This coffee company thinks it can beat Starbucks in China

Hong Kong(CNN Business) After barely a year in business, Luckin Coffee is challenging Starbucks in one of the US coffee giant's top markets.

About 2,000 Luckin outlets have sprung up across China over the last year. That includes a store in Beijing's Forbidden City, the historic cultural site from which Starbucks (SBUX) was famously evicted more than a decade ago.

Luckin plans to have 4,500 outlets by the end of 2019, which would take it ahead of Starbucks to become China's biggest coffee chain. It's luring customers with cheap prices and savvy use of technology, which is forcing Starbucks to up its game.

The rapid of ascent of Luckin to challenge the US chain shows how Chinese upstarts are increasingly rivaling Western brands in one of the world's top consumer markets.

While both serve coffee, the similarities largely end there. Unlike Starbucks' trademark coffee shops, most of Luckin's outlets are tiny booths in out of the way spots that take orders online for both delivery and pickup.

More important, Luckin has placed technology at the heart of its business from the start. Its outlets don't accept cash, instead customers can only pay through the Luckin app, which offers loyalty bonuses.

"It's very convenient and time-saving," said Hans Wang, a 33-year-old researcher in the eastern city of Hangzhou. He places his order using the app and then picks it up in a store.

Customers demand these kinds of services in an increasingly connected China. But until recently, Starbucks didn't offer them.

"Starbucks had a weak point," said Jeffrey Towson, a professor at Peking University and China business expert. "The fact they didn't have delivery is ridiculous. And their app sucked."

Growing rivalry

China is Starbucks' second biggest market after the United States. With around 3,000 stores across the country, it's still bigger than Luckin. Starbucks plans to more than double that number by the end of 2022.

But in June, the company reported a sudden slowdown in growth in China. One of the things it blamed was increasing competition, which analysts interpreted as a reference to Luckin.

There is a growing sense of rivalry between Luckin and Starbucks. In May, Luckin sued the Seattle-based company, claiming it had unfairly monopolized the market.

In response, Starbucks told Chinese state media: "We welcome orderly competition, mutual promotion, continuous innovation, continuous improvement of quality and service, and creating real value for Chinese consumers."

Starbucks is now fighting back. In August, it teamed up with Alibaba (BABA), China's largest e-commerce company, to launch home delivery services. A month later, Luckin announced its own tie-up with another major Chinese internet company, Tencent (TCEHY).

Yuwan Hu, an analyst at Daxue Consulting in Shanghai, said that competition from Luckin is also prompting Starbucks to go more upmarket by focusing more on its Reserve brand in China. The outlets offer consumers more premium coffee options in a larger, more luxurious retail space.

Starbucks' Reserve Roastery in Shanghai, which opened in late 2017, is the company's biggest store in the world.

Luckin is focused on competing on price, according to Hu. The company promotes discounts on Tencent's popular social network, WeChat, and its coffee is generally cheaper than Starbucks'.

Suyu Meng, 25, who works at a tech startup in Beijing, said she's torn between the two brands. She is drawn to Luckin's cheaper prices, but also likes the more high-end experience at Starbucks, where she can meet up with friends.

Coffee's answer to Xiaomi

Towson described Luckin as the coffee industry equivalent of Xiaomi, the upstart Chinese smartphone maker that became one of the country's top brands by selling cheaper alternatives to Apple's (AAPL) iPhone.

To succeed, Luckin doesn't necessarily have to overtake Starbucks as China's top coffee brand. Analysts say the market is big enough for both of them.

For the time being, Luckin is losing money as it seeks to grow, a common situation for young startups.

"We haven't set a timetable for profit," spokesman Du Yang told CNN.

In December, the company raised $200 million in new funding from investors, giving it a valuation of more than $2 billion, according to Du.

The long-term challenge for both Luckin and Starbucks is converting more of China's traditionally tea-drinking population to coffee.

People in China consume just five cups of coffee a year on average. Americans guzzle about 400.

"The question for them now is, 'How much do Chinese like coffee?,'" Towson said.