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Soumik Kar

Lead Story

Smelling the coffee
Why Starbucks is taking a measured approach to expansion of its coffeehouse chain in the country

Krishna Gopalan

"We believe in our strength to redefine the café market in India by offering consumers the highest quality coffeehouse experience" —AVANI DAVDA, CEO, Tata Starbucks

 

Avani Davda isn’t a regular coffee drinker: green tea is more her style. For the past couple of years, though, Davda has been chugging several cups of coffee everyday, trying new flavours and brews. She’s even got a favourite variety now — aged Sumatra, which is also the preferred bean of Howard Schultz, chairman, president and CEO of Starbucks. It’s a very happy coincidence — Davda is CEO of Tata Starbucks, the two-year-old joint venture between the $1.21-billion Tata Global Beverages and the $14.9-billion Starbucks Coffee Co. And, just like its young CEO, the Indian coffee chain, too, seems full of beans.

SPREADING THE AROMA

Starbucks’ rapid growth across the world offers rivals a masterclass in ubiquity

In the past 18 months, Starbucks has opened 36 outlets across four Indian cities. For their part, rivals say that Starbucks’ original plan was to take store count to 350 by end-2015. The 34-year-old Davda, who’s been with the Tata Group since 2002, when she joined Tata Administrative Services straight after her MBA, is tightlipped about Starbucks’ expansion plans, although she does reveal that the Seattle-based coffee chain will open stores in Chennai and Hyderabad later this year. “India offers tremendous opportunities for Starbucks’ growth. We believe in our strength to redefine the café market here by offering consumers the highest quality coffeehouse experience,” she says.

Starbucks is the world’s largest coffeehouse chain, with over 19,000 outlets in 62 countries. Its India plans, though, have had some early stumbles. The chain first planned an India foray as far back as 2007, in partnership with Future Group, which was set aside as the global economy slowed down. Then, the original target for the current joint venture, in which the partners have invested ₹400 crore, was to open 50 stores in 2012 itself; that has clearly not been achieved. As the chain picks up momentum in India, the big question is, can Starbucks replicate its astounding international success here as well?

Not your average joe

When Jerry Baldwin, Gordon Bowker and Zev Siegl opened the first Starbucks outlet in Seattle in 1971, they couldn’t have imagined their little roasted coffee bean outfit would grow so big one day that it would have its own parody outlets. But the transformation from small local business to one of the world’s best recognised brands isn’t the work of Starbucks’ founders; rather, the credit for that metamorphosis goes to a former employee, Howard Schultz, who bought the chain in 1987, merged his Il Giornale coffeehouse outlets with Starbucks, and never looked back.

Now, case study after case study has been written on Starbucks’ caffeine-charged growth in a market where coffee consumption was on the decline and how the brand has almost single-handedly created a gourmet coffee cult in the US, and even elsewhere. And all this with very little traditional advertising. So, what did Starbucks do right?

In a word, ubiquity. Walk a couple of blocks anywhere in New York City and the aroma of freshly-brewed coffee will waft out from a Starbucks store somewhere close by — there are over 200 stores in Manhattan alone and 11,457 in the US. So, Starbucks is often the first choice for someone looking for a hot drink. It helps, moreover, that the US has a morning coffee culture and many of the white-collar professionals Starbucks targets prefer to grab their shot of caffeine from a coffeehouse rather than wait for the machine to brew it at home. Yes, the paper cup with the mermaid logo is more expensive than what you’d get at a McDonald’s or Dunkin’ Donuts, but Starbucks has unashamedly flaunted its premium positioning right from the start — and in these days of economic slowdown, is still considered an ‘affordable luxury’ by people who are cutting back on other expenses.

