China is Starbucks' 2nd biggest market, but sales are slumping. Here's why.

• Starbucks' comparable sales in China are slumping, with a 14% drop in the most recent quarter.
• Its then-CEO put it down to weak consumer spending and a coffee store "price war" in a July investor call.
• China is Starbucks' second-biggest market but analysts question how well its format works in China.

Starbucks has been struggling in China.

Comparable store sales, a key measure for the restaurant industry, were down 14% in its most recent quarter.

China, the world's second-biggest country by population, is a crucial market for Starbucks. The coffee giant has more than 7,300 stores there, nearly 20% of its total footprint — making China its second-biggest market after only the US. It's targeting 9,000 stores by 2025.

Starbucks opened its first store in mainland China in Beijing in 1999.

Shanghai was also chosen as the location of the second Starbucks Reserve Roastery, after Seattle.

In mid-August, Starbucks named Chipotle CEO Brian Niccol as its new boss in an abrupt management shake-up. One of his key priorities could be turning around its Chinese business.

Sales slump

Starbucks' comparable store sales in China have been incredibly volatile over the past five years.

Comparable sales are determined by two components: The number of orders placed and the average order size.

In previous years, sales were massively affected by China's strict zero-COVID policy. But in recent months, they've been hit by cautious consumer spending and increased competition, then-CEO Laxman Narasimhan told investors in July.

"Unprecedented store expansion and a mass segment price war at the expense of comp and profitability have also caused significant disruptions to the operating environment," he said.

Comparable store sales have been negative for the last two quarters. In the most recent quarter, to June 30, both the comparable transaction count and average ticket size were down 7% year-over-year. The average ticket size has been steadily declining over the past two years.

In particular, fewer occasional customers have been visiting in the afternoons and evenings, Narasimhan told investors in April.

Increased competition

The rapid growth of the coffee-shop sector in China means there's simply "too much competition," Sherri He, who leads the China unit of consulting firm Kearney, told Business Insider.

She said it was Starbucks' "number one challenge" in China.

Narasimhan told investors in April that there was "fierce competition among value players" in China.

Luckin Coffee, Starbucks' biggest rival in China, has nearly three times as many stores as Starbucks in the country after monumental unit growth. Luckin was only founded in 2017 but it has more than 20,000 coffee shops, the vast majority of which are in China.

Luckin has a much broader presence across China than Starbucks, including in smaller cities, the analysts said. Nearly a quarter of Starbucks' Chinese stores are in Beijing and Shanghai, and the vast majority of its other stores are in tier one, new tier one, and tier two cities, according to a Bank of America report from April.

Other major competitors in China include Cotti Coffee, McDonald's McCafe, and KFC's KCoffee.

Not all Chinese consumers want the Starbucks experience

Coffee is "still a growing habit" in China, Dave Xie, a partner at Oliver Wyman focusing on consumer goods and retail, said. "Lots of consumers just drink tea."

And when they do go to a coffee shop, they generally care much more about the product than the experience, Xie said.

"Starbucks is a consumer-centric company, but for Luckin it's really product-centric," Xie said. Luckin has a "very rapid product innovation cycle" with much more frequent launches than Starbucks, he said.

The Chinese coffee chains are much more "agile" at adapting to trends and cater more closely to the flavors favored by Chinese consumers, He, the Kearney partner, said. This includes Luckin's focus on sweet and milky beverages, with a brown sugar boba latte and a hugely popular coconut latte that accounts for 70% of sales at some stores, Bloomberg reported.

Xie said that Starbucks' "third place" model — the idea that it's an alternative space to work and home for people to spend time — had worked in 2017 and 2018, when people were more willing to pay for premium products, but that this was no longer the case. Luckin, in comparison, has smaller-format stores with less seating and a focus on automation and standardization, he said.

Starbucks executives have repeatedly told investors that its premium positioning in China is a crucial part of its strategy. But because of this, Starbucks is limiting its potential customer base.

Starbucks is "not targeting the mass but the middle class," in particular white-collar professionals, He said.

Starbucks typically charges between 30 and 40 yuan ($4.20 to $5.60) for a 16-ounce drink, including Americanos, flat whites, flavored lattes, teas, and Frappuccinos, according to its website. In contrast, Luckin often has promotions that discount it down to 10 yuan a cup ($1.40), He said.

"We're not interested in entering the price war," Starbucks China CEO Belinda Wong told investors in January. "It is our aim to be the best and lead in the premium market."

But Reuters reported in May that Starbucks had significantly increased its use of discounting in China to compete with local rivals. Wong acknowledged in January that Starbucks' use of promotional offers in China had led to lower average check sizes.

Economic growth is slowing, and consumer spending is growing more cautious

China's economic growth has slowed. It grew just 4.7% year-over-year in the second quarter of 2024, missing forecasts.

"China's obviously a tough market, and it's not just Starbucks," Brian Yarbrough, a restaurant analyst at Edward Jones, told BI.

Luckin's same-store sales were down more than 20% in its two most recent quarters.

Consumers are "increasingly rational and pragmatic," Xie said. This makes the price gap between coffee chains an even "bigger challenge" for Starbucks, He said.

Starbucks remains optimistic

Starbucks executives say the chain is focused on its long-term plan in China.

Narasimhan said in January that Starbucks was focused on offering more coffee-forward, locally-relevant products in China and opening stores in smaller cities "where we see meaningfully stronger new store economics."

He noted that the company was "well on track" to meet its 2025 target of 9,000 stores in China.

Starbucks added more than 800 new Chinese stores in the year to June 30. The chain has continued to grow in China "in the hope that there's some market shakeout," but in the short term, "it's a pretty tough road that they're going through right now," Andy Barish, an analyst at Jefferies, said.