China’s Luckin Coffee is back from the brink and beating Starbucks (2024)

AFTER revelations of accounting fraud at coffee chain Luckin Coffee emerged in 2020, many believed it was over for the company seen as China’s answer to Starbucks.

Today, Luckin has not only survived but staged an extraordinary comeback as its cut-price lattes attract a growing number of customers, beating Starbucks to become the country’s biggest coffee retailer last year. Once derided as a cheap imitation of the Seattle-based giant, it’s now being emulated by other Chinese chains and even Starbucks appears to have taken a page or two from its playbook.

Luckin’s recovery shows there’s still growth to be found in an economy grappling with deflation and a property crisis. It also presents a lesson on how global giants, if not careful, can quickly find themselves on the back foot in the world’s second-largest consumer market – one that’s become more complex and localised than in the previous era of fast and easy growth.

For Zang Zhongtang, the former senior vice-president at Luckin, it validates a growth story thrown into doubt by the company’s scandal.

“Most people thought it was going to die,” said Zang, who quit in 2020 although he was not involved in any wrongdoing. “Obviously, it was wrong and unlawful to fabricate data. But you still have to acknowledge the great design that was its business model.”

The key plank of that model is labour-saving automation and digitalisation which cut down costs and turnaround time.

Such tech-enabled efficiency is still the driving force behind Luckin’s rapid growth and ability to undercut Starbucks, said the 46-year-old Zang. He now works at China’s NaaS Technology, an electric vehicle charging services company.

The company’s focus on cashless, takeout kiosk counters, originally designed to save costs, paid off during the Covid years as strict lockdown policies restricted in-person exchanges.

Post-pandemic, the chain’s 9.9 yuan (S$1.84) coffees have become even more popular among younger Chinese who do not have the time or budget to lounge at Starbucks. Many are accustomed to getting what they want quickly, with ridesharing cars arriving in minutes and groceries often delivered within half an hour.

Its recent growth to over 18,500 stores, roughly double from a year earlier, was also led by a push beyond huge, tier-1 cities such as Shanghai and Shenzhen into the vast hinterland where Starbucks has not yet ventured.

To entice greater swathes of China’s tea-drinking population to try coffee, Luckin developed drinks catering to local preferences for sweet and milky beverages.

Luckin pinksheet shares have risen more than 12 times from their lows following the scandal, although they are still 63 per cent lower than their 2020 highs on Nasdaq and recently weighed down by a quarterly loss on expansion costs and heavy discounts.

Starbucks has often shrugged off Luckin’s threat. As recently as January of this year, the US company appeared to dismiss Luckin’s low prices as a temporary phenomenon.

“You see an influx of mass-market competitors focused on fast store expansion and low-price tactics to drive trial. This will shake out over time,” Belinda Wong, who oversees Starbucks in China, told analysts.

Yet Starbucks has begun to struggle. For the quarter to March, sales in China sank 8 per cent from a year earlier, compared with a 42 per cent surge at Luckin.

After a slowdown in the US and China, it also issued a profit warning so shocking that founder Howard Schultz weighed in from retirement. His suggestions included revamping its mobile ordering and payment system – Luckin’s strong suit.

Chief executive officer Laxman Narasimhan told analysts on the earnings call that Starbucks was playing the “long game” in China, and the company declined to comment further for this story.

Private equity backing

Luckin’s recovery may not have been so easy, or even possible, without the backing of private equity fund Centurium Capital, which doubled down on its investment rather than back out following news of the fraudulent accounting. The fund stepped in with US$240 million in 2021 to help Luckin with mounting legal fees and fines.

Centurium chairman David Li’s admiration for Luckin founder Lu Zhengyao, whose rental car startup CAR he had previously invested in, was widely known. Yet Li also decided that Luckin needed to break off its relationship with Lu to stem the crisis, according to sources familiar with the situation at the time.

Li replaced the charismatic entrepreneur with Guo Jinyi, one of Lu’s few lieutenants who hadn’t followed him out.

Centurium sent in its own team, closing down underperforming stores and hiring executives to keep the remaining ones running smoothly. It also helped Luckin incorporate a franchise system, allowing it to open more stores easily.

Luckin emerged from bankruptcy in April of 2022, just 14 months after filing for protection. In May, Guo proclaimed to investors that Luckin “has been reborn and is essentially a new company.” (Centurium became Luckin’s controlling shareholder and Lu no longer owns shares in the company.)

While Luckin has distanced itself from Lu, who has since started a rival coffee chain called Cotti, industry insiders and former executives such as Zang said its original, digital-savvy model is still giving it an edge over competitors.

Lu had brought in programmers from CAR, and its digital-centric infrastructure made it more of an e-commerce company than a traditional, bricks-and-mortar food retailer, analysts said.

“Luckin was trying to create a new retail model with an Internet mindset,” said Bernie Gao, an analyst at market research firm Mintel.

From the start, Luckin’s smartphone app cut down wait times for consumers, while also providing the company access to valuable data on consumer behaviour and preferences, helping it to improve service and to develop hit products. The company also used it to mount aggressive coupon campaigns to keep luring customers back.

