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Lessons in the Luckin Coffee debacle

The Chinese coffee chain, which filed for bankruptcy last week, holds some key lessons for U.S. restaurants, says RB’s The Bottom Line.
Luckin Coffee bankruptcy
Photograph: Shutterstock

The Bottom Line

Last week, the Chinese coffee chain Luckin Coffee declared bankruptcy in the U.S., hoping to hold off a bunch of lawsuits as it seeks to reorganize.

It was only the latest episode in what has been a roller coaster ride for the company, which emerged out of nowhere in 2017, became the largest coffee chain by unit count in China two years later, went public in the U.S., and in 2020 was revealed to be faking sales and transactions.

The Chinese market in which Luckin operates is vastly different from the U.S.—far more Wild West-like. And the basic problem here is faked numbers, rather than some broader market issue.

Yet there are still lessons that U.S. restaurants and the people that deal with them can take from the Lucikin debacle. Let’s look at three of them.

Beware of growth

When Luckin burst onto the scene many of us watched its growth with our jaws to the floor. It got a lot of attention, some of it from yours truly. Early last year we asked, “Is Luckin Coffee the future of the restaurant business?

In our defense, in that same article we wrote this:

“As a general rule, it is a good idea to be wary of such amazing growth stories, because it can be difficult to manage that growth. A company can add a lot of locations and suddenly realize the demand for them simply isn’t there. Most of the super-fast industry growth examples usually come crashing down at some point.”

That was true before Luckin and it is certainly true now. It is true in China and the U.S. and anywhere else restaurant companies build more restaurants. Overaggressive growth is one of the biggest dangers in the restaurant business.

The list of chains that grew too fast only to overheat is long—Boston Market and Quiznos, to name just a couple of particularly famous examples. There are also extreme examples of companies that take extraordinary steps to demonstrate growth numbers or back them up. In the early 2000s Krispy Kreme apparently used questionable accounting to satisfy Wall Street results on its growth. More recently, Burgerim proved to be a franchise boiler room that sold an unworkable concept to unsuspecting franchisees.

At Luckin, pressure to back up growth numbers clearly led to faked transactions and sales. While most companies won’t do that, they do risk the future of their brand by not being more cautious when it comes to new locations.

Remember your market

When the short-seller Muddy Waters Research first questioned Luckin Coffee’s growth, it called the company “a fundamentally broken business that was attempting to instill the culture of drinking coffee into Chinese consumers through cutthroat discounts and free giveaway coffee.”

Coffee consumption in China is definitely growing. Starbucks itself believes that makes the market particularly attractive. Yet Chinese consumers drink fewer than four cups of coffee a year, compared with 300 for the typical U.S. consumer, CFO Patrick Grismier said in 2019, according to a Sentieo transcript.

Yet Starbucks also has some well-defined tea brands, notably its Teavana concept that it largely brought in-house in 2017. The market for coffee in China may be growing, but it takes time to build the level of demand that would warrant the number of stores. Luckin in September 2019 launched tea beverages, but until then had been primarily a coffee concept. By that time the damage had largely been done.

The market for coffee simply wasn’t big enough to warrant the level of growth and sales Luckin was expecting, at least without a tea brand to offer the product consumers really like in that market. Building demand for a product takes time.

Technology does not guarantee success

Luckin still operates close to 4,000 stores in China, though that is smaller than it was at its peak last year. But its technology-enabled operation is still worth noting, given the growing role that digital orders, cashless payment, delivery and takeout are all playing in the restaurant space—even when we don’t consider the pandemic.

The company operates a central technology system and uses data analytics and artificial intelligence to improve operations. It used glorified vending machines to bring its locations to certain markets and also introduced areas to its coffee with delivery-only units.  

All of these elements are not just the future of the restaurant space, they are increasingly the present—more brands are using delivery-only locations to introduce their concepts to specific markets, for instance, and data analytics and artificial intelligence are commonplace at many big brands right now.

But technology doesn’t guarantee success. You may be able to order on an app and pick it up easily and the company may be using information to see what works and what doesn’t, but at the end of the day a company needs a product people are willing to buy at the price offered.

A delivery-only location is great. But that delivery-only location may not do much business in the end of the product doesn’t resonate with consumers.

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