For All the Coffee in China

By William J. Holstein

When Ming Cui, a 55-year-old consultant, travels to central Beijing for business meetings from his home in the suburbs, he doesn't look to tea for an early morning pick-me-up. Instead, he grabs a cup of coffee—a habit he first developed while living in New York—and luckily for him, he now has many options to choose from.

Starbucks today has more than 90 outlets in the Chinese capital alone, making it Cui's most convenient choice. But in his opinion, Costa Coffee, a unit of Britain's Whitbread PLC, has a better brew, so he favors it—even though the chain has fewer outlets and higher prices. Still another option for Cui is Pacific Coffee, a Hong Kong-based company that operates shops in Beijing and across China in a partnership with a major Chinese state company called China Resources Enterprise, Ltd.

It's essential to buy a cup of coffee from one of these companies before a meeting, says Cui. "If you like coffee," he says, "you have to bring your own, because most Chinese offices will offer you only tea or water." Cui also hits the coffee shops to use their Wi-Fi and sometimes hang out with friends. "They tend to be crowded and noisy, so you don't have your formal meetings there," he adds.

Coffee's Western Allure

Coffee has arrived in China, historically a nation of avid tea drinkers. The trend has been gathering momentum for more than a decade, and now Chinese consumers in more than 50 cities—not just Beijing and Shanghai—can get a jolt of joe at coffee houses, often with Western brand names. U.S. companies such as McDonald's and KFC, a unit of Yum Brands, Inc., have vast presences in China, and also sell coffee. In fact, McDonald's ranks second in total coffee sold here after Starbucks, thanks to the popularity of its McCafé specialty coffee shops, says Euromonitor International, an independent strategy research firm that focuses on consumer markets.

Other channels for coffee have also sprouted up: Nestlé, based in Switzerland, sells its popular Nespresso single-serve coffee machines and pods through high-end boutiques in urban areas. The Chinese buy coffee beans for home consumption over the Internet, and many, like Cui, also pick up beans while on trips to places like Hong Kong and New York. Overall, Euromonitor estimates that total coffee consumption grew by 9 percent in volume in 2011, and will continue to grow at about the same rate for years to come.

The coffee phenomenon has attracted the attention of China experts, both personally and professionally. "When I go to China, I'm always trying to find caffeine to get through the jet lag," says Jeffrey Wasserstrom, author of China in the 21st Century: What Everyone Needs To Know. Wasserstrom, who is also chairman of the history department at the University of California at Irvine, says the Chinese consumption of coffee is a "marker of modernity or sophistication." The brew, he says, is "something you drink to demonstrate a connection to the global world."

The Rising Consumption of Coffee in China The symbolic meaning of coffee varies within China, he notes. In Shanghai, which had extensive contact with the West in the 1920s and 1930s, coffee shops display black and white or sepia pictures of that era, marketing the nostalgia of a bygone period. Beijing did not have as large a foreign presence, and so coffee connotes something slightly different there. "It represents a new stage of globalization," Wasserstrom suggests.

It's not likely that coffee will ever fully replace tea in the hearts—or mouths—of the 1.3 billion Chinese. They still consume larger quantities of tea, and the Western coffee chains have adjusted their menus to reflect that. Costa, for example, offers Mandarin Iced Green Tea in China, along with their usual lattes and cappuccinos.

And coffee drinking is still largely an urban, middle-class phenomenon popular with those in their 20s to 40s. That means most of the 600 million Chinese living outside major cities have not been exposed to coffee-drinking culture at all, nor have most of the older Chinese who still frequent tea houses. And the under-20 crowd is still more likely to consume Coca-Cola.

The Starbucks Phenomenon

The coffee trend started in earnest in 1999 when Starbucks opened its first retail outlet in the Chaoyang district of Beijing, on the Third Ring Road near the China World Trade Center. It targeted mostly expatriate foreigners working in the trade center, but then Chinese who were exposed to foreigners started sampling the beverage, and the habit quickly spread. Chinese shops began to compete against Starbucks, often using green, circular logos in their front windows like that of the Seattle-based company. As one might expect, Starbucks was not happy about having its intellectual property rights violated and has tried to have the perpetrators shut down via the Chinese court system. Such copycatting continues to be a constant irritant for Starbucks.

Starbucks found itself at the eye of a political storm in the summer of 2007 over an outlet they had next to the Forbidden City—the vast, sprawling complex overlooking Tiananmen Square that once housed China's emperors. Chinese officials alleged that the Starbucks shop was commercializing Chinese culture. Starbucks closed that store, but it has kept up a relentless pace of openings.

The Rising Consumption of Coffee in China Today the company has 577 outlets in 48 Chinese cities, including about 250 that are operated as part of a Starbucks-branded joint venture with Taiwan-based Uni-President Group, mostly in the Shanghai area. In 2011, the company says it opened one store every four days on average, and it expects to have 1,500 outlets by 2015 in China, which will surpass Canada as the company's second largest market after the U.S. The Chinese market has proven to be quite profitable for Starbucks, as well—the company says comparable store sales have grown by more than 20 percent for seven quarters, and the stores enjoy a healthy profit margin of 28.1 percent.

Seeking to insinuate itself more deeply into the Chinese mindset, Starbucks has struck a deal to secure a supply of coffee beans grown in southwestern Yunnan Province, which borders Vietnam and Laos. It was during the French occupation of Indochina that the French encouraged locals to start growing coffee beans here. Now Starbucks promotes the fact that Chinese coffee grown in China is available in its stores in Beijing and elsewhere. "It makes the product seem less completely foreign while still having a foreign caché to it," says Wasserstrom. Some coffee retailers also have started buying beans from sunny Hainan Island (located off the mainland coast in the South China Sea), where huaqiao (or, Chinese returning from overseas) brought the practice with them. Hainan-grown coffee is sometimes mixed with coconut powder, for a distinctly South Seas taste.

Despite the unpredictability of China's economy and the country's fluctuating attitudes toward the West, it's universally expected that Chinese coffee consumption will continue to grow. More and more people are expected to move to large cities and take office jobs that pay well by Chinese standards. These Chinese have more leisure time and should find it attractive to socialize with friends after work in coffee houses, rather than in tiny private homes or apartments. The competition for their business will be intense—McDonald's, for example, plans to open a store every day over the next three to four years, and many of them will contain McCafés within them, according to Euromonitor. And while it's anyone's guess which players will emerge on top, one thing is fairly certain: in China, coffee is here to stay.

William J. Holstein, a former Hong Kong-based reporter for United Press International, is an award-winning writer who has spent 30 years specializing in global business issues, including innovation, organizational transformation, competitiveness, and governance. His books include "The Next American Economy"; "Why GM Matters: Inside the Race to Transform an American Icon"; and "The Japanese Power Game: What It Means to America."

The following securities were not held by the T. Rowe Price New Horizons Fund, the T. Rowe Price Small-Cap Stock Fund, or the T. Rowe Price Value Fund as of June 30, 2012: Starbucks, McDonald's, KFC, Nestlé, Whitbread, Pacific Coffee, China Resources Enterprise, Uni-President Group. The funds' portfolio holdings are historical and subject to change. This material should not be deemed a recommendation to buy or sell any of the securities mentioned.

T. Rowe Price and William J. Holstein are not affiliated.

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