Consumer Insights | Starbucks "Anti-Internal Competition": How the coffee industry is navigating through the long winter

After a long period of expansion wars and price wars, the Chinese coffee industry is about to reach a turning point.

The Political Bureau meeting first proposed to prevent "internal competition," which deserves the attention of all industry professionals and investors.

Luckin Coffee announced its latest convenient store charging rules: if a single store's gross profit exceeds 8,000 yuan, a 10% service fee will be charged.

In the latest financial report for the second quarter, Luckin Coffee's stock price plummeted by 7%. The core reason is that the growth rate of store numbers hit a two-year low on a quarter-on-quarter basis. With 1,371 new stores added in a single quarter, compared to an average of 2,500 new stores added in the previous three quarters, the growth rate was nearly halved.

Source: Luckin Coffee financial report, TF Securities Overseas

Starbucks, on the other hand, stated in its latest financial report:

"The daily and weekly sales in the Chinese market are gradually rebounding."

The operational changes of these important leading companies all indicate one signal —

"The most intense market share battle in the Chinese coffee industry is coming to an end, and Chinese consumers' confidence and demand are gradually recovering."

Performance rebounds, emphasizing strategic stability

Starbucks handed in a somewhat struggling financial report.

In the third quarter of the 2024 fiscal year, Starbucks achieved revenue of $9.11 billion, a year-on-year decrease of 1%, lower than the market's expected $9.24 billion; net profit attributable to shareholders was $1.05 billion, compared to $1.14 billion in the same period last year, a decrease of 7.8% year-on-year.

However, unlike the last time the financial report declined and the stock price plummeted by 15%, this time Starbucks' stock price unexpectedly rose by 2.65%. The divergent stock price trend reflects a change in the market's view of Starbucks.

The capital market has already seen an important industry turning point.

Source: Starbucks financial report

Although this is Starbucks' second consecutive declining financial quarter:

1. Global comparable store sales decreased by 3%;

2. Overall customer traffic decreased by 5%;

3. Comparable store sales in China decreased by 14%.

However, the total revenue in China reached $733.8 million, a 5% increase from the previous period, signaling a stabilization and rebound after hitting the bottom.

The current macroeconomic weakness in the U.S. and Chinese consumer markets remains Starbucks' biggest challenge.

For example, the second-quarter reports of major U.S. consumer companies are revealing a trend: American consumers are also starting to save money; before the interest rate cut, American consumers will still fluctuate in a weak cycle;

Just as Starbucks CEO Laxman Narasimhan said on the conference call:

"More and more consumers are choosing to buy Starbucks packaged coffee at grocery stores,

The deteriorating consumption environment is dragging down store sales."

In plain language, Americans are also tightening their belts and starting to "downgrade" their consumption The issue in the Chinese market still revolves around "consumer confidence", as people seem to be cutting back on spending to save more.

It's rare to hear consumers say "Starbucks' products are not tasty anymore" or "Starbucks' quality is poor", most people are choosing short-term alternatives "to save money".

This is reflected in the data showing a 7% decline in both average spending per customer and the number of customers - not only are people drinking less, but they are also opting for cheaper options.

Competitors are also facing the impact of the harsh winter, with Luckin Coffee achieving a 35% revenue growth in the second quarter, but a 13% decline in net profit. This has left the capital market "astonished". It also indicates that the unsustainable cash-burning expansion war will eventually backfire on the company's profits.

During the earnings call, the Co-CEO of Starbucks China, Belinda Wong, emphasized:

"In a competitive environment with frequent promotional activities, we maintain a high degree of restraint to avoid price wars."

The meaning behind the five words "avoiding price wars" is actually about insisting on not compromising quality, continuing to produce good products, and seeking innovation.

Awakening old customers, embracing new customers, and waiting for the recovery of the economy and consumer confidence.

Industry inflection point is approaching, unsustainable cash burning

There is a question that the market is concerned about, when will the endless price wars come to an end?

This answer may be revealed soon.

