Starbucks vs. Luckin Coffee: the Battle in China Heats Up

Despite growing concerns about a slowing economy and increased competition in China, Starbucks (NASDAQ: SBUX) is committed to continued expansion in a market that used to be dominated by tea. Starbucks, among other big name brands, is helping to drive China’s growing interest in coffee.

Starbucks has become increasingly dedicated to its global efforts, especially in China. This became apparent with the introduction of Kevin Johnson as CEO in 2017, who understood that success in China would rely on targeting a more digital-savvy crowd than in the US.

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Since becoming CEO, Johnson has outlined a plan to have 6,000 stores across China by 2022. They continue to deliver progress on that goal, introducing 600 new stores in China throughout fiscal 2019. The company now has a presence of over 4,000 stores in the country.

Starbucks Now, a unique experience in Beijing

Starbucks showed massive improvement in China when they opened their first Starbucks Now store in July 2019. The store debuted in Beijing and there are plans to implement the layout in more locations through fiscal 2020.

Starbucks Now, which features a special beverage and food menu designed for on-the-go people, dedicated areas for delivery and online orders, and limited seating help provide an experience that anyone can enjoy, gives customers an innovative experience that not only appeals to its traditional, cafe-loving customers, but also the evolving world of digital ordering and quick service. The layout hasn’t completely removed seating from the store, something that competitor Luckin Coffee (NASDAQ: LK) rarely provides, but has added features to better accommodate mobile order & pay and delivery services. The improved layout will allow Starbucks to limit overhead with less employees and be able to open up stores more quickly.

Competition is brewing in China

Starbucks’ expansion efforts in China come at a good time with Luckin Coffee lurking in the shadows. The China-based company, which went public just six months ago, immediately announced plans to expand thereafter. At the beginning of 2019, Luckin Coffee had approximately 2,380 locations in China — compared to the nearly 3,700 Starbucks stores at that time.

With 2019 nearing an end, Luckin has already caught up to Starbucks with both companies listing over 4,000 stores in China.

And while Luckin Coffee plans to have more than 4,500 stores in China by year’s end, according to CFO Reinout Schakel, it comes at a cost.

Compared to a year prior, Luckin Coffee saw operating losses climb from 486 million yuan ($69 million) to 591 million yuan ($83 million), a 194% increase. This was mostly due to their growth, but low-priced products with low profit margins and a loyalty program that gifts coupons generously have also contributed to the high operating losses.

Although most of their stores are designed for pickup, they plan to implement more cafe-style locations to compete with Starbucks. This will only drive operating costs more.

Luckin Coffee has, however, posted incredible revenue earnings throughout 2019 — they reported about $216 million in Q3 revenue, a massive upgrade from their $35 million posted in the prior-year quarter.

Starbucks, on the other hand, has shown routinely impressive revenue growth to close out their fiscal 2019. In fiscal Q4 2019, Starbucks reported $803 million in net income, a rise from $756 million in this quarter last year. They also saw revenue rise to $6.75 billion last quarter, up 7.1% from their fiscal Q4 2018 ($6.3 billion).

This is only the beginning for Starbucks in China

China is known for being a tea-loving nation, but the growing middle class is starting to shift their focus toward coffee. Luckin Coffee has found success with providing convenient and cheap coffee, but Starbucks is quickly showing that they can counter that model.

Starbucks has had a presence in China for over two decades, something Luckin hasn’t had. The new and improved Starbucks Now could eliminate a lot of the “edge” that many analysts believe Luckin Coffee has over Starbucks.

Starbucks has an almost unrivaled ability to improve store layout, customer experience and implement new technology, while keeping the traditional cafe environment. The company has made it easier for customers to order online and pickup at-store, they’ve introduced new artificial intelligence to improve efficiency in the workplace, they have enhanced their rewards program, and have implemented new popular beverages like Nitro Cold Brew.

In their Oct. 30th Q4 earnings call, Chief Financial Officer and Executive Vice President Patrick J. Grismer detailed an outlook for fiscal 2020 that shows more global growth. They expect a total revenue growth of 6% to 8% and a non-GAAP operating income growth of 8% to 10%. This falls in line with their ongoing growth model.

After all, people mostly love Starbucks for their innovative and tasty drinks — and that’s something no company can take from them.

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Ryan Brennan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool owns shares of Luckin Coffee Inc. The Motley Fool has a disclosure policy.

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