Coffee Wars: How the arrival of Cotti has sparked a price war
Luckin vs Starbucks vs Cotti Coffee vs Lucky Cup
Things that caught our attention
Dada Nexus, consisting of delivery platform Dada Express and instant retail marketplace JD Daojia, has shown its first-ever profit on a non-GAAP basis in Q2 2023. (source) We wrote about the company in Need for Speed: Instant Retail last month.
SHEIN acquired 1/3 of the equity of SPARC Group, the mother company of Forever 21. The two fast-fashion players will use each other’s on and offline channels in the future. (source)
Alibaba's Hema (Freshippo) is opening a new format in September: Hema 'Black Label Store' Premier. Products sold are said to be "premium but not expensive" (source). We wrote about Freshippo in Redefining Fresh: Alibaba's Freshippo and the New Frontier in Grocery Business, and Ed wrote about the many Hema formats on ChinaTalk.nl.
As Douyin did with Taobao a few years ago, TikTok is starting to ban links to external webshops while it tries to build GMV for TikTok Shops. (source)
The GTV of Meituan’s in-store group-buying business in the second quarter exceeded 150 billion, a year-on-year growth rate of 120%. The GTV of Douyin’s local services in the same quarter was 66-67 billion, missing the 70 billion goal (source). We wrote about the local services battle between the two in Food Fight! Douyin’s local services business
PDD Holdings, reported 66% increase in revenue to RMB 52.3 billion ($7.21 billion) for Q2 2023, better than Alibaba's (12%) and JD's (4.85%) (source). According to our estimations, Temu saw about $2 billion in GMV in the same quarter. Temu has launched in Southeast Asia (Philippines) and the Middle East (Israel) in the past few days. It is now operating in 39 countries, one year after its launch. Read our full deep-dive on Temu: Temu: from $0 to $3 billion in 10 months.
Chinese baijiu producer Moutai and Luckin Coffee will jointly launch a latte product on Sept. 4, priced at about CNY20 ($2.74). The drink will be available for a limited time. (source) Not a baijiu fan? Maybe the ‘dopamine coffee’ we discuss in this newsletter is more your cup of … coffee.
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Introduction
This week, we are taking a deep dive into China’s coffee market, which has been seeing drastic changes ever since Luckin Coffee entered the scene in 2017. We unravel how Luckin’s fraud scandal eventually led to the rise of a new competitor, Cotti Coffee. We will explore Cotti’s franchise model and compare it with other market players. Next, we will descend into the ‘sinking market’ where Lucky Cup, a chain originating in Henan, gets involved in the battle for the consumers in lower-tier cities.
No story about coffee would be complete without Starbucks. We elaborate on the battle between the American chain and Luckin and how the latter has changed the strategies of Starbucks over the past five years. Finally, we zoom out and look at the coffee market as a whole and some of the newer specialty coffee chains that try to survive among the ‘big boys’.
We hope you enjoy this extensive deep dive.
The Luckin scandal
Luckin Coffee launched in 2017. What made the company unique, as well as interesting for tech watchers, was its online-to-offline integration. Instead of lining up at a Starbucks, coffee consumers could order in the Luckin app and pick up their coffee or have it delivered. As a matter of fact, you could only order and pay in the app. This made Luckin one of the frontrunners of a model that has become a standard in catering in China. It also allowed the company to have a complete picture of who their customers were, and use internet growth strategies by pushing promotions to them through the app and WeChat official accounts and mini-programs.
When Luckin launched, it used an aggressive strategy of discount coupons that lowered the average price of a cup to RMB 10, while Starbucks charged around RMB 30. As a result, Luckin quickly became popular and the pre-purchased coupons ensured that customers would return. At least until they ran out of coupons and had to make a new purchase decision.
As most of you will know, Luckin had its IPO in 2019, just 19 months after being founded, but would delist even faster in 2020 after a disgracing fraud scandal. Luckin was exposed to have made up RMB 2.2 billion ($310 million) worth of sales, a claim to which Luckin admitted in April 2020. It had sold vouchers worth tens of thousands of cups to companies that had ties to founder Lu Zhengyao (Charles Lu). A month before its IPO, a group of Luckin employees also engineered fake transactions by purchasing numerous vouchers. All this gave the company a much higher revenue than the actual stores generated. [1]
On the costs side, Luckin Coffee also made more than RMB 1 billion in payments by a fictitious procurement employee to newly set up suppliers. Like with the companies that bought large amounts of vouchers, many of these suppliers turned out to have links to Luckin, Lu Zhengyao’s friends and family or two of Lu’s earlier ventures, auto-rental firm CAR Inc. and a Chinese ride-hailing firm called Ucar Inc. Money circulated in and out of the company through this network, inflating sales and expenses. [1]
At the time, Lu Zhengyao said: “My style may have been too aggressive and the company may have grown too fast, which has led to many problems. But I by no means set out to deceive investors.” [1] But Luckin’s fraud case has damaged already frail trust in investments in Chinese companies and resulted in new calls for U.S. audits of Chinese companies listed on US stock exchanges.
Luckin settled fraud charges with a $180 million penalty fine and as part of its ‘rehabilitation’ process, Lu Zhengyao, CEO Jenny Qian, COO Liu Jian and six others were ousted, as we described last year in Luckin's Revival. So what do you do as an ousted founder?
Luckin Relax store in Beijing.
If at first, you don’t succeed…
After being kicked off the board of Luckin Coffee, Lu Zhengyao first started an unsuccessful noodle chain (Qu Xiaomian 趣小面). It failed because it could not secure capital (we wonder why).
Lu’s next venture was the ‘ready-to-cook’ food brand Shejian Yingxiong (舌尖英雄), which he started with some of his loyal team members from previous ventures, including Luckin. During the pandemic, young people could not go out to eat and realised they lacked cooking skills. The idea was that Shejian Yingxiong would help them with ready-to-cook products.
Lu’s new venture was founded in the second half of 2021 and signed up 6,000 franchisees in early 2022. It wanted to open 3,000 stores in 5 months but despite RMB 2.1 billion in funding it proved another failure because of the pandemic. At its peak, there were 300 stores and the project was shelved because of lack of scaling effects. Franchisees started complaining they couldn’t make money, and stores started closing one after another. [2/3] Currently, there are only 100 stores left and the concept is not developed anymore.
After two failed projects, Lu decided to return to more familiar territory. Early September 2022, he announced he was back in the coffee market with former Luckin Coffee CEO Qian Zhiyaa (Jenny Qian) and a new brand called Cotti Coffee (库迪咖啡 Kudi Kafei). On October 22nd 2022, the first store opened in Fuzhou, quickly followed by WeChat mini-programs. It offered 40 products, mainly coffee, tea, smoothies, etc., priced between RMB 18 and RMB 32. For example, an American coffee was RMB 25 and a latte was RMB 30. It offered RMB 9.9 coffee as a trial promotion. Cotti said it would also offered light snacks, meals during lunch and even alcohol in the evening. [4]
Part of Cotti’s brand launch brochure. [2]
The Cotti model
Lu Zhengyao’s common strategy is to have a fast start and quickly occupy and dominate the market before opponents can react. Because of difficulties in raising funding like Lu and Qian did for Luckin, Cotti has no finances to open a large number of self-operated stores. The founders chose a different business model this time: a form of franchising. A franchise model works well in this strategy because a franchisee can rely on local contacts and resources. By empowering the franchisee and supporting them with brand marketing and product supply, volume can be increased quickly and the brand can be exposed to many consumers.