The cup that cheers

Starbucks has a major presence in China in just 15 years

And it’s not just in the US. Starbucks’ international expansion, too, has worked on similar lines. From its first overseas store in Tokyo, Japan, in 1996, to its presence now in over 60 countries around the world (see: The cup that cheers), the company has consistently brought non-coffee drinkers into its fold, both by simply being there, as well as its promise of a unique ‘Starbucks experience’. The result: the company now has over 8,300 outlets outside the US, including 1,000 stores each in traditionally tea-drinking Japan and China, which it entered in 1999. The China and Asia Pacific region brought in 6% of the company’s revenue last year, compared with 74% from the Americas. But where the Americas grew at 11% and Europe, Middle East and Africa registered just 2% improvement, China and Asia Pacific clocked 27% growth in 2013 compared with the previous year (see: Rollin’ in the green).

Rollin’ in the green

In less than 20 years, Asia contributes heavily to revenue

Now, Starbucks wants to brew similar success in India as well, 15 years after it entered China. The timing is certainly right. A 2013 report by Technopak estimates the organised café market to be worth $290 million, that is, slightly over 10% of the total $2 billion organised market for food services in India. That is up from $170 million in 2011, and predicted to hit $725 million in 2018 (see: Full of beans). 

Full of beans

The café market is estimated to clock a CAGR of about 13-14% over next five years

While the café culture in India is growing and presents a great growth opportunity, this market is very different and, hence, very challenging for newcomers. From the choice of first beverage in the morning, to the people who throng coffeehouses to the attitude towards cafés… everything is at the other end of the spectrum from what the American coffee major is used to. 

Certainly, Schultz has admitted on record that “over time, this is going to be one of the best markets in the world for Starbucks.” If that’s not challenging enough, it also faces a local competitor that has figured out the perfect brew for this market.

A potent brew

In upmarket Juhu on a February afternoon, K Ramakrishnan finally locates a table at the CCD Lounge. As the people around dig into pizza and pasta and almost incidentally sip their coffees, the president (marketing), Café Coffee Day (CCD), explains how coffee consumption in India is very different from the US. “There, 80% of coffee is drunk on the move and accompanies people from their cars to their workstations to meetings. In India, that number would not be more than 20%.” Here, Ramakrishnan adds, coffee has a “cool” perception, and it’s fashionable to go to cafés, for both students and professionals. But the price they are willing to pay is a function of their affordability. 

A lot has happened over coffee

CCD is the market leader in terms of retail footprint

This is where CCD has hit on the magic formula. The leader in the café business (see: A lot has happened over coffee) operates its 1,550 outlets in three main formats, depending on the location and size of the store and the menu offerings. So, there’s the regular café (1,495), the premium Lounge (51) and CCD Square (4), which serves single-origin (rather than blended) coffee. Apart from these outlets, CCD has also set up 600 takeaway kiosks called CCD Xpress, and 16,000 vending machines in corporate offices around the country.

Expansion at CCD has been driven in a grid of verticals and formats, where verticals include transport hubs, shop-in-shops, hospitals, highways, college and corporate campuses. The objective has been to combine verticals and formats to tailor-make an outlet that suits the customer cluster that exists in any location. The company doesn’t say so in as many words, but this flexibility in formats allows it to calibrate stores and get the economics right based on location and affordability — pricier Lounges and Squares at expensive locations that attract more affluent clientele, and cafés at more affordable locations  — without losing out on either scale or image. “Fundamentally, our belief is that there is a need for a hangout at arm’s reach. Our expansion simply follows this belief and we have been relentless in expansion irrespective of market conditions,” says Ramakrishnan. Going forward, the plan is to get to 2,000 outlets by 2015. Will this include more Lounges to take Starbucks head-on? Ramakrishnan is circumspect. “Expansion and format choice are purely functions of the opportunities available.” 

Not surprisingly, Davda doesn’t comment on how big a competitor CCD is and how Starbucks plans to take it on. But she is clear: Starbucks will have only one format of stores and one price across India — any fine-tuning will be only in terms of size. That is how Starbucks operates everywhere else in the world and it won’t be any different in India. 

