Luckin Coffee Updates: Luck In Hand (Part III)
Moat: Product Innovation
2) Product Innovation
If LKNCY’s proprietary technology was equivalent of Apple’s iOS, its innovative products launch would be similar to Apple’s new product launch every year. LKNCY differentiated its new product development in two perspectives:
Catering to the local Chinese consumers’ taste;
Leveraging its unique R&D process to generate high hit ratio of blockbuster product launch.
2021 is a watershed year for Chinese coffee drinkers. Before 2021, all the coffee shops seemed to serve the same set of menu that is similar to that in the US or Europe, basically Americano, Latte, Cappuccino and expresso, etc. We could hardly remember any product innovation for coffee drinks then and our thesis is that the coffee shops then focused more on customer education than product innovation. However, between 2015 and 2021, several local tea drinks chains were launched and successfully gaining momentum, e.g. Nayuki Tean, Hey Tea, and Coco. Their products are mainly sweet milk tea based and totally redefined what could be included a cup of tea (red bean, boba, fresh fruit etc). Coffee drinks were also sold in those stores, but not as a big draw but more as a component (if caffeine is needed). Looking back now, that seemed to suggest that local Chinese preferred sweeter taste than the bitterness in their drinks.
When Luckin was first founded, it offered the same traditional coffee menu and competed on pricing. In 2019, the company hired the current Senior Vice President Weiming Zhou, a 20 year product development veteran who had working experience in Yum Brands, Coke Cola and Meituan. With the young professionals (born after 1990) as targeted customers, LKNCY likely in 2020 shifted its product R&D focus to milk based and juice based hybrid drinks that remove the bitter taste and cater more to young Chinese taste palette than traditional coffee.
The company has a dedicated in house product R&D team of 50 - 60 people (could be more now), led by SVP Zhou, which developed a digitalized (what a surprise) R&D process. This R&D team launched 77 new products in 2020, 113 in 2021 and 108 in 2022. In 2023 they orchestrated the phenomenal launch of the first ever co-branding product Jiangxiang Latte, a mix of Chinese liquor and latte, which sold over 100 million yuan in the first day.
Per a case study done by CEIBS, LKNCY’s R&D system is composed of five stages:
Product analysis. In this stage, the team will generate the rationale and preliminary design for the potential blockbuster products based on the analysis of consumer data.
Menu management. Based on deliverables from the product analysis and existing product menu, the team develops the product specifications for the potential new products.
Product R&D. A mechanism of “internal horse race” is adopted to new product R&D, i.e. several small groups are developing new products based on the same product specifications and eventually deliver 10-20 potential products. Then the best product is selected via multiple rounds of internal blind tasting.
Product Testing. The team will conduct both internal and external testing on the newly developed product by R&D and make necessary changes accordingly.
Product Optimization. After the new product is finalized, this team will make final finetuning to make sure the product takes into consideration of potential issues of raw materials supply chain and in store preparation process, i.e. the product could be prepared easily and consistently by the store staff. After the product is optimized, it will be temporarily placed into the new product database and wait for the right time to launch.
During the R&D process, the company’s marketing and store operation teams will also participate and provide input. The marketing team will help decide on the pricing, targeted customer segment and corresponding marketing strategy while the store operation team will create new product preparation SOP and supply chain arrangement for the stores.
Apparently, the R&D system worked and worked very well. More importantly, the company launched at least one blockbuster product each year. If Luckin were a hedge fund, it would have discovered and formulated its trading edge that enabled fund to make at least one Michael Murray type of “biggest trade” EVERY year.
The market did not feel that impact until 2021, that is why we called 2021 a watershed year for Chinese coffee drinkers. It is actually more so for LKNCY shareholders. During 2Q 2021 the company’s revenue suddenly took off significantly and also started to generate operating profit. The secret weapon behind this breakthrough was the launch of coconut milk latte on April 21, 2021, which became an instant hit with 420,000 cups sold in 40 days and 10 million cups sold in the month of June 2021 alone. By its first anniversary in April 2022, coconut milk latte had become the first blockbuster product by LKNCY with cumulatively 100 million cups sold (see screenshots below).
Source: Company official wechat channel.
With the unprecedented success of coconut milk latte, the company kept launching new hit drinks every year, e.g. the cheese flavored latte in 2022 (6.6 million cups sold first week after launch) and Jiangxiang latte in 2023 (5.4 million cups sold in the first day of launch).
This high hit ratio of new product launch, combined with the accelerated store openings and effective new customer acquisition, has created a dominant leading position with a uniquely deep moat for LKNCY now.