Because of the pandemic, many people were unemployed or about to lose their jobs and looking for new opportunities. If they had connections and some capital, they could join a franchise model. Lu and his team also tried the franchise model with ready-to-cook meals of Shejian Yingxiong, with franchisees being regional agents. When this failed, they tried again with coffee, but in a different way.
Cotti provides ‘branding, product, supply chain and operation services’ to franchisees (affiliates) that open stores. In other words, Cotti doesn’t have to make the same high investments as its competitors that run self-operated stores. [4] As we’ve written in Luckin's Revival, Luckin has also been using a franchising strategy to grow in lower-tier cities, and more than 30% of its stores are now franchisees.
Cotti’s franchising model is labelled ‘profit-sharing joint operation’. It does not charge brand usage fees or franchise fees in the early stage. The franchisee finds a store and renovates it, requiring an investment for as little as RMB 138,000, according to Cotti. When the store is ready, Cotti sends a store manager, barista, etc., responsible for the daily operation. The affiliate does not need to worry about operations and procurement. [5]
The ‘joint operation’ franchise model of Cotti is similar to that of Luckin. Under a pure franchise model, franchisees can decide if they participate in promotions and have certain autonomy over pricing. With Cotti and Luckin, stores have to follow the company's policies and there are high requirements for operational and management capabilities.
Except for decoration, equipment, raw materials and other expenses, Cotti Coffee does not charge franchisees a fixed fee. Cotti adopts a direct management model: the store manager is trained and stationed by Cotti, and the salaries of employees and store managers are uniformly set by Cotti. Franchisees do not participate in operational decision-making; they just supervise. Before March, franchisees could choose between an affiliate-operated or direct-managed model, but after bad experiences with chaotic management, Cotti cancelled the affiliate-operated option. [6]
Cotti also had some self-operated stores. Of the 3,000 stores that had opened in May, the proportion of self-operated stores is less than 10%, with 5 or 6 per city. No additional self-operated stores will be opened in those cities. All other stores are franchisees. Cotti plans to convert all the self-operated stores into franchisees as well. On the one hand, Cotti does not want to invest resources in the management of staff at self-operated stores. On the other hand, in the future, Cotti wants to be listed as a supply chain company, not a catering company. It has adopted a similar model to Mixue Bingcheng 蜜雪冰城 (more on this later) in terms of supply chain. Its goal is to reduce the price of raw materials through extreme cost control, and to make profits through the supply chain, selling raw materials to its franchisees.
Each affiliate store has a cash flow bank account. Each month the difference in balance at the start and end of the month are determined, and the withdrawals by the store (RMB 30,000 per month on average) are added to calculate the store’s revenue. Rent, raw materials and labour are deducted and according to Cotti, 84% of stores see a positive cash flow. [7] But this does not take into account the affiliate's investments…
On a side note, Luckin Coffee also launched a ‘franchising with stores’ model in May 2023. It is based on the joint venture cooperation model, and it is a new mode launched for investors who are operating stores or stores with their own property rights during the lease contract period. Shops must be located in shopping malls, shopping streets, office buildings, universities, hospitals, transportation hubs, and scenic spots. [8]
Cotti Coffee store in Xi’an, July 2023.
The application process
Cotti’s franchisees first commit to paying an intent deposit of RMB 5,000 and upload pictures and videos of the suggested location. The primary criterion for location selection is the traffic flow. For instance, Cotti expects an office building shop to have a traffic flow of more than 1,500 or 2,000 people. For university stores, it requires 8,000 to 10,000 people. If a franchisee's application does not meet these standards the application will not pass.
Cotti also asks if the location attracts the main target group and how many people pass the exact store location. Aspiring franchisees must shoot at least two videos of the floor traffic passing the store’s door. Sometimes a Baidu Heat Map of the crowd density is also requested.
Another criterion is the presence or lack of, competitors’ stores (Starbucks, Luckin, milk tea shops) around the store location and the sales data of those stores. Especially when there is a Luckin store, franchisees should provide the number of daily cups sold. For milk tea shops, they need to provide 1-2 months of operating income data (e.g. RMB 150,000 - 200,000 for a Mixue Bingcheng or Coco Milk Tea).
Cotti seems to be closely following Luckin in its store location selection. But the number of remaining good locations might be limited, so Cotti might have to spend more on rent or settle for third-rate locations. Our own observations confirm this. Of the six Cotti locations we’ve seen in first- and new first-tier cities, three were relatively hidden in basements, dead-end streets and other spots with bad visibility.
A tucked-away Cotti Coffee.
If an application does not pass, the franchisee must resubmit it with additional information. After the location is approved by Cotti, the franchisee pays another RMB 295,000, which is the cost of opening a standard store. It includes a RMB 50,000 deposit (refunded when the store stops its operation), RMB 165,000 for equipment and RMB 57,000 for counters and bars. Decorations and rent come on top of these costs.
Initially, franchisees could arrange decoration by themselves and hire a third-party team, but Cotti found that this often resulted in substandard work with many irregularities. Even connecting water and electricity could come with quality issues. Therefore, from April onward, franchisees must use one of several decoration companies designated by Cotti. Decoration costs are RMB 1,500 per square metre.
Required investments per store type in RMB. Source: cotticoffee.com August 2023.
Because the barriers of entry are lower than with Luckin, Cotti attracts many young entrepreneurs. There are three types of people that tend to join Cotti as a franchisee: [7]
Former Luckin franchisees who made money with Luckin but moved to Cotti because of tightening franchise policies at Luckin.
Investors with no prior experience who want to try something but don’t know how.
People that are somewhere in between these two extremes.
Some franchisees have also switched from Lu’s previous project, Shejian Yingxiong, to Cotti.
Luckin doesn’t allow franchisees to open a store within 1 km of an existing store. It has experienced how two stores that were 1 km apart and sold 500 cups a day dropped to 400 when a new store was opened in between. That new store sold 300 cups a day. But a store in the suburbs might be able to sell 600 cups.
Still, many Luckin franchisees also opened a Cotti store because they were worried that others might open a Cotti store in the same business district. Since they can’t open in their own name, they will ask friends to do so and start a partnership. An estimated 10-20% of Cotti franchisees also run a Luckin business.
The costs of joining Cotti as a franchisee are much lower than Luckin's, ranging from RMB 160,000 to RMB 300,000, depending on the size of the store. Joining Luckin as a franchisee used to require an investment of at least RMB 700,000 and an area of 70 square metres. [9] More recently it has downgraded these required investments, but they are still higher than Cotti’s.
While Luckin has lowered its franchise thresholds from 70 to 40 square metres, decoration costs that franchisees need to pay have increased significantly. The overall costs of opening a store are relatively high: RMB 250,000 - 350,000, including a one-year deposit. Equipment costs are RMB 220,000, and signage and decoration are both RMB 30,000. The company’s total costs are about RMB 480,000, excluding rent and transfer fees.
