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Costa Coffee’s plan to conquer the dragon

From the July 2015 issue.

Costa Coffee’s Managing Director of Asia tells GCR Magazine about ambitious expansion plans in the world's most sought-after market.

Patience may not be a word one would immediately associate with Costa Coffee. The company’s track record for growth has quickly propelled it to become the second largest coffee chain in the world.

However, it’s a strategy the United Kingdom-based company hopes will help it reach an ambitious set of goals for expansion in a fellow tea-drinking nation.

Costa announced plans to nearly triple its locations in China to 900 stores by 2020, after reporting impressive corporate sales growth of 17.9 per cent to US$1.45 billion as of the financial year to 26 February.

It also aims to increase stores in the UK from 1931 to 2500, and double the Costa Enterprises business in the same period, which includes self-serve coffee bars, both in the UK and internationally.

While the Whitbread-owned coffee chain has already been in China several years with mixed success, Costa Managing Director of Asia Esteban Liang tells GCR Magazine that perseverance will be key to achieving its goals.

“We are here for the long term,” he says. “I think it’s important when you are talking about the Chinese market.”

But while the chain is optimistic about growth in a market brimming with potential, experts and analysts are divided on how quickly it will see a return on investment.

Changing the fabric of society

A lot has changed in the coffee industry since Costa was created in London in 1971 by two brothers, Sérgio and Bruno Costa, who sold their specialty blend to a handful of caterers.

From the time they opened their first shop, the company has swiftly become the largest and fastest-growing coffee chain in what is now one of the most successful sectors in the UK economy.

According to Allegra Strategies, which produces detailed research on the coffee market, Costa has 46.5 per cent of Britain’s coffee shop market. United States-owned Starbucks Coffee Company is its closest competitor in the country, claiming a relatively meagre 27 per cent. Costa’s home-grown success is evidence of a new trend changing the way a nation of tea drinkers has come to drink coffee.

But Britons aren’t actually drinking more coffee. In fact, consumption levels today are lower than they were in 2006.

At 2.8 kilograms per head, its consumption is a fraction of Germany at 7 kilograms, Sweden at 7.1 kilograms, and France at 5.5 kilograms.

According Jeffrey Young, Managing Director of Allegra Strategies, there are several reasons the coffee shop industry is thriving in the UK.

“It’s very much replacement of instant coffee and an increase of coffee instances out of home, which is driven by more outlets,” he tells GCR Magazine. “Also the environments are much more inviting … spaces that people want to spend more time in.”

The growing popularity of cafés is quickly replacing pubs as choice venues for social gatherings, and Young believes the UK market is far from saturated. With sales growth of approximately 10 per cent per year, both in terms of coffee shops and express locations, he says Costa is well positioned for success.

“Costa is outperforming the UK market,” he says. “It’s growing faster than everyone else.”

Other analysts, however, were more reserved in their optimism about the company’s expansion efforts. Panmure Gordon Analyst Anna Barnfather agrees that while there is plenty room for potential, the number of competitors stepping up their game in the UK may pose a future threat to success.

“We are concerned about the rate of growth because the competition is stepping up,” she says. She explains that Starbucks is gaining momentum in the UK, and Caffè Nero also has an ambitious growth plan.

Scratching the surface of opportunity

The UK isn’t the only tea-drinking nation in the midst of a café revolution.

The International Coffee Organisation (ICO) estimates coffee consumption in China was approximately 1.9 million bags in 2013-14, and has been growing at some 15 per cent annually over the past 10 years.

“China is a country that has undergone incredible economic transformation in the past few decades,” Chief Executive Robério Oliveira Silva tells GCR Magazine. “The boom in [China’s] economy, the growth of a middle class with disposable incomes, and the growth in competition between coffee companies for Chinese customers have contributed greatly to the increase in consumption.”

But coffee isn’t the only thing Chinese consumers are getting a taste for. Analysts say that as Chinese consumers start acquiring a taste for coffee, it will evolve to the type of specialty drinks available in Western style cafés, such as Starbucks’ beloved Frappuccino line of frozen coffee beverages.

Furthermore, like their counterparts in the UK, a growing number of customers are steering towards coffee shops for social gatherings.

“It’s not just about coffee consumption, it’s about the social change,” says Barnfather. “It’s about wanting to go sit and dwell in a café.”

The increasing popularity of coffee and café culture in China has several international players setting their sights in Asia. While the US’ Starbucks is leading the pack, China has proved a tougher market for Costa to crack.

