CHIYANG ZHANG
Stakeholders expect the rapid expansion of China’s retail cafes to continue, but a successful outcome is not certain.
By Dan Bolton
Coffee went unnoticed for a century after arriving in China in the 1890s. Tea-loving Chinese today still drink less than 2% of the world’s coffee, but the eyes of the industry are turned to what may become the most dynamic coffee market on earth.
Chinese consumers new to coffee find the aroma of freshly roasted coffee strange and the brew bitter. Noting these concerns, when Nestlé first began operations in 1990 it packaged its Nescafé brand of instant coffee with sugar and powdered creamer. Folgers and Maxwell House quickly followed and by 1999, when Starbucks opened its first cafe, there were enough curious locals to build on that success. Chinese consumers still prefer milk-based, sweetened, and flavored brew ― but now they pay top dollar. (See pg 55 China’s Contempory Coffee Scene)
Due to the pace of coffee shop openings, it is now possible in every major city to order a single-origin, custom roast, pour-over ― the hallmark of third-wave shops.
Domestic consumption tripled to 3.2 million 60-kilo bags in China during the past four years, according to a study published in June by the US Department of Agriculture (USDA). Imports of roast and ground coffee have increased from 79,000 bags in 2012/13 to an estimated 800,000 bags in 2017 and consumption of instant coffee will top 1.5 million bags. In Yunnan, the arabica harvest is projected at 2.2 million 60-kilo bags for 2017/18.
Samuel Eli Gurel, processing expert and instructor at Torch Coffee, says that tea and coffee are in real competition. “Tea is primarily drunk as a beverage while coffee is primarily consumed for some other purpose,” he says. Coffee shops are a social scene where young coffee drinkers shoot selfies; and they are a business office away from the office. They are also a place to relax for mothers and a study hall for students, and a familiar stop for tourists. China is embracing the idea of a “third space,” perhaps not as readily as the west but “travelers notice the sprouting of locally branded cafes. If a Starbucks store is not available to fulfill the desire for premium coffee… then a local equivalent would be happy to fill its shoes,” writes analyst Alt Perspective on the Seeking Alpha blog.
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This explains why the number of cafes grew from a handful to 75,000 during the period 1990-2012 and doubled to 130,000 in the five years that followed.
A striking trajectory is evident. In urban areas coffee sales have skyrocketed, increasing by 10% to 15% per year for the past two decades. Shanghai-based China Market Research Group predicts coffee consumption there will grow about 20% annually as the relatively well-off shift their spending from material goods to experiences such as coffee drinking. Coffee may be king in the Americas where it generated an estimated $74 billion in 2015, but the Chinese market is enormous ― potentially worth more than a hundred billion. Analysts predict China could consume 300,000 metric tons annually by 2020 making it the largest coffee market in the world.
Starbucks certainly sees an opportunity. In July, the company acquired the remaining 50% of its East China joint venture in a transaction valued at $1.3 billion. It is the largest single acquisition in the company’s history. It brings Starbucks control to 1,300 stores in 25 cities in affluent Shanghai and Jiangsu and Zhejiang provinces. Starbucks, with 25,734 stores globally, operates 3,000 stores in 130 Chinese cities and employs 40,000 workers. The company announced it will open 500 new shops a year with a goal of 5,000 stores by 2021.
Not a sure bet
Dave Seminsky has been working in coffee in China for 10 years. His Shanghai coffee shop, which sources coffee locally and offers top quality beans from around the world, is a haven for enthusiasts. The Sumerian brand he launched in 2011 is doing just fine. China’s coffee sector has attracted a lot of attention worldwide, he explains.
“In tier 1 cities, specialty coffee has flourished but even the best Starbucks locations make only $15,000 per week (compared to an average $31,000 per store in the US),” according to Seminsky. “Disposable income is climbing... but the average consumer is broke, they make $3,365 per year. That doesn’t equate to a $4-$6 daily Unicorn Frappuccino,” he said. By his count “there are 261 million people in China with an annual income of $6,220 who could occasionally or routinely afford premium coffee,” he said. There is a clear trend toward quality:
“Last year South America accounted for 10% of coffee imports; Africa 6%, and Central America 3%. Comparing 2016 to the proceeding five years from 2011, those three origins picked up a combined market share of 12% illustrating a sizable shift towards more premium quality coffee,” he said.