According to Cotti’s brand manual, it will launch two store types:
Standard stores with an area of 80-200 square metres
Mini stores (for pick-up) with an area of less than 50 square metres
At the end of 2022 and early 2023, Cotti allowed some franchisees to open a few shop-in-shop stores and mini-stores, but now that it has sufficient franchisees it does not allow those models anymore.
A shop-in-shop Cotti Coffee in Xi’an, July 2023.
Explosion of stores
At its launch, Cotti said it hoped to open 2,500 stores by the end of 2023, 6,000 by 2024, and 10,000 by the end of 2025. On December 11th 2022, it had 50 stores, and 1,000 franchisees had paid the intention fee. [10]
Cotti considered the fast growth targets feasible because coffee consumption in China still grows steadily. In 2018 the average per capita consumption in China was 6 cups, one of which was freshly ground. In 2022 it had increased to 9 cups, 6 of which were freshly ground. Considering how annual per capita consumption in Germany is 800 cups, South Korea 400 cups and Taiwan and Japan each 300 cups, there is still a lot of potential in the new market. [5]
By early April, a little over five months after opening its first store, Cotti said it had 1,000 stores, a milestone that had taken Luckin 8 months. But only about 600 of these stores had actually opened. Cotti had some 1,300 stores in the pipeline that had signed franchising agreements and were being renovated. [6] The main thing slowing down openings is that stores must obtain local hygienic food licences. The specific processing cycle depends on local policies, and the approval time varies in different regions.
If Cotti is to be believed - and you never know with these founders - it had 2,500 stores in 7 months and 4,000 by the end of June. On August 4th, nine months after Cotti’s launch, it claimed to have opened 5,000 stores, more than double its original goal for the whole of 2023. Cotti was able to accelerate its store growth by changing its strategy in early 2023. It started focussing on allowing existing franchisees to open second and third stores. [11]
Even considering the acceleration, the number of 5,000 stores remains questionable since Cotti had about 400 stores in March and was opening stores at a speed of 100 per month at that time. [10] In April, a Cotti employee said they were opening 10-20 stores per day in North and East China and had 450 stores preparing to open.
Although it was reported that 5,000 franchisees had paid the intention deposit, on May 30th, the official information was that 3,000 stores had been opened. Some of these might already have been closed. Cotti claimed it had only ever closed 15 stores in its first seven months of existence. But independent media quoted data showing Cotti had opened 2,699 stores and closed 173 in the May-July period. [7]
Since the intention fee is paid after passing the application requirements, the 2,000 stores that have not ‘opened’ since must have been approved but not yet paid the investment of RMB 300,000 yet (see ‘The application process’), or are in the process of renovating. When travelling in China in June and July we came across several Cotti stores that were obviously still in the process of renovation.
Cotti stores under renovation.
The rapid expansion of the number of stores came with its own problems, e.g. shortages of counters and equipment. For instance, Cotti has completely grabbed the manufacturing capacity of the Thermoplan BW4C coffee machine, resulting in sky-high prices for the machine on the second-hand market. [7] In June, Cotti started tightening the application review of new franchisees and raised the price and profit share ratio of coffee machines.
With the focus on opening stores, Cotti’s human resources couldn’t keep up. At competitor Luckin, one manager is responsible for 50 stores. There are monthly plans, including number of visits to the stores, food safety inspections and daily communication with franchisees. Negative reviews, video surveillance and other operational KPIs are monitored and reported by the franchisees on a weekly or daily basis. Cotti doesn’t have such tight oversight and support (yet) and besides the process of opening, there is little guidance. This is a risk, especially if franchisees mostly care about sales and less about customer satisfaction and food safety, and may impact the development of the brand.
Cotti plans to sell all its self-operated stores in the second half of the year and transfer staff from those stores to positions involving store inspections. The focus will shift to increasing frequency of store visits, counselling and KPI tracking. Oversight will get more strict.
Cotti claims that the fast expansion isn’t their initiative but reflects the ‘market demand’. Fast expansion isn’t that difficult in the coffee market, especially with a franchise model, since the business is highly standardised and the complexity of equipment, raw materials and supply chain is relatively low. What’s more, Cotti can use years of experience with Luckin. [7]
‘Cuppycat’
A meeting with potential franchisees at the end of 2022 made clear that from the team to the product, to the equipment, to the site selection, Cotti almost exactly replicated Luckin’s model, up to including some of Luckin’s product innovations and flagship products like coconut latte. [9]
Cotti seems to have no shame in mentioning its connection to Luckin, which has proven an effective approach in recruiting franchisees. [6] Cotti’s sales staff even introduces the company as made by ‘the inventors of Luckin’. [9]
Cotti had 1,000 employees in May and 50% of its core staff came from Luckin. [5] Cotti had poached Luckin staff with higher salaries and hijacked several shop locations Luckin was working on. It also planned to acquire Luckin locations once their current contracts expire. [9]
Like Luckin before it, Cotti uses low-cost coffee coupons, large-scale celebrity marketing and sponsorships. Cotti has won the sponsorship of the Argentine National Football Team.
There are a few differences between Cotti and Luckin, though. Unlike Luckin, Cotti does allow the opening of franchises in first and second-tier cities. A franchisee who joined Cotti in the municipality of Tianjin said he did so because he couldn’t join Luckin. But in a third or fourth-tier city, he would have preferred Luckin and in a fifth-tier city Cotti because of the lower pricing.
Product innovations
Cotti is constantly launching new products like snacks and desserts, American hot dogs, and breakfast sets, keeping up with current trends and ideas, always meeting the changes in the consumption habits of the younger generation. [12]
Cotti’s product team of 40 people launches new products every two weeks. The team is divided into sub-teams that compete through China’s characteristic ‘horseracing’ mechanism. By May, Cotti already had 70 products. [5] The company can launch 40-50 new products yearly, while Luckin can launch 70-80.
Luckin once launched so many new products that store staff found it hard to keep up. Cotti might face the same challenge. It has no system that can track and manage product launches; individual stores need to track product performance themselves.
Classic products like lattes, Americanos and cappuccinos contribute relatively little to store revenue and often don’t even appear in the top 10 products. Instead, some of the new products are very popular and can account for up to 60-70% of sales. But at the moment it is difficult to calculate the actual contribution of individual products of a store.
Cotti menu, July 2023.
Art and Oats
As far as branding goes, Cotti used red instead of Luckin’s blue, but it still went for a trendy image.
For example, it teamed up with Swedish oat milk brand Oatley (active in China since 2018) to create three co-branded products, stressing the marriage between plant-based ‘milk’ and coffee that has become a trend among young consumers. [12]
Three co-branded Oatmeal Latte products by Cotti and Oatley: pure, brown sugar and osmanthus & oolong tea flavours. Image source: Cotti. [12]
In July, Cotti and Oatley created a special coffee art exhibition in Beijing’s 751 Area to promote the new products. Afterwards, it moved mini versions of the exhibition to flagship stores in Beijing, Hangzhou and Shanghai. The two also created co-branded coffee cups, canvas bags and other merchandise. [12]
Cotti also used the artwork of 20th-century Mexican artist Frida Kahlo. It has clearly positioned itself as an ‘art coffee’ brand.
