Industry Insights | The Consumer Market Is Stirring with Undercurrents: How Coffee Brands Can Break Through?

The development of the Chinese coffee market has roughly gone through four stages: instant coffee era, Italian coffee era, specialty coffee era, and new retail coffee era.

• Instant coffee era (1980-1990)

In 1989, instant coffee entered the Chinese market. Nestle introduced instant coffee in China, gradually bringing coffee into the sight of Chinese consumers. Instant coffee began to become popular, and the emergence of coffee machines and technological upgrades laid the foundation for the widespread commercial popularization of coffee. During this period, foreign brands entered the Chinese market, initially establishing Chinese consumers' perception of coffee and cultivating their consumption habits of drinking coffee.

• Italian coffee era (1991-2000)

The social experience atmosphere of Italian espresso cafes is beginning to be emulated by the founder of Starbucks. While Chinese coffee brands are pursuing the quality of their coffee products, they are also focusing on creating a good coffee social experience. In 1999, Starbucks, a representative brand of European and American cafes, opened its first store in China, and consumers began to pay more attention to the social experience of coffee shops. During this period, under the influence of Western culture, the penetration rate of espresso gradually increased. With the development and expansion of commercial real estate, espresso has gradually become a choice for consumers.

• Gourmet Coffee Era (2001-2015)

The wave of boutique coffee has risen, leading to a polarized coffee market. Mature coffee brands have strengthened their scale-based chain operations, and well-known chains have launched high-end stores, such as Starbucks' launch of the Starbucks Reserve store program. Emerging independent specialty coffee shops continue to appear, and under the influence of the coffee craze, independent coffee shops focusing on boutique coffee routes have begun to emerge. During this period, the emergence of boutique coffee has gained recognition from some consumers, meeting their personalized needs, while traditional chain coffee has focused on satisfying emotional and social needs.

• New Retail Coffee Wave (since 2016)

Internet coffee brands have begun to develop rapidly, with the establishment of coffee brands pioneering the new retail model for internet coffee. In 2018, internet coffee represented by Luckin Coffee relied onO2O modelRapidly capturing consumers. Driven by big data, coffee shops have begun to strengthen their new retail layout, using big data to reach users. Starbucks has launched a Tmall flagship store, and the offline 'KFC Express' has evolved from a third space to a fourth space with takeaway as its main focus. During this period, cost-effective freshly ground coffee brands have met consumers' demand for 'fast and cheap' by leveraging strong capital support, innovative marketing, and price advantages.

In 2021, the market scale of China's coffee industry reached 348.4 billion yuan. With the change in public dietary concepts, the Chinese coffee market is entering a stage of rapid development. New brands are emerging at an even faster pace, and it is expected that the coffee industry will maintain a high growth rate. By 2025, the market scale in China may exceed 400 billion yuan.

From the perspective of the structure of coffee products in China, instant coffee still occupies the main market for coffee consumption. As consumers' acceptance of coffee culture gradually increases, the status of ground coffee in the coffee market is expected to further improve. Compared with developed countries, the per capita consumption of ground coffee in China is relatively low, but the consumption in first-tier and second-tier cities has approached that of mature coffee-consuming markets. Ground coffee has shifted from a social beverage to a daily consumption item.

Under the influence of the consumer habit of drinking coffee in first- and second-tier cities, coffee shops are relatively concentrated there. Overseas instant coffee brands have a distribution rate of over 50% in first-tier city stores. Since coffee shops emphasize social needs, the drinking space and atmosphere become one of the important considerations for consumers. Therefore, coffee shop brands prefer to locate in popular business districts with high foot traffic as their first choice for location.

Although the number of cafes in China's coffee market is nearly saturated, independent cafes still accounted for as high as 87% in 2019, while the chain rate of the coffee shop industry was only 13%. Most of the existing cafes are independent ones, and although there are many of these types, they have not yet achieved economies of scale.

With the expansion of well-known brands and the increasing number of consumers choosing chain brands, the chain penetration rate of freshly brewed coffee shops is expected to increase. The saturated coffee shop market offers limited room for new independent coffee shops, but it is conducive to the expansion of leading brands within the industry, further building brand effects.

