Luckin Coffee is opening stores in China at a rapid pace to compete with Starbucks, but is its business model sustainable?
Most of us have a morning coffee on the way to work and in many areas, it is no surprise to have several local Starbucks (NASDAQ: SBUX). However, the coffee giant has some new competition in the Chinese market, with Luckin Coffee (NASDAQ: LK) opening stores at a rate of 2-3 new stores per day. Since the $10 billion Chinese coffee company went public in May, it’s share price has doubled, crushing Starbucks, which only gained about 10% over the same period.
What is Luckin Coffee’s point of difference?
Firstly, the coffee retailer’s prices are 20% lower than Starbucks. Starbucks continues to sell at the same prices it does in places like New York. Secondly, the company is one of the first chains to go completely paperless. This means that everything is digital — all orders are placed and paid via the Luckin app and then delivered to customers at requested locations or collected in-store. Not only is this an efficient way forward for the coffee retailer, but it is also better for the environment. Soon after, Starbucks announced its partnership with Alibaba (NYSE: BABA) and added delivery options for more than 2,000 of its China-based stores.
What are the downfalls of its business model?
Luckin has created the image of a very affordable coffee shop through its aggressive promotional discounts. For instance, Starbucks’ average cost for a coffee is $4.30 a cup, while Luckin is way more affordable at $1.50. However, based on the poor margins and steep net income losses, it may have to raise its prices at some stage to be sustainable.
The company posted its third-quarter report last year, with revenue soaring 558% annually to $209 million. But on the bottom line, its net loss expanded to $74 million compared with $67.8 million the year prior. It has been a volatile few months for Luckin stock too. Most recently, the stock dropped by 8.5% amid concerns sales will be affected by the coronavirus outbreak in China.
Should Starbucks be worried?
The Chinese company operated more than 4,500 stores at the end of December across China, topping Starbucks who had 4,100 shops. But Starbucks shows no sign of slowing down and has continued to post impressive revenue growth. In quarter one of 2020, Starbucks reported $885.7 million in net income, which is up from $760.6 million the year before.
Overall, Starbucks generated $1.6 billion from its international locations and its Chinese stores in the first quarter, which was mainly driven by 1,380 net new store openings. The popular U.S coffee retailer has kept to its strategy of comfortable stores, with fewer but larger locations across the Chinese market.
However, the ‘get-and-go’ approach from Luckin Coffee and the local cultural knowledge could lead to dominance over Starbucks. China has a rapidly changing marketplace, something that many other international brands, such as Amazon (NASDAQ: AMZN) haven’t been able to keep up with. Only time will tell if Luckin’s Coffee proves to be profitable and sustainable.
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MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in Luckin Coffee and Starbucks. Read our full disclosure policy here.
Written by Alsha Coppolina.