Ep. 32: Luckin Coffee, Starbucks Challenger or a New Breed of F&B for the 21st Century?

Transcript

(Y: Ying-Ying Lu; R: Rui Ma;)

[00:00] Y: Some crazy stuff has happened in China tech in the past week.
R: I’m sure you’ve seen the news on the arrest of the Huawei CFO, as well as the alleged suicide of one of the most prominent ethnically Chinese venture capitalists in Silicon Valley.

Y: Yes, Rest in Peace Professor Zhang Shoucheng 张首晟.
R: But we won’t be talking about those today, because here at TechBuzz we focus on the broader technology sector trends and product innovations in China.

[00:24] Y: And on that front, it’s been a relatively quiet week. Which means, we are going to serve up an episode that we began preparing a long time ago, by popular demand, but we are just getting around to presented now.
R: Which story? Well, it’s the story of Luckin Coffee, the on-demand, hybrid online-offline coffee chain unicorn startup that’s turning heads in China with its rapid expansion and innovative business model.

[00:50] Y: So, what is Luckin? Is it just a coffee chain? Or does its rise tell us something interesting about how brands are increasingly using offline presence to acquire online customers?
R: Is it just serving piping hot cups of joe, or are there interesting technology components here that we can learn from and adapt to other businesses? And is it really all that innovative, and if so, what are the insights we can export to other markets?

[1:18] Y: The narrative has been one of Luckin versus Starbucks, which is interesting. But we also think there are other trends at play, and that narrative is the one we want to explore today.
R: Let’s not brew any more suspense, and get right to it!

[1:55] R: Hi everyone! We are TechBuzz China by Pandaily, powered by the Sinica Podcast Network!
Y: We are a weekly podcast focused on giving you a peek into what’s buzzing within the tech community in China.
R: We uncover and contextualize unique insights, perspectives and takeaways on headline tech news that don’t always make it into English language coverage. So you can be smarter about the world of China tech.
Y: TechBuzz China is a part of Pandaily.com, an English language site that tells you “everything about China’s innovation.” I’m one of your two co-hosts, Ying-Ying Lu.
R: And I’m your other co-host, Rui Ma. We’d like to thank our listener Sean Stannard-Stockton for the suggestion to do an episode on this week’s topic. We’d also like to acknowledge our partners DealStreetAsia and SupChina, creator of the Sinica Podcast Network! In addition to Techbuzz, you can also find the Sinica podcast, a weekly discussion of current affairs on China.
Y: You can also find NüVoices, a podcast on women, as well as the new business-oriented ChinaEconTalk, and of course the Caixin-Sinica Business Brief from China’s leading business magazine. Be sure to check these out! And oh yeah, if you enjoy listening to us, please take the time to leave us a rating or review on iTunes, Facebook or wherever you get your podcast!

[3:17] R: So Ying-ying, between the two of us, you are the only one who actually ordered from Luckin. Tell us about that experience.
Y: Well, it was a sweltering day in early August of this year. And the first location I went to, there wasn’t actually a store there. It was more of a kiosk. Also, I wasn’t able to order, even though I was already there in person and even though with WeChat pay! I had to first download the Luckin app and link my phone number and payments to place an order. Meanwhile, everyone else was doing a quick pickup of an order they had placed through the app.
R: Or delivery people picking up orders right?
Y: Yeah. Because Luckin’s model is basically that of preparing coffee at small outlets for takeaway or delivery of orders placed through an app.
R: And honestly, that’s all there is to it. You open the app, geo-locate yourself or choose a store, select whether you are picking up the order yourself or needing delivery, and … place your order. And as you noticed, most people did that first, instead of showing up at the store and then ordering.

[4:23] Y: Yup. Because it’s not an actual cafe. It’s an on-demand cafe. An Uber for coffee. Most of its stores are not cafes in the traditional sense, where you sit down and enjoy your cup of joe, but like the kiosk I found myself at. In fact, a recent headline on Luckin asked, “How come Luckin has hundreds of stores, but you don’t see any of them?”
R: Good question. But I think that can be answered nicely by going back to the founding story of Luckin. And how convenient that you referred to Luckin as Uber for coffee, because that’s not too far off from the background of the founding team.

