Wednesday, 2024 April 17

Luckin Coffee trapped in RMB 9.9 dilemma amid Cotti Coffee’s resilience

Luckin Coffee may be the largest coffee chain in China, but even it cannot escape the pressures of keeping up with the “price war” in the domestic coffee market. In the fourth quarter of 2023, Luckin witnessed significant declines in sales growth for self-operated stores, operating profit margin, and net profit, despite maintaining a decent growth in revenue of 91.2% year-on-year.

Apart from seasonal factors and the lackluster performance of new products, the primary culprit behind this downturn has been the competitive pressure exerted by rivals like Cotti Coffee. To counter this, Luckin increased its investment, maintaining low prices while bolstering subsidies to its franchisees, diluting its profit performance for the quarter.

Luckin is presently facing a scenario akin to Meituan, entangled in a trifecta of macroeconomic factors, seasonal fluctuations, and heightened competition. To outmaneuver rivals, besides engaging in a price war, Luckin embarked on a store-opening spree in Q4 2023, adding a net total of 2,975 stores, marking a 22.4% increase over the previous quarter and surpassing 16,000 stores by year-end.

In addition to contending with Cotti in the lower-tier markets, Luckin intensified its presence in tier-one and tier-two cities in Q4 2023, densifying its footprint in these areas. However, this not only diluted the sales volume at existing stores but contributed to a decrease in sales growth of self-operated stores to 13.5%, the second lowest level in two years.

In response, Luckin’s stock price plummeted by 40% in just four months since reaching a peak of USD 38 in October 2023. Concerns about Luckin’s long-term viability are compounded by Cotti’s resilient outlook, contrary to market speculation.

Aggressive store expansion and subsidy strategies

Luckin’s downturn is partly self-inflicted, driven by the frantic pace of store expansion and its subsidy strategies. In Q4 2023, it set a new record by adding nearly 3,000 stores in a single quarter, effectively doubling its total in just one year, influenced in part by Cotti’s similar strategy.

Luckin adopts a more balanced model between self-operated and franchised stores compared to Cotti’s reliance on franchising, though both brands have pursued comparable growth strategies, with Cotti exhibiting greater aggressiveness in execution. While Luckin took two years to reach 4,000 stores and six years to surpass the 10,000 mark, Cotti expanded three times faster.

Since Q3 2023, Luckin has lowered its threshold for new store openings to accommodate more franchisees, leading to a surge in new stores in subsequent quarters.

Aside from penetrating lower-tier markets, Q4 2023 witnessed Luckin’s expansion into new areas within tier-one and tier-two cities, particularly streetside locations. This strategy, aimed at increasing self-pickup orders to optimize delivery costs, underscores the importance of store density in consumer decision-making amid homogenized products and pricing.

However, the negative repercussions of high-density store openings are apparent, notably in the decline of same-store sales growth, which hit a multi-year low of 13.5% in Q4 2023, exacerbated by heavy subsidies and seasonal factors.

Luckin’s average single-cup price dropped from RMB 15 (USD 2.08) to around RMB 13  (USD 1.81) between Q2 and Q4 2023, with some stores adjacent to Cotti Coffee issuing daily RMB 9.9 (USD 1.38) vouchers, applicable to most products, further intensifying price competition.

Luckin’s daily sales volume also dipped to 400–450 cups per store in Q4 2023, with a notable downward trend from October to December. In Q3, the craze for the alcohol-infused “sauce-flavored latte” partially masked the damage caused by Luckin’s aggressive subsidy strategy. However, the problems began to be magnified when sales shrunk in an ostensible off-season.

Before the price war, the general payback period for Luckin’s franchisees ranged from 6–15 months. But low-price competition has extended this cycle. To ensure the interests of partners, Luckin also increased subsidies to suppliers in Q4 2023.

One franchisee revealed that, before Q4 last year, Luckin provided a subsidy of RMB 1 (USD 0.14) per cup for products sold using the RMB 9.9 voucher, but after that quarter, it changed to guarantee a gross profit per cup for franchisees (selling price minus raw material cost) of RMB 4 (USD 0.56). If it’s less than RMB 4, it will be topped up to RMB 4. Cotti did not introduce similar subsidies.

This long-term strategy sacrificed Luckin’s profits in the short term. Luckin’s net profit for Q4 2023 was only RMB 290 million (USD 40.2 million), and although it still showed decent year-on-year growth year-on-year, 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 seen as the less favored party in this competition.

A franchisee who had previously joined Luckin and now switched to Cotti told 36Kr that, if the current subsidies continue, Cotti could face a wave of closures shortly after China’s national day this year.

This conjecture stems from Cotti’s large-scale expansion initiated in April and May of the previous year. With many franchisees remitting store rents every six months, the franchisee explained, “If Cotti’s stores continue to incur losses within this period, franchisees may opt to transfer their stores and cease rental payments.” In contrast to Luckin’s stable cash flow derived primarily from self-operated stores, Cotti’s subsidies often rely on funding from franchisees themselves.

However, Cotti’s situation appears slightly more optimistic than portrayed. Despite the decline in store openings in Q4 2023, there were no significant store closures until November. The aforementioned franchisee revealed that, over the past eighteen months, while profits were not substantial, losses were also minimal. Most store owners eagerly anticipated the peak season.

In Q3 2023, Cotti introduced subsidies for new delivery platforms and adjusted existing subsidies to be stackable, aiming to support suppliers. Cotti’s subsidy policy is multifaceted, encompassing basic single-cup subsidies, multi-store subsidies, competitive subsidies, and rent subsidies. The peak subsidy period spans from the end of the second quarter to the beginning of the fourth quarter. One franchisee noted that Cotti curtailed its subsidy strategy in November and December, with the subsidy per cup dwindling from RMB 4–5 (USD 0.56–0.69) during peak periods to RMB 1–2 (USD 0.14–0.28). Consequently, Cotti experienced a 25–30% decrease in daily sales volume in Q4 2023, averaging around 200 cups.

This downturn may be attributed to Cotti’s constrained cash flow. Following massive expansion in the second and third quarters, Cotti’s new store openings in the fourth quarter sharply declined, amounting to less than half of Luckin’s. Beginning in November, the number of Cotti closures surged significantly. According to GeoHey, Cotti shuttered a total of 854 stores over the past three months while opening only 470 new ones, resulting in negative growth in its store count.

Despite these challenges, it remains premature to conclude Cotti’s demise. While its store openings declined in Q4 2023, large-scale closures did not occur before November. Cotti’s subsidy strategy, though complex, has been adjusted to sustain suppliers and maintain competitiveness.

Cotti’s store closures increased significantly from November, potentially due to cash flow constraints following massive expansion in earlier quarters. However, attributing Cotti’s performance solely to the off-season would be hasty, with the true outcome contingent on store closures persisting into subsequent quarters.

As 2024 unfolds and competitive pressure from Cotti recedes, Luckin’s focus shifts to narrowing the scope of its RMB 9.9 vouchers while continuing its aggressive store-opening plan, edging closer to the predicted ceiling of 25,000 stores.

Nevertheless, the decline in Luckin’s daily sales volume in Q4 2023 surpasses previous seasonal impacts, raising concerns about hitting growth ceilings earlier than anticipated, as transactional user growth lags behind store expansion.

KrASIA Connection
KrASIA Connection
KrASIA Connection features translated and adapted high-quality insights published on 36Kr.com, the largest and most influential technology portal in Chinese language with over 150 million readers across the globe.
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