outlook business _ smelling the coffee

8/10/2019 Outlook Business _ Smelling the Coffee

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29/10/2014 Outlook Business | Smelling The Coffee

http://www.outlookbusiness.com/article_v3.aspx?artid=289933 2/7

A Technopak reportestimates theorganised cafmarket in India tobe worth $290million, over 10% ofthe $2 billionmarket for foodservices

"In the US, 80% ofcoffee is drunk onthe move. In India,that number isntmore than 20%" KRamakrishnan, President

(marketing), Caf Coffee

Day

been achieved. As the chain picks up momentum in India, the big question is, can Starbucksreplicate 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 Seattlein 1971, they couldnt have imagined their little roasted coffee bean outfit would grow so bigone day that it would have its own parody outlets. But the transformation from small localbusiness to one of the worlds best recognised brands isnt the work of Starbucks founders;rather, the credit for that metamorphosis goes to a former employee, Howard Schultz, whobought the chain in 1987, merged his Il Giornale coffeehouse outlets with Starbucks, andnever looked back.

Now, case study after case study has been written on Starbucks

caffeine-charged growth in a market where coffee consumptionwas on the decline and how the brand has almost single-handedly created a gourmet coffee cult in the US, and evenelsewhere. 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 NewYork City and the aroma of freshly-brewed coffee will waft outfrom a Starbucks store somewhere close by there are over200 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 coffeehouserather than wait for the machine to brew it at home. Yes, the paper cup with the mermaid logois more expensive than what youd get at a McDonalds or Dunkin Donuts, but Starbucks hasunashamedly flaunted its premium positioning right from the start and in these days ofeconomic slowdown, is still considered an affordable luxury by people who are cutting back

on other expenses.

And its not just in the US. Starbucks international expansion, too,has worked on similar lines. From its first overseas store inTokyo, Japan, in 1996, to its presence now in over 60 countriesaround the world (see: The cup that cheers), the company hasconsistently brought non-coffee drinkers into its fold, both bysimply being there, as well as its promise of a unique Starbucksexperience. The result: the company now has over 8,300 outletsoutside the US, including 1,000 stores each in traditionally tea-drinking Japan and China, which it entered in 1999. The Chinaand Asia Pacific region brought in 6% of the companys revenuelast year, compared with 74% from the Americas. But where the

Americas grew at 11% and Europe, Middle East and Africaregistered just 2% improvement, China and Asia Pacific clocked27% growth in 2013 compared with the previous year (see: Rollinin the green).

Now, Starbucks wants to brew similar success in India as well, 15years after it entered China. The timing is certainly right. A 2013 report by Technopakestimates the organised caf market to be worth $290 million, that is, slightly over 10% of thetotal $2 billion organised market for food services in India. That is up from $170 million in2011, and predicted to hit $725 million in 2018 (see: Full of beans).

While the caf culture in India is growing and presents a great growth opportunity, this marketis very different and, hence, very challenging for newcomers. From the choice of firstbeverage in the morning, to the people who throng coffeehouses to the attitude towardscafs everything is at the other end of the spectrum from what the American coffee major isused to.

Certainly, Schultz has admitted on record that over time, this is going to be one of the bestmarkets in the world for Starbucks. If thats not challenging enough, it also faces a localcompetitor 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 CCDLounge. As the people around dig into pizza and pasta and almost incidentally sip theircoffees, the president (marketing), Caf Coffee Day (CCD), explains how coffee consumptionin India is very different from the US. There, 80% of coffee is drunk on the move andaccompanies people from their cars to their workstations to meetings. In India, that numberwould not be more than 20%. Here, Ramakrishnan adds, coffee has a cool perception, and

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"Starbucks willnever be able torival CCD in termsof sheer scale andmarket share inIndia" Pankaj

Ghemawat, Professor of

global strategy, IESE

Business School

"In any part of theworld, coffeedrinkers are apassionate lot andwill pay for topquality" KSNarayanan, CEO, Pan

its fashionable to go to cafs, for both students and professionals. But the price they arewilling to pay is a function of their affordability.

