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Why lower-tier markets are gold mines for Luckin Tea

China’s fastest-growing coffee chain, Luckin Coffee (Nasdaq: LK) recently announced plans to run its tea brand independently. Luckin Tea is now focused on expanding into China’s third- and fourth-tier markets. Such markets were once overlooked by many brands yet have gained a lot of attention recently. 

Infrastructure driving market growth

Domestic policies have ensured lower-tier markets are well positioned for rapid digital growth.  Among the Chinese government’s top agendas is to build infrastructure in lower-tier markets that include highways, railways, roads, as well as increasingly advanced telecommunication systems. This policy reduces the gap between top-tier markets and lower-tier markets. These  days, people get most of their information via the internet. Brands can more easily access lower-tier markets through improved logistics systems. According to a Morgan Stanley report, household consumption in lower-tier markets is expected to triple between 2017 and 2030. As for Luckin, it has simply taken advantage of the infrastructure gains and seeks to serve markets in which consumers are already familiar with online purchasing and delivery experiences.

Source: CEIC and Morgan Stanley

Increased purchasing power

Research finds that consumers in lower-tier cities have potential to become regular coffee or tea consumers. In 2016, Individuals working within third- and fourth-tier markets earned about 55% of the disposable income earned by their first-tier city counterparts. However, they are expected to earn about 64% by 2030. Average food and beverage expenses in smaller cities are similar to bigger cities, but people living in first- and second-tier markets typically spend comparably more on housing-related expenses such as loans or rentals. Housing is usually cheaper in lower-tier markets. As a result, people don’t have such heavy financial burdens. Therefore, in terms of discretionary income, individuals within lower-tier markets have more flexibility to allocate expenses as they wish. People in such markets are therefore perhaps more likely to reward themselves with a cup of coffee or tea. The price of a Luckin drink isn’t a barrier for many consumers, so the brand will likely find it easy to penetrate new markets.

Photo from Luckin

Peer influence on consumption of “status brands”

In recent years, awareness of status brands has dramatically increased in lower-tier markets thanks to digital media. Local consumers are influenced by their friends who work in big cities. De-regionalization is the term that Alimama used in its report to describe the departure from the dragging-behind pace of culture and economy sometimes present in smaller markets. Of course, Luckin cannot deliver a cup of coffee from Beijing to a small city, but people are more than ready to welcome new Luckin outlets into their cities. For many consumers in smaller markets, Luckin is already an icon of upscale urban life. It is a status brand for them, one with which they can showcase their refined lifestyle. 

This July, while in Hefei, the capital city of Anhui Province, I looked up nearby coffee shops on Dianping and discovered some telling comments about Luckin. Some users said they knew the brand prior to finding a local outlet, either from their friends or from a visit to a major city. One person, for instance, said her friend who had been on a business trip to Shanghai had recommended Luckin.

Tea beverage popularity in lower-tier markets

Luckin Coffee is a success in first- and second-tier cities due to its strong business strategies and operational efficiency. Despite brand awareness in lower-tier cities, coffee is not always a good stepping stone to quickly boost sales in China. Tea beverages, on the other hand, might very well be the perfect ice-breaker for Luckin’s expansion into smaller markets. Data from Meituan-dianping suggests tea shop growth in 2018 mostly came from lower-tier markets. A local report released in March 2019 likewise indicated that young consumers in small cities are willing to pay more for a tea drink than a casual meal.  

The tea beverage industry in top-tier markets is already saturated. Luckin has smartly maneuvered its way out of direct competition. It has found that lifestyles can more easily be changed than commonly thought because people in smaller cities are often eager to deregionalize. For example, red wine is consumed in Mianyang, which is a traditional baijiu (a distilled liquor made from grain) production city according to a report. As Luckin Tea stores sell both tea beverages and coffee, the brand is likely to influence the development of new drinking habits among lower-tier market consumers.  

Each lower-tier market has distinctive characteristics

Third- and fourth-tier markets are smaller than provincial and municipal-level cities. Local people are the experts of their area. It can be time-consuming and cost-ineffective for big brands to conduct market research to understand each individual market. Locals are the best resources that brands can rely on. By launching its new franchising model, Luckin partners with franchises to establish stores in strategic, high-traffic locations. Lower-tier market consumers typically spread information through personal networks. Relationships tend to be more acquainted and trustworthy, while opinions and pressure from peers can be a unique sales driving force. People who join the partnership become the cheerleaders for their own business. Lower-tier markets unquestionably give Luckin an additional, crucial marketing channel.

(top photo from Pixabay)

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