China’s Coffee Industry is Brewing
In a nation of avid tea drinkers, coffee continues to gain ground.
By Nathan Barlow
Oct. 9 – Coffee first made its initial appearance in China when a French missionary in the 1890s planted beans throughout Yunnan Province. Over the next hundred years, coffee would go largely unnoticed but, as is the case with many things in China, the market has changed quite a bit over the last 20 years.
This is part one of a three-part series detailing various facets of China’s coffee industry. Part two, dealing with coffee trade in China, can be found here while part three, dealing with domestic production, can be found here.
China on the World Coffee Stage
China is far from being the world’s biggest coffee market. The United States is the world’s largest coffee market in terms of total consumption and value totaling in excess of US$30 billion yearly. The average American consumes an estimated 441 cups yearly, while the Finns and Norwegians both consume over 1,000 cups annually on average. By comparison, the average Chinese person consumes just four cups of coffee annually.
However, there is some good news: China’s coffee market has grown by an estimated 10-15 percent annually in comparison to the worldwide average of just 2 percent over the past decade. In 2006, coffee consumption in China was roughly 45,000 tons, and some analysts predict this number could reach 300,000 tons annually by 2020.
The Old Timers
The arrival of Swiss company Nestlé to China in 1990 followed by Seattle-based coffee giant Starbucks arriving in 1999 greatly exposed modern China to a wide array of coffees from around the world. However, while both foreign companies have been (and still are) immensely successful in the Chinese coffee market, they have targeted distinctly different market segments.
For instance, instant coffee accounts for upwards of 80 percent of all coffee consumption in China – of which Nestlé controls 75 percent. Instant coffee’s characteristics are inexpensive, convenient and lower quality coffee. Given the average Chinese consumer’s limited prior interaction with coffee, this has proven to be a highly effective method of widespread affordable consumption.
Starbucks, however, has taken a different approach and targets the upper income level Chinese with beverages costing up to 50 percent more than their U.S.-based counterpart products. Most Starbucks beverages in China will cost upwards of 30RMB (or about US$5). In contrast, Nestlé’s Nescafé instant coffee can cost as little as RMB1.5 (US$0.10) per packet.
Despite Starbucks’ especially high costs in China, the company has thrived and continues to expand. Specifically, the brand intends to open 1,500 stores in China by 2015, currently opening an estimated one store per day.
In 2011, a Starbucks outlet in China averaged US$600,000 in annual revenues. Furthermore, Starbucks’ Chinese outlets are more profitable, with China/Asia Pacific operating margins in the last quarter of 2012 at 33.7 percent in comparison to 20.8 percent in the United States.
Also, to no surprise, Shanghai is currently the coffee culture capital of China – boasting over 100 total Starbucks outlets, the highest average annual coffee consumption levels per person, and a prominent café culture.
“It’s no doubt that one day China will become our second largest market after the United States, and it’s possible that, over many years, potentially the largest one,” Starbucks CEO Howard Schultz recently told the China Daily.
While Nestlé and Starbucks had radically different methods for getting the Chinese to drink coffee, both have succeeded. This success in part can be attributed to their recognition of the Chinese as unique consumers with different tastes and habits than those of American or European consumers.
These coffee pioneers recognized that Chinese consumers did not like the bitter taste associated with black coffee or espresso, and have tailored their beverages accordingly. For example, Nestlé’s Nescafé packets include sugar and powdered milk, and Starbucks emphasizes milk-based drinks like frappucinos, lattes and mochas in their China practice.
In addition, Starbucks has gone the extra mile and localized their outlets by emphasizing large seating areas since Chinese tend to not like to take their drinks to go. Local Chinese customers now value the “Starbucks experience” – i.e. preferring to sit with friends and have something to eat with their coffee. Starbucks’ Chinese menus also reflect local flavor, with choices like green tea tiramisu and Chinese moon cakes available at their stores.
The Scramble for China
In 2010, Starbucks ruled Chinese coffee sales with a 66 percent market share in the coffee retail sector. While Starbucks maintains the standard for coffee sellers in China, new forces in the coffee retail space have recently emerged in the form of coffee chains and numerous independent cafes.
British coffee chain Costa Coffee entered China in 2006 and currently has over 250 stores in China with the goal of a total of 500 stores by 2016 – accounting for 8.9 percent of the coffee retail market.
On the other hand, global fast food giant McDonald’s boasts over 1,400 outlets and has successfully introduced its McCafe coffee shop concept in hundreds of its locations throughout China, with plans for a total of 750 locations by the end of this year.
