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The background: The coffee-shop sector has enjoyed a decade of rapid expansion as branded chains have taken over the nation's high streets.

But the next few years should see a slowdown in growth. The market is maturing, with inner cities already reaching saturation point. As a result, chains are looking to product development and extra services such as music and internet access to drive sales growth, rather than franchising and licensing. There may still be scope to open shops in the suburbs and rural regions, but such expansion is unlikely to go unchallenged by the anti-globalisation lobby.

UK consumers have embraced coffee-shop culture with gusto since branded shops started to appear in the 90s. Clutching a cappuccino has become such an integral part of the day for many urbanites that the market was worth £449m last year, a rise of 109% since 1999, according to Mintel.

There are now an estimated 1600 branded coffee shops, with expansion beyond the metropolises and into the regions.

The top four branded chains - Starbucks, Costa Coffee, Caffe Nero and the smaller Puccino's - now control 69% of the UK's branded coffee shops, compared with 57% in 2000. Coffee Republic, formerly a branded chain, is withdrawing from the specialist market as it converts its shops into delicatessens.

US chain Starbucks is on a major worldwide expansion programme to meet its target of 25,000 outlets by 2010. In the UK it is the biggest player, with 425 stores at the end of 2004, double its number five years ago.

Accordingly, it is visited by more Britons than any other chain, with 19% of all adults going to one of its outlets in the three months to November 2004.

There are domestic successes too: by the end of 2004, Whitbread-owned Costa Coffee was not far behind Starbucks with 370 branches, while independent chain Caffe Nero owned 198.

Much of the expansion within this sector is the result of licensing, where outlets appear in existing retailers such as bookshops and department stores, and franchising. The cost of this rapid expansion has invariably been felt by local independent coffee shops that do not have the financial muscle to stand up to the big brands.

Growth of the chains

All the main players have gone through periods of aggressive expansion, often opening outlets in close proximity to each other and to independents to grab share. This strategy has pushed up the cost of rent, while not always producing the necessary sales.

In the past year, the market has matured. Mintel says operators are turning to product development and adding services to grow revenues instead.

Starbucks - the world's biggest coffee-shop company - started out in Seattle in 1971. It acquired the Seattle Coffee Company in 1998, giving it 65 locations in the UK, and overtook Costa Coffee in 2002. It has established some in-house brands such as its iced coffee Frappuccino and its tea, supplied by its subsidiary Tazo Tea Company.

The US chain has agreed strategic deals with bookshop companies such as Waterstones and Borders to open cafes in store. Starbucks has also been expanding its Wi-Fi service, allowing laptop and PDA users to gain high-speed internet access in 154 of its shops.

Starbucks is one of the corporations heavily targeted by anti-globalisation groups, which have accused it of worker exploitation. It has also been the subject of some protest in the UK, as the domination of high streets by multinationals has risen up the political agenda.

Its expansion has come at a cost, and in 2003 Starbucks saw losses of almost £18m. But the investment seems to be paying off, as the company is expected to turn a profit this year. Its managing director Cliff Burrows has admitted the coffee-shop sector is not an easy market, but that it is easier for Starbucks now than it was four years ago.

Costa Coffee operates several different-sized outlets depending on its location. It has been a leading player in the transport retail sector, with concessions in airports and railway stations as well as on board some airlines. It also offers a wholesale supply division for caterers, health clubs and offices. Since 2002 the chain has been branching out with hot food and salads. It has also started to offer broadband access in some stores in a deal with BT Openzone.

Italian focus

Caffe Nero opened its first shop in 1990, and in 2001 floated on the London Stock Exchange. As with its rivals, it has expanded rapidly, and was one of the fastest-growing companies in Europe in 2004. Along the way, it has picked up sites from Aroma and Coffee Republic.

The chain has tried to set itself apart by focusing on its Italian-inspired style - it imports most ingredients for its meals from Italy. It moved into profit last year, with pre-tax earnings of £1.9m in the six months to November 2004.

