other stores are in tier 1, tier 1 and tier 2 cities, according to an April Bank of America report.

Other major competitors in China include Cotti Coffee, McDonald’s McCafe and KFC’s KCoffee.

Not all Chinese consumers want the Starbucks experience

Coffee is ‘still a growing habit’ in China, Dave Xie, a partner at Oliver Wyman focusing on consumer goods and retail, said. “Many consumers only drink tea.”

And when they go to a coffee shop, they generally care much more about the product than the experience, Xie said.

“Starbucks is a consumer-centric company, but for Luckin it’s really product-centric,” Xie said. Luckin has a “very fast product innovation cycle,” with much more frequent launches than Starbucks, he said.

Coffee chains in China are much more “nimble” in adapting to trends and are more closely attuned to the flavors favored by Chinese consumers, said He, the Kearney partner. That includes Luckin’s focus on sweet and milky drinks, with a wildly popular brown sugar boba latte and coconut latte accounting for 70 percent of sales at some stores, Bloomberg reported.

Xie said Starbucks’ “third place” model — the idea that it’s an alternative space at work and home for people to spend time — worked in 2017 and 2018, when people were more willing to pay for premium products , but that this was no longer the case. Luckin, by comparison, has smaller format stores with fewer seats and a focus on automation and standardization, he said.

Starbucks executives have repeatedly told investors that its premium positioning in China is a crucial part of its strategy. But because of this, Starbucks limits its potential customer base.

Starbucks “doesn’t target the mass, it targets the middle class,” especially white-collar professionals, he said.

Starbucks typically charges 30 to 40 yuan ($4.20 to $5.60) for a 16-ounce drink, including Americanos, flat whites, flavored lattes, teas and Frappuccinos, according to its website. Instead, Luckin often has promotions that bring them down to 10 yuan a cup ($1.40), he said.

“We’re not interested in getting into a price war,” Starbucks China CEO Belinda Wong told them in January. “Our goal is to be the best and the leader in the premium market.”

But Reuters reported in May that Starbucks had significantly increased its use of discounting in China to compete with local rivals. Wong acknowledged in January that Starbucks’ use of promotional offers in China has resulted in a smaller average check size.

Economic growth is slowing and consumer spending is becoming more cautious

China’s economic growth slowed down. It rose just 4.7% year-on-year in the second quarter of 2024, missing forecasts.

“China is obviously a tough market and it’s not just Starbucks,” Brian Yarbrough, restaurant analyst at Edward Jones, told BI.

Luckin’s same-store sales fell more than 20% in its most recent two quarters.

Consumers are “increasingly rational and pragmatic,” Xie said. That makes the price gap between coffee chains an “even bigger challenge” for Starbucks, he said.

Starbucks remains optimistic

Starbucks executives say the chain is focusing on its long-term plan in China.

Narasimhan said in January that Starbucks was focusing on offering more locally relevant coffee products in China and opening stores in smaller cities “where we see significantly stronger store economics.”

He noted that the company is “on track” to meet its 2025 goal of 9,000 stores in China.

Starbucks added more than 800 new Chinese stores in the year to June 30. The chain has continued to grow in China “hoping that there will be some shakeout of the market,” but in the short term, “it’s a pretty rough road that they’re going through right now,” said Andy Barish, an analyst at Jefferies.