This is where CCD has hit on the magic formula. The leader inthe caf business (see: A lot has happened over coffee) operatesits 1,550 outlets in three main formats, depending on the locationand size of the store and the menu offerings. So, theres theregular caf (1,495), the premium Lounge (51) and CCD Square(4), which serves single-origin (rather than blended) coffee. Apartfrom these outlets, CCD has also set up 600 takeaway kioskscalled CCD Xpress, and 16,000 vending machines in corporateoffices around the country.

Expansion at CCD has been driven in a grid of verticals andformats, where verticals include transport hubs, shop-in-shops,hospitals, highways, college and corporate campuses. Theobjective has been to combine verticals and formats to tailor-make an outlet that suits the customer cluster that exists in anylocation. The company doesnt say so in as many words, but thisflexibility in formats allows it to calibrate stores and get theeconomics right based on location and affordability pricier

Lounges and Squares at expensive locations that attract more affluent clientele, and cafs atmore affordable locations without losing out on either scale or image. Fundamentally, ourbelief is that there is a need for a hangout at arms reach. Our expansion simply follows thisbelief and we have been relentless in expansion irrespective of market conditions, saysRamakrishnan. Going forward, the plan is to get to 2,000 outlets by 2015. Will this includemore Lounges to take Starbucks head-on? Ramakrishnan is circumspect. Expansion andformat choice are purely functions of the opportunities available.

Not surprisingly, Davda doesnt comment on how big a competitor CCD is and how Starbucksplans 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 Starbucksoperates everywhere else in the world and it wont be any different in India.

The cup overflows

Its 6.30 pm on a Sunday and the Starbucks at Thanes Viviana mall looks pretty crowded withdating couples and families. Since the mall threw open its doors in June 2013, Viviana hasattracted tenants such as Marks & Spencer, Lifestyle and Manchester United Caf. Starbuckscame on board in September and has a 2,000 sq ft store on the ground floor. An earlier visitduring the week had shown several empty leather sofas, with a few scattered businessmenand middle-aged couples occupying the remaining seats, but the barista says the pace willpick up soon; he predicts the cafs 125-seat capacity will be stretched to the limit once theCinepolis 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 similarmix of customers, all catering to the upmarket clientele the mall targets.

Starbucks isnt cheap neither in India nor outside. Certainly,dollar for dollar, Starbucks in India is priced nearly on par with theUS and China, and it is priced around 1.5 times CCD. It is alsomore expensive than CCD Lounge. Its a wise choice to continuethe premium positioning through menu and dcor in India, says

Pankaj Ghemawat, professor of global strategy, IESE BusinessSchool, Barcelona. Starbucks will never be able to rival CafCoffee Day in terms of sheer scale and market share in India, nordoes it need to do so in order to be successful. Focusing on theniche of consumers who are looking for a distinctive premiumexperience and have positive feelings about Starbucks as aforeign brand could pay off nicely, he explains.


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India Food Solutions

"Barista Lavazzahas a rich heritagedrawn from a 119-year-old Italianbrand; othersdont" NilanjanBhattacharya, COO,

India and SAARC

Starbucks issticking toupmarket locations.In malls, it takes upspace on theground floor, whichensures higherfootfalls, but comesat a premium

A niche positioning may be fine but it cant be a substitute forscale, especially for a company that has built its reputation andbusiness on ubiquity as the No.1 cafe in the world. Starbucks is agathering 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 consequenceof its premium pricing is that Starbucks outprices itself from the biggest customer group in thecountry youngsters, especially students, who are notorious seekers of value for money.Thats a reality Davda accepts in an interview with Reuters last year, she said, I am notalienating the student population it is an aspirational brand for them and I think at somestage [they] want to make it part of their daily habit. But at this stage, maybe they think its notaffordable because they are looking at other competitors.

