China Consumer

Coffee or tea?

Luckin Coffee plans tea spin-off – switching to a franchising model


Failed a recent taste challenge

In early September, nine coffee drinkers came together for a blind tasting – hosted by a consumer group in Hangzhou – to judge six different coffee brands sold in the city. To their surprise, coffee from Family Mart, the Japanese convenience store, was ranked first. Even more surprising, Starbucks and Luckin Coffee, the domestic coffee chain that is looking to topple the US coffee giant in China, came respectively second-to-last and last in the taste test.

After the results were published, critics were quick to comment: “Starbucks, Costa [which tied with KFC for second place] and Luckin Coffee are the professionals when it comes to coffee, while the remaining brands [McDonald’s, Family Mart and bakery Casa Miel] are considered more or less amateurs. This is like judging Yao Ming [the former basketball star] and Pan Changjiang [a comedian] to see who can jump higher, the result should have been very obvious,” wrote ZnCaijing, a finance portal.

Luckin Coffee, valued at about $5 billion after going public on Nasdaq in May, must now be hoping that its tea offering will be more appealing to critics’ tastes. Early this month, the company announced that it will spin-off its tea business from its coffee operation. The new unit will operate its own brand as Xiaolu Tea, or ‘Fawn Tea’ in English. It will also runs its own physical stores, as well as an online app for deliveries.

Luckin only started selling tea-based beverages at its 3,000 stores around the country in July.

Unlike Luckin’s coffee brand, which concentrates on first and second-tier markets and targets white-collar workers (that mostly want to grab-and-go) Xiaolu Tea will focus on smaller cities. The concept requires more retail space allowing consumers to sit, mingle and relax.

More importantly, Xiaolu Tea will adopt what the company calls a “new retail partnership model”, which effectively is a franchising approach.

An operating partner of Xiaolu Tea will be responsible for identifying a store location and taking on most of the expenses of running it, such as interior design, staff costs and rents. Luckin’s head office will provide brand marketing, product development and supply chain management expertise.

Luckin will not charge a franchise fee in the initial stage. However, the company will take a certain percentage of profits once the franchisee breaks even.

Industry observers are mostly supportive of the move. While the coffee market in first and second-tier cities has reached a period of “explosive growth”, reckoned Wang Guoping, an industry analyst, tea-based products are much more popular in third- and fourth-tier cities, where there is much less competition.

Still, the fact that Luckin chose to expand its new venture via the franchise model also suggests that the three year-old firm has less spare capital to deploy – even after raising $560 million from its New York listing.

Luckin has been growing rapidly but also burning through cash at a dizzying rate. In the second quarter alone, it posted a net loss of Rmb681.3 million ($99.2 million).

“Investors are very generous: as long as you have a good story, they will give you all the capital you want. But they are also very ruthless: once the bubble bursts, they are the first to leave. The day Luckin announced its second quarter results, its share price fell almost 17%,” 36kr, a tech portal, commented. “So right now, what Luckin needs is a new story that will help maintain its growth rate. That is why it is now betting so heavily on Xiaolu Tea.”

Still, Luckin is not the first brand to separately target coffee and tea. Back in 2017, Starbucks launched the specialty tea brand Teavana across the US, focusing mainly on high-end shopping malls. But sales were so disappointing that by early 2018, the coffee giant had closed all 379 Teavana stores.

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