The cup overflows

It’s 6.30 pm on a Sunday and the Starbucks at Thane’s Viviana mall looks pretty crowded with dating couples and families. Since the mall threw open its doors in June 2013, Viviana has attracted tenants such as Marks & Spencer, Lifestyle and Manchester United Café. Starbucks came on board in September and has a 2,000 sq ft store on the ground floor. An earlier visit during the week had shown several empty leather sofas, with a few scattered businessmen and middle-aged couples occupying the remaining seats, but the barista says the pace will pick up soon; he predicts the café’s 125-seat capacity will be stretched to the limit once the Cinepolis 14-screen multiplex opens in April. There are two other coffee chains in the mall — Gloria Jeans has two outlets while Barista has one — and they are equally full with a similar mix of customers, all catering to the upmarket clientele the mall targets. 

Starbucks isn’t cheap — neither in India nor outside. Certainly, dollar for dollar, Starbucks in India is priced nearly on par with the US and China, and it is priced around 1.5 times CCD. It is also more expensive than CCD Lounge. It’s a wise choice to continue the premium positioning through menu and décor in India, says Pankaj Ghemawat, professor of global strategy, IESE Business School, Barcelona. “Starbucks will never be able to rival Café Coffee Day in terms of sheer scale and market share in India, nor does it need to do so in order to be successful. Focusing on the niche of consumers who are looking for a distinctive premium experience and have positive feelings about Starbucks as a foreign brand could pay off nicely,” he explains.

A niche positioning may be fine but it can’t be a substitute for scale, especially for a company that has built its reputation and business on ubiquity as the No.1 cafe in the world. “Starbucks is a gathering place for the entire community and our customers are people of diverse ethnic, income and age groups with varying tastes and interests,” insists Davda. But a consequence of its premium pricing is that Starbucks outprices itself from the biggest customer group in the country — youngsters, especially students, who are notorious seekers of ‘value for money’. That’s a reality Davda accepts — in an interview with Reuters last year, she said, “I am not alienating the student population — it is an aspirational brand for them and I think at some stage [they] want to make it part of their daily habit. But at this stage, maybe they think it’s not affordable because they are looking at other competitors.” 

That is obviously a conscious choice Starbucks has made in India. And as it happens, the coffeehouse has seldom got its strategy wrong, going by its expansion in other key markets. Before Starbucks entered Japan, the coffee market there had two clear segments. The first tier comprised stores located near offices where cafés charged $5-7 for a cup of coffee — since most offices in Japan have small waiting areas, people who ended up early for meetings could kill time here. The second tier had coffee stores on railway platforms, where a cup of joe cost $1. Starbucks smartly took the middle ground, pricing its coffee at $2.5 initially, creating a huge market for itself. Also, its stores were no-smoking zones since coffee beans would absorb the smoke and spoil the flavour. In a country filled with smokers, this approach, paradoxically, worked: women who had an aversion to cigarette smoke flocked to the stores. “This eventually led to young men following them to the store,” says Suresh Kotha, professor of strategy and entrepreneurship at the Foster School of Business, University of Washington, Seattle, and the author of several case studies on Starbucks.

In India, evidently Starbucks has realised taking CCD head-on in the affordable segment may not be as good an idea as making its own market in the premium segment. So, smartly, Starbucks has priced its coffee at the median, higher than CCD and CCD Lounge but less than Costa Coffee and The Coffee Bean and Tea Leaf (CBTL). 

Partly, that relatively attractive pricing has been made possible by its sourcing arrangement with Tata Coffee, a subsidiary of Tata Global Beverages, which allows Starbucks to save on 100% import duty while maintaining consistent quality. The Mumbai launch was the first time Starbucks used locally sourced and roasted beans in a store opening. And in February 2013, Tata Coffee set up a plant at Kushalnagar, Coorg, in Karnataka, to roast and package green coffee beans for all Starbucks stores in India. Over time, the 375 MT plant will also supply coffee to select Starbucks markets outside India. The Indian Espresso Roast variety is sourced locally from this plant, while a new India-specific coffee, India Estates blend, was created by the two partners to celebrate their first anniversary.