[4:57] Y: The now celebrity CEO of Luckin is a 43-year old woman by the name of Qian Zhiya, or Jenny. She wasn’t well known prior to Luckin, but within entrepreneur circles, she was known as one of the hidden weapons of one of China’s leading transportation companies, 神州优车, or Ucar.
R: Ucar has a few main product lines. Car rentals, ride sharing, a car selling platform, and a financing arm, for buying cars. So, using American companies as comparables, that would be like having a Hertz, an Uber, a Cars.com, and a Carsdirect under the same platform.
Y: We won’t go into the convoluted story of Ucar here, but basically, Jenny was a founding employee and at the Ucar rental division for over ten years. She rose from an administrative role to become COO and EVP of the rental division in 2014.
And it’s not a small company. It’s a listed company on the Hong Kong Stock Exchange, and the first half of this year, it had about $450mm in revenue.
R: It was also operations heavy. Qian Zhiya was responsible for more than 1000 stores across the country, in 300 cities, more than 100,000 vehicles, and more than 40,000 employees. And apparently she was very good at it. The founder and CEO Lu Zhengyao 陆正耀 has himself said many times: “I am only responsible for strategic planning and and business operations. As for how we actually operate, it is all up to Zhiya.”

[6:32] Y: So any doubts about Jenny’s operations expertise can probably be put to rest here. No doubt Luckin is growing even faster than Shenzhou, which took a decade to be where it is today, but she’s already done it once, which probably helped instill investor confidence that she can do it again.
R: So that’s where the rapid offline expansion comes in. But there’s also the on-demand part. Because Ucar launched a ridesharing business in 2015. That business is more like Uber premium, in the sense that it’s supposed to be professional drivers. Earlier this year, a report showed that it was in second place compared to Didi, with almost 3 million MAU, but first place in terms of customer satisfaction. Of course, that’s a fraction of Didi’s near 100 million users, but strictly speaking, it’s in a different market segment.
Y: By the time Jenny left Ucar, she was COO of the entire group, and so we can safely assume that she also oversaw the rapid growth in mobile-enabled on-demand services from the ridesharing business. And what is Luckin but a marriage of offline storefront expansion plus an on-demand experience on the smartphone?
R: Exactly. I think that’s why even though this is her first time as a founder, she’s been able to attract tremendous amounts of venture capital, because there just aren’t too many people who have the background she does, crossing over from offline to online, with experience in B2C, but also some B2B, because there are lots of business needs for these services too.

[8:06] Y: But also because of the strong endorsement from her former boss and the success of Ucar itself, in which she was instrumental.
R: That’s true, because she started Luckin with the team’s own capital and a loan from Ucar CEO Lu Zhengyao. But that must have been some massive loan because it wasn’t until July that they announced the closing of their Series A, and all of the investors who participated, with the exception of GIC, had some tie to Ucar or related businesses.
Y: Joy Capital, for instance, was a former Ucar investor. Which explains why Luckin is such a high conviction bet. Altogether, the investors agreed to put in $200mm USD and value the company at $1bn post-money. And just like that, a company that was founded in November 2017 was officially a unicorn by July 2018. That’s less time than it takes to grow an actual baby!
R: Since then, the news about Luckin has always surrounded the number of stores that it has, probably because this is the metric that is easiest to understand. Before completing their Series A, Luckin was at 525 stores in 13 major cities. That was at the end of May this year. But now, as of the beginning of November, it’s in 21 cities with over 1400 stores.

[9:31] Y: Almost tripling in stores means an equal hike in valuation? Not quite but close. Reuters reported that Luckin might raise another round of up to $300mm, valuing the company at up to $2 billion.
R: There were even rumors of Luckin talking to investment bankers about an IPO plan, which they have since denied. What do you think, is it going to beat Pinduoduo’s record to listing, which was just around three years?
Y: It just might. OK, let’s do the thing that every article does first, which is compare it to Starbucks, then we will explain why that doesn’t make much sense.