That is obviously a conscious choice Starbucks has made inIndia. And as it happens, the coffeehouse has seldom got itsstrategy wrong, going by its expansion in other key markets.Before Starbucks entered Japan, the coffee market there had twoclear segments. The first tier comprised stores located nearoffices where cafs charged $5-7 for a cup of coffee sincemost offices in Japan have small waiting areas, people whoended up early for meetings could kill time here. The second tierhad 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 storeswere no-smoking zones since coffee beans would absorb thesmoke and spoil the flavour. In a country filled with smokers, thisapproach, paradoxically, worked: women who had an aversion tocigarette smoke flocked to the stores. This eventually led toyoung 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 onStarbucks.

In India, evidently Starbucks has realised taking CCD head-on in the affordable segment maynot 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 lessthan Costa Coffee and The Coffee Bean and Tea Leaf (CBTL).

Partly, that relatively attractive pricing has been made possible by its sourcing arrangementwith Tata Coffee, a subsidiary of Tata Global Beverages, which allows Starbucks to save on100% import duty while maintaining consistent quality. The Mumbai launch was the first timeStarbucks 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 greencoffee beans for all Starbucks stores in India. Over time, the 375 MT plant will also supplycoffee to select Starbucks markets outside India. The Indian Espresso Roast variety issourced locally from this plant, while a new India-specific coffee, India Estates blend, wascreated by the two partners to celebrate their first anniversary.

That sourcing alliance was necessary for Starbucks to competehere after all, thats also CCDs key competitive advantage,and something that puts other international chains on thebackfoot. CCD uses domestic coffee, grown on its ownplantations in Chikmagalur, Karnataka. The Rs 1,090-crore

Amalgamated Bean Coffee Trading Co, which owns CCD, has10,500 acres of coffee plantations, which produce 7,000 tonne ofcoffee every year. The chain sources its requirement entirely fromthese plantations.

At the opposite end, at the California-based CBTL chain, sourcingbeans internationally is a big part of expenses for its 29 storesacross seven cities in India. Globally, too, we only purchase specialty-grade Arabica coffeebeans from small farms and private estates in East Africa, Latin America and the Pacific. Inany part of the world, coffee drinkers are a passionate lot and will pay for top quality, says KSNarayanan, CEO, Pan India Food Solutions, the company that has brought CBTL to thecountry. That may be true, but there is no question of achieving scale in India without beingprice-conscious, as most multinational companies have discovered. Even Barista, the firstentrant in the caf 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, Baristarealised the folly in embracing premium pricing and rejigged its strategy, making its menumore affordable. Still, the coffee chain has changed hands twice already. Incidentally, Baristawas initially a Tata joint venture with Turner Morrison. Says Nilanjan Bhattacharya, COO, Indiaand SAARC, at Barista Lavazza, There are different consumer segments in each businesscategory and the caf industry, too, caters to different consumer sub-groups. What we believeis that when a consumer walks into a Barista Lavazza caf, he is well aware that he is walkinginto a caf that has a rich heritage drawn from a 119-year-old Italian brand, which the otherplayers in the segment do not have. But that confidence in customer association has nottranslated 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 thatStarbucks will really face a challenge. That is when it will need to take a close look at themenu, pricing and format, points out Vishwadeep Kuila, founder of marketing consultancyBrand Vectors, and the former CEO of Oriental Cuisines, which owns brands such as ChinaTown, the French Loaf and Le Chocolatier.

For now, Davda is confident. She says, The discerning Indian consumer appreciates a qualityexperience delivered at the appropriate value and we are uniquely positioned by way of ourofferings, 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.


