Cotti Splashes Past 10,000-Store Milestone, Fueled By Relentless Price War

Key Takeaways:

• Despite reaching the 10,000-store milestone, Cotti’s obsession with beating Luckin through price wars could ultimately threaten its long-term sustainability
• International expansion could offer Cotti a better path forward than its low-price strategy in the saturated China market

By Hugh Chen

For entrepreneur Lu Zhengyao, there was little time for crying over spilt coffee after being ousted from his baby, Luckin Coffee LKNCY, following a major fabricated sales scandal in 2020. Lu quickly threw his energies into Cotti Coffee, a Luckin clone that is even more Luckin than the original. The new chain has been widely perceived as Lu’s revenge and comeback attempt to show he’s still king of China’s coffee hill.

Now, Lu is also trying to take his show on a global expansion path that could provide some relief from the overheated China market. But such a path is hardly without perils, bringing the chain up against other global players like Starbucks SBUX, even as Cotti’s innovative financing model could show signs of strain due to large numbers of store failures at home.

Last week Cotti celebrated its two-year anniversary with the opening of its 10,000th outlet in Doha, Qatar – topping off an expansion that would leave even some of China’s most aggressive chains out of breath. In announcing the milestone on its Instagram account, the company marked the occasion with the type of price-based promotion that has become its hallmark, offering all beverages for 10 riyals, or the equivalent of $2.75.

While Luckin was once lauded for its rapid development – including its breakneck two-year path from establishment to IPO – Cotti has now surpassed its predecessor in terms of expansion. By comparison, Luckin took six years to reach the 10,000-store mark in 2023.

But Cotti has even bigger ambitions, with a goal of reaching 50,000 stores by the end of next year. While many of the additional stores would be convenience-style booths within convenience stores and gas stations, Lu’s determination to outpace his former offspring is evident.

Cotti has achieved its rapid rise by replicating many elements of Luckin’s early formula for success, particularly its strategy of aggressive subsidies. But there’s also a fundamental difference in the two chains’ funding models. While Luckin’s rapid expansion was fueled by investor capital, Cotti has yet to announce any institutional investment rounds, which seems largely due to Lu’s tarnished reputation following the fraud scandal at his previous venture.

Instead, Cotti employs a sophisticated supply chain financing model, according to an investigative report by financial outlet Late Post. That model sees the company partner with banks that act as guarantors to secure extended payment terms from its suppliers, effectively using supplier credit as a source of working capital for its rapid expansion.

Beyond The Rivalry

Cotti’s fixation on competing with Luckin is evident in its strategic decisions. Multiple local media have reported that franchisees are incentivized to establish Cotti stores near Luckin locations. According to Late Post, franchisees setting up stores within 100 meters of Luckin outlets receive triple the subsidies compared to those that set up 200 meters to 300 meters away.

Cotti has also become legendary on China’s coffee scene for its low-price strategy, which has dealt a blow not only to Luckin but also the more upscale Starbucks and just about everyone else. Under the weight of those low prices, Luckin reported its self-operated same-store sales plunged 20.9% in the second quarter. Starbucks last week also said its same-store sales in China fell 14% in its latest fiscal quarter through September.

Checks by Bamboo Work show that nearly all coffee products across Cotti’s e-commerce platforms are priced at 9.9 yuan, or $1.39, per cup, from mega-cities like Beijing down to smaller ones like Changsha.

Luckin pioneered the 9.9 yuan pricing model, though with certain restrictions like weekly purchase limits and quantity caps. But Cotti took the approach to new levels in early 2023 by offering unlimited purchases of all products at 9.9 yuan. Cotti’s Chief Strategy Officer Li Yinbo said the company plans to maintain its current 9.9 yuan pricing strategy for another three years, according to a report last week from local media New Retail Daily.

The price war initiated by Cotti has already taken a toll on the bottom line at Luckin, which has responded with its own price cuts since early last year to remain competitive. In the first quarter of 2024, Luckin recorded its first quarterly loss in two years, attributing it to factors including lower product prices, intensified competition, and seasonal effects.

While Cotti appears confident it will emerge victorious from this price war, such a strategy may be shortsighted. Instead, the company might be better served by focusing less on winning its grudge match against Luckin and more on establishing a more sustainable business model.

The current price war is already showing signs of strain despite Cotti’s determination to stay the course for the next three years. The extremely low prices often put franchisees at risk, especially given their significant upfront investments in equipment rental and other startup costs.

While reaching 10,000 stores within two years is impressive, a less visible side to this rapid expansion is the shuttering of many franchises just as quickly as they open. According to third-party research data cited by local media Xin Finance, Cotti opened 476 new stores during a 90-day period in early 2024, but also closed 826 in that time – resulting in more than 300 net closures.

Even more concerning, some Cotti outlets, struggling with razor-thin margins, have reportedly crossed food safety boundaries to cut costs – a recipe that looks ripe for producing a food safety scandal. A Cotti employee recently took to Chinese social media platform Xiaohongshu to expose that their store had been using expired milk and frozen goods.

While price wars may benefit coffee drinkers at all stores in the short term, they ultimately suffer if product quality deteriorates as a result. While Cotti has disclosed little about its financial position, there’s no indication it possesses a larger war chest than Luckin, nor any guarantee it will emerge victorious from the current competition.

Still, the choice to celebrate its 10,000th store milestone with an overseas location could signal a shift in strategy that looks more promising. That focus on international expansion might indicate that competing with Luckin is becoming less of a priority, though Cotti will still encounter Starbucks and other international chains, as well as local players, in such markets.

While the international focus represents a modest strategic pivot, the company has already made significant progress on that front. According to data from Canyan, Cotti operated 7,412 stores in China as of Oct. 7, suggesting its overseas presence has grown to over 2,000 locations – more than a quarter of its total store count.

Going forward, Cotti’s success will likely depend on its ability to move beyond its fixation with challenging Luckin through price wars at home. Despite intense competition, China’s coffee market continues to grow at double-digit rates, offering significant opportunities, particularly in lower-tier regions where coffee is still a relatively unknown and somewhat exotic drink. At the same time, its financing model could also be coming under pressure if many of its franchisees fail, leaving banking partner guarantors to cover their unpaid debts.

At the end of the day, Lu Zhengyao probably needs to set aside his grudge match with his former brainchild if he wants to succeed with Cotti. Accordingly, the company would do well to set its sights on building a more sustainable business model beyond simply competing on price and building new stores at such a breakneck pace.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.