[10:10] R: OK, so per Starbucks’ last earnings call, China remains its second largest market after the U.S., and the fastest growing, with double digit growth in total transactions. It’s got 3,400 stores there. Supposedly, every 15 hours, a new Starbucks opens in China.
Y: I’m pretty sure all of our listeners have been to a Starbucks somewhere. And let me just say, at least compared to the storefronts in the U.S., the Starbucks in China actually tend to be nicer. First of all, they’re newer. Second of all, it’s considered a premium brand in China versus mass market in many other places. So that’s reflected in the locations, the decor, and the prices of the drinks themselves.
R: Yeah, you coffee snobs please don’t judge me, but I do drink Starbucks coffee, usually just the daily brew or an Americano, and it’s usually 50% more expensive in China than in the U.S. Before, it used to be that logistics and other non-labor operating costs hiked up the prices. But I also think part of the reason that it continues to command such a premium is that it’s considered an imported good, a luxury brand, and the thing about China that some of my F&B entrepreneur friends learned is that, if you don’t price your product at a premium, people might actually think you don’t have the quality to back it up.

[11:37] Y: True story. In any case, Luckin obviously took a cue. While it claims to be a better value than Starbucks, its standard Americano, for example, is 21 RMB or $3, not that much cheaper than the Starbucks China one, which will run you about $3.50. Sure, it’s about 15% cheaper, but not really a steal, especially since I can get that for $2.50 here in downtown San Francisco.
R: Well, that’s the standard stated pricing, but in actuality, it is a lot cheaper, because if you buy 2, you get one free, and if you prepay for 5, you get 5 for free, so that’s like almost half off, which is why so many people have tried Luckin. And in most cities, it is free delivery if your order is above $5, which is just 2 of the cheapest coffees. And of course then, you get that third for free of course.

[12:31] Y: Jenny is playing the subsidy game here, just like many other startups in China when they first get started. She’s stated publicly that the price of Luckin coffees now are lower than the cost, so she’s losing money on every cup. In fact, she’s kind of flaunted, or at least acknowledged, the fact that she’s prepared 1 billion RMB, or about $150 million USD, of cash to burn on customer acquisition. That’s very Chinese thinking there, and definitely evocative of the practices we saw in bikesharing, groupon clones, basically every industry in Chinese tech.
R: We’ll see if that works. She’s further stated that she really admires Lei Jun, the Xiaomi founder who has promised to never make more than 5% on his hardware. I don’t know if that means she’s prepared to commit to the same thin margins, but I doubt it, I think it’s just PR. And I would hope for her investors’ sake that she’s just kidding.
Y: But wait, we got sidetracked on the price, which is a differentiator right now, but maybe not so much of one when the subsidies end. But the other aspect, which is the storefront, is totally not comparable to Starbucks.

[13: 43] R: I mean, Starbucks is so successful because it created and scaled the concept of the third place. That still remains its mission statement. To be a neighborhood gathering place. To be the third place, between work and home.
Y: Luckin is the opposite. So it claims to have 4 types of stores, which range from the largest, Elite, which is like their flagship store, probably going for a Starbucks Reserve feel, then the Relax tier, which is like a normal sit-down cafe, then to a Pickup store, which is probably what I visited, just for pickup, and finally a Kitchen concept, which I don’t really know, but from the description is, well, just a kitchen.
R: Only the first two remotely sound like Starbucks cafes. Or cafes at all. And they are the minority, because most of Luckin locations are Pickup or Kitchen concepts. Even for the Relax version, which are few and far in between, a reporter noted that it in no way felt like a “third place,” but more like a place where people take a short break, and don’t loiter.