5/7



Rentals account forthe largest chunkof costs and therates arent cheap,so Starbucks maybe looking at anextended break-even for its outletsin India

"Its only when thenumber of storescrosses 200 thatStarbucks willreally face achallenge" Vishwadeep Kuila,

Founder, Brand Vectors

Do the math

Not surprisingly, Starbucks is sticking to upmarket locations at least for now in keepingwith its premium strategy. In malls, it has taken choice space on the ground floor, whichensures higher footfalls, but comes at a premium. We dont compromise on our locations. Wepick our spots very well, says Davda. That essentially means locations where footfalls andtraffic 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 WestCoast as in the East Coast of the US, says Kotha. Its all about how the economics works out.

When the first store opened at Mumbais 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, butindustry trackers say the outlet has a daily revenue of Rs 1 lakh,which goes up to Rs 1.25 lakh on weekends. By contrast, aMcDonalds in that area or in Connaught Place in New Delhiwould have a daily collection of Rs 2.5 lakh, says a rival.

The flagship Starbucks at Bengalurus Koramangala is said tohave a weekday collection of Rs 75,000 (Rs 1.25 lakh over

weekends), while the Viviana Mall outlet makes Rs 50,000 a dayduring the week, going up to Rs 90,000 on weekends. Those

sound like good numbers but, remember, theres a bigger price tag attached with Starbucksevery step of the way. A basic CCD outlet requires an investment of Rs 50 lakh for theinteriors, installing the air-conditioning etc. Starbucks in comparison spends at least twice asmuch, with a typical outlay of Rs 1.2-1.3 crore per store. That means break-even for the USmajor will take longer.

Heres how the math works. With an average ticket value of Rs 90-100, an average CCDoutlet earns about Rs 40,000 on weekdays and Rs 50,000 on weekends, that is, about Rs 13lakh 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 astissues, cups and wi-fi account for another Rs 1 lakh, leaving the outlet about Rs 2 lakh afterall expenses. At this rate, it will take just over two years for the store to recover its Rs 50 lakhcapex.

Now, consider Starbucks. The average ticket value at Starbucks

is higher than CCD at about Rs 150. Taking a weekday revenueof Rs 70,000 and Rs 1 lakh over the weekend, thats an income ofRs 24 lakh a month. The proportion of food and beverage costsand running expenses is about the same as CCD 25% andover 50%, respectively but incidentals work out costlier atabout Rs 2 lakh, which leaves the outlet around Rs 3 lakh after allexpenses, half again as much as a CCD caf. But Starbuckscapex is more than double that of CCD, so it will take over threeyears 40 months to break even.

Which doesnt sound bad at all until you remember that this isthe ideal scenario. In reality, break even can take much longer,especially in the current economic climate. Whether it is a rise inraw material costs, a surge in power tariffs or, at the other end ofthe equation, revenue dropping as the novelty factor dries upthere are many reasons why those numbers could get pushed.Then, rental accounts for the largest chunk of costs, and the going rates arent cheap, soStarbucks 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 rentalsare 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 brandshave substantial pull power. This works very well for a brand such as Starbucks since it can


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"In India, the Tatascan be oftremendous helpwhen it comes togetting greatlocations" Suresh

Kotha, Professor of

strategy and

entrepreneurship,

University of Washington

Tatas considerableretail presence Westside, Croma,Landmark, Star

Bazaar Titan andTanishq offersscope for shop-in-shop outlets ofStarbucks

negotiate the rent with the mall owners. This is an advantage that is not always possible at ahigh street location.

The present plateau in commercial real estate prices will alsohelp. Rentals in key markets such as Delhi, Mumbai andBengaluru have not moved upwards in the past year and, in fact,have dropped at locations such as Nariman Point and BandraKurla Complex in Mumbai and MG Road in Bengaluru. And sincecompanies such as Starbucks typically enter into nine- to 15-yearagreements, the negotiations are likely to be in the coffee chainsfavour. Break-even typically comes after a bit of a wait, so itmakes sense for the store to be housed in the same place. Thereis a built-in reasonable increase in rentals every three to fiveyears, Kashyap adds.

