Starbucks bets on China's new social mobility

Wednesday, November 29, 2006

By Janet Adamy in Shanghai, The Wall Street Journal

To make Chinese people familiar with Starbucks coffee, barista Stephanie Chen pours customers a 30-milliliter sample and invites them to join her for a tasting. Then she blurts out the first thing that comes to mind when the brew hits her palate.

"Dry land," Ms. Chen declared recently after slurping a robust blend from a tiny white cup. "In the west in China, it is always hot and dry and it reminds me of those places."

Ms. Chen's tastings are an important part of Starbucks Corp.'s plans for global growth. The Seattle company aims to one day have thousands of stores here, eventually making China its largest market outside the U.S.

But Starbucks faces a big obstacle as it goes after the market here: Most of China's 1.3 billion people don't care for the chain's signature product. In tea-drinking China, coffee has such a narrow following that until recently many Starbucks here didn't brew drip coffee unless a customer ordered it.

Starbucks is betting that a new generation of Chinese with growing spending power and an appetite for high-status brands will flock to its stores because Starbucks embodies China's new sophistication.

"Coffee represents the change," says Wang Jinlong, president of Starbucks Greater China, while sitting at a riverside Starbucks here on a hot afternoon. The patio was packed with young adults fidgeting with cellphones as they sipped lattes and Frappuccinos topped with whipped cream. "The disposable income is concentrated on the young people and this is the place they want to come."

Starbucks's strategy in China points to a dilemma facing many Western companies who covet the nation's huge market: Should they change their offerings -- or attempt to change Chinese tastes?

So far, most of the company's plan has involved the latter. Starbucks is hoping to draw Chinese customers first by offering a new type of informal gathering place. Once patrons are inside, their coffee education begins. The chain stacks cream-and-sugar counters with brochures titled "Coffee Brewing Wisdom" and others that answer questions like "What is espresso?" Workers float through stores passing out small cups of pumpkin spice latte and other drinks.

Some of the most successful Western companies pushing into China have tailored their products to suit locals. Yum Brands Inc., owner of KFC, the largest restaurant chain in China, is starting a Chinese fast-food chain to sell noodles and rice. General Motors Corp. has restyled a Cadillac for China. The model has a more luxurious back seat given that many affluent Chinese have their own drivers.

Whether Starbucks succeeds in China will also be an important barometer of social and economic change. A 480-milliliter latte -- what Starbucks calls a "grande" -- costs about $3.50 in Shanghai, a luxury considering the average income in this city is about $3,800 a year. Despite the steep price, Starbucks's ability to charge a premium has been a critical component of the chain's overall success. Rather than lower drink prices, then, executives say they are considering making certain food items less expensive as a way to attract more customers.

Starbucks faces competition from a new generation of Chinese teahouses that offer both traditional beverages and a coffeehouse culture. The chain also has to navigate lots of pesky roadblocks. Financial regulations prevent the chain from offering a Starbucks payment card. If Starbucks wants to tinker with its offerings, adding white-chocolate mocha drinks in China, for instance, it has to get government approval to import the flavoring.

Starbucks is relying on Mr. Wang to smooth over these hurdles. The Beijing native worked for the Chinese government in the early 1980s and helped it form its first partnerships with overseas auto makers before joining Starbucks in 1992, when it had 120 U.S. stores. He left the company in 2000 to return to China, then rejoined Starbucks in 2005 to lay plans for its Chinese expansion.

Mr. Wang has a different strategy than the one Starbucks has used to blanket the U.S. Instead of enticing customers with coffee, he wants to make the gathering-place element of Starbucks the initial draw, particularly because living spaces are small here and people need a place to congregate.

Most of Starbucks's 436 locations in mainland China, Taiwan and Hong Kong offer more food and seating than in the U.S. About 90 percent of orders are consumed inside the store. The U.S. average is about 20 percent, Starbucks says. Crowds peak in Chinese Starbucks during the afternoon. Mornings are so slow that employees spend them restacking displays of coffee mugs.

