Zhong Jinglin, an entrepreneur in his twenties, was surprised to find that a milk tea shop that he had opened with his friends in China’s southern Guangdong province was suddenly surrounded by 20 other, similar tea-houses. “There should be room for growth for the milk tea industry, but it’s important to choose the right location. And you need to keep up with heavy competition these days,” he said. Zhong and his friends had to close their business a year later, after revenue plummeted sharply, from about 6,000 yuan (US$925) on their first day to about 1,000 yuan a day, followed by losses. Zhong’s experience represents a snapshot of the industry, which features both a fast growth in the number of businesses, as well as an increasing number of firms shutting down. Between 2014 and 2018, milk tea companies grew at an annual compound growth rate of 23 per cent, according to company information and data provider Tianyancha. But about 26,000 tea-houses collapsed in 2019, with only 18.8 per cent of the total number surviving for more than a year, data from iiMedia Research shows. The coronavirus pandemic wiped out more than 130,000 such firms, or 43 per cent of the total market, as of the end of November last year. Nonetheless, hot money continues to flow into the industry. Investment into tea drink makers hit a 10-year peak in the first six months of this year, with more than 5.3 billion yuan flowing in, according to Chinese Venture magazine. Investment last year amounted to just 170 million yuan, in comparison. The industry is at a crossroads where it must contend with over competition and an investment frenzy. “There’s a bubble in the overall milk tea industry, and the mania of investment should be blamed,” said Zhang Yi, iiMedia Research’s CEO. “How to improve their products and services, especially providing healthy food that tastes good and is cheap, is the most important problem facing all these companies.” Lai, a Shanghai native in his twenties, buys milk tea as an occasional treat, usually on the weekend. “I don’t drink too much milk tea because of health concerns. Milk tea has a lot of additives and sugar, which means I can gain weight easily, or worse, get diabetes [if I drink too much milk tea],” he said. Preferences have changed, with more Chinese consumers concerned about food safety and health. Typical milk tea consumers, 70 per cent of whom are millennials and Generation Z , care most about the quality and safety of tea drinks, a survey by CBNData shows. About 70 per cent tend to choose less sugar in their orders, it said. Milk tea brands have noticed this trend. Shenzhen-based Nayuki Holdings and Haytea, which is owned by Shenzhen Meixixi Catering Management, for instance, make their tea products with fresh fruit, real milk and less sugar. These “new-style tea drinks” have taken the industry by storm and created a segment that could be worth about 110 billion yuan this year. But they have also increased their prices to more than 30 yuan per cup, or 10 times the price charged by lower-tier brands. Nayuki has also tried to create differentiation by expanding its shops and creating a “third space” for young people to socialise between school or work and their homes. But these efforts have come at a cost. At Nayuki, cost of materials and staff – around 20 individuals for a standard Nayuki teahouse – amounted to 66.6 per cent of total cost in 2018 and 2019, and 68 per cent last year. Its store level operating profit growth has, however, slowed down in the same period. The company lost close to 137 million yuan from 2018 to 2020. The capital market reacted accordingly – Nayuki fell 13.5 per cent on its debut in Hong Kong despite being the first milk tea stock in the world. This may lead to investors realising that the sector might not be as lucrative as it appears. “The main target of the so-called new-style tea drinks are white-collar workers and students that are very young. They are also very price sensitive,” said iiMedia Research’s Zhang. “To some degree, a market for higher-end tea products does not exist. Or let’s say … it’s hard to meet the challenge of other brands whose products are cheaper while being good.” But milk tea firms continue to enjoy high valuations. Haytea finished a new round of fundraising in late June that reportedly values it at 60 billion yuan. Tea maker Teakoo’s parent DimensionZ, which was established in 2020, raised more than 100 million yuan in a series A funding round. Shanghai-based Auntea Jenny also raised around 100 million yuan in a similar funding exercise last month. A variety of new players have also entered the market. China Mengniu Dairy, beverage giant Hangzhou Wahaha Group, confectionery maker Shanghai Guan Sheng Yuan Food, which produces the famous White Rabbit confectionery, China Post and carmaker GAC Group – all giants in other fields – have joined the fray. Investors and entrepreneurs view China’s milk tea market along the lines of the coffee industry in the US, and believe there is more room for growth, said George Ren, a senior partner at Roland Bergers in Shanghai. “But if more players flock to the higher-end market selling milk tea at around 30 yuan a cup, or current players continue to have similar products – that raises questions [about their business models],” he said. An acceleration in consolidation lies ahead. “Just as Starbucks controls the bulk of the US market, after having beaten other coffee chains, there will be a similar fight in China’s milk tea market,” Ren said.