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A little more than a week ago, Starbucks (NASDAQ: SBUX ) found itself embroiled in a major scandal in China. A Starbucks location in Hong Kong's Bank of China Tower didn't have a water source in the store, so workers were brewing coffee with water taken from a tap in a nearby bathroom. As pictures revealed, this tap was just a few feet away from a urinal. While Starbucks obviously was not using water from a toilet to brew coffee, the story quickly became known worldwide as the "toilet water" scandal.
Claims of customer mistreatment can quickly lead to a broad-based consumer backlash in China. As a result, some shareholders -- like my colleague Tamara Rutter -- have worried that Starbucks could take a big hit in China, just as Yum! Brands (NYSE: YUM ) did following revelations about abnormally high levels of antibiotics in KFC China's chickens. This would be a big loss for Starbucks, which views China as a massive growth market that will soon be second only to the U.S. in revenue.
Fortunately, Starbucks has reacted quickly to this issue and moved to repair the damage by switching to distilled water and offering an apology to customers. Just as Apple CEO Tim Cook was able to dispel a growing backlash over Chinese warranty policies a few months ago by offering an apology, Starbucks' apology and change in practices should be enough to placate its Chinese customers. Shareholders should keep an eye on the company's results in China, but there is probably no need to worry.
Backing down was the right move
Clearly, the decision to use water from a bathroom faucet for brewing "premium" beverages was a failure of common sense. While a Starbucks spokeswoman initially argued that the water from the faucet was filtered and met local and World Health Organization safety standards, that didn't appease many customers. Just as revelations about "pink slime" in ground beef grew into a nationwide scandal in the U.S. despite the product's safeness, the "toilet water" backlash showed that perception is just as important as reality for food and beverage providers. To put it another way: The customer is always right.
Fortunately, Starbucks quickly reversed course, and the president of Starbucks Asia-Pacific issued a full apology. This time, Starbucks forthrightly stated:
The water used in all beverages served at our Bank of China Tower store has always been safe for consumption, and in strict compliance with local regulatory and World Health Organization standards. However, we've always held ourselves to a higher standard in whatever we do, and we fully recognize that the location of the source was entirely unacceptable.
We sincerely apologize for failing to meet our own high standards and the high expectations of our customers.
It will take a few months to see for sure whether this apology will be sufficient to win back the trust of Chinese Starbucks customers. However, it's encouraging that Starbucks relatively quickly admitted fault. As long as none of its other locations turn out to have similar water arrangements, Starbucks has a good chance of recovering quickly from this slip-up.
Starbucks is in the midst of a major growth campaign in China and hopes to double the number of cafes it operates in the country to 1,500 by the end of 2015. If a significant number of people stay away from Starbucks after the "toilet water" scandal, it will severely crimp these expansion plans.
However, Starbucks did the right thing by immediately changing its water source and then apologizing for failing to meet its own high quality standards. Ultimately, this incident is more likely to be an unfortunate blip rather than a game-changer that destroys Starbucks' reputation in China. Starbucks shareholders should be attentive to any long-term fallout, but for now it looks like the coast is clear for Starbucks to maintain its growth trajectory in China.