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Chinese coffee wars may be heating back up with $400 million investment by McDonald's China

Tanner Brown

The fast-food giant plans to open thousands of McCafé stores in its second-largest market

A previous version of this report appeared under a headline that misstated the magnitude of the McDonald's China investment. The story has been corrected.

BEIJING -- Its meteoric rise, seemingly out of nowhere, made Chinese startup Luckin Coffee one of the most talked-about newcomers ever in the country's vast beverage market. More notably, it grew so fast, opening thousands of stores across the country, that it seemed Starbucks finally had a serious competitor.

In the span of roughly two years, Luckin (LKNCY) opened more stores than Starbucks had in its 20-year reign in China, and Luckin's cut-rate prices had consumers flocking to its grab-and-go locations.

That phase of China's coffee wars came to a screeching halt, however, when the Chinese government accused Luckin of fabricating hundreds of millions of dollars in revenue and profit (link), leading to a slew of lawsuits against the company and resulting in its delisting from the Nasdaq.

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Starbucks (link) has since faced more minor competition as Canadian coffee and donut chain Tim Hortons stormed into China last year and is rapidly opening stores selling coffee at a fraction of the premium Starbucks (SBUX) price point.

But this week came news of a possible bigger threat to the dominance of Starbucks. McDonald's (MCD) announced it will invest 2.5 billion yuan ($380 million) over the next three years to open 2,500 McCafé locations, nearly all of which are to be located within McDonald's stores, on top of its existing 1,500. Starbucks has 4,700 locations in China.

"As China's coffee market grows with speed, consumers will understand more about coffee and fall in love with it," Phyllis Cheung, CEO of McDonald's China, said in a statement. "Our goal is clear: Where there is McDonald's, there is McCafé."

McDonald's said its McCafé expansion will focus on lower coffee prices, deliveries and a selection of new food items. Cheung specifically mentioned the company's ability to pair quick but hot snacks with drinks sold at McCafés.

It's yet to be seen if lower-priced, less premium coffee will be a winning strategy against Starbucks' higher-end offerings that average roughly 30 yuan ($4.60) per cup. Nearly 75% of coffee consumed in China last year was instant coffee, according (link) to London-based research firm Mintel. Freshly ground coffee, whether at home or in-store, accounted for only 18%, but was the fastest-growing coffee segment and is expected to see continued rapid growth.

Store sales of coffee in China surpassed 42 billion yuan ($6.4 billion) last year, far lower than the U.S.'s comparable figure, but with a faster growth rate of roughly 15% annually, according to Mintel.

Shares of McDonald's have edged up about 1.7% in the trading days since the announcement, while the S&P 500 is up 0.6% over that five-session span.

Last Wednesday, McDonald's gave out what it said were 10 million free coffees in more than a dozen Chinese cities.

At a McCafé in central Beijing last Thursday, college student Wang Jian sipped an Americano while eating a sausage-and-egg breakfast sandwich. When asked about his coffee habits, he said, "I like the coffee. It's fine. But I'm here for this," he said, holding up his McMuffin before taking another bite.

Tanner Brown covers China for Barron's and MarketWatch.

This story was first published on Nov. 20 and has been updated.

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11-24-20 1254ET

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