Analyst Insight by Brian Morgan.
In March 2011, Starbucks Corp announced an agreement with Green Mountain Coffee Roasters Inc in which they would begin selling Starbucks and Tazo branded pods for the Keurig K-Cup single cup brewing system.
Starbucks had been licensing pods for use with Kraft’s Tassimo system but ended this arrangement as of March 1, 2011. The new deal brings together the leading premium coffee company in the US with the market leader in coffee pod sales, and should help make these positions all but unassailable for the two coffee manufacturers.
Starbucks eyes a growth segment
Starbucks is touted as bringing premium coffee beverages to the forefront of American culture and is a pioneer in the specialist coffee arena. However, due to the economic recession and shifts in consumer spending, the company in recent years has experienced increased competition from companies such as Dunkin’ Donuts, Caribou Coffee and the 2009 introduction of the McCafé line from McDonald’s.
Over the past few years Starbucks has tried to counter this competition by looking for revenue streams beyond its traditional in-store offerings.
Various trials with bottled drinks and breakfast foods met with mixed success, until the 2009 launch of Via Ready Brew, the company’s premium instant coffee that surpassed $100 million in sales during its first year.
The rapid success of Via coincided with the company’s announcement of a new strategy to greatly expand its grocery sales as a complimentary platform to its retail stores. This ultimately led to the breakup with Kraft Foods as a distributor and even to a redesigned logo removing “coffee” from the Starbucks name, all with an eye towards building a more varied product lineup.
With Starbucks branded K-Cups, Starbucks will immediately gain access to another high growth product segment in coffee pods that could become a cornerstone of this new grocery strategy along with Via. Starbucks had been an early adopter of pod technology through its Tassimo offerings, but Tassimo and Senseo were launched during a period when coffee pods systems struggled to catch on with consumers in the mid-2000s.
Though pods have been ubiquitous for a number of years in offices, it is only in 2009-2010 that they have seen great success in the retail market, nearly doubling in sales each year to surpass US$500 million in 2010. This period has coincided with the rise to prominence of the Keurig and Nespresso systems in the US, both seen by consumers as being of slightly higher quality.
The first deal Starbucks announced following its break from Kraft was with Courtesy Products, to bring single serve coffee to more than 500,000 hotels throughout the country. But this deal with Green Mountain indicates a much greater commitment to the single serve concept.
The greatest barrier to sales is adoption of the expensive Keurig machines, which typically are in the US$100 range and can still seem confusing to consumers used to traditional drip coffee makers. Starbucks has announced that both the pods and machines will be sold in its stores starting in early 2012, which should help them gain visibility and reach consumers already loyal to the Starbucks brand.
Green Mountain finds the jewel it needed
Although the company was not responsible for the first coffee/tea pods, Green Mountain was able to find success by combining its pod technology with a stable of several popular licensed regional coffee brands. This allows consumers to already have a familiar product to try although they may be new to the single serve pod machine brewing process.
In recent years the company sought greater control by buying out these licensed manufacturers, including Tully’s, Timothy’s and Diedrich, and completing the task in 2010 with the purchase of Canada’s Van Houtte.
At the same time, new licensing deals with national brands like Caribou, Folgers, and Celestial Seasonings were struck, at a time when Green Mountain made a push into national grocery chains.
Just two weeks prior to the Starbucks announcement, Green Mountain signed a deal for Dunkin Donuts pods to be licensed and sold in Dunkin Donuts outlets starting in fall 2011. With these two deals, Green Mountain now has three of the top five selling US coffee brands on its system. This should help attract some of the many customers loyal to these brands who may have been reluctant to purchase a pod coffee machine in the past.
Though all pod coffees can perhaps be considered premium due to their higher cost, Starbucks is the first nationally recognized super premium brand to be used with K-Cups, and in fact has this exclusivity built into their agreement. This will give Green Mountain its first direct competitor to Nestlé’s Nespresso pod system, which has become the clear premium pod leader in international markets and also has started to see some momentum in the US.
Nespresso seems to have emerged as the most serious long term threat to Green Mountain’s top position in pod sales. Nespresso does not have the same level of distribution as K-Cups, nor the same brand recognition as Starbucks in the US though, and this new arrangement should solidify Green Mountain’s lead.
Shifting landscape creates long odds for some competitors
The Starbucks deal immediately adversely impacts the major US pod competitors. Kraft’s Tassimo system, which had been positioned as a more premium quality system due to its inclusion of dairy components to make specific blended coffee drinks, immediately loses its most prominent premium brand and perhaps takes the most direct hit.
Senseo from Sara Lee, Nespresso from Nestlé, and Flavia from Mars all now face a much more formidable competitor at the top. But all of these companies also have the bulk of their sales in other product segments, so the overall health of their business is not at stake.
One of the hardest hit competitors may be one who is not a big player in coffee pods but was looking to become one: Peet’s Coffee. Peet’s is a premium coffee specialist chain that is the chief competitor to Starbucks in the Western states. Like Starbucks, they began to struggle during the recession years as the pace of outlet expansion slowed.
Their stated strategy was to move into the coffee pods segment, and in 2010 Peet’s made an unsuccessful bid for Diedrich Coffee, the primary K-Cup manufacturer in the Western region. Later they tried to work out a licensing deal with Green Mountain, though now this seems unlikely to occur.
As a result of this tenuous position, reports surfaced in late March that Peet’s was looking to sell itself to Starbucks. Such a deal would give Starbucks some much needed immediate access to grocery distribution in the region, but there is also quite a bit of overlap in Starbucks and Peet’s locations, with many within one block of each other in places like California.
The Peet’s premium brand is also a direct competitor to Starbucks and not a lower-priced complimentary fit like Seattle’s Best was when the company acquired it in 2003. While barriers seem to exist for such a merger, it does seem likely that Peet’s will be the first to take a new direction in light of the Starbucks-Green Mountain partnership. With the strength this alliance represents, they may not be the last.