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Why Kopi Kenangan leads Indonesia’s VC-backed coffee wars

A couple of years into Indonesia’s coffee wars, and one company appears to have separated itself from the pack.

Kopi Kenangan’s recent series B round, which was led by Sequoia Capital, brings its total disclosed funding to US$137 million. That’s miles ahead of Fore Coffee, its fellow venture-backed competitor, which has raised US$9.5 million to date. Kopi Kenangan expects to operate 500 stores by the end of the year, with an eye on international expansion post-pandemic.

Photo credit: Kopi Kenangan

There are several factors behind Kopi Kenangan’s seemingly quick rise to the top. It sells affordable beverages geared towards the mass market and has solid economics, especially when it comes to rent. And unlike many new tech ventures, it’s based on a model that’s proven to be profitable.

But will that growth last? The consumer food and beverage (F&B) business can be fickle, and it’s a competitive space: Many other players are competing for the same demographic, which indicates how low the barriers to entry are. Things might also change once the company leaves the hypergrowth stage.

Rent is a crucial factor

Data from Kopi Kenangan

Based on financial data provided by Kopi Kenangan, the company’s profit margins at the store level is from 34% to 42% compared to 33% to 36% for a typical global coffee chain.

Kopi Kenangan hit these numbers even if its cost of goods sold is higher, as it aims to provide quality beverages at lower prices. In comparison, many global chains in Indonesia operate on a franchise model, where the parent company licenses its brand and other assets to franchisees in exchange for a fee (generally around 7% to 10% of revenue).

Franchising is popular among F&B brands seeking to expand quickly, but having ample venture capital funding lets Kopi Kenangan bypass this method. CEO Edward Tirtanata says the company currently has no plans to adopt the model.

On the other hand, established global chains also offer food and merchandise, which help beef up the bottom line. Kopi Kenangan is planning to go into food – primarily grab-and-go snacks like bread or desserts – and already started selling merchandise like t-shirts and coffee tumblers.

“If you compare us to legacy brands, the missing revenue mix is actually the food, and hopefully we can bridge that gap with incumbent brands by introducing snacks,” Tirtanata says. “It can create double-digit sales growth.”

A Kopi Kenangan outlet in Jakarta / Photo credit: Kopi Kenangan

An even more crucial factor appears to be rent. A VC from a major regional firm that hasn’t invested in coffee says that if rental costs are not managed well, it can kill a coffee shop outright.

“Starbucks is a real estate play,” he notes. “That’s why their coffee is expensive – otherwise, they can’t afford a big, fancy place in a strategic location.”

This ties in with the “third place” concept popularized by former Starbucks CEO Howard Schultz, where the space becomes a venue where customers can work or socialize outside of the home and office.

In contrast, majority of Kopi Kenangan’s outlets are small, grab-and-go stalls inspired in part by bubble tea brands. Tirtanata says that rent makes up 6% to 8% of the company’s revenue, which is roughly half of an international chain like Starbucks or Coffee Bean and Tea Leaf (15%). By not providing seating space, Kopi Kenangan can offer cheaper beverage prices, thus passing on the rental savings to the customer.

Rent is one area where Kopi Kenangan and Fore Coffee have different approaches. While Fore Coffee also emphasizes the tech-enabled, grab-and-go model, it does offer seating areas in many of its outlets – much more so than Kopi Kenangan, Tirtanata says.

A Fore Coffee outlet in Jakarta / Photo credit: Fore Coffee

Though he doesn’t know Fore Coffee’s internal numbers, Tirtanata deduces that the larger spaces could mean rent might add up to a double-digit percentage of revenue.

“It’s not necessarily a bad thing, [but] just a different choice,” he says. “If they get higher revenue because of that bigger space, then maybe it’s a good thing as well.”

However, Fore Coffee chief executive Elisa Suteja says that only 10% of its outlets have a sizable seating space.

