The Luckin Coffee SEC filing is out. So we can finally see their numbers. This is Part 2 of what I think is being misunderstood about Luckin. Part 1 is here.
#5: Luckin is not really about increasing mass-market coffee consumption in China.
Luckin is engaged in a Herculean effort to get Chinese to drink more coffee. They are making it convenient on smartphones, opening thousands of outlets and providing lots of subsidies (with venture capitalists funding the effort).
More Chinese coffee consumption is the big potential upside of their business plan. Can they increase the amount of coffee Chinese drink (currently very low at 4-5 cups per year per capita)? Coffee growers around the world should be thankful for what Luckin is doing.
However, this is not really about selling a beverage. This is why we don’t see similar efforts in apple juice. Or milk. None of those beverages are loaded with caffeine and sugar like coffee.
Luckin is actually engaged is a massive effort to increase the use of a stimulant in China. They are trying to create a convenience-based habit and mild addiction.
Coffee starts out as something you enjoy. It’s a nice drink and it’s a nice experience to go get it. This then becomes a daily habit (having a coffee every morning) and it also becomes a mild addiction (a medium mocha has 75mg of caffeine and 25gm of sugar). Retail coffee is really about enjoyment plus a daily habit plus a reasonable chemical addiction.
And the way you create a daily habit plus an addiction is to make your product super convenient to access. You make it available everywhere so that customers can get it whenever they have the slightest impulse. Habit creation depends on an immediate reward whenever you have the impulse. That is why ciggarete companies used to put vending machines everywhere. Note: a daily habit like coffee is good. But smoking +20 cigarettes per day is really powerful.
As this enjoyable drink and experience becomes a daily habit and a mild addiction, you create stable consumer demand. That is why we see Starbucks stores all over the world. But we do not see outlets for apple juice, tea or milk. Note: Bubble tea, which Chinese consumers really like, has very little caffeine.
#6: Starbucks is not the competitor Luckin needs to worry about.
Luckin is an innovative business model that has a lower cost structure and greater convenience than Starbucks. They replaced Starbucks’ high traffic and high visibility real estate with lots of small pick-up outlets. And they run everything through a smartphone which makes it convenient to order, pay and pick up. As mentioned, it’s a low price plus convenience business model. It’s also direct-to-consumer model, which means no need for shelf-space at retailers. That’s all great.
However, that is pretty similar to the strategy for convenience stores (7-11, Hao De, etc.). They have lots of small locations. They are convenient (hence the name convenience stores). And these stores already sell fresh brewed and ready-to-drink coffee. So what is the difference between Luckin and 7-11?
I think Luckin is still cheaper because they don’t have the stores. But the difference is probably mostly the mobile app. It is easier to use. And Chinese are digital-first consumers.
But a nice mobile app is just not that hard for 7-11 and others to offer. Plus, they are well positioned to digitize their existing customers.
If Luckin succeeds and does increase coffee consumption in China, expect these convenience store giants to respond. Expect them to add fresh-brewed coffee apps to their already huge geographic footprint of very convenient locations. That could be a big problem for Luckin.
Luckin’s mobile-first, pick-up business model puts them in an interesting space between Starbucks and 7-11. And this may not be a sustainable position. Note: Luckin and 7-11 are both mostly selling coffee as a product. While Starbucks is 50/50 about the product and the experience.
Another potential competitive threat is China’s digital giants. Alibaba has already partnered with Starbucks. And JD could partner with another company or offer retail coffee itself. Plus you can never really predict what Meituan (a local service giant) will do. Any of these companies could present a big competitive challenge very quickly.
#7: Luckin’s success or failure will ultimately depend on three factors: increasing demand, a competitive barrier and management behavior.
So I brought up a lot of factors. And the IPO filing is full of various issues and red flags. But I think this is all going to come down to three main factors.
First, Luckin needs to increase demand for their product. And I have argued this is not just about selling coffee. It is also about creating a habit. If they move the needle on coffee consumption in china, all their negative operating numbers become positive (probably)
If Luckin gets more traffic and gets to operating break-even (per outlet), that will attract competitors. The convenience stores and the digital giants are the ones I’m worried most about. You might also get lots of smaller players opening pop-up kitchens for mobile-ordered coffee. What competitive barrier will Luckin have against them?
Right now, Luckin doesn’t have a competitive barrier. They are going for operational scale and efficiency. They might also be able to lock in consumers with loyalty programs. And they might build up their brand sufficiently that they become a daily habit for their consumers.
But I just don’t see any strong competitive protection. Keep in mind, Starbucks’ main competitive barrier is its high traffic and high visibility locations. Their real estate is what is hard to replicate. And, ironically, this is exactly the thing Luckin’s pick-up business model has removed. Luckin’s model got them a lower cost structure but they also probably sacrificed retail coffee’s best competitive barrier.
The third factor (after increasing demand and a competitive barrier) is management incentives and behavior. Are they owner-managers that are focused on creating value over the long term? Is this just a short-term play to build something fast and then cash out by IPO or sale? I would be paying a lot of attention to management and owner incentives and behavior.
That’s my take. I hope this is helpful.
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