India's coffee king

From selling plain vanilla coffee beans and bags for years and years, VG Siddhartha ventured into the café business some 20 years ago. As India’s consumption story blossomed, Siddhartha’s Café Coffee Day became a popular meeting place for professionals and a cool hangout for teenagers. From nothing, Café Coffee Day today has 1,500 cafés across the country serving 200,000 cups of coffee every hour. That translates into ₹1,400 crore in revenues for his diversified group, which is into financial services, software and logistics. Having conquered India, Siddhartha wants to grow his enterprise into one of the top café chains in the world. That dream is worth a few billions, but before getting there, he has to deal with Starbucks and a multitude of other global players on his home turf. As Coffee Day Enterprises waits in the wings to hit the public market, chairman Siddhartha talks to Outlook Business in an exclusive interview about his strategy to deal with competition and to propel growth.

Café Coffee Day has managed to move from the commodity business to setting up a café business and you have grown quite rapidly since the time you started. While the strategy is bang on, the execution is still a work in progress.

In this process of evolution, I would be kidding myself if I said I have got it 100% right. I come from a financial services background without any knowledge of branding. Getting into the coffee business was just a fluke. We started off with exporting coffee and realised two years later that it would not take us too far.

My role model is a company called Tchibo in Germany (a chain of coffee retailers and cafes). I remember reading about them in 1994 and I was taken aback. Tchibo started in a 10x10 store in 1949. I was inspired by that and started with 20 stores in South India selling coffee powder. In 1995, we decided to take the café route since there was a bigger opportunity for value addition here. In the coffee powder business, the markup is 100%, while in the café business it is as much as 800-900%.

My colleagues in marketing did not think it was such a great idea. We looked at how other brands internationally built the business and that is how we learnt. We have got only 70% of it right, although we have done a good job with our new outlets, which are as good as any international cafe. When we came to Mumbai 14 years ago, we put up small stores because we were not sure if the market was ready and also the rentals were too high. Had we opened 1,500 square feet-stores in Mumbai at that time, we would have gone bankrupt.

Our key competitor at that time was paying 70% of revenue only towards rent. That strategy clearly did not work well for them. Now the market has changed. You will see a lot of changes in our stores over the next three years. From the bean to the cup, we do not have any middlemen. We are a 19-year-old start-up with an ambition of being among the top brands globally in the coffee retail business.

Yes, I agree with you, we have to improve, although you must also look at the great American brands and how they were placed when they were 20-years-old.

A bane for retail business in India is high lease rentals. How do you keep that cost down and give your outlets a better chance to be profitable?

We have five-seven corporate relationships where we only have revenue-sharing agreements. For them, CCD becomes a complementary service. This is the case with highway petrol pumps,for instance, where levels of hygiene have improved since they house our outlet. Of our outlets, 25% operate on a revenue-share model.

Who do you see as competition?

Our focus is on beverages. The way we see it, there is only one competitor in this market. Our price point and the higher price point are completely different. If multinationals are looking at 3% of India, we are looking at 30%. Over the last three years, as our cafes got better, we witnessed a tremendous increase in footfalls.

As a customer, there is a great level of inconsistency across outlets and that is worrying. In Mumbai, this inconsistency is around the ambience of the stores, the taste of coffee, availability of food and service standards.

Over the last year and a half, we are doing a lot to improve the customer experience. Initially, our staff was trained for just six days. Today also we do that, but a month later, we train them again for another ten days. For someone earning ₹10,000 per month in Mumbai and having to travel two hours to work, quality of manpower is always a tricky issue. However, training can make things better.

Currently, we have a training school where 500 people are trained each year. This is in Bengaluru and we will have three more. They will be training them for three months. The government is spending money on youth empowerment too. If we increase our training programme from six days to three months, the quality will improve tremendously.

Speaking of ambience and hygiene, there were a lot of stores that were opened in 1999 without a washroom. That time, as I said, it did not make sense to put up large outlets. However, over the past one year and a half, in Mumbai alone, we have opened 20 stores of over 1,000 square feet each. These stores have a better ambience. That is why I said earlier that we are only 70% there. This business is not rocket science. We realise we have made mistakes and will rectify that.

Fixing manpower is one thing but inventory management in food is not easy. How do you tackle that? Also, how will you maintain consistency in the quality of beverages served?

Two years ago, food was bought from 210 vendors and today, there are just four. Today, the bread comes in and we just put the filling before it goes through the cold chain. Three years ago, there was no cold chain. I think our food quality has become better, but there is more scope for improvement.

As for coffee, a lot of companies have technology for mechanised brewing. Ours is handcrafted coffee, which probably makes it inconsistent. We can manufacture our own machines and that can be done when we think we need to. That can be done in a little over a year’s time.

We have 1,545 stores and 600 small kiosks. In the last four years, we are the only ones who have had same-store growth. If our quality was not up to the mark, this would not have been possible.

You have multiple formats and multiple price points which is a great strategy, but where do you see growth coming from?

When we entered the business in 1996, we thought India will take 15 stores and Bengaluru can take three stores. Of the 2,000 café outlets, we have 1,545.

We are not in the value segment. I would like to believe we are the third place—when you do not want to meet someone at office or home, you visit us. You don’t call people to a QSR. The Snapdeal founder told me recently he went to one of my Delhi outlets 45 times to discuss an investment. Our café becomes a meeting place and that is really why 60% of our income comes from beverages. Food is complementary and we will do things like serving a cookie with a cappuccino. We want to keep that 60% intact. Food will never exceed 40% of our revenue.

