In the vast landscape of the coffee industry, one name has been making headlines and capturing the attention of both consumers and investors alike – Luckin Coffee. Often referred to as “China’s largest coffee chain,” Luckin Coffee has not only achieved this prestigious title but has also overcome a tumultuous past, emerging from a significant scandal to become a thriving success story. In this article, we delve into the fascinating background story of Luckin Coffee, dissecting its incredible journey and unveiling the key strategies that propelled it to the forefront of China’s coffee market, even surpassing global giant Starbucks.
Luckin Coffee’s Impressive Rise
The Coffee Craze in China
As the 2010s dawned, Starbucks was enjoying rapid growth in China. The Chinese market for premium coffee was expanding, presenting a lucrative opportunity for entrepreneurs. In 2017, two Chinese visionaries, Jenny Qian and Charles Lu, decided to take on Starbucks and create their own coffee empire. Thus, Luckin Coffee was born, opening its first store in January 2018.
Luckin Coffee set itself apart with a focus on technology and a commitment to cashless transactions. Customers could only pay using the Luckin Coffee app, and they even incorporated artificial intelligence into their operations, from choosing store locations to optimizing pricing and supply chain forecasting.
Rapid Expansion and Investment
In just half a year after its first store opening, Luckin Coffee raised an impressive USD 200 million from investors, including Singapore’s sovereign wealth fund GIC . The company embarked on an aggressive marketing campaign, employing celebrity promoters and saturating Chinese media channels with digital advertisements. They offered enticing discounts, including free drinks to new app sign-ups, which attracted a growing customer base.
By October 2018, Luckin Coffee had expanded to 1,300 stores, establishing itself as the second-largest coffee company in China, trailing only Starbucks. By January 2019, they boasted a staggering 2,500 stores and appeared poised to overtake Starbucks in the near future.
Their success story led them to the United States, where they executed a successful initial public offering (IPO) on the NASDAQ in 2019 under the ticker symbol LK. This IPO gave them a valuation of USD 2.9 billion valuation within just three years of establishment.
But at the time Luckin Coffee was still consistently operating at a loss. Despite branding itself as a tech-driven disruptor of the coffee industry, the company faced immense challenges. Their strategy, while innovative, had a critical flaw. Luckin’s model relied heavily on affordability, offering coffee at prices so low that profitability became an elusive dream.
They lured customers with deep discounts, often giving away coffee for free to first-time customers and offering existing customers discounts of up to 80%, an unsustainable situation where they spent $3 for every $1 of coffee sold.
The Allegations and Downfall
Because of this, not everyone was convinced of Luckin Coffee’s success story. In January 2020, Muddy Waters, a renowned short-selling firm, released an anonymous 89-page report alleging that the company had artificially inflated its profits by up to 88%. The report relied on extensive video surveillance data, estimating store revenue based on customer traffic and purchases.
Additionally, it revealed that Luckin Coffee had inflated its advertising expenses by 150%, a move aimed at explaining declining cash reserves despite reported high revenues. Luckin Coffee vehemently denied these allegations, labeling the report as malicious and announcing an internal investigation to vindicate its financials.
The Shocking Revelation
To restore investors’ confidence, the company assembled an independent team for internal investigations. In April 2020, Luckin Coffee released the findings confirming that it had indeed fabricated $310 million worth of sales in 2019. This revelation shattered any remaining doubts about the company’s fraudulent practices. The stock plummeted by 97%, leading to the ousting of the CEO and COO, and the NASDAQ’s notice of imminent delisting.
To make matters worse, the Chinese government imposed a $9 million fine on Luckin Coffee, and the SEC fined the company $180 million for deceiving investors, pushing the company to the brink of bankruptcy.
Rebirth and Resurgence
Luckin Coffee continued to operate its stores despite being delisted from the NASDAQ, trading on over-the-counter markets under the ticker symbol LKNCY.
In February 2021, the company filed for Chapter 15 bankruptcy protection in the United States, which allowed them to restructure their business while continuing day-to-day operations in China. They also secured $240 million in financing from a Chinese private equity firm, Centurion Capital.
Luckin’s New Strategy: A Triumph of Innovation
The turning point for Luckin Coffee came when new management took the helm, orchestrating a remarkable transformation within just three years. The company’s stock price experienced a strong rebound, soaring from its lows USD 1.39 in 2020 to USD 32 in 2023. Their success can be attributed to a two-pronged approach: cost reduction and revenue growth.
To combat the hemorrhaging losses, Luckin implemented rigorous cost-cutting measures. They ceased reckless store expansion and closed underperforming outlets, focusing on optimizing their existing locations. This shift marked a complete reversal from their previous strategy.
Luckin also axed unprofitable side ventures, such as their retail vending machines and fruit juice joint venture, redirecting resources to their core coffee business. Most significantly, they slashed spending on sales and marketing by more than half, trimming it from USD 180 million in 2019 to USD 82 million in 2023.
Additionally, Luckin scaled back the level of discounts offered to consumers in 2020, effectively raising prices. This move, combined with the absence of free coffee promotions, did lead to a drop in sales volume. Still, it was a necessary step to steer the company toward profitability.