Stores sell green-tea cheesecake and Chinese moon cakes, traditional pastries served during the Mid-Autumn Festival. The drink menu is anchored by the same coffee-based beverages as in the U.S., and tea plays only a minor role on store menus.

Competitors consider the drink strategy a weakness given the distinct palate of the Chinese. "They will enjoy tea more than coffee," says Garvin Lau, a general manager for Real Brewed Tea, which has about 100 new-age teahouses in China that attract the same young clientele as Starbucks. The stores sell basic tea drinks for as little as $1.75 each.

Real Brewed Tea aims to be "the Starbucks of tea," Mr. Lau says. It has carefully studied the Seattle chain. Real Brewed Tea's stylish locations have high ceilings, bright green chairs and menus that tell customers the chain is "determined to become a lifestyle."

Other multinationals are also betting coffee will catch on with upper-income Chinese. Sara Lee Corp. recently began selling its Senseo coffee machine, a high-end home brewer, for about $100 in Chinese retail outlets.

Starbucks's success could hinge on attracting what Mr. Wang calls the "little emperors." China's one-child rule created a generation of individuals who have been pampered by parents and grandparents and have the means to make indulgent purchases. Instead of believing in collective goals, these young people embrace Starbucks's ethos of individuality that the coffeehouse perpetuates through customized drinks, personalized service and unique music, Mr. Wang says.

"Their view of this world is very different," Mr. Wang, 49 years old, says. "They have never gone through the hardships of our generation."

The son of textile-factory workers, Mr. Wang grew up in Beijing during the Cultural Revolution, when millions were sent to villages to perform manual labor. He was assigned to teach English, and then to work for the Chinese government after he finished college. The government sent him to law school in the U.S. to help China better understand American law.

After he graduated from Columbia University's law school in 1988, Mr. Wang planned to work in the U.S. for a year and return to China. But the Tiananmen Square protest crackdown rattled the country. He moved to Seattle and took a job at the law firm Preston Gates & Ellis.

In 1992, Starbucks hired him to start its legal department in the U.S., and four years later, he helped open its first stores overseas in Japan. Then Starbucks started looking at China.

The company surveyed Chinese consumers and came up with a list of the top 20 reasons they visit cafes. Coffee-drinking ranked sixth. Consumers said the No. 1 reason they go to cafes is to have a place to gather.

Executives didn't think the coffee part stood in their way. They hoped the appeal of the brand and experience of sitting inside Starbucks would be enough to draw Chinese. Many of Starbucks's espresso drinks are so heavily sweetened they don't taste like coffee, and some Frappuccinos don't contain any coffee. In 1999, Starbucks opened its first China store in Beijing's China World Trade Center.

Expansion was slow. Government regulations forced Starbucks and other international retailers to open stores through partnerships with local firms. Starbucks left many of the operating details to the partners and told them to call if they needed anything, executives say.

Hsu Ta-Lin, chairman of H&Q Asia Pacific, which invested in Starbucks' first stores in Beijing, says that after the first year, he "certainly did not have the feeling this was going to be a resounding success," and remained concerned that drink prices were too high.

By then, Mr. Wang was restless to return to China. He had promised his Chinese wife he would take her back home. In 2000, he left Starbucks and moved to Hong Kong, then Shanghai. He was so bored he says he felt physically sick. So he volunteered his expertise to a chain of convenience stores -- his way, he says, of helping to create something new for China.

Meanwhile, he kept his eye on Starbucks. He saw Chinese businesses, including a dairy company, growing faster than the coffee chain. The government had installed new regulations that promised to make it easier for multinationals like Starbucks to expand without local partners. On visits back to Seattle, Mr. Wang met with Starbucks Chairman Howard Schultz and urged him to move more quickly. "In China, there's only one speed: faster," Mr. Wang told Mr. Schultz, both men recall.

"I knew he was right but we didn't have the right people," Mr. Schultz says. Late last year, Mr. Wang came back to Starbucks to lead the expansion.

Mr. Wang overhauled the company's growth strategy to focus more on adding stores in China's metropolises instead of entering a lots of new cities.