And then, we have 137 stores on India’s highways. We have a washroom, kids can have a clean ice-based drink and so on, which people really value. The way I see it, India can have thousands of stores on the highways at our price point. On the Kanyakumari-Madurai highway, we have two stores; between Goa and Mangalore, we have three stores. That is a very small number.

In three-five years, we will see students and small businesses using these cafes so much more because internet connectivity will come free. It will be possible to have a meeting.

Today’s youngsters are willing to spend unlike us. We have sold 1.3 billion cups of coffee and tea this year and every hour we sell two lakh cups. In the last five years, we have grown 30% in that business. Last year, we sold 18 truckloads of sugar sachets.

We want to be one of the top coffee brands globally. We can build a business that can deliver value in the long term. This is only the beginning of the dream and our growth story.

One would imagine internet should have been offered ahead of Starbucks' entry.

4G is where the game will be. If we had done something last year, we would have been stuck with the service provider. I have been visiting a coffee shop in Singapore since 1994 and by 9 pm, it would be dead. I was there four months ago,along with a colleague and we counted, there were 63 people who visited around that time to drink a coffee or eat a pastry. They were all working. I see this in Bengaluru too. Youngsters would like to come and use the internet. We just have to get it right on pricing.

You shut down 175 stores last year. That is a huge number. What went wrong?

We will put up 135 stores every year and will close 10-20 stores. In Mumbai, we took 400 square feet stores 10-12 years which do not make that much sense today. Ahead of the listing, we wanted to do a one-time clean up.

Has finance been a constraint in refurbishing stores given that you have ₹2,800 crore in debt?

That is a wrong perception. We have one listed company in our portfolio, Sical Logistics, where we hold 53%. It has debt of ₹800 crore and assets worth ₹2,000 crore. It has nothing to do with our balance sheet except that we own 53%.

Another company is Tanglin Developments, which is a SEZ business that builds office space and leases it to companies. Overall, it has four million square feet and a rental income of ₹120 crore. That company has a debt of ₹800 crore and has a 135-acre park. This means you have to knock off a total debt of ₹1,600 crore.

The holding company has a debt of ₹1,000 crore, which will be down to ₹500 crore. In the coffee retail business, we have a net debt of only ₹300 crore, of which we will repay ₹125 crore and be left with ₹175 crore.

We have ₹2,000 crore worth of stock in Mindtree and ₹500 crore in Sical Logistics. Just the dividend from these two companies is enough to take care of the ₹500 crore debt.

The reason for the ₹1,000 crore-debt in the holding company was because we needed money to buy over the shareholders — Sequoia Capital and Goldman Sachs — in the retail business. Another ₹200 crore was borrowed to buy Mindtree shares. In that sense, if we sell the Mindtree shares, we are a debt-free company. We do not want to do that as it has given a 40% return for the last 16 years.

Why are you bringing the consolidated entity to the public market? Would it not have made more sense to list only the coffee business?

When private equity came into our company five years ago, they fundamentally liked the retail brand. The fact is 34% of my company is owned by investors. When they came to me, barely 15% of the value was in the non-coffee business. Today, the other businesses have grown beyond our expectation, and the valuation of the listed stock we hold itself is ₹2,500 crore.

Our overall valuation has increased three times since the last round of funding and that is because we have grown in the last five years. Last year, our revenue was ₹1,432 crore in the coffee business and we can grow by 18-20% from here. We sell 100 million cups of coffee and tea to corporate India every month. That is not a small number. We will keep growing.

We are committing that the IPO proceeds will go into the retail coffee business and to clear debt in the holding company. That debt again was raised to buy retail coffee interests from other shareholders. There will be no capital allocated from the holding company to the other businesses.

In the consumer and retail sector, companies make losses for several years before they come to an inflection point from where cash starts gushing in disproportionately. As a company, where are you on that curve?

This year we should make a profit. Last year, we had an Ebitda of ₹199 crore and from that level, we can grow at 15-20% each year. Before competition came in, we were sure we had to be at 1,500 stores. In the last five years, we put in 180-200 stores each year and that takes 18-24 months to mature. Besides, depreciation on that also hits you. Speaking of Ebitda, it is futuristic and I cannot speak much. I would think India will have 5,000 stores over the next five years.Going by what I have been reading, India will be a $65 trillion economy by 2050. If the economy can grow 30 times, well-managed companies can do much better.

Starbucks in Japan has exhibited some flexibility when it comes to pricing. At some point, they will look to expand in a big way in India by having smaller outlets and lower prices as well...

We have four price points today. For instance, what we charge in Marine Drive will be different from what we charge in Navi Mumbai. Where we are sitting right now (the Square format) is comparable to any international format. Our regular stores are very different. We are 57% cheaper than competition. Will they reduce prices by 40% and still be able to pay rentals at those prices?

Did Starbucks ever offer to buy you out?

I do not think money can buy over people with passion. We have 13,500 people working for this brand. Yes, we also have attrition, though employees at above-the-store level have stayed with us. At the top level, we have 700 people with an attrition of not more than 5-6%. In 15 years, we will be a brand that India will be proud of. We have one store at Prague railway station (there are 14 in the city), which is a 150-year-old heritage building. Indians visit this store often and are constantly clicking pictures of themselves there. As Indians travel abroad, they will build this brand.