Luckin Coffee Is Running Out Of Luck
COVID-19 and China
A Luckin Coffee store in Beijing. PHOTO: ZHANG Fan for EqualOcean

Luckin Coffee (瑞幸咖啡) has been giving Starbucks a run for its money since the Chinese coffee start-up opened its doors in 2017. While targeting similar consumers to its global counterpart, Luckin Coffee began offering delivery services and attractive discounts in hopes to quickly tap into China’s coffee market.

However, saw an overwhelming loss in the first quarter of 2018. Reuters reported the firm recorded a CNY 800 million loss last year, and a Chinese report indicated a loss of CNY 850 million in the first quarter of 2018. This raises the question of why Luckin Coffee is deciding to pursue an IPO at this stage and why the company shows and voices no concerns over their continuous losses.

Additionally, the company is seeking a USA IPO at USD 3 billion in 2019, according to Seeking Alpha. In exchange for the IPO, it’s also seeking a USD 200 million loan from banks such as Goldman Sachs and Morgan Stanley, according to Reuters.

Why Luckin Coffee's Losing Steam

The argument is that Luckin Coffee can afford to lose the money as it “already raised hundreds of millions of dollars in venture capital,” according to The Motley Fool. Perhaps the motives behind Luckin Coffee’s loss strategy persistence is that it’s confident in long-term returns. By relying on subsidies, hefty marketing investments, and rapid expansions, it hopes to build and sustain a network effect and establish dominance in China’s coffee market.

However, while it may stick in minds of consumers and investors, its persistence in charging lower prices than its global counterpart, Luckin Coffee won’t be able to upgrade its brand and differentiate itself from other coffee brands besides being the first that comes to mind. In turn, this will substantially harm its brand in the long-run as the company continuously burns money without investing in effective long-term strategies.

Subsidy Reliance

Luckin Coffee’s reliance on subsidies is concerning. With subsidies, Luckin Coffee is able to price its products lower than Starbucks. It’s also able to do excessive promotions such as frequent discounts and the “buy-one-get-one-free” model to drive growth. According to Reuters, Luckin Coffee’s chief marketing officer, said, “there’s no point talking about profit. He also told Reuters that part of the firm’s strategy is to use subsidies to lure in users for the next few years.

While it’s normal business operations to engage in promotional activities once in a while to award loyal customers or boost advertising, it doesn’t help in long-term loyalty as there’s no incentive for consumers to buy from Luckin Coffee as its quality isn’t far from smaller coffee brands.

Therefore, when subsidies run out, Luckin Coffee’s prices will increase which consumers will turn toward cheaper substitutes or better-quality products. In addition, with tea brands such as HeyTea (喜茶) also looking to get a slice of China’s coffee market (see more in this article), it’s getting increasingly competitive to lure and enhance user stickiness.

Brand Image

To enhance its brand image, Luckin Coffee spends a hefty amount on marketing. Last year, they used TANG Wei (汤唯) and ZHANG Zhen (张震) as spokespeople. While these two influential stars aren’t as pricy as other celebrities like FAN Bingbing (范冰冰), the endorsement fee isn’t a small number. By associating its brand with such celebrities, Luckin Coffee is arguably boosting their brand instead of focusing on their products. In essence, they intend to use a psychological effect to lure white-collared workers.

TANG Wei endorsement
TANG Wei endorsement. PHOTO: Credit to Luckin Coffee

Ofo, the Chinese bike-sharing start-up used a similar strategy with LU Han (鹿晗), a popular Chinese celebrity amongst the younger generation. However, Ofo is on the edge of bankruptcy. While promotions likely weren’t the direct cause and were only a contributor to Ofo’s financial trouble, it’s not a secret that the company paid a large amount for the endorsed posters that used to be splattered on billboards across Chinese cities.

In essence, regardless of how much promotions Ofo did or even celebrity endorsement, it clearly wasn’t enough to boost any user loyalty nor provide any long-term business benefits.

Rapid Expansion

As more businesses adopt the O2O (online to offline) business model, the number of offline coffee shops in China have increased significantly throughout the last decade. 

According to Reuters, Luckin’ Coffee claimed its strive to open 2,500 new stores this year. The company also plans to exceed Starbucks in store count and number of cups sold. Part of Luckin’ Coffee’s strategy is the rapid expansion, a strategy that may cause more harm than good.

While Luckin Coffee’s stores are relatively small compared to Starbucks, it still incurs fixed logistics costs: supply chain management, packaging, equipment, and renovation costs are a couple of examples. According to a Chinese report, Luckin’ Coffee quietly raised its limit for free delivery charges from CNY 35 to CNY 55 in Beijing and Shanghai. If consumer consumption fails to reach this threshold, a CNY 6 delivery fee will be charged. This is an example that logistics costs are expenses new retail cannot bypass.

Luckin's motive behind its rapid expansion is to cover more ground in delivery and walking distance. Each store can serve up to 2km for delivery. Additionally, each store is comfortably within walking distance (5 minutes), is what the company aims for in its rapid expansion.

Bopai, a Chinese O2O auto service company, that went bankrupt in 2016 and YUM China are two examples of how overexpansion can backfire.

According to South China Morning Post, GU Ying, a graduate from the City University of Hong Kong, mentioned “Bopai was overly ambitious in attempting to expand its market share to too many cities. It burned out too much cash in subsidies to attract users.” While YUM China saw an initial growth of 21% in 2011 that turned to a 13% drop in 2013, according to Nikkei Asian Review. Currently, Luckin’s stores outnumber Starbucks across most cities in China, according to CBN Data.

Luckin Coffee's Foggy Future

In Dec 2018, Luckin completed its CNY 200 million Series B financing and has a post-investment valuation of CNY 2.2 billion. This comes 400 days after their first store opened in Oct 2017. EqualOcean also conducted a valuation analysis (see more in this article) on Luckin and predicts it has a valuation range of CNY 20.1 billion to CNY 54.2 billion in 2021. 

Luckin Coffee appears to be pretty confident in their lose-now-profit-later strategy as they believe their continued losses will be profitable in the long-run. Despite their continued losses, their ambition to go for a U.S. IPO and to borrow more money is concerning when the company is already burning enough money as it is. Relying on short-term strategies while neglecting product improvement will cement Luckin as a coffee chain second to Starbucks.

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