Everyone has heard of Starbucks, but have you heard of Luckin Coffee? Founded in 2017, this coffee chain, based in Xiamen, China, quickly rose in popularity. Soon after, it was the second-largest coffee chain in China after Starbucks. In a little over two years, Luckin Coffee opened 2,370 stores and sold 90 million cups of coffee. In 2019, it had a loyal customer base of 16.8 million customers. By March 2019, Luckin Coffee went public on Nasdaq. It initially raised $150 million in Series B funding. After filing its initial public offering, it hoped to raise an additional $510 million.
Luckin Coffee’s mission is “to be a part of everyone’s everyday life, starting with coffee”. Since the coffee market was pretty saturated, Luckin Coffee had to stand out. They decided to leverage their technology-focused approach. This technology-driven model allows them to produce a high-quality, low-cost, and convenient cup of coffee for its customers. Luckin is a 100% cashier-less chain. Their store network consists solely of pick-up stores and delivery kitchens. They also use a strong data-driven approach.
However, their quick success did not last long. After their stock price tripled in two months, people become suspicious of their true financial status. In April 2020, Luckin announced that their Chief Operating Officer fabricated their true sales amount by $310 million. This fraud led to being delisted from the Nasdaq. Their scandal showed that more had to be done to protect American investors since those in China could tell much earlier that Luckin was inflating its numbers. Luckin cared more about gaining customer volume than actual revenue-growing activities. They were creating fake revenue to attempt to meet the expectations of analysts and investors. They did this in numerous ways. For example, they used round-tripping practices and found companies to buy coffee in bulk. They would then buy back the coffee.
The U.S. Senate responded by passing a bill that would ban many Chinese companies from listing their shares on U.S. exchanges. Luckin translates to ruixing in Chinese which means happiness and luck. Ironically, luck was not on their side when the SEC hit them with a $180 fine.
I learned about this scandal while trying to research blockchain. In a study by Tianhao Chen, Chen performs a case analysis of Luckin’s scandal. He claims that blockchain can help prevent and deduct accounting fraud. Currently, in accounting, companies use a double-entry system. Chen argues there needs to be a third set of books that is independent and public. Blockchain can be used to create this triple-entry system. Fraud is often motivated by personal needs and the fact that they believe it will go undetected. Since blockchain would create a public record-keeping system, individuals would be more likely to be caught and thus less likely to commit fraud. Audits would also be easier with the use of blockchain. Auditors could trust their client’s information more, and the audit process itself would be cheaper. The Big Four Accounting Firms have already started making blockchain a reality for the accounting world. For example, Deloitte created Rubix, which allows customers to design their own blockchain-based applications.
Luckin Coffee’s fraud should have been caught earlier. Their sales grew by 90% in quarters three and four of 2019, while their inventory growth was approximately 23%. These contrasting rates of sales and costs should have been alarming. However, because of the number of stores and the high volume of daily orders, inventory inspection was difficult.
Chen claims that fraud happens for three reasons which he calls the fraud triangle. This model consists of motivation, opportunity, and rationalization. Blockchain has the opportunity to mitigate all of these aspects of fraud. By using a distributed ledger, the cost of a person or company fabricating their numbers becomes exponentially higher. To modify blockchain data, a group of miners would need to have control over 51% of the nodes. The necessity of 51% attacks would substantially increase the cost and decrease the motivation of fraud. Also, the opportunity for fraud would decrease with blockchain because it uses a linear transactional database. Companies’ databases would have to be relational, creating a better way to track data. Lastly, the rationalization for committing fraud decreases because smart contracts would serve as automatic controls. Think of smart contracts as code that tells the blockchain to execute in the terms of the contracts. It creates trust in both parties. Rather than relying on human action and decisions, smart contracts could allow accounting processes and audit procedures to be incorporated with accounting standards and requirements.
