Inside the Instant Coffee Wars
Leo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Times certainly have changed in the instant coffee industry. Today, coffee manufacturers create space-age machines that churn freshly brewed coffee out of sleek pods. The once tiny instant coffee market has flared up into a massive battleground, now worth over $20 billion. That's a lot of hot coffee being thrown around, and somebody’s going to get burned. Who's it going to be?
Let’s take a look at the industry’s three main competitors and analyze their products to see which company stands to lose or gain from the instant coffee wars.
Nestle (NASDAQOTH: NSRGF) was the first company to introduce instant coffee brewers to the market. In 2000, Nestle unified all its different coffee machines under a single banner - Nespresso - and developed a concentrated capsule system for its Nespresso machines.
Nestle then used its vast distribution network to spread its machines and pods, and they have enjoyed tremendous popularity in Europe and Asia. However, Nestle sells the Nespresso brewers at a loss in order to generate profits later from its higher-margin coffee pods.
Like printer companies that make their profits from ink cartridges, Nestle soon faced a problem - rival companies were creating cheaper, generic coffee capsules that were compatible with the Nespresso machines. Nestle‘s bid to block sales of these rival coffee capsules was struck down in a German court since it did not possess a viable patent for the coffee capsules.
Green Mountain Coffee Roasters (NASDAQ: GMCR)
Unlike Nestle, Vermont-based Green Mountain Roasters acquired patents to protect its K-Cups coffee technology.
Green Mountain Coffee Roasters, which started out selling organic coffee, became a household name after it acquired Keurig, a manufacturer of single-serve brewing machines. Green Mountain sold the Keurig to drive sales of its K-Cups, which resembled a larger version of Nestle’s Nespresso coffee capsules. Just like Nestle, the brewers were sold at a loss with the intention of recovering the lost revenue with its higher-margin K-Cups.
K-Cups became so popular that Dunkin’ Brands, Kraft and Starbucks (NASDAQ: SBUX) paid license fees to Green Mountain to produce their own compatible K-Cups.
However, when Green Mountain’s K-Cups patents expired last September, investors lost faith. Now any company could produce K-Cups for the Keurig brewers without paying license fees. That irreparably weakened Green Mountain’s business model - if customers flocked to K-Cups from other companies, then it could only sell its loss-incurring Keurig brewers.
That's a recurring theme in this war - massive success followed by rivals creating the high-margin pods or cups without the burden of manufacturing the low-margin brewers.
However, Green Mountain is still the market leader in America and sold two million Keurig units last quarter. It also recently introduced the Vue brewer, which is capable of creating milk-based coffee drinks such as lattes or cappuccinos.
Having conquered the retail coffee market, Starbucks has had its sights on the instant coffee market for a long time. When it first introduced powdered VIA instant coffee, critics believed it would cannibalize its own brand. VIA went on to claim over a third of the instant coffee market.
Starbucks then released its own brewer - the Verismo. The Verismo uses higher-priced coffee pods, and is unable to fully replicate specialty Starbucks beverages without adding additionally purchased syrups. This is different from its rivals’ products, which offer fully mixed concentrated coffee drinks.
Starbucks sold 150,000 Verismo units last quarter - a small but promising start.
Someone’s going to get burned..
In this heated battle, Green Mountain could become the first casualty of the instant coffee war. Green Mountain’s incredible North American growth has slowed significantly, and it must now expand overseas to survive.
Unfortunately, Nestle’s Nespresso single serve brewers dominate 35% of the fragmented market, while Starbucks’ Verismo brewers are a dangerous wild card in domestic and international markets.
Expanding overseas against these two giants will prove to be a difficult task. Both Nestle and Starbucks could easily crush Green Mountain with brute force marketing and expansion. Simply compare the balance sheets of these three competitors.
Source: Yahoo Finance
Green Mountain has clearly brought a knife to a gunfight. With nine times more debt than its cash on hand, Green Mountain is going to have a problem financing its domestic battle against its rivals while simultaneously expanding overseas. Meanwhile, Starbucks has pockets so deep and debt so low that it could wage an endless battle against its rivals.
Starbucks also has the best distribution system of all - its own coffee shops. That gives it a distinct advantage against Nestle and Green Mountain, which must sign deals with individual retailers. Although Nestle has opened its own Nespresso stores in an attempt to increase brand exposure, its brand still lacks Starbucks’ enviable exposure.
Domestic and Global Battles
Starbucks will release the Verismo in China and throughout Asia later this year in an attempt to steal market share away from Nestle. According to a Bloomberg report, Nestle currently controls approximately two-thirds of the instant coffee market in China with its Nescafe brand.
Back at home, Kraft intends to sell Maxwell House and Gevalia K-Cup pods for Keurig machines in 2013. This threatens all three instant coffee companies, since Maxwell House is the third largest coffee brand in the United States after Folgers and Starbucks.
For Starbucks and Nestle, instant coffee is only a growing business segment that complements their respective core businesses of coffee shops and diversified food products. In other words, a low-risk, high-reward affair.
For Green Mountain, however, it’s a fight for the company’s right to exist.
Crunch these numbers:
- Green Mountain’s total revenue last quarter was $946.7 million.
- Only $150.1 million was generated by Keurig brewer sales.
- $850.3 million - or 89.8% of its total revenue - comes from K-Cup sales.
Green Mountain has all its eggs in a single K-Cup. While K-Cups sales are strong, rival products capitalizing on its patent expiration will inevitability marginalize its market share, causing Green Mountain’s top heavy business model to collapse.
I think we all know who's going to get burned first in the instant coffee wars.
Leo Sun owns shares of Starbucks. The Motley Fool recommends Green Mountain Coffee Roasters and Starbucks. The Motley Fool owns shares of Starbucks. You can follow Leo Sun on Twitter at https://twitter.com/leokornsun for more investing ideas.
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