Revenue Growth through Innovation
Luckin Coffee’s remarkable revenue growth can be attributed to three key drivers, the first being product innovation. In 2019, the company stumbled upon a game-changing coffee drink – the Brown Sugar Boba Latte. This innovative concoction combined coffee latte with ingredients traditionally used in boba tea, striking a chord with young Chinese consumers who favored sweeter beverages.
Recognizing this opportunity, Luckin’s management poured resources into product R&D, creating a range of innovative coffee beverages with unique flavors. These drinks appealed to a broader customer base beyond traditional coffee enthusiasts, dramatically expanding their target market. The success of these new beverages allowed Luckin to raise prices while increasing sales volume, a feat that was previously unattainable.
Their commitment to innovation continued, with Luckin launching 108 new products in 2022 alone such as Coconut Milk Latte, averaging one new product every three days. In contrast, global giant Starbucks released only around 20 products that year. This agility in responding to consumer trends was a significant advantage for Luckin, allowing them to consistently introduce blockbuster drinks that drove substantial revenue growth.
Another critical driver of Luckin’s revenue growth was their successful implementation of the franchising business model. While Luckin expanded with company-operated stores in higher-tier cities, they opted for franchised stores in lower-tier cities. This dual approach allowed them to maintain control in lucrative markets while rapidly expanding with lower upfront investment and reduced risk.
Luckin’s unconventional franchising terms, which did not charge upfront joining fees or annual franchise fees, attracted franchisees. Unlike most franchisors, who take a percentage of gross merchandise value regardless of profitability, Luckin based royalties on gross profit, ensuring that franchisees rarely lost money.
As a result, Luckin’s franchise program contributed significantly to its revenue and profit growth, enabling them to dominate the coffee market in lower-tier cities and eventually surpass Starbucks as China’s largest coffee chain. To put into perspective, Luckin’s self-operated 4511 stores in 2020, the number increased 25% to 5652 in 2022; During the same period, the number of Luckin franchise stores went up 5 times from 501 stores in 2020 to 2562 in 2022.
Pandemic Effects: A Game Changer
The COVID-19 pandemic had drastically different effects on Luckin and Starbucks. Starbucks, with its emphasis on spacious sit-down locations, faced challenges as many of its stores were forced to close or experienced reduced traffic. In contrast, Luckin’s self-pick-up and delivery model thrived, especially in office buildings and school campuses.
Luckin consistently outperformed Starbucks in same-store sales growth during the pandemic, with a positive 41% growth in 2Q22 compared to Starbucks’ staggering -44% decline.
Marketing played a pivotal role in Luckin’s resurgence. They shifted from relying heavily on performance ads to emphasizing brand advertising, targeting a younger demographic associated with traits like “Professionalism, Youth, Fashion, and Wellness.” They leveraged popular social media platforms, such as Wechat, Douyin, and RED, and secured an endorsement deal with freestyle skier Eileen Gu, who rose to national stardom during the 2022 Beijing Winter Olympics.
Luckin’s effective marketing strategy helped them establish a strong brand image among young consumers, surpassing Starbucks in popularity. In surveys ranking favorite coffee brands, Luckin soared from the 6th lowest position in 2019 to the top rank in 2022, while Starbucks saw a dramatic decline due to health and safety scandals.
Collaborations with Well Known Brands
Recently, Luckin Coffee has once again found itself in the spotlight, this time for its unique collaboration with Moutai, a renowned Chinese liquor brand. The new drink, a sauce-flavored or liquor latte, created quite a buzz on Chinese social media. Priced at 19 RMB (about $3 USD) per cup, it offers customers a taste of luxury Chinese liquor blended with coffee, a combination that intrigued many.
The co-branded product generated immense curiosity, leading to a rush of sales that quickly sold out most of the stores. The marketing campaign behind this collaboration was a resounding success, with Luckin reporting almost RMB 100 million in revenue, equivalent to more than USD 13.7 million, by selling 5.4 million cups on the first day alone.
This partnership highlights the trend of Chinese drink brands teaming up with luxury or well-known companies, such as Fendi and Louis Vuitton, which has consistently excited consumers. The phenomenon is a testament to successful marketing on social media, where people share their experiences, making it a trending topic. However, it’s crucial to note that while such sensations are remarkable, they are not the finishing line. Companies like Luckin need long-term strategies for sustained success, including innovative marketing and product management in a highly competitive market.
Luckin Coffee’s extraordinary journey from scandal-ridden bankruptcy to becoming China’s largest coffee chain is a testament to resilience and innovation. While luck may have played a part, it was the strategic pivot in management’s focus on building solid business fundamentals, effective marketing campaigns, and a successful franchising model that propelled Luckin to its current heights.
This remarkable transformation of a once-disgraced company serves as a powerful reminder that, in business, with the right team and strategies, anything is possible. Luckin Coffee has proven that even in the face of adversity, a company can reinvent itself, overcome scandals, and surpass dominant competitors within a few short years.