The rise of the coffee shop has had a lasting effect on British consumers' attitudes toward coffee. Many now expect a higher quality of coffee both out of and in the home. In the past five years, the value of the fresh/ground segment of the coffee market has increased 21%, while instant coffee sales fell by 13%, according to Mintel. Douwe Egberts' Espresso Report 2004 found that more than half of consumers prefer espresso-based drinks served by the coffee shops to filter or instant alternatives.

Coffee was the first market to be targeted by the Fairtrade Foundation when it was created in 1994, and the organisation still works to provide fair and constant prices to coffee farmers meeting its criteria. Some of the branded chains offer these products. Costa Coffee has offered some Cafedirect products since 2000, while Starbucks introduced a Fairtrade coffee in the UK in 2002.

Added services

After its heady expansion, the coffee-shop market is seeing a slowdown in growth, so established brands may be forced to look for new ideas.

For example, in the US Starbucks is trying to evolve its outlets into media and community centres. It has introduced CD-burning facilities in 45 of its stores in a partnership with Hewlett-Packard.

Overall, Mintel predicts that consumer spending in branded coffee shops will continue to grow, but at a slower rate. It is forecasting expansion of 41% in the 2005-2009 period, with the market reaching a value of £691m.

This is equivalent to 26% growth when inflation is taken into account.

Premium coffee will continue to appeal to higher- wage earners, and there is still room for expansion beyond the core regions of London and south-east England.

LEADING UK COFFEE-SHOP CHAINS BY OUTLETS

Coffee shop 2004 % 2002 % 2000 % 00-04

%change

in number

of outlets

1 Starbucks 425 39 349 37 221 35 204

2 Costa Coffee 371 34 310 33 250 40 121

3 Caffe Nero 198 18 110 12 62 10 136

4 Puccino's 106 10 95 10 16 3 90

5 Coffee Republic n/a n/a 76 8 82 13 n/a

Total 1100 100 940 100 631 100 460

Source: Mintel Percentages may not total 100 due to rounding.

% CONSUMERS VISITING SPECIALIST CHAINS BY SEX, AGE AND SOCIO-ECONOMIC

GROUP

Any Starbucks Costa Caffe Other

branded Coffee Nero

coffee shop

All 32 19 14 8 5

Men 32 20 13 9 5

Women 33 19 14 8 6

15-19 35 22 14 7 4

20-24 45 27 15 17 7

25-34 45 32 21 14 6

35-44 36 21 18 8 4

45-54 29 15 11 8 7

55-64 29 17 11 6 7

65+ 16 6 6 3 4

AB 48 31 24 15 8

C1 43 27 19 11 5

C2 25 14 10 6 5

D 19 9 5 4 5

E 17 9 6 4 3

Source: NOP/Mintel Survey of 2065 adults on coffee shops visited in past

three months, November 2004.

ANALYST COMMENT

Caroline Bremner Consumer foodservice research manager, Euromonitor

The boom in the UK coffee-shop market is well and truly over. Saturation in London prompted key chains to expand regionally in 2004. However, despite maintaining outlet growth, this led to increased competition and downward pressure on sales.

Last year saw big coffee-shop brands pick off prime high-traffic sites, leveraging powerful branding to compete with rival formats and independents.

In response, regional chains such as Chocolatesoup emerged to compound the problem further for independent operators.

Starbucks, Costa and Caffe Nero remain the dominant players in the UK.

Yet despite Starbucks' enviable position, the company has seen a slowdown in its UK expansion.

Operators are focusing on raising spend per customer by offering food alongside drinks. Starbucks targets breakfast, lunch and snack times with indulgent-to-healthy options. The range is limited compared with other operators, though now that systems are in place to sell food, it will be easier to expand the selection in future. The problem is how to challenge established and well-respected bakery/coffee players such as Pret A Manger.

Caffe Nero's food offer is integral to its concept. Euromonitor research shows that it enjoyed the fastest growth in the UK coffee-shop market between 2001 and 2004. The chain uses in-store ambience as a means of differentiation, promoting 'music with integrity' through its partnership with Just Music. Likewise, Starbucks' Hear-Music arm sells music CD compilations in the UK, and the word from the US is that this will feature prominently in Starbucks' future marketing, with music sold exclusively in-store to help win custom.