Coffee War in China: Starbucks vs Luckin Coffee

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Coffee War in China: Starbucks vs Luckin Coffee

On July 18, 2024, Luckin Coffee opened its 20,000th store in Beijing, marking another big step for the fast-growing Chinese coffee chain. This comes just a year after they opened their 10,000th store in Xiamen on June 5, 2023. Despite the founders being removed after a well-known accounting scandal, the new management used the original vision and technology to turn the company around from bankruptcy to success. Is Luckin now testing a new business model to compete more directly with Starbucks in China?

Both Starbucks and Luckin Coffee released their Q2 2024 earnings. However, the market's reaction to these reports differed significantly, highlighting the contrasting fortunes of these two coffee giants.

Over the past year, investors have responded negatively to Starbucks' performance and prospects, while Luckin Coffee has experienced a volatile journey, still recovering from its previous fraud scandal (read more here) and trading in the over-the-counter (OTC) market.

What has contributed to Starbucks' recent struggles?

Starbucks' CEO, Laxman Narasimhan, acknowledged a challenging quarter in their latest earnings call, citing a disciplined approach to capital allocation amid a complex and dynamic environment. Notably, their comparable store sales in China declined by 11%, primarily due to an 8% drop in the average ticket size. This decline suggests that consumers are spending less per order at Starbucks.

Why are consumers spending less at Starbucks in China?

One factor could be the presence of cheaper coffee options, such as Luckin Coffee and Cotti Coffee. In smaller cities, Starbucks locations are often packed, indicating continued demand. However, in larger cities like Shanghai, Beijing, and Shenzhen, Starbucks stores appear emptier, with intense competition from numerous Luckin and Cotti stores. This trend raises questions about Starbucks' strategy in highly competitive markets.

How is Starbucks responding to these challenges?

Despite the difficulties, Starbucks is not giving up. They have introduced a new growth strategy called the "Triple Shot Reinvention with Two Pumps". It will focus on three priorities: elevating the Starbucks brand; strengthening the company’s digital capabilities; and becoming truly global; customized with “two pumps” unlocking efficiency and reinvigorating partner culture.

How is Luckin Coffee capitalizing on the market dynamics?

Luckin Coffee has been aggressive in its store expansion, with about 2,300 new stores in Q1 and nearly 1,000 in Q4. Their rapid growth strategy raises questions about the profitability and sustainability of their stores. Interestingly, Luckin's stores often have a minimalist setup, reducing operational costs compared to Starbucks' more elaborate stores.

Can Luckin Coffee's approach be sustained in the long term?

Luckin's aggressive expansion and cost-effective operations have allowed them to double their store count, with more than 18,000 stores in China, compared to Starbucks' 7,000. However, their revenue per store is about $46,000, significantly lower than Starbucks' $99,000. This difference could be attributed to various factors, including pricing strategies and store formats.

What is the "Frappuccino Index" and how does it relate to Starbucks and Luckin Coffee?

The "Frappuccino Index" is a measure used to evaluate consumption power and the penetration of international brands in different cities. For example, Shanghai's index is similar to Singapore and Paris, indicating a high consumption power and strong presence of international brands. However, Shanghai's GDP per capita is almost three times the national average of China, suggesting that Starbucks remains a premium brand for many Chinese consumers.

Luckin Coffee's more affordable pricing appeals to a broader consumer base in China, where a significant portion of the population has limited disposable income. Former Prime Minister Li Keqiang's remark that 600 million Chinese live on about 1,000 yuan ($140) per month highlights the importance of affordable options in the market.

How is product innovation driving growth for Starbucks and Luckin Coffee?

Both companies are investing in product innovation to attract customers. Starbucks, for instance, is experimenting with "coffee popping pearls" and a successful lavender series. On the other hand, Luckin Coffee leverages extensive consumer data to launch new products constantly. In Q1 alone, they released 22 SKUs, including Orange Americano and Cherry Blossom Latte.

Luckin's approach to product development is highly quantitative, allowing them to cater to consumer preferences effectively. Their best-selling Coconut Milk Latte, for example, sold 700 million cups in the past three years. This data-driven strategy, combined with aggressive expansion, positions Luckin well in the competitive coffee market.

What does the future hold for Starbucks and Luckin Coffee?

As Starbucks navigates through its challenges with strategic reinventions, Luckin Coffee continues to expand rapidly with cost-effective operations and innovative products. The contrasting strategies and market responses highlight the dynamic nature of the coffee industry and the evolving consumer preferences in China and beyond.