About 14 years ago, I met an entrepreneur who wanted to open up coffee shops around China. I never thought the coffee business would work there. The Chinese would not easily give up their tea-drinking culture for a bitter, overpriced drink, I told him.
Starbucks has proven me wrong. Howard Schultz, the CEO of Starbucks (SBUX), announced that China will soon become its largest market outside the United States. It has opened over 500 outlets in the country, which are more profitable per outlet than in the U.S. even though sales per outlet lags its U.S. counterparts considerably, according to the chain's chief financial officer, Troy Alstead.
What did Starbucks do to succeed in a market where so many other Western food and beverage brands such as Dunkin Donuts, Krispy Kreme, and Burger King have failed to live up to their own expectations?
What Starbucks did right in China is a textbook case study in how food brands can succeed despite rising labor and real estate costs and increased competition on the Mainland.
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Instead of trying to force onto the market the same products that work in the U.S., such as whip cream-covered frozen coffee concoctions, Starbucks developed flavors, such as green tea-flavored coffee drinks, that appeal to local tastes. Rather than pushing take-out orders, which account for the majority of American sales, Starbucks adapted to local consumer wants and promoted dine-in service.
By offering comfortable environments in a market where few restaurants had air conditioning in the late 1990s, Starbucks become a defacto meeting place for executives as well as for the gathering of friends. In other words, Starbucks adapted its business model specifically for the Chinese, rather than trying to transplant everything that worked in America into China, as so many brands such as Best Buy and Home Depot have done. Such approaches often proved shortsighted and ill-fated.
The challenge with pushing dine-in service in large, comfortable outlets rather than take out is that revenue per square meter is less than in the U.S. The average revenue per outlet in China is one third to two thirds of what it is in the U.S., according to Alstead, the CFO.
Starbucks offset the relative lack of revenue in China's outlets by positioning the company and its products as aspirational purchases. The average coffee sold in China is far more expensive than in the U.S.
Carrying a Starbucks cup is seen as a status symbol, a way to demonstrate sophistication and the capability to afford a personal luxury for the up-and-coming middle class in China.
Starbuck's high pricing strategy of specialty drinks allows it to have its Chinese outlets be more profitable per store in China despite the lower sales volume. Overall in Asia, its operating margins are 34.6% in 2011 versus 21.8% in the United States. Too many brands are willing to push for market share by cutting prices in China. In reality, they should aim for fatter margins.
Not only does Starbuck's premium pricing strategy fit market demands but it also allows it to regularly roll out higher-margin specialty products, such as gift sets that offset rising commodity costs. If you think Starbucks is pricey here, imagine what you'd pay in Shanghai. Still, it will be an ongoing juggling act for Starbucks. As China's urbanization rate nears 52%, Starbucks and other companies there need to implement strategies to offset the impact of rising commodity costs.
Meantime, Starbucks has done an amazing job at recruiting, retaining, and training employees. Annual turnover rates 30% or higher are common in China, according to data compiled by my firm. Yet, Starbucks has far lower turnover than the industry average by offering good compensation packages, work environments, and career paths.
One barista who has been working at Starbucks for five years told me, "I feel taken care of by management. I enjoy my job and I enjoy working here so I expect to stay longer." That is a rare comment in a country where job hopping is the norm among younger workers.
Starbucks' service is on par if not higher than many five-star hotels. In interviews with several hundred consumers in Shanghai, the majority of them told my firm they actually preferred the taste of products from competitors but continued to go to Starbucks because of the service.
Far too many multinational companies treat their Chinese employees as second-class citizens with little career development. Their senior management ranks are full of foreigners, Taiwanese or Hong Kongers without any mainland Chinese representation.
Starbucks understood that the value proposition it was offering Chinese was different than in the U.S. They were able to adapt their business model to fit China while keeping their core values. So far, it's working pretty well.