Starbucks to Open China Coffee Farm, Securing Global Supply - WSJ Page 1 of 3

Starbucks to Open China Coffee Farm,

Securing Global Supply
By LAURIE BURKITT
Updated Nov. 15, 2010 10:03 p.m. ET

PUER, China—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.

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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.

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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."

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