Luckin Coffee may be the largest coffee chain in China, but even it can’t escape the pressure of keeping up with the “price war” in the domestic coffee market. In the fourth quarter of 2023, Luckin saw a significant decline in sales growth in its independently operated stores, operating profit margin, and net profit, despite maintaining a fit 91.2% year-over-year revenue growth.
In addition to seasonal factors and faint modern product performance, competitive pressure from rivals like Cotti Coffee was a major culprit in the decline. To counteract this, Luckin increased investment, kept prices low, and boosted subsidies to its franchisees, which weakened its profit performance for the quarter.
Luckin is currently facing a scenario similar to Meituan, entangled in a trio of macroeconomic factors, seasonal fluctuations, and intensified competition. In order to outsmart its rivals, in addition to engaging in a price war, Luckin embarked on a store-opening spree in Q4 2023, adding a total of 2,975 net stores, up 22.4% from the previous quarter and surpassing 16,000 stores by the end of the year.
In addition to competing with Cotti in downstream markets, Luckin intensified its presence in first- and second-tier cities in Q4 2023, densifying its presence in those areas. However, this not only weakened sales volumes in existing stores, but contributed to a decline in sales growth in independently operated stores to 13.5%, the second lowest level in two years.
In response, Luckin’s share price has fallen 40% in just four months since reaching a peak of $38 in October 2023. Concerns about Luckin’s long-term profitability are compounded by Cotti’s resilient outlook, contrary to market speculation.
Aggressive store expansion and subsidy strategies
Luckin’s decline is partly self-inflicted, driven by the company’s frenetic pace of store expansion and subsidy strategies. In the fourth quarter of 2023, it set a modern record by opening almost 3,000 stores in a single quarter, effectively doubling its number in just one year, partly driven by Cotti’s similar strategy.
Luckin adopts a more balanced model between self-service and franchise stores compared to Cotti’s reliance on franchising, although both brands have pursued comparable growth strategies, with Cotti being more aggressive in its execution. While it took Luckin two years to reach 4,000 stores and six years to cross the 10,000 mark, Cotti grew three times faster.
From the third quarter of 2023, Luckin lowered the threshold for opening modern stores to accommodate a larger number of franchisees, which resulted in an boost in the number of modern stores in subsequent quarters.
In addition to its penetration into lower-tier markets, Q4 2023 saw Luckin expand into modern areas in first- and second-tier cities, particularly in high-street locations. This strategy, aimed at increasing pickup orders to optimize delivery costs, highlights the importance of store density in consumer decision-making in the face of standardized products and prices.
However, the negative effects of opening high-density stores are evident, particularly in the form of a decline in same-store sales, which reached a multi-year low of 13.5% in Q4 2023, exacerbated by high subsidies and seasonal factors.
The average price of a single cup of Luckin coffee fell from RMB 15 ($2.08) to about RMB 13 ($1.81) between the second and fourth quarters of 2023, with some stores adjacent to Cotti Coffee issuing daily vouchers worth RMB 9.9 ($1.38) that can be purchased for most products, further intensifying price competition.
Luckin’s daily sales also fell to 400-450 cups per store in Q4 2023, with a significant downward trend from October to December. In Q3, the “sauce-flavored latte” craze with added alcohol partially masked the damage caused by Luckin’s aggressive subsidy strategy. However, problems began to intensify as sales contracted in an apparent off-season.
Before the price war, the general payback period for Luckin franchisees was between 6 and 15 months. However, low-price competition has extended this cycle. To protect the interests of its partners, Luckin has also increased its supplier subsidies in the fourth quarter of 2023.
One franchisee revealed that before the fourth quarter of last year, Luckin provided a subsidy of RMB 1 ($0.14) per cup for products sold using a RMB 9.9 voucher, but after that quarter it changed to guarantee franchisees a gross profit per cup (selling price minus raw material cost) of RMB 4 ($0.56). If it is less than RMB 4, it will be supplemented to RMB 4. Cotti has not introduced similar subsidies.
This long-term strategy sacrificed Luckin’s profits in the low term. Luckin’s net profit for Q4 2023 was just RMB290 million ($40.2 million), and while it still showed decent year-over-year growth, it was the company’s third-worst performance in the past two years.
When will the turning point come?
In the eyes of most investors and franchisees, Cotti is perceived as the less favored party in this competition.
A franchisee who previously joined Luckin and has now joined Cotti told 36Kr that if the current subsidies continue, Cotti could face a wave of closures right after the Chinese National Day this year.
This hypothesis stems from Cotti’s large-scale expansion, which began in April and May of the previous year. Since many franchisees transfer store rents every six months, a franchisee explained, “If Cotti stores continue to lose money during this period, franchisees may decide to transfer their stores and stop paying rent.” Unlike Luckin’s steady cash flow, which comes primarily from independently operated stores, Cotti’s subsidies often rely on funding from franchisees themselves.
However, Cotti’s situation seems a bit more bullish than presented. Despite a drop in store openings in the fourth quarter of 2023, there have been no significant store closures through November. The franchisee in question revealed that over the past eighteen months, while profits have not been significant, losses have also been minimal. Most store owners were eagerly awaiting the peak season.
In Q3 2023, Cotti introduced subsidies for modern delivery platforms and adjusted existing subsidies to be combined, with the aim of supporting suppliers. Cotti’s subsidy policy is multi-faceted, including basic single-cup subsidies, multi-store subsidies, competitive subsidies, and rent subsidies. The peak period for subsidies is from the end of Q2 to the beginning of Q4. One franchisee noted that Cotti reduced its subsidy strategy in November and December, with the subsidy per cup decreasing from RMB 4-5 ($0.56-0.69) during peak periods to RMB 1-2 ($0.14-0.28). As a result, Cotti saw a 25-30% decline in daily sales in Q4 2023, averaging around 200 cups.
Despite these challenges, it’s too early to call Cotti’s decline complete. While store openings slowed in Q4 2023, large-scale closures didn’t occur before November. Cotti’s subsidy strategy, while complicated, has been tailored to retain suppliers and stay competitive.
Cotti store closures have increased significantly since November, potentially due to cash flow constraints following the massive expansion in previous quarters. However, it would be rash to attribute Cotti’s results solely to the off-season, and the true outcome would depend on the persistence of store closures in subsequent quarters.
As 2024 approaches and competitive pressure from Cotti wanes, Luckin is focusing on narrowing the scope of its RMB9.9 vouchers while continuing its aggressive store opening plan, approaching its target of 25,000 stores.
However, Luckin’s daily sales decline in Q4 2023 exceeds previous seasonal effects, raising concerns about reaching a growth plateau earlier than expected as transaction user growth lags behind store expansion.
KrASIA Connection features translated and adapted content that was originally published by 36Kr. article was written by Dong Jie for 36Kr.