At the end of July, a phrase at the Political Bureau meeting was very eye-catching, marking the first appearance of an economic term in history.

"Strengthen industry self-discipline, prevent 'internal competition'."

Bai Wenxi, Vice Chairman of the China Enterprise Capital Alliance, believes that price wars can be a normal adjustment for companies based on cost reduction or market strategy. However, if the price war is purely for market share at the expense of continuously lowering prices regardless of costs, even sacrificing product quality and service, then the nature changes.

The adverse effects brought about by the "internal competition" are continuously affecting all aspects from top to bottom and deserve attention.

At the top, it affects the growth of fiscal tax revenue, impacts national financial resources, and ultimately affects government spending and the economy;

Internally, it weakens the reasonable profits of the entire industry, affects reproduction and research and development investment, and ultimately affects the quality of products and services.

At the bottom, the internal competition of price wars will eventually lead companies to cut positions and benefits, affecting the long-term development of employees.

Starbucks CEO, Nas Hahn, also expressed a similar view during the earnings call.

"Over the past year, the unprecedented store expansion in the Chinese market, and the large-scale price war at the expense of same-store sales and profitability, have also caused significant disruptions to the operating environment."

This view is also validated in Luckin's financial report. In the second quarter of this year, Luckin's operating profit was 1.051 billion yuan, with an operating profit margin of 12.5%, a 6.4% year-on-year decline. The operating profit margin of self-operated stores was 21.5%, a 7.6% year-on-year decline.

Source: Luckin Coffee Financial Report The initiator of the price war, using continuous bleeding to support the expansion strategy, is obviously unsustainable.

The coffee beverage industry, in order to pursue "high-quality development," inevitably needs reasonable and normal business profits.

To safeguard the survival and development rights of employees;

To ensure a reasonable profit margin for the industry chain;

To protect the product quality and safety of consumers.

Innovative channel strategies, huge potential in China

Starbucks China's operating indicators are gradually improving.

For example, the Starbucks Rewards Club saw a month-on-month increase of 1 million active members to 22 million, reaching a historical high, reflecting the attractiveness to new users and the appeal to loyal users;

For example, the retention rate of full-time partners in stores hit a new historical high, maintaining operational stability and high-quality treatment under industry "pressure";

For example, 213 new stores were added, bringing the total in China to 7,306, a 13% year-on-year increase. Innovative channel strategies are a significant transformation for Starbucks.

Starbucks is increasingly focusing on developing online channels. Almost every time I open a short video app, I can see Starbucks' live marketing. This is also reflected in the rapid month-on-month growth of new members in the Starbucks Rewards Club.

Starbucks is also increasing its investment in lower-tier markets, especially using AI to assist in strategic site selection. In nearly 3,000 towns in China, Starbucks is only present in 900, indicating a vast untapped market. However, the difference in the direct-operated strategic model means that Starbucks will also pay attention to the pressure and pace of capital expenditure while expanding.

The company's CFO Ruggeri said, "Today, our first-year return on investment is as high as 70%, with an average cash profit margin of over 30%, thanks to successful management of store development and operating costs, even in the current macroeconomic environment."

This is reflected in Starbucks' ambitious goals: by 2025, the number of stores in China will increase from 7,306 to 9,000, with the opening speed increasing by almost 50% in the last two quarters.

It can be inferred from this point that Starbucks China has crossed the longest winter of macro consumption and industry competition and is about to usher in a spring dawn.

In response to the intense competitive environment, Starbucks chooses to "counter internal competition."

Using innovative social media tools to reach more new users, expanding into more new markets in lower-tier regions, and further increasing user value through a combination of activities and membership systems. The consumption frequency and improvement of loyalty of the highest loyalty Gold and Diamond members, with membership sales accounting for a historical high of 75%.

This is the way of Starbucks, this is Starbucks' strong decision to face the cold winter, not compromising quality and service for a price war.

Reducing quality only requires a one-time compromise on materials, but building a brand requires decades of consistent dedication and investment to win genuine user loyalty. And this is precisely the true ace for Starbucks to cross the long winter