Starbucks Drink Price Increases: Will They Impact the Chinese Coffee Market?

Starbucks Faces Multiple Cost Pressures Leading to Price Increases

On February 2nd, Starbucks CEO Kevin Johnson stated that the company had adjusted pricing twice in the past four months. However, due to salary increases for frontline employees and rising other costs, Starbucks would have to continue raising prices in the coming months.

Beyond rising labor costs and increasing coffee bean prices due to Brazil's Arabica coffee harvest failure, the most significant reason is that inflation pressure has far exceeded Starbucks' expectations. Continuously rising costs have squeezed Starbucks' profit margins, leaving the company with no choice but to raise prices to alleviate the various concentrated pressures.

Labor Cost Challenges

First, labor costs are rising because the Omicron variant has caused a surge in infections. Starbucks in the United States had not properly arranged for comprehensive employee vaccination nor implemented adequate personal and in-store preventive measures, leading to frequent infections among existing staff. This has made it difficult for American Starbucks to attract new employees. Additionally, longer treatment and isolation periods after infection have created a "stalemate" of staff shortages plus instability among existing personnel. To retain current employees, Starbucks has had to implement multiple salary increases and enhanced benefits.

Coffee Bean Cost Increases

The rise in coffee bean costs is due to harvest failures of Arabica coffee beans in Brazil's producing regions. As the world's largest producer of Arabica coffee beans, Brazil has always been one of the primary sources for Arabica coffee bean inventories at the US ICE Exchange, with inventory levels constantly affecting Arabica coffee bean futures prices. Last year was a low-production year for Brazilian Arabica coffee beans, meaning production would naturally be lower than in 2020. Combined with the impact of frost and various adverse weather conditions, Brazil's Arabica coffee harvest continued to decline. The reduction in production created inventory deficits, causing Arabica coffee prices to rise repeatedly, with futures prices reaching a ten-year high.

Originally, 2022 was expected to be a high-production year for Brazilian Arabica coffee beans, which should have alleviated inventory problems. However, in early December of last year, the emergence of the La Niña phenomenon caused flooding from heavy rains that affected Arabica coffee producing regions in Brazil to varying degrees. Among these, Brazil's largest Arabica coffee bean producing region—Minas Gerais—experienced landslides that buried many coffee trees. This cast uncertainty over a year that had initially held great production promise, keeping Arabica coffee futures prices high with preparations for potential further increases. In the past 52 weeks, coffee bean futures prices have already risen from 120.2 cents to 239.20 cents in recent days. This is Starbucks' fundamental raw material and a crucial component of its costs.

Financial Performance and Inflation Pressures

Starbucks' fiscal year 2022 first-quarter performance report, released on February 1st, showed that in the quarter ending January 2nd, sales increased by 18% year-over-year, meaning Starbucks US first-quarter revenue grew by $1.3 billion. However, despite healthy sales trends in the US and pricing increases amid multiple inflationary headwinds intensifying, challenges remain.

The causes of inflation include the recent US Federal Reserve's indication of interest rate hikes (increased borrowing costs for banks/loans), massive currency printing (leading to slower economic development), and balance sheet reduction (removing less important fiscal measures). These factors are expected to worsen the US economy over the next one to two years while requiring the printing of large amounts of money, leading to sharp increases in multiple costs.

Although sales increased by $1.3 billion year-over-year, operating income only grew by $264 million. As Starbucks was hit by many rising costs, including employee wages, supply chain challenges, and new employee training and onboarding, the company stated that total operating expenses increased by $994 million this quarter. Additionally, with variant viruses continuously affecting Starbucks operations, management expects that high costs in the second quarter will not subside. As for how much prices will increase or how many times they will be raised thereafter, Starbucks still cannot confirm, as they lack accurate judgment about future economic developments.

Different Market Strategies: US vs China

Regarding whether this US Starbucks price increase will affect the Chinese market, it actually will not. First, Starbucks China's pricing is already much higher than Starbucks US pricing (after the recent two price adjustments in the US, a large Venti Americano costs $2.95, approximately 18.8 RMB), while Starbucks China's Venti Americano coffee costs 31 RMB. From the pricing, it can be seen that Starbucks China's profit margin is much larger than Starbucks US's, so current pricing is sufficient to withstand the impact of US Starbucks price increases.

Secondly, China's epidemic prevention work has achieved zero tolerance, so in terms of personnel, Starbucks China faces no pressure and still has a large number of staff maintaining the company's overall operations. It can be confirmed that Starbucks China will not experience serious staff shortages (referring to the overall situation). Because Starbucks China still has sufficient labor to maintain operations, there is no need to raise salaries to retain employees.

Furthermore, the Chinese coffee market and American coffee market operate under completely different business models. If Starbucks China were to follow with price increases at this time, it would quickly be unable to survive in the Chinese market. With more and more local coffee chain stores joining, prices are crazily "competing at low levels." During such times, raising prices would not be accepted by consumers.

For the American market, Starbucks is a common beverage, while for the Chinese market, Starbucks is a premium beverage. Luckin Coffee may represent the future survival model for Chinese coffee. Therefore, in the short term, Starbucks China will maintain current beverage prices and may even implement price reductions in the future to compete with Luckin.

Image source: Internet

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