The Covid-19 pandemic and Jakarta’s large-scale social restrictions have significantly affected the F&B industry, including both players. Fore Coffee permanently shuttered 16 stores in April and temporarily closed another 45 during the Muslim holy month of Ramadan, while Kopi Kenangan has temporarily shut down or reduced the hours of around 150 outlets – about half of its total stores.

“The crisis’ impact on any F&B retail business is huge,” Suteja says. “Therefore, I don’t see closing some outlets as a bad thing. It is a business decision that has to be taken.”

Pricing and market positioning

Rent aside, an industry source with knowledge of Kopi Kenangan’s operations says that another point of comparison is pricing and market positioning.

Early on, Fore Coffee had a more premium market positioning, offering primarily espresso-based drinks like Americanos and lattes. In June 2019, a cup of Fore Coffee’s iced Americano cost 35,000 rupiah (US$2.36) – roughly the same price as Starbucks. It also sells teas from Singapore’s TWG brand, while some of its first stores were located in Jakarta’s upscale areas like Senopati and the Plaza Indonesia mall.

Kopi Kenangan and many other brands, on the other hand, serve milk coffee, a homegrown concoction of coffee, milk, and palm sugar (locally known as gula aren or gula melaka).

“Is [Fore Coffee] really a daily coffee for the masses?” asks the industry source.

The VC source agrees, saying that Fore Coffee’s market positioning pits it against Starbucks and third-wave coffee shops instead of Kopi Kenangan and the like.

Customers in the premium segment are spoiled for choice, even when it comes to online orders. GoFood and GrabFood have made products from Starbucks and third-wave coffee shops widely available for delivery.

Ride-hailing drivers queuing for Fore Coffee orders / Photo credit: Fore Coffee

There also hasn’t been a strong enough indication that Fore Coffee is luring customers away from these brands at a sufficient scale. Meanwhile, Kopi Kenangan’s demographic didn’t have an incumbent brand to begin with. Toko Kopi Tuku, which is widely considered a pioneer in the milk coffee trend, is only two years older than Kopi Kenangan.

Fore Coffee has since made adjustments that bring itself closer to Kopi Kenangan in terms of pricing and market positioning. A cup of iced Americano now costs 22,000 rupiah (US$1.49), marking a 40% drop from its initial pricing. But that’s still slightly more expensive than what Kopi Kenangan charges for its signature milk coffee – 18,000 rupiah or US$1.22 – and Americanos – 15,000 rupiah or US$1.

Fore Coffee also launched a palm sugar latte in September 2019, which is essentially its version of the local-style milk coffee. On its GoFood page, the company says this beverage is its most popular.

But some things are harder to change than others. “Even the coffee cups are of good quality and are well-designed,” says the VC source. “At those prices, how much margins are they making?”

Kopi Kenangan has benefited as well from being around longer. It opened its first outlet in August 2017, more than a year before raising its seed funding from Alpha JWC Ventures.

Photo credit: Fore Coffee

At the time of its seed funding, “Kopi Kenangan had operated for roughly a year as a profitable business, with many loyal fans,” says the industry source. He adds that the founder’s experience – Tirtanata previously launched an artisanal tea lounge called Lewis and Carroll, which has multiple locations in Jakarta – is reflected in the quality and consistency of Kopi Kenangan’s products.

Tirtanata is a “foodpreneur,” so “he’s very particular about quality, recipes, and ingredients,” the industry source explains.

Kopi Kenangan is even older than China’s Luckin Coffee, which only opened its first stores in January 2018. Tirtanata had said in a previous interview that Luckin Coffee was an inspiration for Kopi Kenangan to fundraise, but not to start the company.

In addition, Luckin Coffee may not be the best example for Indonesia’s coffee players. While Tirtanata admires the Chinese company’s business model, he regrets the recent troubles, which he believes is caused by a “governance issue.” That said, coffee as a beverage is not as culturally ingrained in China as it is in Indonesia, which is one of the biggest producers and consumers of coffee globally.

