Starbucks Corp. signed a deal with the Chinese provincial government of Yunnan to set up its first-ever coffee-bean farm in the world to cater to a rapidly growing population of coffee drinkers in China amid a global battle for quality coffee beans.
In the southwest province steeped in thousands of years of tea production, the Seattle-based coffee chain is hiring and training local coffee growers. The hope is that Chinese-grown arabica beans, a bitter-earthy variety, will fill the cups of a culture that is acquiring a growing taste for coffee.
Starbucks Chief Executive Howard Schultz said the company will work with farmers to improve yields and incomes. "This creates a significant statement about our commitment to doing business in China and doing business the right way," Mr. Schultz said. The first beans will be harvested in three years. Mr. Schultz declined to offer financial details of the investment.
China's thirst for coffee is surging. Coffee sales climbed 9% last year to 4.6 billion yuan ($694 million), according to research company Euromonitor International. Starbucks currently operates 400 stores in mainland China and has plans to open a thousand more in the coming years, Mr. Schultz said, without being more specific.
China is poised to become Starbucks' second-largest market behind the U.S., overtaking Canada, Japan and the U.K.
Starbucks' 2010 revenue jumped to $10.7 billion, up 9.5% from 2009. International store sales increased 6%. The company, which has a nearly 70% market share in China, according to Euromonitor, declined to provide specific information on its growth in the country. Starbucks is in its second year of recovery after cutting $600 million from its operating costs. U.S. sales are picking up, but the company isn't opening new stores there. Starbucks is looking for new ways to grow.
Some analysts say the company's recent decision to discontinue a supermarket distribution contract with Kraft Foods Inc. signals that it will further move from its retail roots into more packaged-goods production. Starbucks will begin selling coffee machines in the U.S. market, Mr. Schultz said, declining to give a timeline.
Fierce competition is brewing in China. McDonald's Corp. is rolling out new McCafés and adding coffee bars to some existing outlets across China. China Resources Enterprise Ltd, a Hong Kong-based company that currently operates 90 Pacific Coffee chains in Asia, has 1,000 new China outlets in its pipeline, according to the company. Costa Coffee, owned by Britain's Whitbread, PLC, is cranking out more than 250 new stores in the next three years.
Coffee distributors are all bidding against one another for a limited supply of high-quality beans. Aging trees farmed year-after-year in Central and South America are producing lackluster, bland yields, and companies are desperate for new supplies. Nestlé SA is investing $487 million in a decade-long global effort to train and supply thousands of farmers across the globe—from Mexico to Indonesia—with new coffee trees, according to Nestlé.
Global arabica-bean prices are up more than 50% this year and are near 13-year highs due to bad weather and failing crops in Colombia and Central America. To absorb the higher costs, Starbucks in September raised the prices of some hard-to-make and larger-sized drinks, though in the U.S. only. Prices in China, which average $5 for a java chip frappuccino, didn't change.
China exerts a big influence on markets for commodities such as oil, copper and soybeans, but isn't a focus for the coffee market. That looks set to change with Starbucks' foray. In addition, China's potential as a quality coffee producer is in sharp contrast to Asian nations' current reputation as suppliers of a low-quality robusta beans.
Starbucks is hoping that the quality of its Yunnan-grown coffee will be good enough to sell globally. Despite high raw ingredient prices, the partnership with China's Yunnan provincial government isn't about buying cheaper quality, said Mr. Schultz. "We strongly believe it will be as good in the cup as the coffee we currently buy in other markets," he said.
Elevating Yunnan's arabica quality may be a tall order. The company used Chinese beans to launch a special coffee line last year called "South of the Clouds," which is the literal translation of Yunnan. Due to lack of quality and quantity, "South of the Clouds" became a blend. It was offered only in China, Malaysia and Singapore.
Company executives haven't determined how they will market the new coffee in China and internationally, Starbucks said. The Yunnan-grown beans will be shipped to the U.S. for roasting. A roasting plant in Asia is inevitable, though the timing hasn't yet been pegged, said Mr. Schultz.
Until now, Yunnan's beans have been used only for lower-quality instant coffees. Nestlé, which has a 68% share of the instant market, started buying beans from Yunnan in the late 1980s. Since then, other leading coffee companies, such as Kraft Foods and Maxwell House, have been buying China's arabica.
Starbucks plans to offer its Via instant coffee in China, but Mr. Schultz said he hasn't settled on a date. "Consumers here need to develop a better understanding of the coffee culture first," he said.
China has over the past decade encouraged farmers to swap out tea for coffee to bring in higher revenue and tax dollars. The Yunnan government plans to increase the amount of land it allocates for coffee growing and plans to invest three billion yuan in the next decade to increase coffee production to 200,000 tons annually from 38,000 tons.
Starbucks' Chinese consumers have a long way to go to catch up to drinkers in other markets. Single-store sales in China average $600,000 compared to $1 million in the U.S., according to John Glass, a Morgan Stanley analyst.
Growth in China won't be a problem, Mr. Schultz said. "We're watching growth in smaller cities mirror what happened in Beijing and Shanghai," he said. "It gives us confidence about long-term profitability."