Thursday, 2024 February 29

Luckin Coffee dethrones Starbucks in China

Starbucks may be the largest coffee chain in the world, but in China, it’s now left to play second fiddle to Luckin Coffee, which has officially claimed the title of China’s largest branded coffee chain.

After surpassing Starbucks in domestic store count in 2021, Luckin overtook the American coffee chain in terms of revenue too, as of the second quarter of 2023. In this quarter, it even achieved its goal of establishing 10,000 stores ahead of schedule, achieving an operating profit margin of 18.9%.

With China’s domestic coffee market expected to reach a value of RMB 1 trillion by 2025, Luckin’s newfound lead is drawing widespread interest.

Overthrowing the incumbent

Luckin’s latest financial report highlights remarkable progress. In Q2 2023, its revenue surged by 88% year-on-year, reaching RMB 6.2 billion, outperforming Starbucks in China (RMB 5.96 billion).

To celebrate this milestone, Jinyi Guo, chairman and CEO of Luckin, announced that the RMB 9.9 coffee promotion will extend for at least two more years. Luckin will also accelerate the expansion of self-operated and joint-operated stores in the foreseeable future.

In the second quarter of this year, Luckin opened 1,485 new stores, averaging 16.3 new stores daily, and opened a total of 10,829 stores by the end of June 2023. In the Chinese food and beverage market, 10,000 stores represent a massive market scale and volume, which can translate to cost control advantages. Luckin is China’s first coffee chain brand to achieve the milestone of operating more than 10,000 stores.

Luckin also introduced an unconventional franchise model to seize market share. Shop and commercial property owners that are already working with other brands can opt to work with Luckin instead. There are certain requirements such as store locations, business licenses, and distance from pollution, that qualify a franchisee to adopt this model, but it is reported that 247 store applications have already been approved.

Investing in promotions and expansion did not hinder profits, evidenced by a same-store sales growth rate of 20.8%, and a monthly transaction count of 43.07 million, as of Q2 2023. Luckin’s operating profit margin reached 18.9%, with self-operated stores boasting a 29.1% profit margin.

Luckin’s robust expansion plan aligns with China’s rapidly growing coffee market. An Analysys white paper forecasts a 25% annual compound growth rate in China’s freshly ground coffee market by 2025, a rare high-growth avenue in the domestic consumer industry.

In comparison, Starbucks, which adopts a fully self-operated model, added 237 stores in the same quarter, less than a fifth of Luckin’s count. Starbucks currently has 6,480 stores in China and is projected to operate 9,000 stores nationwide by 2025.

Additionally, according to Canyan Data, 47.67% of Starbucks’ stores are located in shopping malls, while Luckin’s presence in such locations stands at only 24.84%. Starbucks’ average customer transaction price is RMB 38.81, while Luckin’s is RMB 18.13.

Recovering from its downfall

Since its debut store at Beijing’s Galaxy SOHO in October 2017, Luckin has dominated the domestic market in less than six years, thanks to its tripartite approach: burn money, offer subsidies, and expand rapidly.

Utilizing promotional strategies like buy-two-get-one-free and peer-to-peer referrals, early-stage Luckin swiftly expanded under founder Zhengyao Lu’s guidance, opening nearly 2,000 stores in a year, albeit at a substantial cost—the company reported losses of RMB 1.6 billion and RMB 3.2 billion in 2018 and 2019 respectively.

In April 2020, Luckin admitted to financial fraud, paying USD 180 million in penalties to the US Securities and Exchange Commission, and announced its delisting, marking the end of this rapid growth phase with Lu stepping down.

Following the settlement, Luckin entered into a new round of financing agreements worth USD 250 million. Centurium Capital contributed USD 240 million, increasing its ownership of Luckin to 17.2%, essentially putting them in control of the company. In July 2020, the company voted long-serving Luckin employee, Jinyi Guo, as the new CEO and chairman of the board.

With the support of Centurium Capital, the new management team led by Guo achieved several things: reveal the facts, remove fraudulent employees, prioritize accountability, retain core talents, adjust development strategies, and transition Luckin toward a modern corporate governance system. Luckin subsequently created a new, digital-enabled business model with people, product, and location as the three main pillars.

Guo was the first to introduce Luckin’s strategy of crafting trendy products. From 2020 to 2022, Luckin launched three hits: “Mascarpone Cheese Latte,” “Coconut Latte,” and “Creamy Dreamy Latte,” driving sales. Over 1.31 million cups of the latter were sold on its debut day, and 6.59 million cups had been sold by the end of the first week. Luckin tested products rapidly like an internet company, launching 77 new items in 2020, 113 in 2021, and 140 in 2022.

Luckin’s core business strategy centers on achieving cost efficiency, according to major shareholder Centurium Capital. This is accomplished by pricing its products within the RMB 20 range to maintain a healthy profit margin while appealing to consumers with superior product quality in comparison to competing alternatives in the same price category.

Reducing costs through economies of scale also gives Luckin leverage in price wars, allowing it to hold off budget coffee rivals. Its RMB 9.9 promotion led to the sale of 39 million cups of coffee in the first week. This year, insiders revealed that each cup of coffee sold through the promotion is “profitable.”

Stiff competition

As of Q2 2023, 3,648 of Luckin’s 10,836 stores are franchises, equivalent to 33.7%, up 2.7% from a year ago. Most of these stores are located in lower-tier markets. However, profit margins in these markets are significantly lower than in top-tier cities, with franchisees taking over two years to break even.

Despite reporting strong financials this year, Luckin is struggling to produce new popular products. Its limited edition “Biluochun Green Tea Latte,” received mixed reviews on Weibo. “The tea is good, the coffee is good, but putting them together feels odd,” said netizens on Weibo.

Its evergreen “Coconut Velvet Latte” has also inspired other coffee and tea chain brands to follow suit, making coconut-themed drinks a standard offering in the market.

In the latter half of 2023, well-known tea beverage brands, including Chagee and Mixue, announced plans to IPO and set up 10,000 stores. Most of them also sell coffee.

According to Tianyancha, China has added 31,600 coffee-related firms so far this year, 70.81% more than the figure reported for the same period last year. Among its rivals, Cotti Coffee, led by Luckin founder and former chairman Zhengyao Lu, serves as the biggest threat, opening 3,000 stores in seven months, significantly faster than Luckin. Cotti Coffee’s price war strategy is even more aggressive, selling a cup of “premium” coffee for only RMB 8.8.

KrASIA Connection
KrASIA Connection
KrASIA Connection features translated and adapted high-quality insights published on 36Kr.com, the largest and most influential technology portal in Chinese language with over 150 million readers across the globe.
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