To build a coffee culture in China, Starbucks has begun with its employees. Many of them had tasted only instant coffee, the most common variety in China, before joining the company. On a recent morning at Starbucks Shanghai headquarters, workers gathered in the lobby and divided into teams for a coffee-tasting competition. They sipped two samples of coffee and guessed which country it came from and its level of acidity. Some workers wrinkled their noses at the taste.

They also hold more formal tastings for customers, like the ones Ms. Chen performs at her Shanghai store. After she pours samples, she tells patrons to smell, then sip the coffee and describe how it makes them feel. Ms. Chen tells customers that it is good for them to drink coffee in the morning. If customers don't like the coffee samples, workers encourage them to come back for another tasting, or offer them a different drink to get them on the "coffee journey," says store manager Bruce Yin.

On a warm summer evening at a Starbucks in downtown Shanghai, customers lined up at the counter to order mango Frappuccinos, fruit and vegetable cups and blueberry cheesecake. Warren Guo, a 30-year-old who works in foreign trade, sat on the patio and shared a piece of cheesecake with his friend David Wang, 35, who also works in foreign trade. Mr. Guo says he doesn't like coffee but comes to Starbucks because there are "many girls."

Fang Sun Yan sipped a latte with whipped cream on the patio while checking her cellphone for messages. The 23-year-old runway model started coming to Starbucks to meet friends. Now she says she has grown "a little bit addicted" to coffee and visits as often as three times a week.

Mr. Wang concedes that coffee culture has caught on faster than coffee itself in China. But Starbucks's sweeter beverages, like flavored lattes and Frappuccinos, are becoming popular. One of the best-selling Starbucks drinks in China is the caramel macchiato, made with espresso, milk and caramel flavoring topped with whipped cream and caramel sauce. It costs about $4 for a grande size.

China's tightly regulated business environment still throws up lots of hurdles for Starbucks. Its fragmented government and currency-conversion limits make banking difficult. "If I want to move money out of China, it's a hellish process," says Charles Jemley, Starbucks vice president of finance in China. Book bags and coffee mugs barely made it out of customs in time for Starbucks to pass them out at a rural teacher-training session it sponsored. Poor water quality in some cities means Starbucks has to install elaborate filtering systems.

Starbucks won't disclose sales or profit details for its China stores. The company cites its expansion in Japan as proof it can carve out a market in a tea-drinking country -- even though the chain has struggled to expand sales there. Starbucks does say China stores have lower sales than U.S. stores. That is offset by cheaper labor and other lower operating costs. Though it declines to provide China-specific details, Starbucks says it plans to eventually have 20,000 locations overseas -- with a substantial portion of those in China, says Martin Coles, president of Starbucks Coffee International.

Competitors say Starbucks doesn't have a wide enough audience to expand significantly in China. Be for Time Tea House has 160 locations in China including many near universities with signs written in English. It offers unlimited drinks for $2.25 to appeal to customers who spend hours smoking, playing poker and celebrating birthdays.

"The really big population comes here," says Chen Yong Hua, who runs a Shanghai Be for Time that is decorated with mismatched wicker chairs and faded Hollywood movie posters. He says Chinese prefer a noisy place like his cafe instead of Starbucks's serene atmosphere because "it makes you feel warm." His most popular drinks are orange juice and bubble tea, a sweet beverage with chewy pearl-shaped bits that customers slurp through a straw.

Mr. Wang says he doesn't think Starbucks's prices are too high for China. Many customers use Starbucks as a cheaper alternative to gathering for a meal or for business meetings. "Customers really perceive our coffee has the value for their money," he says.

On a recent morning, Guo Shi Yuan, a 48-year-old Buddhist monk dressed in a gold robe, ordered a cup of black tea and sat at a downtown Shanghai Starbucks. He had traveled from his nearby mountain village by train to meet another monk to discuss their faith.

"I come here because I prefer the environment more than the coffee," Mr. Guo said while music by Marvin Gaye played in the background. "It makes people feel comfortable."