Further, Taiwanese bakery/café chain 85 Degrees has penetrated the market with a total of 350 stores throughout China and plans to add another 100 stores by 2017. 85 Degrees stores offer not just coffee-based beverages at lower prices than the typical coffee shop, but also freshly baked breads and pastries – something Chinese consumers commonly pair with their coffee.
Hong Kong-based Pacific Coffee is also looking to expand into China. In 2010, China Resources Enterprise (CRE) acquired 80 percent of the company and has one ambitious goal: to open 1,000 coffee shops in China. CRE has a retail network of over 4,000 multi-format stores throughout China, and the company hopes that this will provide Pacific Coffee with a competitive advantage to steal away a considerable market share.
CRE GM Joyce Chan has said: “Our goal is to become the number one coffee house in China.”
Cafés Sprouting Up throughout China
According to market research firm Mintel, the number of cafés in China has doubled from 15,898 to 31,283 between 2007-2012, demonstrating the rapidly increasing coffee consumption levels of the Chinese domestic market. One interesting factor at play, however, is that many Chinese coffee drinkers place greater value on the experience and environment these cafes provide, rather than on the quality of the coffee itself.
For instance, popular coffee blog “Crop to Cup” has written: “Café owners concentrate on the romantic origin of the beans instead of their quality or flavor… it all plays into a romantic image of the old-world European roaster. [And] China loves it.”
Given the average Chinese consumer’s lack of experience with coffee and limited knowledge on varying coffee quality, cafés often use this method to increase their appeal. That being said, some cafés, especially in China’s first tier cities such as Shanghai and Beijing, have started to recognize that a certain market of Chinese consumers are beginning to demand higher quality coffee. These cafés have even begun to offer more specialty coffees of a higher quality – paying close attention to the beans’ specific place of origin, roasting the beans locally on premises, and offering a variety of brewing methods. These specialty coffee retailers not only provide a product of the highest quality, but can also offer an educational consumer experience.
Shanghai-based Seesaw Café emphasizes the education of its consumers through owner Tom Zong’s business model. With a bar layout designed to look like a stage, curious customers can come in to watch the baristas “perform.” In addition, Seesaw Café has an impressive on-site facility known as the “coffee academy” which functions as a comprehensive barista training program that also hosts classes open to the public.
In a similar tale, Nils Weisensee, owner of Shanghai-based Café del Volcán, initially intended to set up a testing space for customers to taste their coffee with the hope of eventually creating a home-delivery coffee service. However, his shop has grown to become one of Shanghai’s most popular coffee retail outlets.
Nils shared a unique situation that he experienced the first few days his café opened – they had not displayed any prices, as they intended to give away the coffee for free (unbeknown to the customer). Yet despite no knowledge regarding price of the product, customers ordered their beverages regardless and only very few inquired about prices. Therefore, Nils learnt early on that the majority of his customers were not price sensitive; rather they simply sought out the best coffee in Shanghai with little attention to price. This has allowed the café to focus primarily on achieving the highest level of quality and service.
Coffee Roasting, Retail and Wholesale
The roasting process is a vital step in achieving high quality coffee – which was, unfortunately, a step that was largely absent in China until recently. The first premium coffee roaster in China was Arabica Roasters (established in 1994) which continues to provide high quality roasted coffee today. However, in recent years, numerous foreign and domestic companies have entered the coffee roasting market to service the wholesale and retail markets.
In Shanghai alone, a number of coffee roasters have sprung up in recent years such as DTS8, Jonas Emil, Render Coffee, Sumerian Coffee, V. Coffee and Yomo, among others.
Adam McLean of Shanghai-based Sumerian Coffee Roasters spoke with me about the challenges of roasting high quality coffee in China, noting lack of education and knowledge. McLean also commented on the difficulty in convincing a hotel or restaurant that their coffee’s quality is important, which would allow them to reap further benefits as their customers would likely appreciate their experience more.
How to Open a Franchise in China
With the Chinese economy still steadily improving, franchising offers foreign businesses a low-cost, rapid growth model that provides easy access to the country’s expanding consumer market and second-tier cities. Further, franchising enables for faster brand recognition, which may draw in consumers that see large brand name chains as being more reliable.
Fueling the growth of franchising in China is changing customer attitudes (a desire for faster, trendier and more convenient lifestyles), an increasing number of entrepreneurs willing to adopt the franchising model, and an increase in the number of Chinese entrepreneurs who want to be franchisers of foreign brands.
In order to operate under a franchising model in China, the most typical structure is through a foreign invested commercial enterprise (FICE) – which is a business entity that allows for foreign investors to trade and sell to the domestic Chinese market. For more information regarding setting up a franchise and the difference between a cross-border/local legal entity franchise, you can contact the experts at Dezan Shira & Associates.
Dezan Shira & Associates is a specialist foreign direct investment practice providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.
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