The Journal. - Can Chinese Customers Rescue Starbucks?

Episode Date: May 9, 2024

Starbucks has a problem: Sales at U.S. stores have fallen sharply and now the company is looking to China, its second biggest market, to boost its revenue. But as WSJ’s Spencer Jakab explains, increased competition there is making that a tall order.  Further Reading: -Starbucks Is Running Out of Americans to Drink Its Expensive Coffee  -The Furious Race for the Future of Coffee Further Listening: -The Underdog Coffee Bean That’s Making a Comeback  Learn more about your ad choices. Visit megaphone.fm/adchoices

Last week, Starbucks released its latest earnings. And they weren't good. Starbucks out with a disappointing set of earnings. Starbucks stock right now is down 12%. The shares, though, getting crushed. I mean, just hammered this weekend. Starbucks has a big problem. Americans aren't going to its cafes as often as they used to.

And the company's solution is to turn to a different market, China. How important is China to Starbucks' business right now? China is extremely important to Starbucks' business. So it is their second biggest market. For the 24 of the last 25 years, they were either the only game in town or the biggest coffee chain out there. But our colleague Spencer Jacobs says, over the past 25 years, the market in China has changed dramatically. It's become suddenly a very saturated one and very competitive for them.

Now a lot of Chinese chains are seen as being almost as good and certainly more aggressive on price. And that's a problem that Starbucks has. Welcome to The Journal, our show about money, business, and power. I'm Kate Leinbaugh. It's Thursday, May 9th. Coming up on the show, Starbucks' disappointing earnings and its plan to use China to turn things around. Attention all soccer fans. From Orlando to Los Angeles, take to the fields of the USA for your next vacation.

Ready to kick off? Discover exciting games and events. Plus, find amazing hidden gems in cities full of adventures, delicious food, and diverse cultures. You'll love it so much you'll want to extend your stay beyond the matches. Get the ball rolling on your soccer getaway. Head to visittheusa.com. Can you introduce yourself and tell us what it is that you do at The Wall Street Journal? I'm Spencer Jacob, and I'm the global editor of the Hurt on the Street column, The Wall Street Journal's home for financial analysis and opinion.

And opinion. So are you going to bring some opinion to this episode? Yes, I am. I'm very opinionated about everything, including coffee. And what's your opinion of Starbucks' coffee? My opinion of Starbucks' coffee is quite positive, but I am one of those cheapskates who very rarely visits. My wife is a teacher, so she gets a lot of Starbucks gift cards. So I sort of mooch off of her. Are you a coffee drinker? I am. I drink about six double espressos a day.

So my bloodstream is 3% coffee. Wow. Yeah, I drink lots of coffee. I make it at home. The Wall Street Journal has some nice machines in the office. And so, yeah, if I stopped drinking coffee, bad things would happen. I just don't often pay for it.

I have nothing against Starbucks. In some ways, Spencer epitomizes the problem that Starbucks is facing. He's a coffee drinker who doesn't want to spend money on it. And the company's latest results showed that there are a lot of Spencers out there. Starbucks's revenue came in far below Wall Street expectations.

One key metric, called same-store sales, had one of its worst declines ever. On a call with Starbucks executives, the mood among Wall Street investors and analysts was not good. Analysts were upset. The tone that analysts had on the call was not good. Analysts were upset. The tone that analysts had on the call was not warm and fuzzy. You know, they were asking a lot of hard questions and saying, you know, let me get this straight. And can you just explain this? And can you just explain it again? And what did they say was at the root of this drop in same-store sales? So the company did make some excuses,

some more credible than others. Of course, there's that old standby, the weather wasn't very good, and 60% of Starbucks beverages or more in some markets are iced drinks now, as opposed to you think of coffee as being this hot beverage. The other thing that they mentioned was that they were not very good at filling orders

in the sense that they had so much demand that people just got frustrated and, you know, they had glitches digitally and they just, you know, they were about to make an order and they dropped it. There are other reasons too, including cost. Part of the problem seems to be that Starbucks is expensive and people are becoming more sensitive about small extravagances like, you know, paying an 80% markup for foamy brown water with a bit of milk and syrup in it. One strategy that Starbucks is

hoping can counter the weakness in the U.S. market is its expansion plans in China, its second largest market, where Starbucks has been since 1999. In 1999, you could barely get a cup of coffee, even going to the grocery store and buying coffee in China. Coffee was a relatively new product in China. It was a tea drinking society. How did Starbucks position its brand there? Because a lot of the marketing, this is before social media, basically, 1999, but a lot of the marketing is word of mouth, is people wanting to be seen with this cool Western thing, having the cup, taking a picture. It was a splurge. It was something that they hadn't tasted before either, in all likelihood, coffee, period. Was it popular? Did it work, this idea? It worked very, very well. Going into China, I mean, they had the market mostly to themselves in the early years,

and they really looked unstoppable. So they went from the first store in 1999, and they're now a little over 7,000. Have you ever been to a Starbucks in China? I have, yeah. I went once in Shanghai in 2019. And so, like, I drink six double espressos a day. So I need to, you know, I made a few visits while I was there,

and I couldn't make it, you know, cook it up in my hotel room. What was the Starbucks experience like in China for you? It was beautiful. The Starbucks that I remember going to in Shanghai was bright, airy, spacious, pleasant. Didn't feel like I was fighting for a table with people just sitting there making it their office with their laptop and all their papers. It was in a very fancy residential area called the French Concession in Shanghai, which is one of the wealthiest areas. It's a nice place where you can sit down and meet friends, just the way Starbucks used to be in the U.S. before it sort of, you know, the places got so busy. Starbucks has successfully created a coffee culture in China, but now it's being burned by its own success.