[14:54] Y: As for the Elite AKA Starbucks Reserve version? We couldn’t tell you what it looks like, because at least as of a few weeks ago, no such store existed. They are all TBD. And I’m willing to bet that is the plan all along, to have very few Elite stores, because let’s face it, Luckin was never going after Starbucks in the sense of taking over the Starbucks third place experience. It is only a threat to Starbucks in the sense that it delivers coffee with brutal efficiency. And Starbucks is going to lose, but probably only those customers who only want caffeine. But it’s not at all in danger of losing those who want to sit down and have a meeting in that third place.
R: Of course, those who just want caffeine and aren’t taking up valuable real estate for hours at a time are probably the most profitable customers. And in China, no one currently owns this segment. There are plenty of foreign coffee brands, sure, like Costa, Gloria Jean’s, Pacific, etc., but they are all fighting against Starbucks with a similar value proposition. Plus, only a very, very small portion of the population are coffee connoisseurs, so they aren’t picky with their coffee yet. In fact, most drink instant coffee.
Y: Yeah, I did too when I went there. But Chinese people are still pretty behind when it comes to coffee culture. Which means, wide open market opportunity. Jenny is fond of citing the fact that in China, only 16% of coffee consumed is freshly brewed, and 84% is instant, whereas globally, the stats are basically reversed, with 13% instant coffee, and 87% freshly brewed.
R: And with per capita consumption in China at 4-5 cups per annum, versus 180 cups in Japan and Korea, and double that in the U.S., there is a lot of room to grow. And actually, it has been growing. Growth rates have been more than 15% per year, versus just 2% globally. Even more conservative estimate says that growth will be 6% each of the next five years to reach almost $12 billion by 2022. But it could still be faster. A recent survey showed that the primary reason why Chinese people don’t drink coffee is because it’s, number 1, expensive, and number 2, it’s inconvenient.

[17:27] Y: Jenny claims that she got big into coffee because she had to work overtime so much. And when she thought about it, she was like, there are so few choices for freshly brewed coffee and none of them solve the pain points of price or convenience, so why can’t I create an option that does? Starbucks, after all, is a $80Bn market cap business, bigger than plenty of tech companies.
R: I, for one, do not believe the “I’m a coffee lover” story at all. Although Luckin supposedly hired some award-winning coffee experts to concoct their brews, and hired away Starbucks trained baristas at great expense, there are many complaints, especially among foreigners, that the coffee is quite average, or even bad. You want to know what my thesis is?
Y: Well, I already know, since you’ve told me, but please do tell us, Rui.
R: While all those market stats are interesting, what Jenny is really building is a New Retail 新零售. This is a very data-driven one, and coffee makes the most sense because she has a relatively tolerant AKA uneducated but fast growing customer base, and few competitors. But also, coffee is a really easily standardized and high frequency product that has value served on-demand, the perfect Trojan horse.
Y: That’s true, with the right training, you can’t mess up coffee that much. But why not tea, especially milk tea, which is absurdly popular in China?
R: Well, relative to coffee, that’s actually got way more competition, with brands like Hey Tea, etc., and also, Chinese consumers are way pickier when it comes to teas of any sort, but much less knowledgeable and thus easy to convince about coffee.

[19:19] Y: But what’s the Trojan horse for? Food?
R: Hey why not? Because Luckin is basically a data-driven F&B delivery business. It’s much more about logistics rather than real estate, unlike Starbucks. In a similar camp but more valuable than Starbucks is McDonald’s, at $140 billion market cap, and we already see how much of that is delivery these days, for multiple markets. McDonald’s is already a big part of UberEats’ business, for example. I think it’s obvious now that there is just a price point of food consumption below which, if you’re starting from scratch today to build the F&B brand of the future, it makes a ton of sense to be mostly or wholly on-demand and delivery based, versus offline occupying a lot of prime real estate.
Y: Well, I think the coffee market is already big enough for Luckin to tackle, but it’s true that they are already going after snacks and sandwiches, just like Starbucks has done, but way faster in rolling out. It’s not hard to imagine that once they have user stickiness figured out, they can add whatever makes sense, informed by the data they are collecting.
R: Yes, like any on-demand company, Luckin is also a data company. That’s its true DNA. Its CMO Yang Fei 杨飞 has said, that from the first day our brand was established, we have relied on technologies and processes such as smart dispatching (of orders), smart ordering (of inventory), smart quality control, and smart marketing.

