Luckin may not last, but its model will
Apr 10, 2019
I’ve spent a lot of the last month trying to understand Luckin Coffee. I’ve untangled how the convenience-focused upstart was built with money from a network with arguably a few too many personal interests at stake and explained the rationale behind questionable freebies and discounts.
I’ve been asked whether Luckin could ever make a profit and become a sustainable business. It’s an interesting dinner party question, but I think Luckin’s story is more than an individual company’s boom and potential bust—it represents a wave of aggressive startups bringing the online world’s “go big or go home” approach to physical assets.
In this article, the third and final of a three-part Luckin series, I’ll explain the bigger issues that will stick with us whether or not the company ever breaks even.
Let’s assume Luckin makes it to IPO. Even if it grows out its store network to be bigger than Starbucks, staves off growing cash flow pressures and successfully IPOs, it’ll have to beat the odds if it’s to stick around. Publicly-listed companies tend not to last very long. The average lifespan of a publicly-listed company is around 10 years. Even when just accounting for those companies in the S&P 500—the crème-de-la-crème of listed companies—the average lifespan is 20 years. The boffins at the Santa Fe Institute worked out that this ‘corporate mortality rate’ applies irrespective of what a listed company does, or its performance before IPO—an aerospace company, microprocessor manufacturer and on-demand media services provider have the same average lifespan.
But what Luckin represents is far more interesting than its balance sheet. Luckin is just the latest in a growing gaggle of companies striving to achieve software-like scale across physical assets, fueled by truckloads of venture capital. Uber, a mobility services platform, has 3 million drivers over 600 cities. OYO, an Indian budget hotel chain valued at $5 billion, has grown to 330,000 rooms across 500 cities in five years and plans to be twice as big as the world’s current largest hotel chain by 2023. Mobike, one of China’s last standing sharebike companies, has 8 million bikes deployed around China.
This drive for software-like scale over physical assets is driven by the growing acceptance and prevalence of “blitzscaling.” That’s Silicon Valley code for the science, art or witchcraft (take your pick) of rapidly building a company to capture large markets—usually relying on years of losses underwritten by investors. Originally developed by Reid Hoffman and Chris Yeh, blitzscaling suggests that, under a certain set of conditions, the payoff for this “going big or go home” approach is enough to justify the risk of an Ofo-like financial meltdown.
But there’s a few question marks around the practice. Some doubt whether blitzscaling can work outside of software. Others reckon it’s a market abomination which uses scale to drive up valuations just long enough to let a few people make rich exits at the expense of investors and sustainable traditional businesses.
Whether you buy into it or not, “blitzscaling” is gaining traction. It’s a course at Stanford which has hundreds of thousands of viewers online. And, as the practice becomes more widespread, it throws up a few interesting questions.
First, there’s the limits. In Hoffman and Yeh’s original formulation, they believed it would only work in winner-take-all or winner-take-most markets. The pair also believed that wannabe blitzscalers need to operate in large markets, have massive or zero-marginal cost distribution, enjoy high gross margins and take advantage of network effects—not all of which make sense for physical goods or assets. It’s a stiff set of criteria, which arguably neither Uber, OYO, Mobike nor Luckin meet. Yet investors have seemingly put their faith in these companies defying gravity and breaking these boundaries.
This faith has allowed blitzscaling to change capital markets. More and more fast-growing startups are headed to IPO while hemorrhaging money. Last year, 83 per cent of firms that went public hadn’t turned a profit. That’s more than the dot-com bubble. And, as the Wall Street Journal analysis notes, the IPO market has seemingly never been so forgiving for fast-growing, loss-making companies. Last year, loss-leaders that listed on US stock exchanges gained an average of 4 percentage points more than profitable companies that listed. That’s more than forgiving; it’s egging them on.
While it’s not unheard of for capital markets to favor growth over profit, there are legitimate questions as to whether blitzscaling promotes companies being used as speculative financial instruments. There are a growing number of critics who reckon VC money results in enrichment of a few folks at the expense of the chumps left holding the corporate equivalent of a polished turd. That’s because the investors who provide capital injections and a healthy dose of hype to take startups from zero to exit get to cash their chips at IPO.
Third, incumbents and small enterprises not blessed with access to seemingly bottomless venture capital need to grapple with new competitive dynamics. If you’re Holiday Inn, what do you do when OYO gets another billion dollars from Softbank to throw at expansion in your key markets? Stick it out and hope the venture capital-backed minotaur implodes? Partner up with traditional competitors against the challenger? Quickly pivot away from core business? Faced with Luckin’s challenge, Starbucks has embraced delivery and doubled-down on e-commerce. Maybe that’s much-needed innovation. But there will be cases were matching blitzscalers to stay competitive might go astray—leading to unneeded capital outlays, blinding incumbents to potential pivots, or mimicking competitors’ moves into a black hole.
As blitzscaling expands from software and digital platforms like Amazon and PayPal to physical assets like hotels, co-working spaces and convenience stores, more industries and companies will have to confront these questions. And, in my humble estimation, these questions are far more interesting than whether Luckin is going to make bank.