The problem is that there has been a far more insane level of expansion just generally in the cafe market in China, where in 2023, according to data from World Coffee Portal, there was a cafe, a branded cafe, opened in China every 20 to 30 minutes. For Starbucks, the road to dominating China is looking to be a tall order. And it involves a pork latte.

That's next. That's next. and take a sip. Suddenly you're on a fresh adventure, becoming the hero of your own night. Unapologetically full-flavored cocktails with a 13% punch. Seagram 13. Dare to make your own luck. Must be legal drinking age. Please enjoy responsibly. Available at the LCBO. Imagine you're in Ottawa

paddling along the Rideau Canal. Oh! Then ziplining across the Ottawa River between two provinces. Ah! Before cycling along a picturesque Oh! Oh! natourism.ca. Okay, so we've got to talk about the pork latte. It's a thing that they tried out in China, yeah, with pork juice and a little slice of pork on top for Chinese New Year. Kate, would you try a pork latte? I would count myself as a more savory person,

but I wouldn't say it sounds appealing to me. No judgment for others. The Chinese palate is different than the American palate. In China, you really have to push the envelope in terms of taste and texture. The pork latte is just smart marketing. And that's just one thing. There are many things that they've introduced. So is this pork latte sort of Starbucks's answer

to compete in China a little bit more like its Chinese competitors? I mean, they always have. You know, they're very innovative all over the world, but especially in China, where people really want to constantly have a new thing. Who has the cool new thing that I want to see what it tastes like and put it on social media and show all my friends that I'm having this weird new thing. And so more so than in the U.S., it's about novelty.

Starbucks executives call things like the pork latte an innovation. And they say it's this kind of thing that will lure customers into its cafes in China, where same-store sales also took a sharp dip this year. And Starbucks' sales in China are dipping, in part because of rising competition from brands like Cati, Costa, and Luckin. So its main competitor in China, its largest competitor, the largest coffee chain in China, which is a local company called Luckin, opened as many cafes in China last year as Starbucks has in its entire history in China over 25 years. Another chain, Cotty, opened almost as many. And then you have a lot of other companies, Tim's China, which is a franchisee

of Tim Hortons, the Canadian donut and coffee chain. And just like in the U.S., Starbucks also faces competition from global fast food chains. McDonald's, KFC, and others opening cafes. Just in Shanghai, you have more than 8,000 branded cafes. Even though Shanghai is a really big city, you don't have 8,000 branded coffee shops in New York City. And a different thing is happening too, which is that tea, which is a competing product, so bubble tea specifically,

has also been in a furious expansion mode to the point that you have in a one kilometer radius of China's 10 largest shopping areas, an average of 50 branded tea shops. And all this competition, can it all survive? That is the question. Can all of these companies survive expanding furiously? I would say maybe not. Is this competition going to change how Starbucks operates in China or positions its business? So the CEO, Laxman Narasimhan, was asked a couple of different ways

during the recent investor call, how are they going to address this? And he didn't propose a new strategy at all in China. And he said that they were not going to change what they do. We said, we've been here for 25 years. We are a premium product. You know, you don't react to this by cutting your prices because if you're perceived as a premium product and then you cut your prices, then you do damage to your brand.

Part of the brand is costing more. And to give you some sense, Luckin Coffee, they have drinks for as little as 10 yuan. 10 and 20, that's the range. Starbucks, typically, their drinks will start at 30 yuan. So it's about two to two and a half times as expensive for the equivalent beverage. While it's not cutting prices, Starbucks is relying on an ambitious target that it set in 2022 to expand stores in China. The company said it would aim to open 9,000 stores by 2025. If they open a new Starbucks in China, they still make money.

They make a pretty nice return on opening that Starbucks, just not as good as it used to be. Starbucks is struggling both in the U.S. and in China. Is this a Starbucks problem or is this an environment problem? I would say it's 80% environment, 20% Starbucks. So some of the things that they cited in the United States in terms of just not being able to execute orders well enough, losing some of their more marginal occasional customers probably is on them. But mostly it's about the American consumer just becoming more cautious and finally saying, you know what, this coffee is really expensive. And is that the same story with Chinese consumers? The Chinese economy is somewhat weak, but that does not appear to be the case. Much harder to tell in China. It's harder to separate the furious expansion of the number of cafes and the change in same-store sales.

I mean, their competitors, the ones that release results, are also showing pretty tepid results. So everyone is suffering from indigestion, so to speak. So where are you in your coffee intake today? Are you going to have another double espresso? Well, it's 2.28 p.m. I'm about due for my last double espresso of the day. So, yeah. This episode has been updated to reflect that the company's financial results are for the quarter ending March 31st. That's all for today, Thursday, May 9th. The Journal is a co-production of Spotify and The Wall Street Journal. Additional reporting in this episode by Heather Haddon.

Thanks for listening. See you tomorrow.