That sourcing alliance was necessary for Starbucks to compete here — after all, that’s also CCD’s key competitive advantage, and something that puts other international chains on the backfoot. CCD uses domestic coffee, grown on its own plantations in Chikmagalur, Karnataka. The ₹1,090-crore Amalgamated Bean Coffee Trading Co, which owns CCD, has 10,500 acres of coffee plantations, which produce 7,000 tonne of coffee every year. The chain sources its requirement entirely from these plantations. 

At the opposite end, at the California-based CBTL chain, sourcing beans internationally is a big part of expenses for its 29 stores across seven cities in India. “Globally, too, we only purchase specialty-grade Arabica coffee beans from small farms and private estates in East Africa, Latin America and the Pacific. In any part of the world, coffee drinkers are a passionate lot and will pay for top quality,” says KS Narayanan, CEO, Pan India Food Solutions, the company that has brought CBTL to the country. That may be true, but there is no question of achieving scale in India without being price-conscious, as most multinational companies have discovered. Even Barista, the first entrant in the café business in the country, learnt it the hard way. Despite the initial lead, it is today far behind CCD that came much later and conquered the market. On the way, Barista realised the folly in embracing premium pricing and rejigged its strategy, making its menu more affordable. Still, the coffee chain has changed hands twice already. Incidentally, Barista was initially a Tata joint venture with Turner Morrison. Says Nilanjan Bhattacharya, COO, India and SAARC, at Barista Lavazza, “There are different consumer segments in each business category and the café industry, too, caters to different consumer sub-groups. What we believe is that when a consumer walks into a Barista Lavazza café, he is well aware that he is walking into a café that has a rich heritage drawn from a 119-year-old Italian brand, which the other players in the segment do not have.” But that confidence in customer association has not translated into Barista scaling up rapidly. It still has only 200 outlets across the country. 

That number is actually quite crucial. “It is only when the number of stores cross 200 that Starbucks will really face a challenge. That is when it will need to take a close look at the menu, pricing and format,” points out Vishwadeep Kuila, founder of marketing consultancy Brand Vectors, and the former CEO of Oriental Cuisines, which owns brands such as China Town, the French Loaf and Le Chocolatier.

For now, Davda is confident. She says, “The discerning Indian consumer appreciates a quality experience delivered at the appropriate value and we are uniquely positioned by way of our offerings, in-store design and experience to provide just that. We provide more than high-quality coffee, but a third place experience, between work and home.”

Do the math

Not surprisingly, Starbucks is sticking to upmarket locations — at least for now — in keeping with its premium strategy. In malls, it has taken choice space on the ground floor, which ensures higher footfalls, but comes at a premium. “We don’t compromise on our locations. We pick our spots very well,” says Davda. That essentially means locations where footfalls and traffic are maximised, be they 2,000 sq ft stores in malls or 150 sq ft outlets within stores. “That discipline also explains why Starbucks stores are not as densely populated in the West Coast as in the East Coast of the US,” says Kotha. It’s all about how the economics works out. 

When the first store opened at Mumbai’s historic Horniman Circle, there were queues of people waiting to get in for days after. Those lines have gone away now as the newness wears off, but industry trackers say the outlet has a daily revenue of ₹1 lakh, which goes up to ₹1.25 lakh on weekends. “By contrast, a McDonald’s in that area or in Connaught Place in New Delhi would have a daily collection of ₹2.5 lakh,” says a rival.