Can this last?

Unlike many new tech ventures, the model for a coffee chain business already exists and is already proven. VCs can therefore directly invest in expansion, which Tirtanata says is an important reason behind Kopi Kenangan’s appeal among investors and how it has managed to raise a large amount of funding amid the Covid-19 crisis.

“VCs invest in growth, and after WeWork’s implosion, VCs invest in profitable growth. After the coronavirus, VCs [want to] invest in companies that have a very long runway,” he says. “Essentially, we don’t burn cash – even during the pandemic we don’t burn that much cash. We have a long runway where VCs know there’s no solvency or going concern issues.”

The VC source concurs with Tirtanata’s view. “What Kopi Kenangan has done right is that they were able to scale profitably, in the sense that each outlet is profitable,” he says. “They can identify locations with good traffic very well, so their strategy to scale has been impressive.”

Landing Sequoia Capital as an investor has become a game-changer, the source adds, as it validates the coffee space as a viable business and investment. The VC firm previously invested US$20 million in Indian coffee chain Cafe Coffee Day before exiting after six years in 2012.

(L-R) Rohit Agarwal of Sequoia Capital India with Kopi Kenangan founders Edward Tirtanata and James Prananto / Photo credit: Kopi Kenangan

That said, consumer F&B is a notoriously volatile space, and the question is whether Kopi Kenangan can sustain the business. It’s often easier for business-to-consumer startups to become profitable because that’s expected in a consumer play, but a lot of times they don’t survive because competition is intense.

“You’re competing in the beverage category, not just coffee,” the VC source points out. “There are a lot of substitutes in the market, like bubble tea.”

The consumer coffee space also has really low barriers to entry, which limits competitive advantage. When the demand picks up at this rate, similar brands will start popping up.

“Maybe Kopi Kenangan can [become a first mover] in the smaller-tier cities, but the competitive advantage from that is also limited – it doesn’t mean that other brands cannot do that as well,” the VC source says. “As more competition comes in, and if there are other players [making] better coffee, customers can switch to another brand.”

Perhaps this explains why Kopi Kenangan emphasizes strong branding, though once the high-growth stage is over, there’s always a chance that the company will be benchmarked like other players in the market. The VC source cites co-working as an example: Once the growth started to plateau, these companies started to be valued like a traditional real estate business instead of a high-growth tech play.

Indeed, there are many other brands in Indonesia similar to Kopi Kenangan with sizable scale. Janji Jiwa, for instance, has over 700 outlets (90% of which are franchised), while Kedai Kopi Kulo had close to 200 outlets by mid-2019. Kopi Kenangan says it currently has 324 stores across Indonesia.

Tirtanata says that acquiring one of these players is not something Kopi Kenangan is actively pursuing. Instead, the company is looking to expand its product mix through the possible acquisition of a snack brand.

Beverages from Janji Jiwa, a milk coffee chain with over 700 locations / Photo credit: Janji Jiwa

There’s also no reason why any of Kopi Kenangan’s competitors can’t go the tech-enabled route and raise VC funding. But the VC source thinks that it comes down to the different drives of each founder.

“When you raise money, you’re giving out ownership in your company, so for them it’s like, ‘Do I want to? Do I need to?’” he says. “Do I care about being the biggest coffee brand in Indonesia or do I just want to own 50 outlets that are profitable?”

Still, the VC source says he likes the coffee space personally, even if his firm hasn’t made an investment there. “It’s still a wildcard for me, but the good thing is that investors won’t lose money,” he explains.

Kopi Kenangan’s profitability may mean more efficient use of capital – even though investors invest, the company may not even use much of their cash. This contrasts with how a lot of tech companies continuously raise funds without making money.

“I’m just concerned about barriers of entry, brand sustainability, brand fatigue – stuff like that,” the VC source says. But all things considered, “it’s a stable investment for a consumer business.”