Chinese coffee shop chain causes a stir in the US

Oliver Gill
May 2, 2019
AFR

Luckin Coffee, a home-grown chain, had 660 outlets across China last August. That total today has almost quadrupled to nearly 2,400. The firm’s stunning growth has caught the attention of many industry watchers since its launch less than two years ago, and last week, the spotlight on it shone even brighter, with its plan to float on the New York Stock Exchange.

The Chinese upstart is vying to wrestle control from overseas raiders that are capitalising on the country’s burgeoning thirst for coffee.

Luckin has a target of 6,000 stores by 2023, which would see it tower over Starbucks – the dominant operator in China. The Seattle-based coffee colossus landed in China in January 1999, with its first store in Beijing’s China World Trade Building, and had first-mover advantage in a nation traditionally thought of as tea drinkers. Now, Starbucks has about half of the market, with 3,600 stores in 150 cities. While its expansion cannot match that of Luckin, China is the company’s fastest-growing market and its second-biggest outside the US.

Not to be outdone, Costa – the world’s second-largest coffee chain – has charged into China, with almost 500 stores there, a substantial number but a target the company said in 2012 that it hoped to reach by 2016. China accounts for 12pc of its stores, putting it on a par with 14 countries across continental Europe combined.

Unsurprisingly, Luckin’s desire to so publicly tap equity markets for cash has led to an assumption that it will take on Starbucks, and to a lesser degree Costa, in a Chinese coffee war.

However, Jason Yu, a consumer and shopper behaviour specialist at Kantar Worldpanel China, suggests the parties can peacefully co-exist. “[Luckin’s] exponential expansion in number of stores over the last two years has been to effectively expand the coffee market in China, rather than purely taking share directly from Starbucks and Costa, whose store expansion is far slower,” he says.

Jonny Forsythe, of market intelligence agency Mintel adds: “I actually think there is space for both Luckin and Starbucks to dominate the Chinese market in years to come. The market is still tiny compared to its potential and sales per capita in Western markets.”

In addition, the Western chains operate in a slightly different segment to Luckin, whose outlets are smaller and focus is on selling fresh coffee fast.

“There is increasingly a divide between consumers wanting fast coffee in the week to fuel hectic schedules and ‘slower’ coffee on weekends or holidays when they have more time to enjoy the ritual and experience,” says Forsythe.

Aided by the “Western halo” effect, overseas chains’ products are seen as more of a luxury in China, to be enjoyed when meeting friends or shopping with the family. “But this leaves the way clear for a local rival more focused on cheap, fast coffee, which may not be premium but is good enough,” Forsythe adds. An integral part of Luckin’s route to market is a delivery service – an innovation being tested in the UK by the major players. They see significant value in servicing office workers in cities, many of whom pay inflated prices to outsourced catering firms.

In China, however, things work a bit differently; coffee delivery is more widely available, partly due to Luckin working with Tencent, the giant tech conglomerate, to develop an app that has been rolled out quickly and is far from being in a testing phase.

“By the time Starbucks responds – which it did last year by merging with Alibaba to create a better delivery app – it is too late,” says Forsythe. “Luckin has already established itself as the de facto delivery coffee choice. This is Luckin’s big USP [unique selling proposition].” Questions persist about Luckin’s stock market debut and whether it might curtail, not assist, its current strategy. The chain posted a net loss of $241m last year on sales of $125m.

There is a good reason why Starbucks, listed on the Nasdaq in New York, is unable to focus on top line growth (seemingly to the detriment of anything else). And having spent almost $4bn on Costa, Coca-Cola will be eager to realise a return on its substantial investment. Both have shareholders to please and dividends to pay – and these are funded by profit not turnover, after all.

“Luckin is suffering big losses due to heavy subsidy and store expansion, but it is trying to rapidly build up scale,” says Yu. “The central question is if they can find a new business model or extend to other categories [such as food] or integrate its supply chain on the basis of current scale.”

He adds that Luckin’s customers “may not be particularly loyal to a specific coffee chain brand”. So if it raises prices, they may go elsewhere as Western convenience store chains 7-11 and Family-Mart offer an in-store coffee alternative. “[Nevertheless] the China coffee market is vast, with penetration of coffee lower than 30pc in lower tier cities,” says Yu. “There is still significant room to grow.”

There are conflicting views as to whether China is the middle of a real coffee war – or more of a phoney one.

Either way, Starbucks and Costa – two chains that have poured investment into the country in the hope of capitalising on its potential – will be concerned about the new kid on the block. Luckin’s decision to float in New York will do little to dampen such concerns

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