The flagship Starbucks at Bengaluru’s Koramangala is said to have a weekday collection of ₹75,000 (₹1.25 lakh over weekends), while the Viviana Mall outlet makes ₹50,000 a day during the week, going up to ₹90,000 on weekends. Those sound like good numbers but, remember, there’s a bigger price tag attached with Starbucks every step of the way. A basic CCD outlet requires an investment of ₹50 lakh for the interiors, installing the air-conditioning etc. Starbucks in comparison spends at least twice as much, with a typical outlay of ₹1.2-1.3 crore per store. That means break-even for the US major will take longer. 

Here’s how the math works. With an average ticket value of ₹90-100, an average CCD outlet earns about ₹40,000 on weekdays and ₹50,000 on weekends, that is, about ₹13 lakh a month. Of this, food and beverage costs are 25% of the ticket value, running costs (electricity, water, rent, salaries, etc.) account for a little over half, while incidentals such as tissues, cups and wi-fi account for another ₹1 lakh, leaving the outlet about ₹2 lakh after all expenses. At this rate, it will take just over two years for the store to recover its ₹50 lakh capex.

Now, consider Starbucks. The average ticket value at Starbucks is higher than CCD at about ₹150. Taking a weekday revenue of ₹70,000 and ₹1 lakh over the weekend, that’s an income of ₹24 lakh a month. The proportion of food and beverage costs and running expenses is about the same as CCD — 25% and over 50%, respectively — but incidentals work out costlier at about ₹2 lakh, which leaves the outlet around ₹3 lakh after all expenses, half again as much as a CCD café. But Starbucks’ capex is more than double that of CCD, so it will take over three years — 40 months — to break even. 

Which doesn’t sound bad at all — until you remember that this is the ideal scenario. In reality, break even can take much longer, especially in the current economic climate. Whether it is a rise in raw material costs, a surge in power tariffs or, at the other end of the equation, revenue dropping as the novelty factor dries up… there are many reasons why those numbers could get pushed. Then, rental accounts for the largest chunk of costs, and the going rates aren’t cheap, so Starbucks may be looking at an extended break-even for its outlets, which could impact its expansion in India.

The star attraction

Yet, one considerable advantage Starbucks enjoys is its brand image. Although high rentals are unavoidable, a high-profile tenant such as Zara or Starbucks benefits the mall owner too, says Manish Kashyap, managing director (transaction services), CBRE, since these brands have substantial pull power. “This works very well for a brand such as Starbucks since it can negotiate the rent with the mall owners. This is an advantage that is not always possible at a high street location.”

The present plateau in commercial real estate prices will also help. Rentals in key markets such as Delhi, Mumbai and Bengaluru have not moved upwards in the past year and, in fact, have dropped at locations such as Nariman Point and Bandra Kurla Complex in Mumbai and MG Road in Bengaluru. And since companies such as Starbucks typically enter into nine- to 15-year agreements, the negotiations are likely to be in the coffee chain’s favour. “Break-even typically comes after a bit of a wait, so it makes sense for the store to be housed in the same place. There is a built-in reasonable increase in rentals every three to five years,” Kashyap adds.

But that’s only in the metros. Rentals in tier 2 cities haven’t dropped and as the company expands further into India in the coming years, it may have to pay high rentals in markets with smaller target customer groups, which will impact profitability. But then, Davda isn’t hinging on unfettered expansion. “It is more important to have a greater share of the consumer. What we need to focus is on opening stores in a disciplined manner and ensure they are financially viable,” she says. “We have opened 36 outlets in 18 months and this is very good going, in our opinion.” 

That means Starbucks’ growth in India will be more measured than how things played out in China, for instance, where it plans to shore up its store count from 1,000 to 1,500 stores in the next five years. Initially, Starbucks set up its stores in Beijing and Shanghai, but soon mayors of small towns invited the company, helping with real estate and other issues. “Even small towns in China have a population of 3 million, and the help from mayors really aided Starbucks’ reach,” says Kotha. 

Can the Tatas help?