“In 2011, prior to opening my coffee business, I looked to Japan to see if I could find guidance towards potential in China. I was overwhelmed with what I found,” he said.
Japan is a traditional tea market often cited for developing a vibrant coffee culture. Consumption increased 800% following the introduction of instant coffee by western multinationals. Coffee production is non-existent yet Japanese drinkers averaged 11.13 cups per week in 2015, according to the Japan Coffee Association. Per capita consumption is 207 cups compared to 369 cups per person in the US (2014). China’s per capita average is less than 4 cups per year. In Japan, the trend is toward greater variety and taste with sales of fresh coffee climbing to 155 billion yen ($1.4 billion) at the expense of instant. Nestlé Japan holds a 34% share of the total market and 60% share of the instant coffee segment, according to Euromonitor International.
“It is hard to dismiss the similarities contributing to the rise of coffee in Japan to the current transformation China is undergoing,” concludes Seminski: “Now the bad news, it took nearly 40 years for coffee to be a broadly distributed product in Japan. China is also a giant land mass relative to Japan which could slow progress. Good news is, if China can match Japan’s consumption that equates to 88 million 60-kilo bags,” he said.
Beginning in 2004 China went from consuming 386,000 60-kilo bags of coffee to 1.9 million bags in 10 years, a 489% increase. “That means in another 10 years it could increase another five times,” says Gurel. “Right now, according to USDA, China is the ninth largest consumer of coffee in the world. A five-times increase will make it the fourth largest coffee market in the world, behind only the European Union, the US, and Brazil.”
Coffee shop density
The fortune tellers are convincing, but careful analysis of coffee economics raises questions as to whether current consumption trends can be sustained.
Shanghai is home to 4,509 cafes, Beijing has 3,489, and Chengdu 3,051. First-tier cities average a coffee shop for every 6,000 residents. Chengdu, with a population of 14.4 million, has a shop for every 4,729 residents. New York City, in contrast, has 8,692 coffee shops, an average of 102 per 100,000 residents (about 1 shop for every 1,000 residents). New York, however, attracts 600,000 commuters a day. The challenge for China is that Americans each drink 400 cups of coffee per year – the Chinese average four cups.
In his April presentation “Dissecting the China Coffee Market” at the Specialty Coffee Association’s annual convention in Seattle, Gurel cautioned that in China exceeding a ratio of 1:20,000 people, at 3 cups per person is unwise. “The market is saturated at that point, making it difficult for individual cafes to sell the minimum 400,000 cups of coffee per year,” he said.
Alan V. Alabastro
President of China visit to U.S. Seattle, WA. Howard Shultz, Starbucks.
There are 1,692 coffee shops in Seattle, the fastest growing major city in America and the city with the greatest density of coffee shops in the US at 253 shops per 100,000 residents (one shop for every 400 residents). Ten American cities, mainly in the northern reaches of the country, average more than 100 shops per 100,000 residents but this average quickly falls outside the most populous cities. Seattle coffee shops serve a much larger metropolitan area that houses 3.7 million people and those coffee drinkers consume 100 times more coffee than the Chinese average.
Euromonitor estimates the market size for coffee served in Chinese cafes reached 20 billion yuan ($2.9 billion) in 2016. About three-fourths of café sales are by Starbucks, which charges a premium price that exceeds the same drink when priced in the US. McDonald’s has not fared nearly as well. The company sold 80% of its business in mainland China and Hong Kong to Chinese owners who embraced the McCafe concept at 2,640 locations with plans to expand in the country’s mid-sized cities.
Gurel cites a recently completed market survey by the Sustainable Coffee Institute to illustrate the retail segment’s vulnerability. When asked to rate cafe performance, 44% of respondents indicated an increase in performance while 37% indicated a decrease in performance with 19% indicating that performance is flat. Rent on the average 1,950 sq. ft. (182 m2) shop is the biggest strain, cited by 32% of respondents. This is probably because shops are selling an average of only 34 kilos of coffee per month.