Luckin Coffee's greatest challenge: outpacing its own shadow

What investors should know about the latest on China's coffee & tea market

Luckin Coffee, currently China's largest coffee chain, has reported higher sales than Starbucks in China according to the financial results for 2023. However, outpacing Starbucks and rebounding from a fraud scandal have become cliché stories that we have mentioned multiple times in our previous posts. We have pointed out that Luckin's real competition comes from domestic brands like Cotti Coffee, which are opening new stores at an incredibly fast pace and penetrating the broader market in lower-tier cities, areas where Starbucks lags behind.

Yet, the question of brand loyalty and whether these coffee giants can maintain a competitive profit margin remains unanswered. Luckin, along with other rapidly expanding domestic coffee chains such as Cotti and 幸运咖啡 ("Lucky Coffee"), has been leveraging promotions, coupons, and low-priced items to attract new customers. As of 2023, Starbucks still maintains a higher profit margin compared to Luckin, despite its slower pace in opening new stores.

China's fast-food and beverage consumption market is substantial, enabling numerous foreign chain brands to win big in the past decade. Well-known names such as Starbucks, KFC, and McDonald's have become household favorites. The coffee sector appears to be the first to face significant challenges from domestic Chinese brands. This emerging trend raises important questions about the future prospects for industry leaders in adapting and sustaining their dominance in this rapidly evolving market.

What lies ahead for Luckin and other leading brands in the coffee chain industry as China's coffee consumption becomes increasingly competitive and saturated? To grasp the answer to this question, gaining a contextual understanding of Chinese consumers' evolving behaviors is essential.

In today's newsletter, I will share with you some crucial trends in China's changing coffee consumption, addressing important areas including consumer consumption trends, the next growth opportunities for China's coffee makers (the larger "sinking market"), and Luckin's ability to remain profitable.

The charts and data in today's newsletter are highlights from our research report by the BigOne Lab team, with insights trusted by over 100 top institutional investors and corporate clients worldwide. Don't forget to subscribe before you continue reading!

Luckin's biggest challenge is to outpace its own shadow

From 2022 to 2023, many domestic coffee brands, such as Cotti, 幸运咖("Lucky Coffee"), and 本来不会有("There was no coffee"), entered the market. But currently, in China's coffee sector, there is an oligopoly of coffee brands, and so far, no brand has emerged that can compete with Luckin.

Takeout orders have emerged as a vital sales channel for all coffee brands, with leading brands achieving over 95% store participation in takeout services on Meituan, contributing more than 25% to their total sales. However, whether in terms of gross merchandise value (GMV) or market share by orders on Meituan, Luckin has a significant lead over the second-place brand.

As of February 2024, the top three coffee brands with the highest shares of GMV and orders on Meituan are Luckin Coffee, Starbucks, and Cotti Coffee. Notably, Luckin has sold twice as many orders as Starbucks.

The overall survival rate of Luckin's stores has been very healthy, with the 3-month and 6-month survival rates of the new stores reaching over 95% for most stores.

From the perspective of store geographic distribution, from January 2022 to February 2024, Luckin's rapid expansion pace has resulted in nearly 70% of its stores having another "Luckin colleague" within 1 kilometer. This density is almost unmatched by any brand.

Luckin's newest competitor, Cotti Coffee, which has been opening stores at an incredible pace, has adopted a "follow strategy," situating new outlets within 0-200 meters of Luckin's stores. After July 2023, Cotti has increasingly focused on opening new stores within the 0-200 meter range of Luckin locations, with Cotti outlets even opening within 50 meters of Luckin stores, accounting for 23% of its overall new openings.

However, while Cotti's "follow strategy" has indeed introduced some competition, Luckin continues to hold a significant advantage. Interestingly, our analysis suggests that Luckin's more formidable competitor might actually be itself. When examining the average orders per store, we found that Luckin's stores are most affected when another Luckin store is within 200 meters. (Note: For this study, we specifically excluded Luckin stores located near a Cotti outlet to isolate the impact of competition from Cotti.)

China's "Sinking Market": The Larger Market and the Next Battleground

Claim your free post and continue reading. You can also get free access by sharing us.