Chinese Discontent Only Minor Setback in Starbucks Growth Potential

It may have been a mistake for Starbucks (SBUX) to open its store in Beijing's Forbidden City. This issue has attracted media attention and Chinese citizen discontent ever since the shop opened in 2000. Last week this issue reached a new height when Mr. Jiang Hongbin, a lawmaker representing the Heilingjiang province, submitted a motion to the National People's Congress to close the outlet immediately.

The Forbidden City was the Chinese imperial palace during the mid-Ming and the Qing Dynasties. The palace was "forbidden" in the sense that, apart from members of the imperial household, no one could enter it without the Emperor's permission. Today it has transformed into a museum and a popular tourist spot, attracting 7 million local Chinese and overseas visitors each year.

The discontent of the Chinese is a cultural issue; it’s about invasion of Chinese culture by western culture, and about how Starbucks doesn’t fit into the environment of the Forbidden City.

Starbucks obviously understands the importance of respecting local culture when doing business in China. In 2006 it has appointed Dr. Eden Woon as Vice President of Government Affairs, Public Relations & Corporate Social Responsibility for Greater China. Dr. Woon was previously CEO of the Hong Kong General Chamber of Commerce, which has played a key role in working on the closer integration of Hong Kong's economy with that of China. Prior to that he was Executive Director of the Washington State China Relations Council and has spent 22 years with the U.S. Government. I found his appointment to be a very good move for Starbucks, as it’s important to pick someone who can lobby the Chinese government and at the same time get the Chinese message back to corporate America.

Starbucks share price has recently reached its 52-week low, but it’s not because of this Forbidden City issue; rather it’s due to its decreasing same-store sales growth figures and a recent Chairman memo.

China is a top priority for Starbucks for its future revenue growth as stated by its Chairman. Yum! Brand (YUM) is operating 1822 KFC and 254 Pizza Hut in China, its China division has contributed ~18% of company profit in 2006. McDonald (MCD) also has 764 restaurants in this fast growing country and is still rapidly expanding. If Starbucks plays the cultural game right, with its current 240 outlets already established in the country, it is very likely that Mr. Howard Schultz’s Chinese dream will come true in a not too distant future.

If you haven’t got a chance to visit China, please don’t under-estimate the Chinese domestic spending power. I used to visit this Starbucks in Beijing daily when I worked in the capital city. Based on my observations I can tell you over that 90% of its visitors are local Chinese and they spend almost the same amount of money for the same cup of coffee as that is charged in Seattle. That’s where the growth potential is coming from.

What’s the harm in shutting down one store (out of the current 240) in the Forbidden City if the Chinese government would allow you to open another thousand in other Chinese locations? As an investor I only look at growth potential and I see the recent weakness as a good bargain potential.

Disclosure of interest: I have a LONG position in SBUX.

Comments

[All Roads]

Siwei,

As someone who frequents Starbucks on a daily basis in Shanghai, I would say that the trend has not changed. there are now 6 Starbucks on Nanjing Road, and business is very good right now.. and primarily rooted in local Chinese consumers (I would wonder what number are returning vs. first and only timers).

one thing I would point out with regard to the Forbidden City is that they have enjoyed 7 years business in that store, and that in and of itself proves that the decision to move in there was the right one. Sure, there have been some flare-ups, and it may be time to go now, however 7 years in a single location is very respectable in the retail world... and even more so when you have hundreds of thousands of people walking by on a daily basis.

No doubt, the Asia market as a whole is one that Starbucks views at strategically very important, and I will be interested to see how the recent flare-up plays out. It may fizzle, it may lead to the shop being closed, but I do not think that it will have a long term impact unless something drastic happens.

[Mike Spencer]

I'm living in Hong Kong and frequently travel to Guandzhou, Shenzhen, etc. and I can tell you that the main problem Starbucks is facing here in Southern China is that there isn't enough places to sit. I constantly see Chinese customers enter stores and leave immediatly because they cannot find a place. Anyone in America couldn't believe such a thing as there are SO MANY Starbucks there.

But I have to say that Starbucks Management is failing miserably to capture this huge opportunity to offer a great experience to brand new customers in China. The experience here is in fact totally unpleasant and I can feel that many Chinese people are not willing to stick to the brand as a result.

Starbucks should definitey consider firing some of the Senior Management crew responsible for the Chinese market.

[John Chan]

Hi Mike,

I totally agree with you, SBUX shall have good chance if they DO EXECUTE correctly.

A friend of mine just asked me after reading my article about whether he should pick SBUX or YUM if he is to choose one, and my answer is YUM.

Even from public domain it is easy to collect enough evidence that YUM is doing better than SBUX at the moment. Just read the followinig 2 presentations from YUM, at least I do NOT see something similar from SBUX.

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I wrote this story mainly because I was triggered by the Forbidden City new, I recommend SBUX just because I think it is a good opportunity to buy as it's close to 52-weeks low, I may have to mention that I am BETTING on a good execution of its China strategy. Of course we shall NEVER buy a stock JUST becasue it's at its 52-week low as it can plummet further if it doesn't have good fundamentals. To this point I do think SBUX is a strong brand within and outside of US.

Mike if you live in HK you shall have visited Pacific Coffee here. (I'm based in HK) Interesting I recently have a chance (in fact a rare chance) to talk to the major shareholder of that company (he sold his shares to Chevailer, a HK listed company). From the conversation he further confirmed to me the opportunity and profitability running such a business in HK and China.

In fact I am planning to write something on YUM, just I don't find something particularly interesting related to China yet.....

[Siwei Zhong]

sorry that I was using my friend's computer , the above 'John Chan' comment is in fact from me.

[Dan Harris]

I completely agree. Starbucks is dead serious about China and it is doing nearly everything right there. I dropped three cups in one in Shanghai and they were immediately replaced. Hell, I could have been at my regular store in Seattle (the U Village one that is always neck and neck with one in Tokyo for highest sales), it was handled so smoothly. Starbucks in China will do just fine.


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