Business

The (Once-Bankrupt) Chinese Coffee Chain Beating Starbucks

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China’s Luckin Coffee is the nation’s top coffee retailer, overtaking even Starbucks. That would be notable itself, but less than 4 years ago the company filed for bankruptcy, making its comeback even more unlikely. The turnaround is in part thanks to the chain’s automated stores, cut-price deals and innovative drinks that appeal to local tastes.

Today on The Big Take Asia, host K. Oanh Ha speaks with Bloomberg’s Rachel Chang on how Luckin managed to turn around its failing business to overtake Starbucks, and asks whether it can hold on to its success as coffee takes off in China, and more rivals emerge.

Further listening: What Does China’s Economic Slowdown Mean For the Communist Party? 

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Here is a lightly edited transcript of the conversation:

Oanh Ha: Earlier this week, in the middle of a hectic news cycle, I got a drink — a pick-me-up– for a colleague, Rachel Chang. She’s Bloomberg’s managing editor for global business in Asia.

Ha: So I have a very special treat for you. 

Rachel Chang: What?

Ha: I got Rachel some coffee – but not just any coffee.

Chang: Wow, where'd you manage to get that? Did it cross borders? 

Ha: Yes, so I think you're holding a coconut latte that came from a Luckin store. All the way from Shenzhen here to Hong Kong. 

Ha: Luckin Coffee is the biggest coffee seller in China, but it doesn’t have a store in Hong Kong, where we’re based. So our fabulous producers arranged a special delivery of some of Luckin’s most popular flavors, like their coconut latte.

Chang: Amazing. Can I actually try it right now? 

Ha: Yes, yes yes, hold on we’re going to try it together.

Chang: Mmm…It’s like 2000 calories.

Ha: (Laugh) Well that aside, it’s actually pretty good. 

Chang: It's very good. It's very delicious. I mean, I'm not a connoisseur. I'm sure that coffee, fancy coffee people would hate the taste, but fancy coffee people also hate Starbucks. 

Ha: (Laugh) That's true.  

Ha: Rachel used to cover Luckin, during its early days in 2017 as a startup. And in just seven years, Luckin has outpaced Starbucks, who opened its first store in China as early as 1999. And today Luckin’s become the dominant coffee retailer in the country. And it’s done that with a mix of creative products, from its salty cream-cheese-and-tea latte to a popular alcohol-infused coffee. 

Ha: I think we should try it.

Chang: Yeah, definitely. Although it might be a little bit late for caffeine and a bit early for alcohol.

Ha: Well, you know somewhere, somewhere in the world it’s cocktail hour.

Ha: But Luckin’s astronomical rise was unthinkable at one point. In 2020, the company was on the brink of collapse, after a major accounting scandal wiped out its stock value, sending it into bankruptcy.

Chang: People really just thought, well, this company is done for. They had to close a whole bunch of stores. And people, I guess, just really assumed that this company would just be fading away. 

Ha:  Luckin not only survived but it staged an extraordinary comeback. Earlier this year, the company reported its fourth-quarter earnings. Total sales revenue in 2023 reached $3.5 billion dollars in China, surpassing Starbucks for the first time. 

Chang: Luckin understands the local tastes and the local behavior of consumers much better, and they have been very successful. And the global giants have been on the back foot, you know, and whether you're talking about Nike or Apple or Starbucks, you know, all of these companies have been humbled in some ways in China. 

Ha: Welcome to the Big Take Asia from Bloomberg News. I’m Oanh Ha. Every week, we take you inside some of the world's biggest and most powerful economies, and the markets, tycoons and businesses that drive this ever-shifting region. Today on the show: how Luckin Coffee went from filing for bankruptcy to beating a coffee titan like Starbucks in China. And what its rocky road says about competition in the world’s second-largest consumer market. 

Ha: Luckin Coffee was founded in 2017 by Lu Zhengyao and Qian Zhiya. At that time, they were working at a car rental company called China Auto Renting Inc. – or CAR Inc. – which Lu founded.

Chang: So Lu Zhengyao was already a very successful entrepreneur. CAR Inc. was really his most successful venture and at the time Qian Zhiya, Jenny, was a very trusted executor of his team, and so she was really the person who came up with the original idea that there's a lack of coffee essentially in China. 