[20:52] Y: Chinese people love to use the word “smart” in everything, but in this case, I think it’s not a stretch. Of course the delivery dispatching system is routed by software. And software-based inventory forecasting and equipment monitoring I am pretty sure others do as well. But while every retailer dreams of personalized recommendations and product curation, Luckin, born in 2017, can actually do it, by requiring everyone to order through its app, and therefore keeping track of everything electronically.
R: That’s right, not only can you not order without the app, you can’t pay with cash. Everything is done on the mobile. Every interaction is captured digitally. So instead of constantly comparing Luckin to Starbucks, we should really be comparing it to companies like Cloud Kitchen and Kitchen United. The former, by the way, is the subsidiary of the new company ex-Uber CEO Travis Kalanick founded.
Y: What do these startups do, you ask? Well, they vary in business model, but the one key insight they have is that there is a growing segment of what are called “off-premise” diners due to the proliferation of on-demand services. So that’s what they do.
R: For example, Cloud Kitchens offers the kitchen, delivery, and marketing for you to create a successful online-only restaurant. Some other ones work with only established brands and chains, but effectively offer the same infrastructure as a service pitch.

[22:23] Y: The current mainstream iteration of food delivery is that it’s still primarily from restaurants with a physical offline presence. But that’s expensive, and is it really all that necessary? Why not just be delivery-only? And these startups are providing the infrastructure for that to happen.
R: One of the biggest players is Uber itself, through the UberEats division. Using data, they have approached entrepreneurs and said — hey, there’s a need for a certain type of cuisine in your neighborhood based on the orders we see, want to offer that through our app? By the way, you don’t need to open another physical location. It will be online only.
Y: Because it’s online-only, the kitchens can be anywhere, even in basements, as long as it makes sense logistically for delivery. And guess what, UberEats has already helped launch 1600 of these “ghost” or virtual restaurants in the 300 cities it operates in.
R: Sounds exactly like the pickup-only kiosks or kitchens that Luckin has, right? A lot of them, as we mentioned, are difficult to find, because they’re just not meant to be a storefront at all. They are really “ghost” stores.

[23:33] Y: That’s what happens when you re-think F&B, something that Starbucks has trouble doing. A typical case of the Innovator’s Dilemma. So come on already, Luckin isn’t really Starbucks. It’s a cloud cafe that chose to own its own brand, versus just building infrastructure, like some of the US-based startups we mentioned earlier.
R: But that’s because again, in China, coffee is still a blue ocean sector. Especially amongst office workers. Which is really Luckin’s primary target. In fact, it’s basically opening up locations inside of office buildings and on corporate campuses now. Some of these aren’t even discoverable to outsiders, only to employees.
Y: If that’s what it’s doing, what was that deal then about it suing Starbucks for unfair business practices then? Because Starbucks required exclusivity in some of the leases it signed, making it impossible for other coffee chains to be located in the same complex?
R: Well, I don’t know for sure, but in my opinion, while the lawsuit has some basis, I think it’s mostly PR, because again, Starbucks has such an amazing brand and crystal clear value proposition. What’s the easiest way to leverage all the work Starbucks has done? Constantly compare yourself to it, of course … make sure that you are never mentioned without “Starbucks killer” in the tagline.

[25:00] Y: This isn’t to say that Luckin can’t eventually become more Starbucks-like. Jenny has said repeatedly that a delivery-only brand isn’t sustainable. Not only does the user experience take a cut — your coffee isn’t going to be as piping hot or icy cold after thirty minutes — but also delivery costs are rising rapidly, and that includes the packaging costs necessary for a good delivery experience.
R: But that doesn’t necessarily mean she’s going to go the “third place” route either, as a core strategy, because that’s super expensive as well. She does mention self-pickup as a core business model. So, what if we take that and run with it? What if there are so many Luckin outlets that most users can pick up their own coffee, and have that food on-demand as it’s meant to be consumed?
Y: You mean, like Luckin outlets everywhere? Like how there were or still are bikes in China everywhere?
R: OK, not that crazy, but along similar lines, yes! Why not? It’s already kind of looking that way in terms of kiosk density. The average delivery time is 18 minutes and only 0.4% exceed 30-minute-delivery, which by the way, means you get your order on the house. Anyway, I had the luck of going to a private event featuring Joe, the former CTO of Mobike, a few weeks ago, and got to ask him a lot of questions. Well, first I made sure our story about Mobike was accurate, and I’m glad to tell Techbuzzers that yes, it was.
Y: Oh I’m sure it was, we did a ton of research for that one.
R: What he also said though, and I think is a larger trend, not just in China, but in the U.S., is one of offline customer acquisition being cheaper than online.
Y: You mean companies are using the ubiquitous offline presence of a product to convert customers into online users.
R: You see that with of course all the bikesharing and scooter sharing, where the biggest advertisement for the product is just the bike or scooter itself. For Mobike, for example, their marketing spend was minimal, for a very long time. The bikes themselves were the key to draw in more users.