Cotti uses the slogan "Drink Cotti, stay younger" (喝库迪，更年轻, He kudi, geng nianqing) to position itself as a young brand. It followed the ‘dopamine’ trend of very cheerful and bright colours that we’ve seen in China in recent months by launching bright fruit drinks. Sponsoring sports clubs like Argentina’s national team and events like the 2022 Chengdu Marathon are also meant to appeal to the young audience. [12]
Artful cups and ‘dopamine’ products.
(Please note, the second half of this article is only available for paid subscribers)
Price War
To promote new stores, Cotti used discounts, online celebrities in livestreams promoting the brand and discounts, celebrity sponsorships and an acquisition campaign on Douyin. It launched a variety of different levels of discounts, such as cups for RMB 0.99, RMB 5.5, RMB 6.6, RMB 8.8 and RMB 9.9. While these have increased volume, the increase in turnover has remained relatively small; their main purpose was to increase the popularity of the brand. In case you are confused about these prices, note that 6.6, 8.8. and 9.9. are all auspicious numbers in Chinese culture, 6 standing for things going smoothly, 8 standing for prosperity and 9 for longevity.
New customers get six cups of Cotti for RMB 9.9 a cup. In Q1 2023, it launched a promotion on Douyin, selling coupons for RMB 8.8 that could be exchanged for any product in a Cotti store. By early March, Cotti claimed to have sold 3.4 million RMB 8.8 coupons. [6]
These discounts were mostly not subsidised by Cotti and paid by the franchisee. However, for stores that signed an agreement before March 31, 2023, Cotti subsidised discounts ranging from RMB 50,000 to 100,000 for different store types. But with the Douyin price, even the top-selling stores in Beijing were still losing money. [6]
Cotti sparked a price war among the coffee chains. After its RMB 8.8 promotion, Luckin responded by offering RMB 9.9 per cup, once a week. Lucky Cup (幸运咖, not to be confused with Luckin) even launched a promotion offering RMB 9.9 for two cups of coffee. [13] Guo Jinyi, chairman and CEO of Luckin, said, “The RMB 9.9 coffee discount will last for at least two years to further increase market share.” [13] The average price of a cup at Luckin dropped by RMB 1-1.2 in Q2 2023 because 1,500-2,000 stores near Cotti stores joined the RMB 9.9 promotion in April. [7]
Cotti 8.8 promotion and recruitment notice for baristas, July 2023.
Luckin followed by launching more RMB 9.9 group-buying coupons, especially in Douyin livestreams, and sold 10 million coupons in one day. When Luckin responded to Cotti’s promotion with its own 9.9 campaign, many of its ‘lost’ customers returned.
Cotti was originally planning to raise its prices in April, but when Luckin started its 9.9 campaign, Cotti’s sales dropped by 30%-40%. When Luckin reduced the number of coupons, Cotti’s sales somewhat stabilised in May. Then, in June, Cotti launched a RMB 1 promotion for new users, with an existing user getting an RMB 0 coupon as a reward for recruiting a new user.
In June, Luckin’s cup volume increased by 30%, but partially owing to the discounts, profit did not increase, and gross profit was down by 5%. Labour costs went up by 33% from May to June (RMB 30,000 to RMB 40,000). Some losses were also caused by customers deviating from the standard product, like requesting to reduce or remove ice (there was a bit of a controversy about the amount of ice Luckin used). Overall, a store’s profit margin dropped from 20% to 13-14%.
When Luckin first introduced the RMB 9.9 campaign, its stores couldn’t cope with it. Human resources could not keep up and new staff needed to be trained. This led to chaos and frequent employee turnover.
In the end, Cotti did not win over that many Luckin customers. Most of Cotti’s customers are won over from milk tea shops and fast food chains like KFC and Mcdonalds’ McCafé, as well as other coffee chains such as Nova, Xiaoka 小卡, Lucky Cup 幸运咖. Some of these smaller coffee brands are expanding their franchisees (see ‘The fight for the sinking market’) but might not be able to subsidise a price war with Cotti.
Milk tea shops have also been affected by the price war between coffee stores and their flavoured drinks. One milk tea store owner said that its annual sales dropped 30-40% when Cotti Coffee opened nearby and had to close one of its two shops. [7]
Subsidies
For sales prices below RMB 9.5, for instance, the RMB 8.8, RMB 6.6 and RMB 1 campaigns, Cotti subsidises RMB 9.5 per cup, and RMB 10 in case of two stores. For the RMB 0 coupons, only the raw material costs are reimbursed. All the subsidies cannot be withdrawn in cash and can only be used for ordering supplies.
Luckin only reimbursed franchisees RMB 2 for each RMB 9.9 cup. In other words, for the 9.9 campaign Cotti franchisees were not subsidised, while Luckin franchisees made RMB 11.9 per cup.
More recently, Cotti said that the current policy is to subsidise RMB 9.5 - 10 to affiliates for each cup. For new customers, the subsidy has been further increased to RMB 11.5 - 12. Each store has its own QR code, so discounts can be tracked to individual stores. [7]
Pricing
Even without the discounts, Cotti is cheaper than Luckin: a coconut latte at Cotti is RMB 11.9 and RMB 18 at Luckin. The cost price of a cup of Cotti coffee is RMB 7.7, and the profit per cup at the regular sales price is 8.3 yuan. [9]
The exact cost price depends on the number of cups sold though. According to Cotti, at 400 cups per day, the costs of a cup of coffee breaks down as follows: [5]
Li Yingbo, Chief Strategy Officer of Cotti Coffee (and formerly Luckin Coffee) said in an interview: “When total costs are less than RMB 9, a regular sales price of RMB 10-15 should give franchisees a reasonable profit margin. (..) Although we have a coupon of 9.9 yuan, not all consumers will use a coupon.” According to Cotti, only one in two customers use a coupon when purchasing a product. “The average income of a single cup should be between RMB 11 and 12.” [5] In March, Cotti’s average sales price was RMB 11 per cup. [14]
Do franchisees make money?
A franchisee with RMB 200,000+ sales mentioned he was a Top 10 or Top 20 store out of the 5,000. The question is how much sales other stores can generate.
Stores earning less than RMB 20,000 gross profit per month do not pay service fees. Above that, they pay 10%-30% of their gross profit. This would suggest that Cotti does not make any money if the individual store doesn’t. [5]
A Cotti franchisee in Chongqing shared that during the 8.8/9.9 promotion, the store’s average order value was RMB 9-10 and average sales of 300 cups per day. Gross margin was 20-30%, labour RMB 18,000, and rent RMB 7,500. Fortunately, it did see a repurchase rate of 50%. If it can increase the sales price, it has a chance to reach profitability. [6] Cotti promised the average sales price would rise to RMB 10-12 from April to June and RMB 15 for the rest of the year. [6] As we’ve seen, this price increase has not materialised because of Luckin’s counter-attack.
In late March, Cotti said in a meeting that it planned to raise prices to RMB 14 by the end of 2023, RMB 2 lower than Luckin. But until August it has not made any increase. Franchisees are hoping for these price increases because margins are very thin now. Cotti is preparing to reduce the costs of materials as the number of stores grows, thereby improving the gross margin.