Starbucks stores in China have since begun offering mobile ordering services. But Luckin went beyond just taking customer orders online, implementing automation and digital management throughout its system to detect and dispatch orders, for example, when certain ingredients are running low.

This digitalised system enables stores to run on a small number of staff, controlling overhead costs. With few complicated processes to learn, new joiners can usually be trained within two to three days compared with the weeks it can take for those donning Starbucks’ green aprons, according to industry experts.

Boba and coconut lattes

Luckin’s latest growth, though, is not just about automation or discounts. Frequent launches of inventive drinks such as brown sugar boba latte, a take on Taiwanese bubble tea, have also helped to bolster sales.

Coconut latte, a combination of creamy, coconut-flavoured milk with coffee launched in April 2021, has been its biggest hit so far, accounting for around 70 per cent of sales at some stores.

With a dense and velvety mouthfeel, it’s proven a particular hit with those who are not fans of espressos or Americanos – a sizeable portion of Chinese consumers and a demographic Luckin knew it needed to win over to expand throughout the country.

Its menu also lists concoctions such as salty cream cheese and tea latte. New, limited-time items are introduced periodically to drum up interest, especially on social media.

Last year’s launch of an alcohol-infused latte produced in collaboration with Chinese spirits brand Kweichow Moutai created a buzz on platforms such as TikTok and Xiaohongshu, China’s equivalent of Instagram.

“Luckin has managed to find a way to launch these hit items that respond to what people want, leveraging its deep insight into the local consumer mindset,” said Dave Xie, retail and consumer goods partner at Oliver Wyman.

That’s also helped to shift Luckin’s status from a low-cost imitator to a trend-setter and market leader in its own right. As a result, some consumers have begun to question paying Starbucks prices.

“I won’t pay for goods that are way overpriced, especially when the job market is this bad,” said Wency Deng, a Shenzhen-based 35-year-old office worker who has not been back to Starbucks in five years. Besides, she said, Luckin’s coconut latte “just tastes really good”.

Same playbook

To win back customers, Starbucks has recently begun giving out discount coupons more frequently, according to analysts and local customers, even as the company said it’s not interested in entering a price war. It also rolled out its own version of boba drinks in the US, where it’s also encountering a slowdown.

Luckin, however, faces a growing number of homegrown competitors including KFC-operated KCoffee which sells cups of coffee for as low as five yuan to those buying monthly discount cards.

These days, its biggest threat may be Cotti, which was started by Lu in 2022 and already has 7,000 stores nationwide. The company appears to be using the original Luckin playbook by expanding through cash-burning marketing campaigns, analysts said. Brazenly, its shops display banners saying “Luckin’s founders treat you to coffee”. Since early last year, it’s been offering some drinks for as low as 8.8 yuan.

To fight back, Luckin last year launched a weekly coupon allowing customers to buy some of its popular drinks, including those normally priced at 20 yuan, for 9.9 yuan – one factor behind its first quarterly loss since 2021.

Jessica Gleeson, a former Starbucks China executive who now runs her own consultancy in Shanghai for retailers, said there should be room for multiple players in the long run.

The country’s coffee retail market has grown seven-fold since Luckin was founded in 2017 and is expected to double over the next four years, according to beverage analysts. Luckin has helped transform coffee from a drink for special occasions into a morning ritual, she said, and this shift “will benefit all coffee chains in China”.

“Just like there’s room in the fashion market for Uniqlo, Zara and Prada, in a country of 1.3 billion people there’s plenty of room for each of the leading coffee brands to win their category,” she said.

For now, analysts said Luckin is maintaining an edge over Cotti. China’s economic slowdown means Lu would find it difficult to raise the kind of funding – either from private equity or from the public – that he managed to do while at Luckin.

To ensure it makes the most of its lead, Luckin recently opened a new, US$120 million coffee roasting plant in Kunshan, an industrial hub near Shanghai. With an annual production capacity of 30,000 tonnes, it’s China’s biggest, and the company said this will ensure fast delivery of high-quality beans to its expanding retail network.

Zang said he and other former executives used to talk about wanting to turn coffee, previously a beverage for the urban elite, into one enjoyed by the masses – a dream that no longer looks so far-fetched. Luckin’s store openings last month included 11 in Urumqi, the capital of the northwest region Xinjiang.

“Our ambition was to eventually sell coffee in the countryside,” he said. “We’d imagined farmer guys on their break, sipping coffee.”

Despite its dip into the red in the first quarter, the company expects to be profitable for the full year as margins improve. Recently, some customers have noticed it’s cut back on deals. Stephanie Ming, a 36-year-old insurance agent in Shanghai, said she’s lately had to pay 13 yuan rather than 9.9 yuan for coffee because of fewer coupons.

“Obviously, Luckin’s profiting from the fact that we have grown more dependent on it,” she said, adding that she’s tolerating the change. “It’s still way much cheaper than Starbucks.” BLOOMBERG