But thats only in the metros. Rentals in tier 2 cities haventdropped and as the company expands further into India in thecoming years, it may have to pay high rentals in markets withsmaller target customer groups, which will impact profitability. Butthen, Davda isnt hinging on unfettered expansion. It is moreimportant to have a greater share of the consumer. What weneed 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 andthis is very good going, in our opinion.

That means Starbucks growth in India will be more measured than how things played out inChina, for instance, where it plans to shore up its store count from 1,000 to 1,500 stores in thenext five years. Initially, Starbucks set up its stores in Beijing and Shanghai, but soon mayorsof small towns invited the company, helping with real estate and other issues. Even smalltowns in China have a population of 3 million, and the help from mayors really aidedStarbucks 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. Inthe 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 hispartner in India. At one point, we thought we could come here alone and we overestimatedthe complexity, he admitted in a 2012 TV interview. What Tata brings is a unique perspectivein terms of real estate acquisition capabilities, the opportunity to integrate Starbucks into TajHotels, 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 successin the coffeehouse business) to localising offerings andexperience to dealing with bureaucracy. The Tata groupsconsiderable retail presence Westside, Croma, Landmark, StarBazaar, Titan and Tanishq offers scope for shop-in-shop

Starbucks outlets. In the US, Starbucks store sizes vary from 150sq ft to 1,500 sq ft, depending on just such a strategy: it has anarrangement to run cafs inside Barnes & Noble bookstores. Buttheres no guarantee of success with such arrangements. Thesmaller outlets may not get the number of customers required tobe viable (and given Starbucks higher prices, that seems adefinite possibility). Such stores wont be destinations in themselves in any case.

Still, Starbucks wont be the first to try such an initiative, if it does happen CCD has tie-upsto run cafs in Essar Oil petrol pumps and Shoppers Stop stores. Experience shows that thecaf is an add-on activity, not an objective in itself no one drives to the petrol pump for acoffee. Ramakrishnan agrees. In a shop-in-shop format, the footfalls are created by theprincipal and CCD only does a conversion. Still, weve been pretty happy with our experiencewith this format.

Food and beyond

Meanwhile, Starbucks is working harder on other counts. For instance, it is paying closeattention to its food offerings. Rival CCD fine-tunes its menu based on the location idlis athighway outlets, for instance, while a Lounge offers shawarma skewers, nachos and khowsuey. About 30% of CCDs revenue comes from food, while beverages account for 60% andmerchandise makes up the remainder. Starbucks, too, is counting on bringing in a fair chunkof revenue from food. Food will definitely be a key part of our business here and it issomething we will focus on, insists Davda. Catering for its stores has been handed over to TajSats, which has helped develop a menu that keeps in mind local preferences. So, theres acardamom-flavoured mawa croissant that Davda says has done quite well, tandoori paneerroll, 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. AtBarista 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 LavazzasBhattacharya.

Catering to local taste buds is something Starbucks has perfected in other countries too,though its localisation efforts arent a patch on McDonalds. In China, for instance, Starbucksoffers apple-flavoured coffee that is quite a hit, says Kotha, adding that the 20% local palatethat Starbucks offers is usually spot on. In India, the chai latte should take off and attract thecrowds.

Starbucks success in India will call for a presence in many more cities and several differentformats. That means expanding into smaller cities such as Chandigarh, Ludhiana, Indore,


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Kochi, Jaipur and Guwahati, to name just a few where disposable incomes may be high butthe 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 tohave wide appeal and pan-India presence; but if it embraces premium pricing to recover atleast part of the exorbitant real estate costs it will have to bear, it risks alienating a large swathof customers. Ubiquity, in this case, may have to be blended with a dash of flexibility.

Filed In:Authors: Krishna GopalanTags: Food & Beverages | CoffeeSection: EnterpriseSubsection: Cov er Stories

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