By using blockchain, investors can have trust in the transactions happening within a business. Fraud, like the Luckin Coffee scandal, would decrease drastically with the use of blockchain in the accounting field because it would create a stable, traceable, and efficient way of tracking transactions. It would also decrease the motivation, opportunity, and rationalization of fraud. The ability to detect and prevent fraud provides value to both investors and the financial market. Blockchain technology in accounting would reduce financial disclosure mistakes, increasing the quality of accounting data.
https://investor.luckincoffee.com
https://www.npr.org/sections/goatsandsoda/2019/05/17/723193259/what-does-chinas-luckin-coffee-have-that-starbucks-doesnt
https://www.cnbc.com/2020/07/06/investing-fraud-at-china-luckin-coffee-fraud-case-warning-for-investors.html
https://www.investopedia.com/terms/1/51-attack.asp
https://www.atlantis-press.com/proceedings/icssed-22/125973833
https://www.investopedia.com/terms/s/smart-contracts.asp
Hey Mary, it’s interesting to learn about Luckin Coffee and how it quickly rose to become the second-largest coffee chain in China after Starbucks, but then got delisted from Nasdaq due to a financial fraud scandal. It’s concerning how the fraud went undetected for so long. After learning more about it in class and from your blog post, the use of blockchain technology in accounting seems like the best option here. It can create a public, tamper-proof record-keeping system that can decrease fraud and increase the quality of accounting data. It’s fascinating to see how blockchain is being implemented by the Big Four Accounting Firms to make accounting processes more efficient and trustworthy!
Hey Mary! Really interesting story, I enjoyed learning a bit more about Luckin and especially getting a new perspective about Americans investing in companies based out of other countries. Seeing a sales growth of 90% in 1 quarter is insane but the fact is that we can’t truly know how it’s going over there unless we have someone there. I also thought it was really cool that you mentioned blockchain, as Alex said, just to see how it could improve this space too!
Hi Mary! This was a really informative post. I’m surprised that the suspicion related to Luckin came at that late of a time especially because of competitive the coffee industry is with both chains and small coffee shops. I like how you explained the components of what would lead to fraud and how they would be avoided due to blockchain. I wonder how much they are taken into consideration related to cybersecurity for both accounting firms and also for tech companies overall. Great post!
Hey Mary! Great post. It is so true that people are more likely to commit fraud when they think it will go undetected, so having a way to easily expose people committing fraud is a great advancement. I have never heard of Luckin, but considering how many coffee shops there are in the world, I’m surprised we were not more suspicious at a coffee company growing that quickly after being founded in 2017. This is a great case story that I think could prevent similar issues from happening in the future.
Hi Mary, awesome blog post. It is crazy to hear about fraud happening on such a large scale. Great way to piggy back off of our previous class discussion on Blockchain and Web 3.0 and bring a real example of how it could improve society. It will be interesting to see how blockchain technology will integrate into our current financial systems.
Hey mary this post was super informative about fraud and ways of preventing fraud in the future. I had never heard of Luckin coffee before but hearing about this scandal shocked me considering it was such a large attempt and frauding investors. Its cool to see how blockchain could be used in the accounting area because you wouldnt expect it to be valuable there.
Amazing post! This post was very informative as I didn’t know about Luckin Coffee and how it was the second largest coffee chain in China. It is shocking to hear how the COO was able to fabricate 310 million in sales. Blockchain technology will be beneficial to prevent things like these to happen, and it will be interesting to see how the accounting industry uses blockchain in the future to detect fraud.
Super cool post! Crazy to hear about how Luckin’s “insane growth” was not caught or questioned by financial institutions. Also really neat to hear about how blockchain could be implemented to make investors more confident in the money trail and provide proof for valuations of companies. Great read!!
Hi Mary! I’ve never heard of this before until now. It’s crazy how a company that quickly rose to success can fall so hard because of shady financial reporting. But at least blockchain technology could help prevent this type of fraud in the future by creating a transparent and trustworthy system for tracking transactions. Your analysis of the “fraud triangle” and how blockchain can mitigate it was really interesting to learn about. Cool post!
Hi Mary! Great post! I found your blog post on Luckin Coffee’s scandal and the potential use of blockchain in accounting very insightful. It’s unfortunate that Luckin Coffee resorted to fraudulent practices to inflate their sales numbers and deceive investors. Your analysis of the “fraud triangle” and how blockchain can mitigate each aspect is interesting. It’s great to see that the Big Four Accounting Firms are already working on blockchain-based applications, and I agree that the use of blockchain in accounting would provide transparency, efficiency, and security in financial transactions.