To topple the Goliath of coffee, Luckin Coffee will need more than just deep pockets

I’m writing this from my Shanghai office with a steaming cup of latte in my hand.

The brew comes in an elegant blue takeaway cup that bears the silhouette of a stag, with the words ‘luckin coffee’ marked between its antlers. As I sip on the cup’s contents, I detect the acerbic tang of cheap coffee beans used by most coffeehouse chains.

“Just a cup – who doesn’t love it?” So the company’s slogan goes. Indeed, people in China do love their Luckin. But what they love about the brand is not found inside those little blue cups.

In a high-profile listing on the Nasdaq earlier this month, Xiamen-based Luckin Coffee Inc raised a whopping US$561 million.

Investors around the world, from the likes of US’s BlackRock to China International Capital, and even Singapore’s sovereign wealth fund GIC, have been captivated by this purveyor of mediocre coffee, which has set itself up to dethrone coffee behemoth Starbucks in China.

More than just a copycat

Observers who dismiss Luckin as a “copycat” of Starbucks overlook the fact that these two companies have fundamentally different business models.

Where a comfortable lounge is a mainstay in virtually every Starbucks outlet in China, sit-in stores make up less than 1 per cent of Luckin Coffee’s outlets. Most Luckin customers order their coffees using a mobile app before picking it up at an outlet, or have their drinks delivered to their doorstep. This also means that Luckin stores hardly need any cashiers, which is a huge boon in terms of time and costs.

The latte that I’m drinking arrived at my office piping hot, after a 19-minute wait. I didn’t even have to step out of the building for it.

Luckin has adopted the ‘New Retail’ business model – where the consumer experience is king – and this was what helped it achieve phenomenal growth. Its hassle-free delivery service is perfect for the fast-paced lifestyles of the burgeoning Chinese middle class, which is set to make up 76 per cent of China’s urban population by 2022. And as more people move into the cities, the taste for both coffee and convenience is only going to grow.

It helps that Luckin has also cleverly used marketing to its advantage. Its coffee is endorsed by some of China’s most popular celebrities, like Tang Wei and Zhang Zhen, in a sector where coffee shops have typically been content with just in-store discounts.

The numbers speak for themselves. Since the company was founded in 2017, it has grown from a single trial store in Beijing to 2,370 wholly-owned stores in 28 cities, opening more outlets in China than Starbucks has in 20 years. Revenue has soared 3,395 per cent year on year, with its customer base totalling 16.8 million transacting consumers as of March 31, according to its prospectus.

With the US-China trade war still brewing, Luckin is well-placed to benefit even further as Chinese consumers gravitate towards a brand that is not only homegrown, but also cheaper and more convenient than its American competitor.

Everyone loves a David versus Goliath story, and that is certainly part of Luckin’s appeal.

Mind the blind spots

But a closer look at how Luckin uses its capital raises questions about its sustainability.

While Starbucks enjoys a positive margin of mid-30 per cent in China, Luckin has been operating at a negative 50 per cent margin. Its Chief Financial Officer Reinout Schakel has not said anything about when the company might start turning a profit.

The truth is, Luckin’s strategy – to burn through capital in a fiery expansion campaign across China – is a variation on a familiar tune.

Like many Chinese start-ups, the company’s short-term goal is focused on snatching market share using extravagant marketing tactics and generous subsidies. First-time customers get to enjoy a free cup of coffee, along with six vouchers for half-price orders, for instance. Such an aggressive wooing strategy has resulted in a massive net loss of US$241 million in 2018.

How long more will investors tolerate Luckin’s crusade? The market has already been shown how costly a protracted money war can get, like with the fall of bike-sharing company Ofo. Capital can only carry Luckin so far, especially against an established giant like Starbucks, which has the financial muscle and network to take on a head-to-head battle for turf.

Luckin’s subpar coffee and food could, in fact, be its own undoing. When generous discounts prove untenable (and they will), and as Starbucks catches up in delivery capabilities with the help of e-commerce giant Alibaba, there will be little incentive for Luckin customers to stay loyal. Even as Luckin works to expand the overall pie of China’s coffee-drinking market, it runs the risk of having everything taken away by Starbucks one day if – and when – its investors’ trust collapses.

But this does not mean Luckin is doomed to fail. That the company has managed to make Starbucks “panic” and draw the attention of big-name investors in its ambitious and bold approach to a very traditional business is just the first step – the same way David first topples Goliath by hurling a stone at the centre of his forehead, before cutting his head off.

The key now lies in turning that approach into a defensible one as it improves itself, either in food quality or business practices. To truly defeat the Goliath of coffee, Luckin will need more than just money.

If Luckin can discover its long-term vision and, as the Chinese idiom 脚踏实地 goes, keep its feet on solid ground, it will be able to revolutionise China’s coffee culture for good.