What Does Luckin’s Comeback Mean For China’s Booming Specialty Coffee Scene?

Key Takeaways : After a scandal in which the company fabricated hundreds of millions in sales, Luckin Coffee is back with new creditors and eager to regain its reputation. Yet, even as Luckin opens new locations and achieves strong sales growth, it faces a very different coffee market in 2022. Stiff competition from a number of foreign and domestic specialty chains with higher profit margins could cramp Luckin's long-term revenue potential. Nearly two years after it was found to have fabricated more than $300 million in sales – bringing what had previously been billed as China’s high-flying “Starbucks killer” crashing down to earth – Luckin Coffee is eager to tell the world that it is back on track. After delisting from the Nasdaq in 2020, negotiating with bankruptcy courts and creditors and shareholders in the United States and China, shaking up its executive suite, and paying millions in fines, the company recently announced that it has attracted a spate of new investment and restructured for better long-term growth. After opening its first location in 2017, Luckin had big ambitions of blanketing China with its signature quick-service outlets, a goal it met on paper at lightning speed, opening more than 4,500 “stores” as of January 2020 – a few hundred more than Starbucks, which at that time had been in China for two decades. However, in its pre-scandal growth phase, much of Luckin’s heavily marketed corporate persona as China’s great (caffeine) hope was somewhat overblown. For one thing, the vast majority of its thousands of locations were nothing more than pick-up counters for mobile coffee orders, in contrast to the “third place” coffeeshops pioneered by rival Starbucks. For another, Luckin’s hyped “new retail” strategy was always digital- (and primarily mobile-) first, with a key selling point the overwhelming (and, for Luckin, very expensive) use of giveaways and discounts. This, paired with the high costs of blanketing China in digital and physical advertising, made for an extremely costly business plan. In 2018, marketing costs were equivalent to nearly 90 percent of Luckin’s revenue, and to imprint its distinctive blue cups in the minds of consumers throughout China, the company gave away a free cup of coffee for downloading its app – a move that equated to millions of cups of lost revenue. Meanwhile, the company’s regular discounts meant consumers could get more than 80 percent off on menu items. This unsustainable strategy quickly equated to millions of consumers who were largely reluctant to pay full price. In the two years since scandal broke, Luckin has retooled with the support of Beijing-based private equity firm Centurium Capital, which became Luckin’s controlling shareholder after purchasing shares previously held by two of Luckin’s founders. The company shuttered more than 1,000 underperforming stores in 2020 and opened hundreds of new ones in other locations, once again catapulting the company’s retail footprint beyond that of Starbucks. According to company statements, third-quarter 2021 sales doubled over a year prior, reaching approximately $365 million, while operating margins showed an improvement. Last month, the company announced an 81 percent jump in quarterly revenue. Despite Luckin's renewed momentum, China’s coffee scene in 2022 is different from that of 2018 or 2020. Now, the market is populated not just by high-profile foreign giants like Starbucks or Illy but also a rapidly growing number of savvy specialty coffee chains that have made loyal customers of China’s urban middle class. Whereas Luckin long powered its growth through spendthrift marketing expenditure and unsustainably deep discounts, the new generation of Chinese coffee brands instead caters directly to the tastes of young consumers via clever brand collaborations, social media-ready limited-edition beverages, and sustainability-based efforts (as well as affordable – but not solely deep discount-based – pricing). One example of a domestic Chinese coffee brand that could complicate Luckin’s long-term plans is Shanghai-based Manner, which has grown from one streetside stall in 2015 to more than 300 locations throughout mainland China today. One of Manner’s key competitive advantages is its tech connections, which infuse Manner with a digital prowess that Luckin largely lacks. Flush with a 2021 cash injection from the likes of Singapore’s Temasek, Bytedance, and the venture arm of Meituan, Manner already boasts an eye-watering $4.5 billion valuation and is reportedly planning to raise up to $300 million via a Hong Kong IPO to fuel its ambitious expansion effort. But Manner is just one of many domestic chains appealing to the new generation of coffee lovers, and as international specialty chains like Blue Bottle and Japan’s % Arabica expand into the China market, Luckin may struggle to stand out for anything more than convenience, a handful of interesting drinks, and a “Starbucks but cheaper” value proposition. The recent debut of America's Blue Bottle Coffee in Shanghai attracted long lines. Image: BarTalks It is this value proposition that will be most interesting to watch as Luckin continues its comeback tour. Will it crack the code and sort out its unsustainable pricing and discounting strategy to achieve long-term revenue that can offset massive marketing expenditures? Despite sales doubling in the third quarter of 2021, Luckin’s revenue that quarter was just over one-third of that of Starbucks over the same period, owing to the former’s significantly lower prices. If it is ever to “kill” or even make a dent in its foreign – and increasingly domestic – competition, Luckin may need to completely rethink its company identity altogether. Could it, perhaps, introduce slightly higher-end products or product lines with higher profit margins, or collaborate with higher-end brands to improve its reputation? For anyone interested in China’s booming coffee market, the months ahead will be more than just interesting, they will be crucial for Chinese chains both large and small.

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What Does Luckin’s Comeback Mean For China’s Booming Specialty Coffee Scene?