It’s clear though that the initial investment into the store renovation isn’t enough. According to a franchisee: "You need to prepare at least 100,000 yuan of working capital, and it will definitely not make money in the early stage." [6]
From April onwards, franchisees that had completed the contract got RMB 100,000 discount in service fees.
Gross profit currently is about 30-40%, and net profit after deducting rent and labour is 15-20%.
Exact break-even points depend on costs for labour and rent in specific locations. Still, an average Cotti store needs about 400 cups a day to make a profit, but many stores sell less than that. [5] On Xiaohongshu, some franchisees complain about how hard the business is. One store in an office building sold 280 cups per day at RMB 2,600. The cost price per cup was RMB 6.2 and he estimated it would take 2.5 years for the store to break even. [7] The industry standard for payback time is 18-24 months and Luckin’s payback time for franchisees' investments used to be 12-18 months. [14] But the price war changed that …
When Cotti launched the RMB 8.8 and RMB 9.9 campaigns it did not need to subsidise franchisees because they still made a small profit. With Luckin’s RMB 9.9 promotion in response to Cotti, Luckin’s profit margin has decreased, even if it subsidises 1 RMB per cup. The previous average sales price per cup was RMB 17.3, and cost price per cup was RMB 6.7, giving a gross profit of RMB 10.6 per cup. With rising labour and equipment maintenance costs, this has resulted in the payback time increasing, from 24 to 36 months.
A franchisee said to Techplanet [6]: “Luckin burned investors' money in the early stage, and Cotti is burning franchisees' money"
Cotti stores may lose RMB 20,000 to 30,000 per month in the first month of opening. Losses will quickly get smaller and franchisees should be able to withdraw thousands of yuan per month without further investment. Cotti’s owner believes that based on the experience with Luckin, the number of customers will increase with the continuous development of the brand, and the level of profitability will increase. He claims that 40% of the stores are profitable, 20-30% have reached break-even, and 20% are still losing money.
Loss-making stores are mostly in areas where the population is too small compared to the number of coffee stores. According to Cotti’s policy, if a store still performs poorly three months after opening, net profit is negative or gross profit is below a certain level, the company might give some encouragement or incentives. If results do not improve after another 1 or 2 months, Cotti will no longer provide subsidies or promotions and will suggest the store to relocate or close.
There are estimations that one-third of Cotti’s stores might close down by the end of the year. Their current cup volume is supported by Cotti’s subsidies and once these disappear, the volume will not increase. With the RMB 1 deal for new customers, daily cup volume was relatively high at 400 cups. But in July, when the company was unable to raise funds, the subsidy had to be stopped.
The average daily cup volume in the second half of 2023 is expected to be less than 200. This is insufficient according to Cotti’s own calculations. Any profits will first go to Cotti to recover the headquarters investments. There will be little left for the franchisees.
What’s more, on July 1st, Cotti increased the franchise commission ratio. The new structure is as follows:
Cotti service fee . Gross profit = store revenue - cost of raw materials (incl. Food raw materials, packaging, consumables) - online payment fee. Source: cotticoffee.com August 2023.
For stores that had already opened before July, the commission remained the same and will stay that way unless the store relocates.
Potential franchisees that were on the fence might no longer want to open a store. However, Cotti will encourage franchisees to open stores and provide subsidies and loans (annual interest 4%), to those that open a second store. Cotti prefers to have franchisees with more stores over more franchisees. Cotti also recycles stores by dismantling the equipment and cabinets and selling them to new franchisees.
At the end of 2022, Luckin also increased its proportion of brand profit sharing. Before, stores with a revenue of more than 80,000 yuan shared 20% of the profit, and now it has become 30%. [9]
The fight for the ‘sinking market’
According to a 2021 paper by Deloitte, penetration of coffee in first and second-tier cities had reached 67%, with 326 cups/year and 261 cups/year respectively. [15] But the lower-tier cities, also known as the ‘sinking market’ in China, are lagging far behind, making them an interesting growth market for the coffee chains.
As we discussed in Luckin's Revival in December, Luckin’s comeback is partially owed to expanding its chain in the sinking market through franchising. Sales growth of Luckin’s self-operated stores had slowed to less than 10% and the number of stores in first- and second-tier cities was nearing a ceiling. [14]
Luckin had started recruiting affiliates with the promise of not charging franchise fees and low investment rates. The upfront investment to be paid by the franchisee was about RMB 350,000-370,000, including RMB 110,000-130,000 for decoration, RMB 190,000 for production equipment and RMB 50,000 deposit (which would be refunded in full after the contract expired). [16]
In August 2022, Luckin announced it would be temporarily halting the expansion of franchise stores because of the emergence of various counterfeit copycats that claimed to be recruiting affiliates for Luckin. In January 2023, Luckin launched a new round of expansion and began to look for franchisees in 15 provinces and 80 cities. A Luckin employee said: "In low-tier cities, there are only a few good spots, if you can grab them they are yours." [14]
In the new round registering a franchised store of about 80 square metres costs about RMB 380,000, including RMB 180,000 for decoration, RMB 50,000 deposit, and RMB 200,000 yuan for production equipment. In terms of income policy, if the gross profit does not exceed RMB 20,000 yuan, it will be returned to the franchisee, and if the gross profit exceeds 20,000 yuan, a certain proportion of profits will be returned to the franchisee. [17]
In March, Luckin’s self-operated stores covered more than 60 cities, and its franchise stores more than 230 cities. [14] In the second quarter of 2023, Luckin’s operating profit margin (GAAP) reached 18.9%, and the operating profit margin of its self-operated stores reached 29.1%. [18]
During Spring Festival, franchised stores saw a daily volume of 515 cups per day. In March, the daily volume of franchisees was 450 cups, while it was 350 at self-operated stores.
Unlike its competitors, Cotti didn’t wait until it had high penetration in first- and second-tier cities before heading to the ‘sinking market’. It immediately started opening stores in tier-1 to 5 cities. It claims to have stores in every province and every municipality in China and to be the only coffee chain at that. [7]
To win consumers over in the sinking market, coffee chains don't just need low prices but also flavoured coffee since consumers are not yet used to drinking coffee. Because the sinking market is relatively new to coffee the expectation is that all brands will grow in the short term while they still ‘educate’ the consumers and create trial and repurchase. [9]
Educating consumers will require more marketing investments than in the higher-tier cities. Still, Luckin’s financial results show that this seems to be easier than expected; the revenue growth of franchised stores is 91.1%, substantially higher than the growth in franchised stores. [13]
Meanwhile, Starbucks is facing a dilemma as it also tries to expand to lower-tier cities. Its regular high prices will make it even more difficult to beat the likes of Luckin, Cotti and Lucky Cup (see below) there. Lowering prices or introducing low-end products would damage its brand positioning. [18] It is also unlikely to use the franchise model. It tried this before but stopped the approach in 2011 after it found franchising brought too many governance problems. [19]
Lucky Cup
At the end of 2022, Luckin did not consider Cotti a threat and was more worried about competition with Lucky Cup (幸运咖 Xingyun Ka), a coffee chain launched by milk tea & ice cream chain Mixue Bingcheng (蜜雪冰城) in 2017. Lucky Cup is the country’s fourth largest coffee brand after Luckin, Starbucks, and McCafé. [10] It saw its number of stores grow from 12 in 2019 to around 2,000 at the end of 2022, 400 of which were located in its home province Henan. [9] It is mainly active in the sinking market that the likes of Luckin and Cotti are trying to conquer.
