Is Starbucks Making the Same Expansion Mistake Twice? (SBUX, MCD)

Does the US consumers’ taste for coffee translate well into Chinese? It looks like Starbucks Corp. (NASDAQ: SBUX) is determined to find out. Sales and profits have picked up in the last year or so, as Starbucks has closed stores, fired staff, and raised prices. Competition has been stiff, especially from McDonald’s Corp. (NYSE :MCD), which offers low-priced specialty coffee drinks. Starbucks has continued to prosper through that, and now the company thinks it is time to expand again.
Starbucks CEO and founder, Howard Schultz, was in China to open a coffee farm and, according to Bloomberg News,  he said that the company’s “ability to navigate through the financial crisis and come out much stronger gives us reason to start growing the company again.” Schultz plans to open 500 stores in the company’s 2011 fiscal year, which began in October. Of those, 400 will be outside the US.
Schultz also predicted that China will be Starbucks’s highest growth market in two years. Starbucks operates 400 stores in China, where all coffee sales grew by 9% last year, to about $700 million, according to research firm Euromonitor International cited by The Wall Street Journal. Having cut about $600 million in operating costs since 2008, Starbucks has felt the effects of the modest economic recovery as customers returned to its stores. Even the premium pricing has not kept them away.
In China, Starbucks plans to open 1,000 more stores in the next few years. The coffee farm that is being developed will offer Starbucks a ready supply of beans beginning in 2014, helping the company keep a lid on the rising price of coffee worldwide. China’s annual per capita coffee consumption is an anemic 22 grams, compared with Japan’s 3.3 kilograms. There is a lot of room for growth there.
In Starbucks’s favor is its industry-leading 69.8% market share. The rising middle class tide is expected to put a lot more cash in a lot more Chinese pockets over the next 10 years. Combining its market share leadership with more stores ought to give Starbucks a good return.
But its not a slam-dunk. There’s no guarantee that the new middle class will want to spend $5 for a tall skinny latte. And while it’s unlikely that the Chinese economy will collapse, inflation is becoming a bigger issue in the country and if the government decides to try to stamp it out, the new middle class will feel the pressure and, like their American counterparts in 2008, will likely give up the pricey coffee. Expensive coffee drinks are a luxury.
The opportunity for growth in China is real, as Schultz and Starbucks know. That does not mean that it will be easy. The Chinese market is no secret to competitors, either. McDonald’s and privately held Dunkin’ Donuts aren’t sitting on their hands.
And Starbucks doesn’t seem to have the same size plans it once did. In 2008 the company opened 1,669 stores. In 2009 it closed 45, and in its 2010 fiscal year it opened just 223. Going to 500 new stores in 2011 shows some restraint. Whether it’s enough to show profit and revenue growth going forward is the key.
Paul Ausick