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Israel's coffee king takes on Starbucks with US$1-a-cup franchise

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Near Red Square in Moscow, Irina Kushnir waited for her order of coffee. As soon as she learned that a new coffeehouse was selling all items for 50 rubles (S$1.10), the 28-year-old graduate student decided to forgo the nearby Starbucks and join the queue outside the tiny, cable car-like stand.

[TEL AVIV] Near Red Square in Moscow, Irina Kushnir waited for her order of coffee. As soon as she learned that a new coffeehouse was selling all items for 50 rubles (S$1.10), the 28-year-old graduate student decided to forgo the nearby Starbucks and join the queue outside the tiny, cable car-like stand.

"I haven't seen any other coffee shops in Moscow offering cappuccinos at this price," she said, shuffling her way forward in the line of six people.

This is the first Russian branch of Cofix Group Ltd. It won't be the last. Founder Avi Katz, who started the chain in Israel in 2013 and now is the country's biggest coffee-stand operator, has big plans. In addition to Russia, he's planning to expand into the other two top branded-coffeehouse markets in Europe: the UK and Turkey. He's also about to open New York and Madrid offices for Hagshama Fund, his US$650 million real estate investment firm.

But in the competitive business of coffee, it's one thing to succeed in your home country. It's another to try your hand in foreign lands, especially three that are undergoing political or economic turmoil. All the while competing against coffeehouse behemoths Starbucks and Costa Coffee.

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Though absent in Israel, Starbucks owns the most stores in Europe, followed by Costa Coffee.

Mr Katz, 54, says he's counting on the Cofix model: Strip out the chairs and waiters. Sacrifice space and price for volume. Most importantly, find places where the difference between what people pay in shops and what it costs to make coffee at home is huge. Then drastically undercut the competition.

His approach is embodied by the fact that he can't meet with a reporter in one of his own shops - too small. Instead, he's nursing a large cappuccino he doesn't like in a Tel Aviv coffeehouse he doesn't own.

"A new market is opening up to those who couldn't afford outside coffee," said Mr Katz, wearing jeans and a blue polo shirt, a small knitted yarmulke on his bald head. "And for those who already can, they save money. This is my revolution."

Born to an Orthodox Jewish family in Bnei Brak, he left religious seminary for boarding school at age 14. He still devotes 15 hours a week preparing his Wednesday sermon, delivered in his packed living room in Kfar Saba, and is writing an introduction to a book about Ayn Rand. A passage from Genesis in which Jacob professes his unworthiness of all that God has given him is painted in black above the sofas in his corner office at Hagshama headquarters in Petach Tikva, an industrial town east of Tel Aviv.

"There's only one person in all of Tel Aviv who knows what God wants. That's me," Mr Katz said. "Why? Because I know God wants what's best for Avi Katz." Mr Katz found himself a wealthy man in 2008, after he sold his Israeli dollar-store chain for 180 million shekels (S$67.1 million). The next year, he founded Hagshama, which lets small investors allocate investments to global real estate projects. The fund now has about 23,000 investors and operates a second office in London. His fund has yielded an average annual return of about 15 per cent, according to local press reports.

He opened the first Cofix branch in Tel Aviv two years after the largest protests in Israel's history were sparked by rising prices for basic goods like cottage cheese and milk. At the time, Israelis were paying as much as nine times the cost of a homemade cappuccino, said Mr Katz. Cofix now has 161 stores across the country.

Mr Katz has inspired imitators - and angered rivals. Days after opening, Kobi Hakak, the owner of a competitor called Roladin, held a press conference and challenged the quality of Cofix products. With his spokesman, Rani Rahav, he cut up Cofix sandwiches and cakes and invited reporters to taste what he said was Roladin's better quality.

Mr Rahav called the bread verkakte (Yiddish for "crappy") and insinuated the coffee might have come from Syria, a blood enemy of Israel. Mr Katz says the coffee comes from Latin America and Italy.

At one point, Mr Katz rejected a bribe to close down his chain, he said: "When leading a revolution you're always under threat." Cofix in October opened the Moscow shop, the first of up to 1,000 planned Russia branches, for an investment of about US$2 million. Roughly equal partners in the venture are Melson's Group, the Russian food distributor, in charge of purchasing; and ADG Group, which is committed to investing about US$930 million to remodel 39 Stalin-era theatres into commercial centers throughout the capital. They will house the Cofix shops. Mr Katz's initial outlay was several hundred thousand dollars, he said.

At 50 rubles, prices are about one-fifth the cost of a cappuccino at Starbucks. That could serve as a respite to Russians, whose wages have fallen due to economic sanctions by the US and European Union, and who face a second year of economic contraction.

Still, Mr Katz says that high rental costs in one of the most expensive cities in the world will force Cofix to sell 1,700 items per day to break even, compared with 1,000 in Israel.

"Coffee is a high margin product but you have to sell a lot of it to make money,"' said Jeffrey Young, chief executive officer of research and consultancy firm Allerga Group Ltd. "You have to remember, even Starbucks is spreading that profit across 23,000 stores around the world."

Mr Young spoke before Starbucks said last week it plans to add another 12,000 locations globally.

Cofix has added another two branches in Moscow since the opening, Mr Katz says.

Mr Katz says the other major cities he is targeting - London and Istanbul - match his main criterion: Coffeehouses charge six to nine times more for a medium cappuccino than the US$0.40 the ingredients cost consumers, according to data from Allegra.

The timing, however, may be problematic there as well. The UK is still digesting the impact of its decision to leave the EU, and confidence among services firms has fallen since. Turkish President Recep Tayyip Erdogan is consolidating power and resisting efforts to increase rates, key to sustaining the foreign investment on which the country runs.

This erosion of the checks to Mr Erdogan's power isn't conducive to foreign investment, according to Wolf-Fabian Hungerland, an economist at Berenberg Bank. Mr Katz says he's actively seeking partners to open in both countries.

"It's problematic because if investors want to stay for a long time they need to be able to forecast what the government is going to do," said Mr Hungerland, who specialises in Turkey and Russia.

Mr Katz faces psychological barriers, too. People living in major cities like London are less sensitive to high coffee prices, and many want their coffeehouse to be more than a "to-go" factory, says Allerga's Mr Young. That partly explains why Caffix, the London cafe that offered everything on the menu for one pound, failed earlier this year, he said.

"Coffeehouses are places where people talk, relax and take time out of their busy day," said Mr Young. "They've become almost like our sanctuary. For that, people are happy to pay US$5 for a cup of coffee."

Back in the queue, Ms Kushnir gets her order. Satisfied by the quality of the coffee, less so by the quantity of the chocolate cheesecake, she offers a truncated version of Mr Katz's vision for Cofix.

"Not so different from Starbucks," she said.