Starbucks China Sales Under Threat From Price War and Substitution as Local Competitor Locations SurgeAug2

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Starbucks China Sales Under Threat From Price War and Substitution as Local Competitor Locations Surge

Summary: Starbucks’s most recent earnings report showed a particularly steep drop in Chinese comparable sales. Starbucks derived about 8% of its total revenues from China in the most recently reported quarter, but an economic slowdown and fierce competition in that market have slammed the American coffee giant’s local growth. Chinese consumers are cutting back on spending while Starbucks’s top domestic competitors, including Luckin Coffee and Cotti Coffee, are selling their coffee for less than a third of price of a comparable Starbucks beverage.

China is the world’s fastest growing retail coffee market in terms of in-store orders and locations. Starbucks used to have a footprint on par with competitors like Luckin, but the latter firm is set to expand its store count to more than 3x the current number of Starbucks China locations through year-end. Luckin was recently forced to slow its breakneck expansion to avoid a second consecutive quarter of losses, but its huge presence and ability to benefit from the substitution effect may be helping it pry Chinese consumers away from more premium Starbucks offerings.

Related Stocks: Starbucks Corporation (SBUX), Luckin Coffee Inc. (LKNCY)

Shares of popular coffee chain, Starbucks, have dropped by a fifth thus far in the year-to-date period. A short-lived rebound was spurred this week when third fiscal quarter results showed profitability to be as stable as expected by Wall Street analysts. A key drag on Starbucks’s earnings was their revenue from China, which saw same-store sales tumble by -14% – doubling the slowdown witnessed in the same metric in the North American market. China has been a key growth engine for the company, which still managed to open a net 785 new stores in the world’s second-largest economy throughout fiscal 2023, but it has been plagued by fierce competition and an economic slowdown in this locale as well.

Starbucks’s Chinese operation earned $733.8 million in the quarter, an 8.1% contribution to total consolidated revenues of $9.1 billion across the company. Though that is a somewhat narrow portion of the company’s sales, the potential upside in China’s coffee market remains massive. Bloomberg notes that China has just recently become the most branded coffee shops globally with nearly 50,000 outlets, overtaking the US after a boom over the past year.

However, an economic slowdown in China has gripped consumers, slashing domestic retail sales growth to just 2% in June YoY, the weakest pace of annual growth in 18 months. Still, Circana data shows that China led overall growth in global coffee servings have weathered the slowdown, posting a 15% increase last year. That pace was triple the 5% overall rate of growth across 12 major national markets tracked by the company. That sounds great at first glance, but sustained growth in coffee sales may be partially chalked up to an ongoing price war. Starbucks’s primary competitor in China is Luckin Coffee, which sells its coffee for as low as ¥9.90 ($1.40) per cup. Nikkei Asia notes that other Chinese Starbucks competitors, including Cotti Coffee, have reduced their prices to similar levels recently.

Luckin logged more sales than Starbucks China for the first time ever last year, making the Xiamen-headquartered firm China’s largest coffee chain. While Starbucks hasn’t engaged openly in discounting to compete with low-cost comparable beverages at Luckin, Reuters has highlighted a marked increase in previously rare discount coupons being offered by Starbucks through its own mini-programs, social media, and third-party delivery apps, which have effectively reduced the actual pricing of their most commonly ordered coffee beverages by -30% without dropping their listed price. That whittles Starbucks’ roughly ¥30.00 ($4.15) per cup down to ¥21.00 ($2.90). Because it remains dedicated to demanding a large premium – even on discounted items – Starbucks will likely find itself increasingly exposed to the substitution effect if Chinese consumer spending and economic activity is further constrained.

Starbucks’s presence in China is significant at more than 7,300 stores, equivalent to about 44% of its 16,730 store footprint in the US. The Wall Street Journal notes that Starbucks and Luckin had a similar amount of domestic locations in China three years ago. Today, Luckin boasts more than 20,000 stores and will have 3x as many as Starbucks China by the end of 2024. Though Luckin’s strategy of rapid growth and low pricing is clearly meant to crowd out Starbucks’s presence, it is becoming increasingly costly to do so amid softer sales. Same-store sales at Luckin branches fell by a steep -21%, a third more than the drop Starbucks had to swallow. Despite that, Luckin bounced back from its first operating loss in nine quarters in Q1, posting a profit of more than $1.0 billion ($144.6m) in the second quarter. Luckin Coffee’s 7.4% QoQ outlet growth was its slowest since the end of 2022, suggesting that its expansion push may need to be curbed to accommodate for a weaker Chinese consumer. Average monthly transacting customers peaked at 69.7 million, which represented 16% growth from Q1, potentially a manifestation of the aforementioned substitution effect.

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