In Part 1, I argued that Starbucks China most interesting competitor is not Luckin Coffee. It is HeyTea, an upscale Starbucks-type business focused on tea (something Chinese consumers really, really like).
And to their credit, HeyTea appears to be mostly focusing not on digital (or financial engineering) but on product development and continually thrilling their customers. Which leads me to my next reason for why you should keep a close eye on HeyTea.
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Reason #3: They have lines out the door.
I met HeyTea Chief of Staff Joy Tan at a newer upscale shopping mall in Western Beijing. And as it was in the afternoon, most of the restaurants and cafes were mostly empty.
But arriving at the HeyTea outlet I could see a line out the door. And making an impression like that in F&B (that you are popular) is really important. The place was packed.
However, a quick caveat. Long cues in China don’t always mean what you think.
One of my standard questions to MBA students is what does it mean when you see one restaurant with a line out the door. The international students always say “well, that one is popular”. The Chinese students always say “they are paying people to stand there.” Both can be true.
- A couple of years ago, it came out that movie studios in China were paying people to go to cinemas on opening weekend to boost their numbers.
- Today, KOLs routinely buy online traffic to make themselves appear popular.
- And don’t even get me started about all the clever ways Chinese tech companies are currently boosting their user and engagement numbers (especially before going public in the US).
Some of these tactics include just faking numbers and being dishonest. But a lot of it is about being perceived as popular in intensely competitive markets. And there is what Warren Buffett calls the “institutional imperative”. If your competitor is doing something like this, you have to as well. If a competing movie is launching the same weekend as yours and the press is reporting they are sold out (by filling seats), that is going to impact your movie. So if I was running a restaurant in China (I have been involved in two restaurants in the past), I would be pulling every clever trick I could think of to get people in the door and to create the appearance of being popular.
Anyways, it’s something to keep in mind.
In the case of HeyTea, I went to three outlets in Beijing and it was definitely real demand. All three were packed with lines out the door. I even went to one in the Beijing airport at 8pm at night – and it was also packed.
HeyTea and high-priced, creative tea drinks are a consumer phenomenon in China. And speaking with Joy, she mentioned that most of their 220 stores are operating at capacity. People hold places in line for other people, which has resulted in the average order being three drinks (and about 80rmb). And managing their long cues is turning out to be a real challenge. Long lines can impact the consumer experience.
Reason #4: They are growing based on traffic – not investor capital.
HeyTea has around 220 outlets now and they are planning to double that this year. That’s great. And that is how successful retailers and F&B are supposed to grow. They open outlets, build traffic, get them to operating break-even and then open more. You pay close attention to same store sales.
And that is exactly how Starbucks, KFC and McDonalds grew in China. It took Starbucks twenty years to get to 3,300 outlets. And they routinely close stores based on profitability. Although their store closures in China have been much less than in the US.
In contrast, Luckin has grown like a tech company. They have used venture capital money to open +2,000 outlets in about a year. This could be them taking advantage of their more scalable business model (90% of their outlets are just for pick-up). Or it could be an exercise in financial engineering and B2VC. You build something that venture capitalists like, show big growth and go public. It’s a higher risk strategy but it also could work.
Anyways, I like the HeyTea approach. I like to see slow expansion based on foot traffic.
Reason #5: They are well-positioned to move into coffee or caffeine.
F&B is a difficult business, with fickle consumers, endless competition and few durable advantages. So how is Starbucks so dominant almost everywhere?
My simple answer is caffeine and sugar. They are not selling beverages. They are selling a stimulant. Caffeine is mildly addictive and it creates a daily habit. That is what gets you a stable core customer base that comes in every day. None of this happens with juices, milk and most other beverages. Starbucks, Coke, Red Bull and 5 Hour Energy are all in the stimulant business.
So what about doing this in tea?
Most green and black tea has very little caffeine or sugar in it. People like regular, fruit and bubble teas but they don’t get one first thing every morning. Personally, I think someone should offer a morning “energy tea” that is a popular Chinese tea loaded with caffeine.
Interestingly, HeyTea has started to coffee products. They now offer a matcha and brown sugar coffee (a cool name). I think they are experimenting in this regard. I think any movement towards coffee or caffeine could be really interesting.
Final Reason: HeyTea is set up to be acquired.
As mentioned, F&B in China is mostly about thrilling your customers.
The other part is getting the real estate right. Starbucks is awesome at this in China. They have great locations in first and second tier cities. They are always in the high traffic and high visibility locations. And their outlets are fantastic. Most are like modernized versions of traditional Chinese tea houses. Note: They are far better than the dingy Starbucks I used to go to in New York.
HeyTea has been copying Starbucks approach in both locations and quality design. They are going after good locations in Grade A shopping malls. You can find them literally next door in Starbucks in places like San Li Tun. And their interiors are also pretty good. They currently have three store concepts: black industrial retro, white and pink.
But real estate is a game of operational scale. It takes a long time to build a footprint of quality locations. And it is not really HeyTea’s core skill. There are good at creating popular products. There are lots of companies that are good at the blocking and tackling of China real estate. The next logical move is for HeyTea to find a partner to scale up on the real estate aspects.
If HeyTea continues on their current trajectory, I think they are set up to JV or be acquired. Perhaps by Yum! China or maybe even Starbucks. Or maybe by a large retailer or commercial developer with lots of locations and cash. That could get them to +1,000 locations much faster. And there are lots of real estate, supply chain and marketing benefits to scale. We’ll see.
That’s basically my take. If you couldn’t’ tell, I am pretty scared of this whole sector. I find it really difficult and success is rare. So this is a good company to watch. Plus, their products are really great and you should give them a try.
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