China Consumer

Selling a lifestyle

Why Starbucks can afford to raise prices in China

Selling a lifestyle

A sippable status symbol

Back in 2008, Starbucks in the US spilled the business beans rather embarassingly, closing 600 stores in acknowledgement that the company had expanded too aggressively. Part of the problem was store density, with rival outlets cannibalising one another’s business. Another issue was store location, with too many subprime locations where locals weren’t prepared to pay Starbucks prices.

How might these lessons apply in China, where the plan is to reach 1,500 stores by 2015, three times the current level?

In density terms Starbucks has plenty of scope for new store openings and the company is already reaching out beyond places like Shanghai and Beijing, by pushing its presence to smaller cities like Langfang in Hebei province.

Of course, not everyone is going to be able to afford a latte in Langfang, where per capita GDP hovers slightly above $3,000 a year. Clearly Starbucks bosses believe that demand in Langfang will be strong enough to sustain the new outlet. And there is similar confidence for China in general, with the coffee chain announcing in late January that it plans to raise prices nationally because of higher operating costs. All coffee drinks will increase by Rmb2 ($0.32, or about 10%).

“We understand this has an impact on our consumers,” acknowledged Caren Li, a Starbucks spokeswoman, adding that the increases reflect a combination of higher wages, increasing commodity prices and rising real estate costs.

The top-up adds to prices that are already higher than their equivalents in the US. As a benchmark, a tall latte now costs $4.20 in Beijing versus $2.85 in New York, which sounds odd given that most operating costs should be lower in China.

Still, industry observers reckon the increase will do little to dent the popularity of Starbucks in China, where it recently opened store number 500 (located in Beijing).

“I see little or no impact to Starbucks sales,” says Doug Young, on his Business Blog. “In fact, I could even see the opposite, with even more consumers flocking to Starbucks for coffee in order to show the world that higher prices won’t deter them from pursuing the yuppie lifestyle that Starbucks represents.”

It helps that Chinese customers come to Starbucks in search of more than a hot drink. Sipping on a Starbucks cup is seen as a status symbol, and proof of a sophisticated lifestyle. Consumers are willing to pay a premium, regardless of changes in price, says Zou Deiqiang, a professor studying consumer behaviour at Fudan University. That’s because the value they derive from such goods contains intangible elements that are not easily quantifiable. “A lot of people can’t really tell good coffee from bad,” Zou told the China Daily. “If they hold paper cups with a Starbucks logo, it gives them the illusion that they live better than those who don’t drink Starbucks.”

Localisation has also been important. Although some industry insiders say Starbucks has taken longer than companies like Yum Brands to tailor its offering to a Chinese audience, it has now begun to offer a wider range of drinks. Tea is at the forefront, says Shaun Rein of China Market Research Group, recognising the country’s tea-drinking culture.

There are other differences in the China operating model. Starbucks has noticed that about 90% of orders are consumed on the premises (the US average is about 20%). So it has been offering more in-store food and seating options than in other markets.

The caveat to less take-away business is that revenue per square metre is significantly lower than in North America. Troy Alstead, Starbucks’ chief financial officer, told analysts that sales per outlet is at least a third lower in China. But Starbucks manages to offset some of the shortfall by charging more. Although the chain generates a lower volume of sales per store in China, its outlets are usually more profitable than those in its home market. Operating margins in Asia (the financial data isn’t broken down by region) were 34.6% in 2011 versus 21.8% in the US.

As long as customers in Langfang are ready to pay more than those in Los Angeles, the China growth strategy will likely prosper.

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