The expertise of the local partner is invaluable in managing real estate, says Kotha. “In India, for instance, the Tatas can be of tremendous help when it comes to getting great locations. In the absence of a local partner, how can Starbucks deal with the local bureaucracy or politics?” he asks. Shultz, too, has gone on record on the challenges and his expectations from his partner in India. “At one point, we thought we could come here alone and we overestimated the complexity,” he admitted in a 2012 TV interview. “What Tata brings is a unique perspective in terms of real estate acquisition capabilities, the opportunity to integrate Starbucks into Taj Hotels, the ability to bring food from the Taj into Starbucks stores…” 

Certainly, the Tata connection brings in a lot to this joint venture, from sourcing and roasting coffee beans (fundamental to success in the coffeehouse business) to localising offerings and experience to dealing with bureaucracy. The Tata group’s considerable retail presence — Westside, Croma, Landmark, Star Bazaar, Titan and Tanishq — offers scope for shop-in-shop Starbucks outlets. In the US, Starbucks’ store sizes vary from 150 sq ft to 1,500 sq ft, depending on just such a strategy: it has an arrangement to run cafés inside Barnes & Noble bookstores. But there’s no guarantee of success with such arrangements. The smaller outlets may not get the number of customers required to be viable (and given Starbucks’ higher prices, that seems a definite possibility). Such stores won’t be destinations in themselves in any case. 

Still, Starbucks won’t be the first to try such an initiative, if it does happen — CCD has tie-ups to run cafés in Essar Oil petrol pumps and Shoppers Stop stores. Experience shows that the café is an add-on activity, not an objective in itself — no one drives to the petrol pump for a coffee. Ramakrishnan agrees. “In a shop-in-shop format, the footfalls are created by the principal and CCD only does a conversion. Still, we’ve been pretty happy with our experience with this format.”

Food and beyond

Meanwhile, Starbucks is working harder on other counts. For instance, it is paying close attention to its food offerings. Rival CCD fine-tunes its menu based on the location — idlis at highway outlets, for instance, while a Lounge offers shawarma skewers, nachos and khow suey. About 30% of CCD’s revenue comes from food, while beverages account for 60% and merchandise makes up the remainder. Starbucks, too, is counting on bringing in a fair chunk of revenue from food. “Food will definitely be a key part of our business here and it is something we will focus on,” insists Davda. Catering for its stores has been handed over to Taj Sats, which has helped develop a menu that keeps in mind local preferences. So, there’s a cardamom-flavoured mawa croissant that Davda says has “done quite well”, tandoori paneer roll, murgh kathi wrap and chatpata paratha wrap, among others.

But competition is stiff here, too. CCD has been working aggressively on its food portfolio, revamping it a year back by adding more exciting offerings. Ditto for other competitors. “At Barista Lavazza, we launch two menus every year — a summer menu and a winter menu — and both times, the menu is completely overhauled to include new food and beverage items, keeping latest trends and consumer preferences in mind,” says Barista Lavazza’s Bhattacharya.

Catering to local taste buds is something Starbucks has perfected in other countries too, though its localisation efforts aren’t a patch on McDonald’s. In China, for instance, Starbucks offers apple-flavoured coffee that is quite a hit, says Kotha, adding that the 20% local palate that Starbucks offers is usually spot on. “In India, the chai latte should take off and attract the crowds.” 

Starbucks’ success in India will call for a presence in many more cities and several different formats. That means expanding into smaller cities such as Chandigarh, Ludhiana, Indore, Kochi, Jaipur and Guwahati, to name just a few — where disposable incomes may be high but the willingness to hand over three-figure sums for a cup of coffee may be yet to develop. Starbucks will then have to overcome a Catch-22 situation: to become a success it has to have wide appeal and pan-India presence; but if it embraces premium pricing to recover at least part of the exorbitant real estate costs it will have to bear, it risks alienating a large swath of customers. Ubiquity, in this case, may have to be blended with a dash of flexibility. 

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