[27:21] Y: And so this can similarly apply to coffee, where just seeing Luckin kiosks, and people around you with a Luckin cup is a main customer acquisition channel in itself.
R: It’s also the strategy behind the machine-assisted, delivery-first grocery stores like Alibaba’s Hema and JD’s 7Fresh. You plop down a store, and you are acquiring users offline, but they are required to consume in app, digitally.
Y: Of course, Luckin isn’t just relying on that. They have plenty of actual advertisements, including some really fantastical ads featuring noted celebrities, and lots of Focus Media ads, which are outdoor ads, for example in elevators and whatnot.

[28:13] R: But Luckin has a digital soul at heart, which is why despite being compared to Starbucks, we are showcasing it here on Techbuzz China. So what did we learn today, Yingying?
Y: Well, to recap, Luckin coffee is the fastest startup in Chinese history to reach a billion dollars in valuation, taking just about eight months to do so. That’s pretty notable. It was able to do so because of its rapid expansion, to 1400 stores just a year after founding, a lot of which is owed to the heavy operational expertise of its impressive founding team, which is spearheaded by Qian Zhiya, the former COO of a successful transportation company. There, she managed the car rental and ridesharing businesses and oversaw tens of thousands of employees.
R: And although it’s constantly being compared to Starbucks, it’s really not at all the same. Whereas Starbucks made its name by refining the dine-in experience and coined the concept of “third place,” Luckin is hyper focused on the take-out and delivery aspect, which means that its stores are mostly hidden kiosks, not sit-down places.
Y: It has reimagined the F&B experience by being digital-first, meaning that everything is done within the app. That enables it to use data for everything, from delivery, to inventory management, to personalized deals, and of course, for expansion plans.
R: This makes it a much closer cousin to the cloud kitchen startups we are seeing in the US, and also the new retail grocery stores in China, than it is to Starbucks. So while yes, Starbucks is now adding delivery as well through a tieup with Alibaba’s ele.me, that’s really a tack-on solution compared to the digital from day one DNA of Luckin. And by the way, that’s nothing new for Starbucks, by the way, they’ve had delivery partnerships here in the US since March of 2015, although it is curious that they were much slower to roll out in China.

[30:06] Y: It’s too early to tell if Luckin will succeed, especially since they are burning cash like crazy, but they are riding on some fundamental trends that seem very sound. And it helps a lot that they are targeting the Chinese coffee market, which is both large and fast-growing.
R: So our view? The bigger question is not whether or not Luckin is the Starbucks killer, or going to be the first multi billion coffee startup in China, but whether or not its business model holds up — can we use technology to successfully reimagine F&B, beginning with one of the oldest and also seemingly simplest markets, grabbing a cup of coffee?
Y: What do you think? Let us know!

R: OK, that’s all for this week folks! Thanks for listening. We really enjoyed putting this together, and we are always open to any comments or suggestions. PS, we recommend you read SupChina’s profile on Jenny, as well as our friend Ed Sander’s excellent piece on Luckin, the links to which can be found in our transcript. You can find us on Twitter at thepandaily, techbuzzchina, and my personal Twitter account is RUIMA.
Y: And my Twitter handle is spelled GINYGINY. We’ll be back here the same time next week.

TechBuzz China by Pandaily is powered by the Sinica Podcast Network. Pandaily.com is an English language site that tells you “everything about China’s innovation.” Our producers are Shaw Wan and Kaiser Kuo. Our intern is Wang Menglu.