Lucky Cup follows the pricing of Mixue, which adopted a low-price strategy in the milk tea industry and formed a strong market position. Its popular sugar-iced coffee costs RMB 6, while Luckin’s cheapest coffee (at the regular price) is RMB 16. Lucky Cup claims that a Luckin store opening in a small city where Lucky Cup is already active doesn’t hurt it much.[9]
The average price per cup is RMB 6-8. For Luckin and Cotti, that would leave no margin. Lucky Cup’s target group is very different from its competitors. It is mainly located on university campuses, targeting college students that would like to try coffee at an inexpensive price. Meanwhile, Cotti and Luckin are mostly targeting office workers, who have higher standards for quality and branding.
Lucky Cup hopes that when Cotti and Luckin stop their RMB 9.9 promotions, customers will be turned off by the regular prices and switch to Lucky Cup.
Mixue took 4-5 years to open its first 2,000 stores, while Lucky Cup only took one year to reach this number. The reason is that Lucky Cup is linked to Mixue franchisees, enabling them to open faster. About half of Mixue’s stores consist of franchisees, and many of them also opened Lucky Cup stores. About half the Lucky Cup stores are opened by existing Mixue franchisees and some of these even run multiple Lucky Cup stores. Originally the brand was mainly located in Henan province, but it has gradually expanded to the rest of China. It hopes to reach 5,000 stores in 3 years from now.
The Lucky Cup franchise model
The costs of opening a Lucky Cup store consist of a franchise fee (which is currently waived, possibly because Luckin and Cotti don’t have them), RMB 100,000 for equipment, RMB 50,000 for raw materials, RMB 2,000 - 2,500 per square metre for decoration, etc. In Zhengzhou, the capital of Henan province, the average costs are RMB 350,000, less than Luckin and a bit more than Cotti.
Lucky Cup store in Datong, July 2023.
Franchisees need to purchase all materials from Lucky Cup headquarters and get to keep the revenue from products sold without Lucky Cup taking a cut. In other words, it does not take a commission on sales. Franchisees have a gross margin of 55%, and the product prices Lucky Cup sets are aimed at maintaining this level. Lucky Cup’s own profit comes from a 20% margin on the materials sold to franchisees.
In the case of group-buying promotions, e.g. on Douyin, franchisees pay for the discounts. These promotions are seen as customer acquisition and traffic generation. Stores all use Lucky Cup’s cash register system, allowing the company to gather data on products, sales volume, etc. per store.
Lucky Cup audits franchisees through offline inspections by mystery shoppers. Severe penalties are given for violations like hygiene issues or the use of expired materials. Each store is also equipped with four cameras that cover all operating areas without dead spots. Lucky Cup will periodically check high-definition footage for violations. Penalties can include fines and cancellation of the franchise. While Mixue franchisees can open a Lucky Cup store, Lucky Cup franchisees are not allowed to open another store of a brand in the same product category.
At its start, the success rate of Lucky Cup stores was low and some had to change locations or shut down. The brand has shifted from just fast expansion to also paying attention to the quality and performance levels of existing stores. The average store turnover in the first year is RMB 2,000 per day, increasing to RMB 3,000 in the second year. Lucky Cup is also increasing its regional management staff, so they can spend more time on coaching and quality control of stores. If a store success rate of 90% can be reached, that’s a good score for the industry.
Lucky Cup used to have milk tea as well, but this caused conflicts with Mixue stores, which were sometimes located next door. So Lucky Cup dropped the milk tea products and started fully focusing on coffee in 2021.
While the ratio of first- and second-tier cities versus third-, fourth-, and fifth-tier cities at Luckin is almost 7:3, it’s the opposite for Lucky Cup, which will fiercely defend its position in the sinking market. [9] Earlier this year it lowered its prices to as low as RMB 5 and RMB 10 for a coconut latte. This either means a loss or a product that is not based on freshly ground beans as the normal cost breakdown for a latte is: [10]
Coffee liquid: 2 RMB
Milk: 2 RMB
Packaging (cups and lids): <1 RMB
Bags: 1 RMB
Total: ~6 RMB
While Luckin is expanding ‘downwards’ Lucky Cup is expanding ‘upwards’ from lower-tier to higher-tier cities, so expect a more fierce clash with Luckin.
Meanwhile, in upper-tier cities: Luckin versus Starbucks
In 2022, Luckin’s annual revenue passed RMB 10 billion and it turned its losses into a profit for the first time (RMB 1.156 billion). The cumulative number of consumer customers reached 135 million, and the average monthly number of transacting customers was about 21.6 million, an increase of 66.2% from 13 million in 2021. [10]
The pandemic gave Luckin, which focussed on pick-up and delivery - on average, 30% of the total Luckin volume is delivered - an advantage. Its stores are often also located outside shopping malls, unlike Starbucks’. Although it temporarily had to close some stores, Luckin has maintained positive same-store growth since Q1 2021. Meanwhile, Starbucks saw negative same-store growth for five quarters since Q3 2021. [13] It has picked up same-store growth again in 2023, showing 48% volume growth in the second quarter. Keep in mind though that in 2022 Shanghai, where Starbucks has most of its stores, was in lockdown for two whole months that quarter…
In Q4 2022, the monthly sales of Luckin’s self-operated stores reached RMB 153,000, and the monthly sales of Starbucks’ Chinese stores were RMB 238,000 yuan. The gap narrowed after Luckin increased its pricing; the average cup was RMB 15 in 2022 and is now RMB 17. [14] Luckin also went on a store expansion spurt in Q2, opening on average 16.5 stores every day and ending the quarter with 10,836 stores. On June 5th 2023 it crossed the 10,000 stores milestone.
Luckin had already overtaken Starbucks in number of stores in 2021. Starbucks plans to open 3,000 new stores in China by 2025 but is unlikely to ever overtake Luckin again in this KPI. [10] Keep in mind though that the average size of a Starbucks store, which aims to be a ‘third place’ (the place you hang out, after home and work), is much larger. Some Luckin stores are tiny and only serve as pick-up points. Therefore, stores alone does not prove Luckin has overtaken Starbucks.
So, how about sales then?
In the second quarter of 2023, after 5 years in operation, Luckin also overtook Starbucks’ China stores in revenue. Starbucks has been active in China for 24 years. Luckin saw RMB 6.2 billion (an increase of 88% year-on-year), RMB 1.17 operating profit (GAAP) and an18.9% operating margin. Starbucks’ China stores generated RMB 5.9 billion revenue in Q2 and an operating margin of 17.3%. [13]
While Luckin still has about 70% of its stores in first- and second-tier cities, Starbucks has 80% of its stores there. Starbucks has almost 15% of its stores in Shanghai, the most mature coffee culture in China, while Luckin has 7% there. [13]
Starbucks also has a more stable rhythm of opening stores. From May to July it had to close 6 stores, while Luckin closed 109. The change rate of Starbucks is 0.9%, while it is 5.6% for Luckin. [18]
How Luckin changed Starbucks
In a speech in Beijing in April 2023, Starbucks founder Howard Schultz said:”We don’t spend a lot of time paying attention to what our competitors are doing, because our destiny is in our own hands: how do we exceed the expectations of our partners and customers? How to be committed to presenting the highest quality coffee in the world? How to keep customers coming back to Starbucks and recommending it to friends? None of this has anything to do with the competition, it's all about ourselves.” [15] That might be so, but the past 5 years have shown that Starbucks has definitely adapted to the new competitive landscape in China.