Ha: In 2018, the average person in mainland China only drank about three cups of coffee a year. That’s far off from at least 300 cups per person in the US.

Chang: China is a country of tea drinkers. It is really difficult to find normal coffee. When I was working and living in China, you know, you wouldn't really be able to wake up and order good coffee from a five star hotel. It's just not like something that's embedded in their everyday life. 

Ha: Qian saw an opportunity. She quit her C-suite job at CAR Inc., to chase her dream of building a coffee empire. And her boss Lu wanted in.

Chang: How Lu Zhengyao reacted was that he was very supportive. He wished her the best of luck, and he actually invested money himself into Luckin to become a co-founder. 

Ha: With Lu’s endorsement, Luckin raised about 200 million dollars at the end of 2018. By that time, it had already opened more than 2,000 stores across China. Qian and Lu used that money to open more stores and kept the shops small and low cost, which was a very different strategy from Starbucks.

Chang: Starbucks really has this idea of, they think of their cafes as what they call “the third place.” So it's the place between home and office, you know, lush sofas, just a really like pleasant music playing in the background.

Ha: Luckin took another approach.

Chang: Most of their stores were just tiny little kiosks. Definitely not a place to lounge. Just think about, you know, the classic sort of young 20-something Chinese professional, you know, rushing to work and just really needing to wake up, just needing to grab something on the go so that she'll be on for her first meeting. And that's what Luckin is.

Ha: So as basic as you can get in terms of store, kiosk operations.

Chang: Right, but that's because their focus was so much on mobile and takeaways.

Ha: Rachel says Luckin also capitalized on China’s largely cashless society. 

Chang: So, you know, you could order on the app. Pick whatever I want, pay, everything's on the app, right? And then, you could literally just go to the store and then pick it up. Or you can have delivery, which would be so quick, you know, less than 10 minutes and essentially, if you don't want to, you don't have to speak to any human being at all. 

Ha: And doubling down on digitalization not only saved customers time, it also saved Luckin a lot of money.

Chang: For them, it was really about innovation around the back end, right? They would use these digital systems to manage staff to manage inventory. That cut down a lot in costs, a lot in labor and a lot in turnaround time.

Ha: That lean, digital-forward approach helped the company keep the cost of its products down. Today, the average latte from Luckin costs about 11 yuan - that’s less than 2 dollars. Here’s how Luckin’s Chief Strategy Officer Reinout Schakel describes its positioning in the market in an interview with Bloomberg in 2019.

Reinout Schakel: If you look at the product it’s a premium product, if you look at the price it’s a mass market price. And that’s where I think our model is unique because we can do both.

Ha: After an IPO in 2019 that raised more than half a billion dollars, Luckin’s growth accelerated. And within three years of its launch, it was operating about 4,500 stores in China, from top cities like Shanghai and Shenzhen to more remote places like Xinjiang. But its success wouldn’t last long.

Chang: So in 2020, Muddy Waters, which is Carson Block's short selling firm, put out a tweet saying that they had received a whistleblower report on how Luckin was fabricating transactions. And that really just everything just unraveled from there.

Ha: After the whistleblower report, the US Securities and Exchange Commission investigated and charged Luckin with defrauding its investors and fabricating transactions to inflate its revenue. In the wake of the investigations, Luckin’s shares plunged. At its IPO, Luckin was valued at nearly 3 billion dollars. About a month after the fraud allegations came to light, the company’s value tumbled to about 700 million dollars. And in 2021, Luckin filed for bankruptcy.

Chang: Everybody left this company for dead. So it did seem like, you know, the end of the Luckin story.

Ha: But it wasn’t. After the break, Luckin bounces back.

Ha: After an accounting fraud scandal, Luckin Coffee was on the edge of collapse. It filed for bankruptcy in New York in February of 2021 and agreed to pay a 180 million dollar penalty to settle the case with the US Securities and Exchange Commission. But shortly after, someone stepped in with a helping hand.

Chang: David Li is the chairman of Centurium Capital, very close to the founder, Lu Zhengyao. He was one of the original investors in the CAR Inc. rental startup that made Lu's fortune.

