Back in 2017, China’s ¥30 billion ($4.3 billion) premium coffee scene was unique among major categories in China. Whereas most categories were fragmented with dozens of domestic and foreign brands vying for a share of wallets, one company accounted for 80% premium coffee sales. That company was Starbucks.
But in January 2018 an ambitious upstart entered the market selling coffees in Beijing and Shanghai. That company was Luckin Coffee. Luckin was the epitome of a new wave of confident Chinese brands following all of the text book China marketing strategies. It implemented an online-to-offline new retail model, with 30-minute delivery and flashy campaigns engaging key opinion leaders. Most importantly, it sold distinctive takeaway cups of coffee for ¥5-10 ($0.72-$1.44) less than Starbucks.
Within 17 months of opening its first coffee shop, the company had listed on NASDAQ – the fastest company to do so. Fuelled by investor capital, the company continued its single-minded customer acquisition campaigns and expansion which saw a new store opening every 3.5 hours. By the end of 2019, two years after serving its first brew, Luckin boasted 4,500 stores in China – 300 more than Starbucks.
Luckin’s startup-style expansionary mantra is common of Chinese firms where customer acquisition is prioritized above all other business fundamentals. Early last year, Luckin’s Chief Marketing Offer, Yang Fei, noted that “there’s no point talking about profit,” as the focus was scale and speed. The strategy was a wakeup call for the dominant Starbucks, which was forced to follow Luckin by offering delivery in a partnership with Alibaba in August 2018. Luckin won the hearts of many Chinese who were proud that their home-grown battler was taking on the mighty Starbucks, and in many eyes, winning. Luckin was also a darling on NASDAQ, with numerous seasoned commentators noting that it was the fastest growing company they’d ever seen. That hype wooed many investors, pushing the company to a value of almost $13 billion – 150% up from its initial listing in May 2019 – to its pre-coronavirus peak in January 2020, all without ever turning a profit.
Then last week, everything changed for Luckin. An internal investigation found that its COO had cooked the books, fabricating sales of $310 million – 42% of the alleged $732 million in sales last year. The company’s value has since plummeted to around $1 billion. With its current strategy of burning through investor cash and zero-credibility to raise more funds, the former hero challenger brand could well join other much-hyped Ofo-style startups littering China’s company obituaries, while reminding foreign investors of the differences in governance for many Chinese businesses.
What has been fascinating is how Chinese consumers have reacted to the fraud. Downloads of the Luckin app have soared to 300,000 in a day, from a previous high of 100,000. Chinese social media has been abuzz, overwhelmingly in support of their home-grown ‘hero’ – although who knows how much of that was fake. Over half of 80,000 respondents in an online survey chose the option that “I accept Luckin’s apology, it is still a national champion as long as it corrects its mistakes.”
The reaction is representative of a Chinese consumer who is almost expects, and in some ways accepts that many Chinese companies use fake data to fuel their growth ambitions and perceived popularity. Fake data is rampant in social media engagement, KOL followings, ecommerce sales and even travel blogs. For many Chinese consumers, if fake data is a price to pay for innovative companies who sell them cheaper coffee, so be it. For brands relying on that data to make decisions, it is reckless to be blindly guided by that data without cross-referencing other information sources as verification (something we do with the data we source at China Skinny).
Fraudulent behaviour doesn’t justify any sympathy, but a fallen Luckin is a loss for the coffee industry in China. It went a long way to make coffee more accessible, introducing millions of consumers to the beverage. Many of those drinkers are likely to evolve to more sophisticated brews, supporting some great boutique roasters as they ride up the adoption curve. It has created a new wave of caffeine addicts, and the surviving coffee companies are likely to be richer as a result.
Some of what Luckin did was brilliant, and even with its fake sales, it still managed to sell $422 million of coffees last year. It taught us many lessons about the Chinese market, which we have noted before: 1) As saturated as it may seem, with the right products, strategy, funds and focus, there is always room to enter or grow market share in China; 2) Products such as coffee that have seen relatively small consumption levels in China can quickly morph into major categories; 3) Categories traditionally dominated by foreign brands are no longer far out of reach from ambitious domestic brands; and 4) Integrating online and offline initiatives is a powerful way to reach and resonate with consumers and beat the competition. Take from it what you wish, but here’s to more valuable lessons from the dynamic Chinese market.
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