Source: Analysis by Frost & Sullivan

• Upstream: Coffee bean production
  

In terms of global coffee production, coffee-growing regions are distributed between the Tropic of Cancer and the Tropic of Capricorn. Coffee plants are susceptible to frost damage, making it unsuitable for growth at higher latitudes north or south of the equator. South America, Central America, Asia, Africa, and coffee-growing islands are all located in tropical and subtropical regions. In terms of production areas, the coffee production of South America and Central America accounts for about 70% of the world's supply, while the production of Asia and Africa accounts for 20% of the total world supply. Coffee production regions exhibit significant regional characteristics, with Brazil and Vietnam being the world's largest coffee-producing countries. In 2020, Brazil and Vietnam accounted for 38.7% and 16.5% of the global coffee bean production respectively.

From the perspective of the distribution of coffee-producing regions in China, some local areas have already implemented the 'company + base or cooperative' production model. The area planted in the estate and base model is still relatively small, with most still adopting the smallholder or coffee farmer model as the main approach. Yunnan, the main coffee-producing region, accounts for over 90% of China's coffee production, but both scale and standardization effects are relatively low. This also places smallholder and coffee farmer growers in a disadvantaged position in the long-term supply chain.

On the other hand, among Yunnan coffee planting enterprises, there has not yet been a market-leading company with widespread recognition. The long-term lack of a leading brand has led to relatively backward production facilities and technology, resulting in uneven quality of coffee products. This has hindered the further transformation and upgrading of Yunnan coffee in China towards the premium coffee market.

• Midstream: Coffee bean processing and coffee product provision

Looking at the midstream industry, it mainly involves coffee roasting and processed ripe beans. In terms of coffee roasting, coffee beans are first dehydrated,High temperature crackingProcessing procedures such as cooling are followed to turn the beans into light, medium, and deep-dried roasted beans based on their ripeness. These beans are then packaged and transported to major bean processors or directly sold to downstream coffee shops or consumers of roasted beans. For bean processors, they can further refine the beans through grinding, extraction, concentration, and drying to produce instant powder, which enters the market for instant and ready-to-drink coffee. In the roasted bean sector, Jiahe and Liyu are currently still in the first tier of the industry, while companies such as Ming's and Jin Milan are positioned in the middle echelon. Emerging processing enterprises like Doushu and Yongpu are also catching up rapidly and developing vigorously.

• Downstream: Coffee consumption

From the perspective of basic attributes of coffee consumers, women account for up to 60% of them. In terms of consumer age distribution, young people have a high pursuit of quality of life and love to try new things. Coffee consumption has become an essential part of their daily routine. The post-85s and post-90s generations are the main consumers of China's freshly ground coffee market, and future consumption in the coffee market will still be driven by this group of young people.

In terms of coffee brand preferences, Starbucks and Luckin Coffee are mainstream brands consumed by coffee consumers. The public has a higher willingness and awareness of consuming leading coffee brands. Under the impact of new retail, traditional coffee brands are gradually declining, while new brands are rising strongly.

Source: Analysis by Frost & Sullivan

• Store side

As of the end of 2021, there were approximately 120,000 coffee shops in China, with the number of coffee shops in first-tier and second-tier cities accounting for more than 75%. Well-known chain coffee brands such as Starbucks and Luckin Coffee are rapidly occupying the coffee market through store expansion strategies. In contrast, brands following the fine coffee route such as M Stand and %Arabica have chosen different development paths. They have set up far fewer stores than well-known chain brands, concentrating their locations in the core areas of first-tier and new first-tier cities, focusing on providing consumers with high-quality coffee drinks and coffee experiences.

Currently, the independent coffee market in China is still dominated by independent cafes. In 2021, the number of independent cafes accounted for about 80% of the Chinese coffee market, while the number of large chain cafes accounted for less than 15%. Among them, the low chain penetration rate of freshly ground coffee shops results in a smaller number of well-known chain brands in the Chinese freshly ground coffee market. Leading enterprises occupy an absolute dominant position in the Chinese coffee market due to their strong brand strength.