Ha: David Li’s admiration for Luckin’s founder, Lu Zhengyao, was well known in the industry. And he believed in Luckin’s business model. Li’s private equity company, Centurium Capital, doubled down on its investment in the coffee chain. It stepped in with $240 million in 2021, which helped clear Luckin’s legal fees and fines. Luckin also underwent a major shakeup. Despite David Li’s personal connection with Lu, he decided that Luckin needed new leadership to stem the crisis. That’s according to sources at the time. So in 2020, Qian and Lu, the founders of Luckin, were replaced by new executives. And by 2022, Centurium became Luckin’s controlling shareholder.

Chang: Centurium also put in its own people to help Luckin turn things around. Closing down stores, hiring executives, and also very importantly helping Luckin put in a franchise system which allowed it to expand stores easily and quickly.

Ha: With Centurium steering the ship, Luckin emerged from bankruptcy in April 2022, just 14 months after filing for protection. And its small stores were ideal as China adjusted to Covid measures.

Chang: Covid in China was pretty much a really bad thing for all consumer businesses. Because China was so strict about Covid, you know, they, just these huge lockdowns. But then, what was quite interesting was that its business model really insulated it from the worst of Covid. You know, these bare bones, contactless, mobile payment, these kinds of takeout where you didn't have to talk to another human being was actually perfect for Covid.

Ha: Luckin took its new lease on life and went even bigger. On top of cementing its business strategy and setting itself apart from competitors, the company released new, best-selling items. The coconut latte we tried earlier, for example, accounts for around 70% of sales at some stores. And its alcohol-infused Moutai latte sold 5.4 million cups on the first day of its launch, bringing in nearly 14 million dollars in sales. Rachel says a lot of these out-of-the-box concoctions have created buzz on platforms like TikTok and Xiaohongshu, China’s equivalent of Instagram. 

Chang: I think they were just really smart with innovating around the local consumer tastes and doing these like really catchy, consumer friendly collaborations, right? So the Moutai thing, they just always go viral with new things, right? And that's just so important in the really competitive Chinese consumer market. Like, are you able to get attention? 

Ha: Luckin’s now grown to more than 18,000 stores across China, that’s roughly double from 2023. Starbucks, in comparison, has just over 7,000. And last year, Luckin opened more stores than Starbucks has ever done in China.

Chang: You know, Starbucks is kind of facing a broader challenge, a broader struggle. They're not just struggling in China. They're struggling around the world as well. Earlier this year, Starbucks issued a profit warning that was so bad that founder Howard Schultz, who's technically retired, wrote this letter and put it on LinkedIn. Talked about things that Starbucks needs to do better. One of them was mobile ordering and payment, which are exactly the thing that Luckin and Chinese companies do so well.

Ha: Starbucks isn’t the only competitor chasing after Luckin’s success. After founders Lu and Qian were forced out of the company, they went on to start a rival chain in 2022 called Cotti – their brand already has nearly 7,000 stores nationwide. That same year, KFC opened its first takeaway-only coffee outlet, KCoffee. And Rachel says, with KFC’s own delivery network and even cheaper prices, KCoffee is one of the biggest threats to Luckin.

Ha: So Rachel, we have all these coffee newcomers in China fighting to sell a cheap cup that’s also easy and quick to get, right? So how sustainable is Luckin’s success? I mean, especially if its customers are really just loyal to the next cheapest coffee? 

Chang: I think that is the question around Luckin now that it's become so successful with expansion and now that it's come back from the brink is, is the Luckin brand strong enough? Is there more to the Luckin brand than just being cheap and being everywhere, right? Because being cheap and being everywhere is a game that lots of chains can play. Is there brand loyalty or could they easily just be overtaken by Luckin version two? When we talked to this former senior vice president, you know, he would say, he talked about how their ambition was always to sell coffee in the countryside, you know, imagining farmers in deep Yunnan or wherever, sipping coffee on their break. Um, I think it's a nice narrative. 

Ha: Not quite there yet. 

Chang: Not quite there yet.

Ha: But at least for now, Luckin is still the company to beat in China, while it continues to launch new stores and new drinks, like that alcohol-infused Moutai latte. And they’re still packing a punch.

Chang: Maybe put the ice a little bit here. Ooh..maybe a bit too much ice.

Ha: It doesn't taste very alcoholic and it's just the fragrance of it. Like it's, you can smell it from here, but actually you don't taste it.  

Chang: No. Well, I feel it a little bit now. (Laugh) There’s definitely a light buzz going on. 

Ha:  Already?

Chang: It’s very potent right, Moutai.

((Added the transcript))

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