Can Luckin Take On Starbucks in China?

Luckin Coffee (LKNC.Y -3.71%) just finished an IPO, and it plans to add thousands of locations across China as it attempts to supplant Starbucks (SBUX -1.02%) as the country's No. 1 coffee brand. The chain has decided to prize growth above profitability, and it's adding stores as fast as it can. It has grown by offering discounts as a way to get consumers to sample coffee in a country that does not consume the beverage at the rate much of the rest of the world does.

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This video was recorded on May 21, 2019.

Shannon Jones: Let's talk about Luckin. First off, Luckin Coffee, ticker LK. It did make its debut on the Nasdaq on Friday, I believe it was. And this is a company, Dan, that's really taken China by storm. I can't even really put into words their growth story since 2017.

Dan Kline: So there's a couple of different models when you look at businesses. There's the, we're going to open a store, we're going to get to profitability, then we're going to open a second store. This is not the model Luckin has followed. They have decided that there is a huge untapped coffee drinking market in China. Very, very few people compared to the U.S. and even some of the rest of the globe drink coffee. It's a tea-based culture. But Starbucks has shown that if you expose people to coffee, they will drink it, they will pay for premium tea experiences, coffee experiences. Starbucks has gone in and opened 3,000 stores in China, opening about one every 15 hours, I believe is the number. Maybe it's slipped to 18. It's basically one every day. They have shown that if people see coffee, get to try it -- so, what Luckin has done is, they have opened at a breakneck pace without any regard for profitability. Their goal is to just get in the market. They will give you your first order for free. They will deliver it to you. Have you ever used Starbucks' delivery in the U.S. through DoorDash?

Jones: I have not, only because there's two right around the corner.

Kline: It's like a $4.99 fee. Unless you're at a meeting with 10 people -- I did it one day because I was just desperate. I was stuck in the house, I didn't have coffee. My coffee was like $14.

Jones: Was it hot coffee?

Kline: No, it was iced coffee. I live in Florida, I don't think they have hot coffee. [laughs] They do, but I've had like three hot coffees in two years. But, Luckin is doing everything they can to sign you up, to gain membership. They have 15 or 16 million people using their app, which is actually comparable to the number of people using the Starbucks app in the United States, where they've been for 20-plus years, or whatever the actual number is. So their goal is to get you to drink coffee. And they've done that exceptionally well.

They IPO'd so they could have money to grow in an unprofitable way. And at some point, they will flick the switch and stop heavily couponing and giving you your first order for free. Maybe they'll still keep some of those levers for first-time customers. But at some point, the price will go up, and they will still be cheaper than Starbucks.

Jones: Yeah. And I want to go back to the Luckin model because compared to Starbucks, Starbucks is of course more of the retail setting, I can come sit down --

Kline: It's a people-driven model.

Jones: Right, it's a very people-driven model, whereas Luckin is pretty much a grab and go/ delivery model, which in theory should drive down a lot of the overhead costs. You were talking about profitability.

Kline: And it's much more heavily automated. When you look at a Starbucks vs. a Dunkin Donuts in the U.S., Dunkin Donuts has spent money on its espresso platform, they've totally redone it. But it is not a barista who knows a recipe making it for you. It's a button. It's a machine, it's very much like what they do at McDonald's. Frankly, it's similar to the machines at a high-end rest stop where you can get a latte, a hot chocolate, a cup of soup, all from the same machine. Luckin does not have the five people behind the counter that Starbucks has. Now, there is going to be a coffee snob like me who isn't going to do this. But if your only exposure to coffee was at a restaurant or the occasional, I don't know what the coffee situation is with convenience stores in China. But if it's generally bad coffee, this is going to be a big step up. So, it's very much the Dunkin Donuts model of, yeah, we're selling you an iced coffee. Hey, how about on a splurge day, you spend twice as much money and get a macchiato? That's what Luckin is doing. And I think it's going to be very, very good for Starbucks.

Jones: Yeah, I definitely think in China, it's not going to be a winner-takes-all model at all.

Kline: I don't think it is because it's an entry-level brand. If I've never had a cappuccino, which sounds preposterous now, but when I was in high school, a cappuccino was something you got at a French restaurant. I had like a fancy aunt who took me, and I had my first like cafe au lait in a big bowl. Coffee houses were rare, and they were artsy. These things weren't on the menu at 7-Eleven or McDonald's. So the first time you have this at Luckin, at some point, you are naturally going to go, "Hey, I like this macchiato thing. What about the fancy place over there, Starbucks, that charges twice as much?" You may not become an everyday Starbucks customer. You are going to become a luxury Starbucks customer. And with the population base and the tiny, tiny percentage that drinks coffee, if Luckin can create a coffee market, some of those people will graduate to Starbucks. And that's going to be very good. I think these two companies can absolutely play well together.