Luckin has had an enormous impact on Starbucks’ operations. Before Luckin's arrival it did not offer delivery. Unauthorised third parties on delivery apps were offering to buy Starbucks and bring it to you for a service fee. After Luckin started to catch on it became clear that there was a big market for people that didn’t care all that much about Starbucks ‘third place’ and just wanted affordable coffee in a convenient way.
In 2018 Starbucks teamed up with Alibaba to fend off Luckin. Starbucks coffee delivery, merchandise and gift cards could be ordered on a virtual store accessible through various Alibaba platforms. Ele.me, Alibaba’s meal delivery service, became the exclusive delivery partner for Starbucks. Starbucks pick-up stations appeared in some of the Hema (Freshippo) supermarkets and Hema would also deliver from the ‘Star Kitchens’ that made the coffee for these stations. In 2019 Starbucks coffee could also be ordered through Tmall Genie, Alibaba’s smart speaker.
A Starbucks pick-up station inside Hema (Freshippo), April 2019, Hangzhou.
In 2019, Starbucks launched ‘Starbuck Now’ in its app. Miming Luckin’s successful business model, consumers could order and pay for coffee through their mobile phones and pick their orders up at any chosen Starbucks store. In the same year Starbucks even tried setting up ‘Starbucks Now’ stores that stripped the whole Starbucks concept down to the ‘Luckin essentials’ of pick-up and delivery by third party couriers. In Beijing’s financial district there even was a Starbucks Now located right next door to a small Luckin store.
Starbucks Now store, Beijing 2019. (Image source: Froukje de Jonge)
Starbucks Now store, Beijing 2019.
By 2019, 10% of Starbucks’ sales came from online and 7% was delivered. At the same time, only 1% of Starbucks’ sales in the US was delivered. [20]
Left: Starbucks Now advertised on doors of stores. Right: Starbuck Now app, offering pick-up and delivery.
In 2020 the Starbucks Now service was also connected to Alibaba’s Taobao, Amap, Koubei and Ant Group’s Alipay.
In January 2022 Starbucks’ exclusive partnership with Ele.me came to an end. While its products remained available on Ele.me, it also launched its Star Delivery service (星巴克专星送) on Meituan. Consumers who place an order for Starbucks through the Meituan Waimai App enjoy exclusive discounted products and access to membership benefits. Meituan Delivery (美团配送, Meituan Peisong) provides Starbucks with this complete distribution system. It also equipped its couriers with co-branded work clothing and gave them special training on coffee delivery. [21]
In March 2023, Starbucks teamed up with Alibaba’s AutoNavi (AMap) mapping service for curb-side pick-up services for commuting car drivers. After a customer programs a route in the app an order can be placed through a built-in Starbucks applet, which will locate the best Starbucks store on the route. Starbucks receives the estimated arrival time of the customer and has a staff member waiting at the intersection. The customer doesn’t have to leave the car and the process of picking-up the coffee can take less than 10 seconds. Starbucks started the pilot with 100 stores in Beijing and 50 in Shanghai (which has less cars than Beijing). If successful, the company plans to have 1,000 stores across the country offering the service in 2024. [15]
Starbucks curb-side pick-up service. Image: Starbucks China.
Meanwhile, online channels are growing in importance for Starbucks. Its Q2 2023 report shows that Star Delivery (delivery service) increased 63% YoY and accounted for 23% of total sales. Coffee Express (self-collection) increased by 64% YoY, accounting for 23% of sales. Both hit record highs. [19]
As business through pick-up and delivery services at Starbucks keeps growing, and the importance of‘third place’ diminishes for consumers frequently using these services, the price difference with alternatives becomes all the more tangible. How many people that are not coffee purists will consider these other brands and leave Starbucks behind?
Starbucks has now even put aside its pride and has started offering group-buying discounts that bring the price down from RMB 30 to RMB 20. [22] On Ele.me and Meituan, consumers can buy Starbucks with free shipping and every now and then with discounts. [19]
Starbucks realises it has become highly dependent on digital innovations. In August 2023, it announced the establishment of the Starbucks China Innovation and Technology Center (SITC) in Shenzhen. It is supposed to improve the company's technical capabilities and data infrastructure and drive the digitalisation of its stores and channels. The centre is expected to start operations in September 2023 and will invest RMB 1.5 billion in the next three years. [23]
Zooming out: China’s Coffee Market
Industry experts expect that the penetration of the coffee market will be 33% by 2030, and 480 million Chinese will be coffee drinkers of instant and/or freshly ground coffee. The coffee market’s growth is mainly driven by rising income.
According to industry data, China’s coffee market will maintain a 25%-35% growth in the next few years and will soon be a trillion yuan large. [12] According to data from China Insights Consulting and the International Monetary Fund, the CAGR (compound annual growth rate) of the coffee market from 2015 to 2020 was 13.8%, ranking top 1 in the soft drink industry. [15]
According to the data from Qichacha, there are 177,000 coffee-related enterprises in China. In 2021 and 2022, the number of newly registered companies increased by 15.9% and 37.7% year-on-year, respectively.
In 2021 and 2022, 74 fundings with a total of RMB 8 billion took place in the sector. For all the current coffee brands, stopping burning money and achieving profitability has become the first priority for survival. [10] Still, from April to June, the number of group-buying coffee orders increased by 250%. [12]
Chinese young people need products that are less bitter and look for sweeter options. This is reflected in the development of products. Many local coffees are more like ‘milk tea’ and Luckin's popular ‘Raw Coconut Latte’, which sold 100 million cups in one year, consists of 50% (coconut) milk, 35% ice cubes and only 15% coffee. In 2021, Luckin launched 113 new products, on average one every 3 days. [18]
A year later, in 2022, Luckin’s R&D team launched 100 new drinks, helping the sales of self-operated stores grow from RMB 74,000 in 2021 to RMB 168,000 at the end of 2022, while the gross profit per cup increased from RMB 3.6 yuan to RMB 10. [14]
Meanwhile, Starbucks stays more true to ‘real coffee’ and global routines.
Smaller players
The market has been seriously stirred up since the arrival of Luckin. But there are still many smaller brands besides the four leaders (Starbucks, Luckin, Cotti and Lucky Cup) we have focused on in this report. Let’s round up by having a quick look at the rest of them.
