Who Will Come Out on Top in the Chinese Coffee Wars?

Key Points

• China's massive population size makes it a market in which many firms are always jockeying for positions to achieve growth.
• Two players stand out in the battle over the country's coffee industry.
• How do these firms match up, and who will win going forward?

Right now, a war is raging in China over which company will lead the market in a product that humans around the world love: coffee. Successful entry into the Chinese market is something Western companies have been coveting for decades. With over 1.4 billion people, China has 17% of the world's population. Many firms see it as a huge growth opportunity.

Here, we'll explore the two leading players in this coffee battle: a Western firm known worldwide and a domestic Chinese company that has made a name for itself over the past few years. We’ll look at the history of the two firms in the consumer discretionary sector and the current state of their competition and consider what could happen next.

Starbucks Is Seeing Its Dominance in China Fade

Starbucks NASDAQ: SBUX is the worldwide powerhouse in coffee, founded in Seattle, Washington. The company entered the Chinese market early, all the way back in 1999. The country is by far the firm’s most important outside the United States, having now amassed over 7,300 stores in China.

Despite this massive number of locations, sales have been floundering in recent quarters. In fiscal Q2, comparable sales in China declined 11%, driven both by smaller average order sizes and fewer transactions. Comparable sales exclude sales from new stores. Opening new stores boosts revenue but doesn't mean existing stores are doing well.

In fiscal Q3, the decline increased, with comparable sales dropping 14%. As it does in the U.S., Starbucks positions itself as a premium coffee brand in China, selling at a significantly higher price point than the competition. This has likely influenced the recent sales decline, as Chinese consumer confidence neared its all-time low in July. With low confidence in the economy, consumers may be switching to lower-priced options to save.

Luckin Coffee Is Now the Team to Beat in China

Luckin Coffee OTCMKTS: LKNCY entered the Chinese market in 2017. After the company went public in 2019, it faced a fraud scandal, and NASDAQ delisted it. But now, the firm is fully back on its feet and is taking Starbucks to task.

The company has seen massive growth in its store count over the past year, increasing from around 11,000 locations in Jun. 2023 to nearly 20,000 in Jun. 2024. Almost all of these are in China, with some in Singapore. The company operates around two-thirds of the stores, while it uses a franchise-like model to operate the rest.

The company now has higher revenues than Starbuck’s Chinese business after less than a decade of operation. However, more recent results are difficult to parse out due to the company’s rapid store growth. In the company’s Q1 results, its total revenue grew 42% from the previous year. In Q2, revenues increased 36%.

When we look at the comparable store sales from company-operated stores, we see that they fell 20% and 21% in the last two quarters, respectively. This larger drop compared to Starbucks is interesting, considering Luckin’s much lower price point. The price of a Luckin 16 oz latte is one-third that of Starbucks.

It could signal that through a period of low economic confidence, Starbucks has wealthier customers who are actually less affected than Luckin’s, causing a smaller drop. It could also be that the rapid store count growth is causing cannibalization, with new stores taking sales from existing ones.

However, with such rapidly growing overall revenues compared to Starbucks, it might not matter. Management has stated its goal is to increase market share, and it is certainly doing that. It has increased its average monthly number of customers by 136% since Mar. 2023.

Luckin Needs to Stay Aware of Challengers in This Ever-Competitive Space

Right now, it seems Luckin is winning the coffee war in China, especially after the company’s profits recovered nicely in Q2. Rapid expansion costs and a pricing battle in Q1 contributed to a $12 million loss; however, profit reached $120 million in Q2.

Luckin feels poised to continue winning, based on its already strong position and commitment to grow rapidly even if it results in a bad quarter. Luckin has to continue fighting off low-cost domestic competitors like Cotti and not dismiss Starbucks. It’s possible that Starbucks's new CEO, who takes over this month, could introduce a big change in Chinese strategy that could shake things up in this intense battle.