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Starbucks Faces a Trio of Growing Rivals in China

By Leo Sun – Aug 15, 2018 at 8:10PM

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The coffee chain faces competitive threats in one of its most important markets.

Starbucks (SBUX -4.44%) stock has gone nowhere over the past 12 months, thanks in part to ongoing concerns about the coffee giant's decelerating sales in China. China was once Starbucks' hottest growth market, but the region's comps fell 2% last quarter, compared to 3% growth in the second quarter and 6% growth in the first quarter.

Starbucks blamed the slowdown on a government crackdown on unapproved third-party delivery services, as well as its lack of a reliable in-house delivery option. Starbucks believes that it can fix those issues with a new partnership with Alibaba (BABA -3.11%) and the latter's delivery service.

An courier delivers Starbucks coffee.

Image source: Starbucks.

However, Starbucks seldom mentions competing coffee chains in China, which arguably represent bigger threats than rogue delivery services. Let's take a look at three rivals that could cause headaches for Starbucks in China, where it now operates more than 3,400 stores.

Luckin Coffee

In May, Beijing-based Luckin Coffee announced that it had opened 525 locations across China in less than nine months after its launch. The start-up raised $200 million during its latest funding round, which boosted its valuation to $1 billion. Luckin's top investors include private equity firm Centurium Capital and Singapore's sovereign wealth fund GIC.

Unlike Starbucks, which is rooted in brick-and-mortar stores, Luckin is built from the ground up as a digital platform. Its customers need to download its mobile app to place orders, and they can only pay through the app's digital wallet or Tencent's WeChat Pay. Nearly half of its stores are dedicated to fulfilling express deliveries.

A Luckin Coffee ad featuring Chinese actress Tang Wei.

Image source: Luckin Coffee.

Starbucks often shuns traditional ads, but Luckin plasters celebrity-sponsored ads all over major cities. Luckin's drinks are also about 20% to 30% cheaper than Starbucks' comparable drinks. Earlier this year, Luckin tried to pick a fight with Starbucks by accusing it of monopolistic behavior in an open letter -- which the coffee giant dismissed as a publicity stunt.

85°C Bakery Cafe

85°C Bakery Cafe was founded in 2003 in Taiwan, which Starbucks includes in its Greater China region. Since then, the "Starbucks of Taiwan" has opened over 1,000 locations across Taiwan, mainland China, the United States, and Australia. The vast majority of its stores -- which offer a wide range of baked goods and cheaper coffee than Starbucks -- are located in Taiwan and China.

Starbucks clearly sees 85°C as a threat, both in China and abroad. Back in 2013, it blocked the opening of an 85°C Bakery Cafe near Los Angeles, claiming that its contract with the shopping center prohibited other "espresso-based" coffee chains from being opened there.

At the time, Steve Scauzillo of the San Gabriel Valley Tribune accused Starbucks of "bullying" the chain, and declared that the coffee giant was displaying "the worst kind of corporate petulance." Despite that setback, 85°C continues to grow (with a new location in Seattle, which opened last year), and shares of its parent company, Gourmet Master, have nearly doubled over the past five years.

A cup of coffee with coffee beans in the background.

Image source: 85°C.

Costa Coffee

Whitbread's (WTB -0.77%) British coffee chain Costa Coffee was founded in 1971, the same year as Starbucks. Costa operates over 3,400 locations across 31 countries, making it the world's second-largest international coffee chain. Costa's coffee is usually slightly cheaper than Starbucks' coffee, but remains pricier than comparable drinks at Luckin or 85°C.

Like Starbucks, Costa views China as a major growth market. It currently owns over 440 stores across the country, but it plans to boost that number to 1,200 by 2022. Costa also recently bought out one of its two joint venture partners in China to tighten control over its regional expansion.

Whitbread doesn't disclose Costa's sales growth in China, but its total international sales rose 8.5% annually in fiscal 2018, and grew another 4.9% during the first quarter of fiscal 2019. To keep pace with Starbucks, Costa is also investing heavily in the expansion of its digital and delivery ecosystems.

Is Starbucks overconfident?

Starbucks' initial growth spurt in China was mostly fueled by the growth of China's middle class, a shift from tea to coffee, and the "luxury" appeal of pricier coffee. Starbucks' recent results indicate that this strategy is producing diminishing returns, yet it continues to drive the region's sales growth with new store openings -- which could backfire if those stores don't generate positive comp sales growth.

Starbucks wants to blame its problems in China on weak delivery capabilities, but growing competition is a major problem. In addition to Luckin, 85°C, and Costa, Starbucks is also competing with McDonald's McCafe and countless convenience stores offering decent coffee at much lower prices across China. Simply put, Starbucks is drowning in the market that it helped create.

Leo Sun owns shares of Tencent Holdings. The Motley Fool owns shares of and recommends Starbucks and Tencent Holdings. The Motley Fool has a disclosure policy.

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