Pacific Coffee, once second only to Starbucks, has closed 277 stores in three years. It had 166 stores left at the end of March. It is now behind Starbucks, Luckin and Costa in market share. [22] Pacific entered the mainland in 2011 and surpassed Costa in number of stores in 2015. In the end, the Pacific Coffee brand is not strong enough to justify its high average price of RMB 30 per cup. It looks like it won’t be able to upgrade and renovate its stores and might have to lower its prices to survive. [24]
Manner, SeeSaw and M Stand are three specialty coffee chains. Their coffee is priced at RMB 20-40 and they have daily volumes of 200-330 cups (500-600 during peak days), just 1/3rd of Luckin’s. Of the three, Manner has the most stores (more than 700) and daily sales of 200-500 cups per store. [22]
A SeeSaw coffee store in Beijing, July 2023.
SeeSaw and M Stand have larger spaces and higher prices. Manner spends less on store space and more on employee training and compensation. For instance, the monthly salary at Manner can go up to RMB 8,000 but only RMB 5,000 at SeeSaw. Manner staff get five weeks of paid training in its headquarters in Shanghai.
The 2017 founded M Stand, in which Xiaohongshu invested this year, has no training program; employees learn on the job. M Stand had 356 stores in 28 cities by the end of May 2023. [25]
At the end of 2022, Manner had 583 stores, older player Costa had 430 stores, M Stand had 279 stores, SeeSaw had 130 stores. The price ranges of Manner, M Stand, Costa, and Seesaw are around RMB 20-30. Unlike Luckin, most of these brands tend to be located in shopping malls. Manner will normally be in basements, while M Stand will not be in the main traffic flow like Starbucks, which is normally near the entrance, but still in a visible position.
Manner is said to have the best value for money proposition; a good classic product at a relatively low price that will appeal to high-frequency coffee drinkers that don’t want to try all kinds of new products. Still, while a cup of latte is RMB 11-13 at Luckin, it is RMB 18 at Manner.
Manner store in Beijing, July 2023.
M Stand stands out in store design, but it is said to have limited staffing per store: only two persons operating from 8 am to 10 pm, so most of the time there is only one person. This might prevent a good customer experience.
Costa and SeeSaw develop slowly and are in a state where they are trying to maintain capital and make profits.
Canadian Tim Hortons had 648 stores by March 2023. Among them, there were 551 self-operated stores and 97 franchised stores across 40 cities. [25]
Costs for coffee stores normally break down as follows:
Rent: 8-15%
Cost of goods: 25-30%
Labour: 18-24%
Other costs (licences, utilities, etc): 15%
EBITDA: 16-34%
The cash flow will be highest for commercial areas, followed by office and residential areas. A store in a shopping mall can make about twice the revenue as one in an office area, but the rent will be much higher. Net profit is highest for office areas, followed by commercial and residential areas.
At the end of the day, inexpensive coffee by the likes of Luckin sees 2-3 times as much sales as the specialty coffee of these three. All three brands find it difficult to reach an average daily revenue of RMB 10,000. Still, Manner, which had 700+ stores in June, is planning to open 1,500 in 2023 and 10,000 in ‘the future’. [22]
And then there are the many convenience stores and fast food chains like McDonalds and KFC that also sell coffee …
Conclusion
Despite the fierce competition, the market as a whole has lots of growth potential. Starbucks’ founder Schultz has predicted that the Chinese market will become bigger than the US market. That might take a while though; currently the Chinese market is about 1/8th the size of the US’. [13] Cotti is already lending a helping hand; it has expanded the coffee market; much more consumers are drinking coffee than before its launch.
Meanwhile, Luckin has taken its first steps overseas, opening nine stores in Singapore between March and July 2023. [26] In this new market, Luckin will have to compete with many established brands, among which the ‘Singapore Luckin’ Flash Coffee. Flash was founded in 2020 and is backed by Rocket Internet. [27]
In the writer’s own experience, Cotti might grow fast in number of stores but in several cities where I have seen Cotti (Beijing, Xi’an, Shanghai), the locations were often inferior to those of Luckin. They were often tucked away in corners or the lowest basement levels. Half of them still seemed to be in the process of renovating.
I ordered Cotti a few times. One time, when I had ordered a ‘dopamine coffee’, it was horrendous, the other time, the cappuccino was on par with Luckin but took a long time to be served. As a pick-and-go concept you don’t really want customers to arrive and still have to wait. Some franchisees seemed a bit inexperienced still.
Luckin still claims that Cotti has no significant influence on its business and that most of Cotti’s customers are converted milk tea customers. Luckin believes that without sufficient financial support, Cotti will collapse. At the same time, Luckin expects its own profit to decrease year-on-year because of the long lasting RMB 9.9 campaign. It does however expect its number of users to increase by 30% and more if many Cotti stores close their doors.
Excluding Starbucks, an experienced franchisee estimates that in the segment of franchise-based stores, Luckin could hold 50% market share, Cotti 20% and the other smaller companies 20%. That is assuming that Cotti will survive.
If it does, it could break through the 10,000 stores milestone as Luckin just did, in a year or so. But if this is feasible will depend on its ability to subsidise this growth like its doing with the current stores. The question is who will be willing to fund this venture of a notorious fraud.
Key Takeaways
Cotti Coffee is a new coffee chain started by ousted Luckin founder Lu Zhengyao. It claims to have opened 5,000 stores within nine months, using a franchise model that does not require much start-up capital.
In Cotti’s direct-managed franchise model, franchisees have less freedom than in other franchise models, but they only pay Cotti if there is a gross profit of more than RMB 20,000.
Cotti eventually wants to become a supply chain company, earning money from selling raw materials to franchisees, not unlike the model competitor Mixue Bingcheng is using.
Many of Luckin’s staff and franchisees moved to Cotti Coffee. An estimated 10-20% of Cotti franchisees also run a Luckin business, even though Luckin does not allow this.
The investments for a franchisee to open a standard Cotti store (RMB 300K) are significantly lower than at Luckin, where they can be as high as RMB 480K.
Cotti has attracted many new users through member-get-member schemes and discounts. These have eroded the profit margins of franchisees and made it hard for any shop that sells less than 400 cups per day to make any profit. It has also increased the pay-back time for the investment in the shop to more than two years.
Luckin responded to Cotti’s discounts, and a price war erupted. Luckin claims that many of its ‘lost’ customers returned, Cotti hasn’t significantly hurt its business, and it is mostly milk tea drinkers that switched to Cotti. Participation in the price war has, however, also increased pay-back time for franchisees to 2-3 years.
While there is sufficient potential for growth in coffee drinking in the lower-tier cities, the limited number of good store locations will see Cotti and Luckin clash with Lucky Cup.
Luckin has overtaken Starbucks in the number of China stores in 2022 and in China revenue in Q2 2023. While Starbucks’ founder claims not to watch competitors much, Luckin has certainly forced the American chain to adapt. Nowadays, almost half of Starbucks’ revenue consists of pick-up and delivery of coffee. Starbucks has also become more open to offering discounts.
The penetration of the coffee market is expected to be 33% by 2030, with 480 million Chinese coffee drinkers. Many of these will drink flavoured ‘semi-coffees’.
Smaller players like M-Stand, SeeSaw, Manner, Tim Horton, Costa and Pacific will find it hard to survive as bystanders in the battle of the giants.
Sources
Six Degrees Intelligence, a leading global expert network/quantitative research firm that operates in China. Augmented with information from the articles below.
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