It has grown to nearly 350 locations since it first stepped foot in China in 2007, but its presence has been met with mixed success, with some locations even closing.

“We’ve been disappointed in the rate of growth because [Costa has] been [in China] more than five years and they don’t seem to be getting the model of the formula right,” says Barnfather.

She believes this is a large part of why the company’s future growth probably won’t live up to its hype: “They do have very attractive long- term growth, but I think it’s not as exceptional as some market commentators have calculated.”

She explains that international expansion is not profitable because the company is building scale, and worries the UK concept is not so easily exported into the Chinese market.

“It’s about getting critical mass and scale, and it’s about adapting the product on offer and branding behind it to suit Chinese consumer tastes,” she says. 

According to Costa Coffee’s Liang, however, the company’s most successful locations have proved there is definitely an appetite for what Costa has to offer. He says its locations in some of China’s largest cities, such as Beijing and Shanghai, have seen the most success due to a concentration of younger, more urban audiences who are open to new experiences and Western influence.

“We have those customers who really want to try coffee,” he says.

It’s a lesson the company is definitely taking into consideration as part of its future growth strategy. Liang said the company will concentrate on setting up its new shops mostly in 13 main cities within the next few years.

“I think the potential of growth in China is huge,” he tells GCR. “If we want to reach meaningful numbers ... we have to explore into other cities as well.”

Battle of the brands

While Costa has proved that it understands its target audience in the UK, the question now is: how will it stand out and make its brand relevant in a budding new market?

“I think the market is really huge,” says Liang. He explains that while competitors such as Starbucks and Korean-style coffee shops also have their sights on expansion, there is more than enough room for everyone.

“I think we have to stay true to our values, and we will have our customers,” he says. “I think China is big enough to house several international coffee brands and local ones as well. I think we have a winning formula.”

ICO certainly lends credibility to this insight. As the 17th largest coffee consumer in the world with a population of 1.4 billion people, China’s per capita consumption is just 83 grams, or 5 to 6 cups per year, and growing.

And while instant coffee makes up approximately 99 per cent of retail sales, coffee chains are helping fresh roasted coffee grow at a faster rate.

“The rising popularity of coffee shops and coffee culture in general is promoting growth in fresh roast and ground coffee,” says the ICO’s Silva. “As disposable incomes rise, consumers tend to ‘trade up’ to a more premium product.”

With hopes these consumers will trade up to its brand, Liang believes Costa’s handcrafted coffee is one of the key differentiating points that sets it apart from competition.

“I think it’s the quality of coffee ... but then it’s also the environment and, of course, the service,” he says. “I think if we manage to have these three things in place, we will be very competitive in the Chinese market.”

Allegra Strategies’ Young echoes this enthusiasm.

“I think there is room for a variety of brands targeting different customers,” he says. “We don’t see any issue with expansion in China. It’s a market with lots of growth potential. I think as the second largest player in world … they are well positioned to make it a success in China.”

Up for the challenge

Shortly before revealing Costa’s ambitious expansion goals, Whitbread Chief Executive Andy Harrison announced he would be leaving the company to take over as Chairman of home retailer Dunelm in July.

Harrison will definitely be a tough act to follow. In the past five years, the company’s revenues have grown 13 per cent per year, driving a 17 per cent per annum growth in its earnings per share, which has increased the company’s market capitalisation from US$3.8 billion to $14.9 billion. Whitbread Chairman Richard Baker, who is leading the succession process, is confident the company will being able to keep delivering a strong performance.

“Whitbread has gone from strength to strength under Andy’s leadership, delivering consistent rapid and profitable growth built around our strong brands and the company’s unique culture,” said Baker in a media release last April.

“Whitbread has a clear strategy, ambitious growth milestones, and the strength of leadership to successfully deliver these goals.”

Despite market shares taking a drop after Harrison’s announcement, analysts don’t believe his departure will affect any fundamental changes in Costa’s growth plans.

“I don’t think it has much impact on the strategy going forward,” says Barnfather. “I think the Costa team is very autonomous in creating the right strategy for Costa Coffee,” says Young. “I don’t expect the next person is going to come along and mess with it.”

But while full of optimism for the UK coffee shop phenomenon, with a consistent growth path over the past 10 years, Allegra Strategies’ Young cautions it’s not time to rest on their laurels.

“There is no room for complacency because consumers are becoming more savvy,” he says. “The vibrancy of the coffee scene in Britain is rising up a notch every year … Costa has to keep developing and keep innovating to stay ahead in the chain side of the market.” GCR

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