China remains a nation of committed tea drinkers, despite the persistent, considerable hype surrounding the Luckin Coffee chain.
This 18-month old, homegrown brand, which is on track to open more stores in China than Starbucks, believes it can beat the Seattle-based coffee pioneer through the simple — if costly — strategy of persuading customers to drink coffee by paying them to do so. The evidence is unconvincing.
Most urban Chinese are not drinking much more coffee than they were two years ago, an FT Confidential Research survey shows, with only those living in first-tier cities — China’s richest consumers — increasing their intake markedly. Just 29 per cent of respondents from third-tier cities said they drank coffee once a week, down from 31 per cent two years ago (we did not survey in rural areas, where the frequency would be much lower). China imported less coffee last year than it did in 2016.
If anything, Chinese consumers are drinking more tea than ever before — including new variants such as fruit and bubble tea. Tea shops make up more than 70 per cent of freshly-made drink outlets compared with 53 per cent two years ago, according to Meituan Dianping. The food-delivery app says the tea orders it receives rose 24-fold from 2016 to 2018, compared with a 10-fold increase in coffee orders.
The fact that the Chinese drink an average of 6.2 cups of coffee per year compared with Taiwan’s 209.4 cups — according to the Luckin IPO prospectus — implies there is plenty of untapped potential. But this arguably says more about China’s refusal to drink more coffee, two decades after Starbucks first opened in Beijing and 40 years after the opening up of the Chinese economy.
This undermines the investment case for Luckin, which went public in New York last month. The Xiamen-based company’s prospectus boasted a “technology-driven new retail model” to drive consumption of coffee in China and aims to have 10,000 stores operating by 2021, a dizzying pace of expansion compared with the 20 years it has taken Starbucks to open 3,700 stores.
Although most Luckin outlets are designed for takeaways, rather than offering the cookie-cutter lounge experience of Starbucks, this is an expensive business to run. Since inception, Luckin, whose losses ballooned to Rmb1.6bn ($231m) last year from Rmb56m in 2017, has essentially lost two cups of coffee for every cup of coffee sold. (Luckin did not respond to a request for comment.)
Shares fell below their $17 IPO price in the days after Luckin’s May 17 debut but were last trading above $21, boosted by positive coverage from analysts.
Starbucks flatters Luckin in emulating chunks of its business model, such as co-operating with Alibaba’s Ele.me on delivery and introducing ordering and pick-up functions via the Starbucks app.
But take away Luckin’s generosity with consumers and the business model does not look so rosy. In our survey, Luckin did well with consumers regarding the taste of its coffee, but the results also showed that coupons and discounting are the biggest motivator for buying the brand.
Luckin is notoriously generous with consumers, even by Chinese online-to-offline service standards. Sign up to the app and get a free coffee. Get a friend to sign up and get another freebie (Luckin’s claims of 17m transacting customers include these). Buy two, get a third free. The offers are so generous and so abundant that a small market has emerged online in Luckin coupons. Consumers have come to rely on such offers — lower spending on marketing, including coupons and discounts, helped the company cut losses by just over Rmb100m in the first quarter of 2019, but the number of new customers fell by more than a third from the previous quarter.
Factoring in discounts, we estimate consumers are paying barely less than Rmb10 for a cup of Luckin coffee — cheaper than coffee served in convenience stores such as FamilyMart and 7-Eleven.
FT Confidential Research has spent years surveying consumers on online to offline services. This is the first time that the generosity of discounts has been cited by consumers as their main reason for choosing a brand (in April 2017, for example, it came third among reasons for consumers to choose ofo, a now near-defunct bike-sharing service).
This partly reflects how little coffee is drunk in second-tier and lower cities, where nearly 45 per cent of respondents said they drank Luckin because of the price. Asked what they would do if the discounts were taken away, 38 per cent of respondents in first-tier cities said they would still drink Luckin, and just 6 per cent of those living in second-tier and smaller cities.
China’s car-hailing and food-delivery apps have been criticised for burning billions to build market share, but such companies can at least claim credit for trying to disrupt an established service. Luckin is trying to create something out of nothing, and spending hundreds of millions of renminbi doing so.
Lu Zhengyao, Luckin’s founder and its biggest shareholder, tells a good story about Chinese market potential. In Luckin, he is repeating a trick he first performed with Car Inc, a company looking to cash in on a culture of car renting in China that is yet to emerge. Car Inc went public in Hong Kong in 2014 — giving early investors their exit — where the shares have languished below their IPO price for more than three years.
Without a dramatic change in Chinese consumer tastes, Luckin shares are at risk of a similar fate.
— Frank Zhang, Director of Consumer Research, FT Confidential Research
scoutAsia is a corporate data and news service from Nikkei and the FT, providing in-depth information about more than 660,000 companies across more than 20 countries in east Asia, south Asia and Asean. This exclusive scoutAsia Research content has been produced by FT Confidential Research.
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