The market position of cost-effective coffee brands represented by Luckin Coffee and Lian Coffee is gradually improving, and the daily consumption attribute of freshly ground coffee is being increasingly emphasized. In the cost-effective coffee market, coffee sales are still mainly through convenience stores, targeting student and white-collar groups. Competition mainly focuses on store ownership, sales locations, and prices.

• Brand aspect

Currently, Chinese coffee brands are facing a market competition landscape where traditional, boutique, and new retail categories coexist. In addition to established leading brands such as Starbucks and Luckin Coffee, many emerging brands are also making diversified attempts and brand shaping efforts based on their unique business philosophies, as the market structure is not yet fully determined.

Source: Analysis by Frost & Sullivan

• Product Trends —— The Rise of Fine Coffee

As the consumption demand of coffee consumers in China continues to upgrade, it is expected that the specialty coffee route will become a focus of leading brands' strategy for upscale positioning.

Taking the leading brand of freshly ground coffee, Starbucks, as an example, since 2014, Starbucks has focused on developing high-quality specialty coffee. As a premium brand under Starbucks, there are three store formats under the "Savor" brand: Savor stores, Savor Coffee Shops, and Savor Baking Studios. To meet the evolving needs of the coffee market, Starbucks also plans to open 1,000 Savor stores globally and 20-30 Savor Baking Studios. Since Starbucks' Savor stores entered the Chinese market in 2014, they have opened over a hundred stores so far, providing specialty coffee enthusiasts with higher-quality products and a more upscale immersive experience. Under the strategic leadership of leading brands in exploring the specialty coffee route, the freshly ground coffee market is gradually developing towards specialization, quality, and high-endization.

On the other hand, specialty coffee brands that focus on brewing quality coffee are widely popular in various cities. Consumers' enthusiasm for boutique coffee brands remains high, and their popularity will surpass traditional chain coffee brands in the future. The emergence of boutique coffee is related to the third wave of the coffee market, which emphasizes improving coffee quality, highlighting the importance of sustainable development, and innovating methods of brewing coffee. As consumers drink coffee, they have higher demands for both the quality of the coffee and the experience of tasting it.

From the consumer evaluations and feedback of various cities, it is evident that consumers in these cities have a significantly higher average enthusiasm for boutique coffee brands such as Peet's Coffee, Seesaw, and %Arabica compared to large chain coffee brands and cost-effective coffee brands. These brands are priced much higher than those of chain stores like Starbucks, and their coffee quality comes from better-quality beans and grinding techniques. In addition, with unique store logos and social media marketing strategies, they cater to the young consumer's desire for trendy and online-famous things. This differentiated positioning has successfully tapped into the diverse demands of young consumers for freshly ground coffee brands.

• Sales Trends - The Rise of Convenience Channels

Currently, the convenient consumption scenarios for coffee consumers account for over 70%, and consumer behavior changes are driving the layout changes in channel distribution for freshly ground coffee brands. The 'quick service store' and 'convenience store' models have not only broken through the original coffee consumption model dominated by large coffee chains represented by Starbucks but also restructured the cost structure through internet technology, reaching out to the emerging mass coffee consumption market.

From the perspective of sales channels, 'fast coffee' in the form of convenience store coffee, express shop coffee, and coffee takeaway is gradually becoming popular and has become the mainstream market in the short term. Take Luckin Coffee as an example; from 2014 to 2019, the proportion of its express shops increased from 44.5% to 92.5%. This type of store not only facilitates consumer access but also saves on labor and rent costs for businesses. The convenience store channel is reshaping the market for Chinese ground coffee brands.

• Brand development trend

Against the backdrop that the sales of boutique coffee products and convenience stores are expected to become mainstream, the main brands in the industry will focus on comprehensive product value and large-scale chain brands suitable for multiple scenarios. Brands that offer a 'fast-paced coffee' sales scenario combined with the concept of 'slow life' will gradually seize market share.