Storm Clouds Over Green Mountain
John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
So it seems that Kraft Foods (NASDAQ: KRFT) is planning to start selling single-serve K-cup coffee pods for both its Maxwell House and Gevalia lines. They aren't the first third-party coffee producer to make K-cups for Green Mountain Coffee's (NASDAQ: GMCR) Keurig brewing system, but there is one significant difference between the K-cups that Kraft will make and those produced by other companies such as Dunkin Donuts, J.M. Smucker and Starbucks... the Kraft K-cups aren't licensed from Green Mountain.
As you might remember, the patent for Green Mountain's K-cup design expired last month. A few private label coffee brands such as those offered by Kroger Company and SuperValu have already announced plans to take advantage of the patent expiration, but Kraft's announcement is the first of its kind from a major coffee producer. Maxwell House is the third most popular retail coffee brand in the country, trailing behind only Starbucks' retail offerings and Smuckers' Folgers coffee. Kraft will be the only company in the top 3 that isn't paying royalties to Green Mountain for its K-cups.
The move is a good one for Kraft since it makes its coffees available to an additional customer base without the additional cost of royalties that the company would have to pay if the K-cups were licensed. Kraft produces the competing Tassimo single-serve brewing system, so the production of K-cups allows them to market to both the customers who purchased their system and customers who chose the Keurig system instead. I think that it's unlikely that Kraft's production of coffee pods for a competing machine will hinder Tassimo sales as consumers are likely to make their decision on one machine or the other based on more than just the availability of a single coffee brand; even if sales are hindered slightly, it's unlikely to be significant enough to negate the increased revenue from Maxwell House and Gevalia K-cups.
For Green Mountain, however, the move by Kraft has the potential to be significantly more troubling. In the short term they could potentially benefit from it; Green Mountain's stock prices actually rose following the announcement, and some consumers who were on the fence about buying a Keurig system might give in and make the purchase if they're a fan of one of Kraft's brands. The availability of the two coffee brands could increase the overall value of the Keurig systems for some users, which wouldn't necessarily be bad for Green Mountain even though they wouldn't be making any royalties off of the Kraft-based K-cup sales. There are two potential problems that could stem from this announcement, though, and either problem could make Green Mountain's current struggles to maintain its valuation worse.
The first problem is that the Kraft K-cups will be competing directly with those produced by Green Mountain or using Green Mountain licenses. The exact amount of the K-cup market share that Kraft could take remains to be seen, and while some of the licensed brands may hold their own against Kraft's entries, Green Mountain's own K-cups may not fare as well. It's true that netting a royalty off of licensed K-cups is better than nothing at all, but the loss of market share by Green Mountain's own brands could be damaging to the company's bottom line since the company obviously stands to make more per sale on its own products than off of someone that uses their license.
The second problem is that while Kraft is the first major coffee producer to create unlicensed K-cups, they won't necessarily be the last. If Kraft's offerings are successful, other coffee brands could see this as inspiration to make their own unlicensed coffee pods. Green Mountain will obviously retain some licensees, but there is a very real danger in the long term of more coffee brands joining Kraft's ranks and going the unlicensed route. This is especially a danger when you consider local and regional coffee producers who might have a higher retail coffee market share within the area they operate since Keurig owners could get their favorite local brews instead of the more commercial options they would have to choose from otherwise.
Don't mistake this for a death knell for Green Mountain; while the problems I mentioned could be very serious in the long-term, the company still has time to strengthen its brand and solve its valuation problems. It needs to take action, however, because that time is not indefinite. The company's problems go beyond just unlicensed K-cups, but over time the weight of those unlicensed coffee pods may start to weigh very heavily on Green Mountain's bottom line.
Croaxleigh has no positions in the stocks mentioned above. The Motley Fool has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters and short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters. Motley Fool newsletter services recommend Green Mountain Coffee Roasters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.