What Is Starbucks Up To This Time?

Starbucks (Nasdaq: SBUX  ) got a fresh taste of the single-serve home market when it introduced its VIA instant coffee packets. Now it wants to play a bigger role in one-cup brewing.

The barista baron struck a deal earlier this week with Courtesy Products to offer up its single-serving brews through 500,000 hotel rooms outfitted with Courtesy's CV1 brewer. Reports indicate it's also negotiating with Green Mountain Coffee Roasters (Nasdaq: GMCR  ) for a presence on that company's Keurig brewing systems, but it may have even bigger plans than that.

Shares of Green Mountain Coffee fell 8% yesterday, after a Starbucks memo from CEO Howard Schultz to key executives leaked to Reuters.

"Green Mountain has done a very fine job introducing single-serve brewer technology to the U.S. market," Schultz reportedly wrote. "But as I have said, these are very early days, and history has demonstrated time and again that patents alone do not determine market winners -- deep customer engagement, best-in-class experiences and quality do."

Schultz peppers the memo with compelling data points.

  • A whopping 80% of Starbucks customers do not own a single-cup brewing system.
  • Just 6% of U.S. households have a single-cup brewer, compared to 40% market penetration in Germany.

"The single-serve segment of the coffee industry is poised for a sea change of innovation," Schultz reportedly wrote.

Making molehills out of Green Mountain
Some of Green Mountain's Keurig patents expire next year, and it remains to be seen how it will be able to protect its intellectual property beyond that. Starbucks is either negotiating in public or it's legitimately interested in introducing a revolutionary brewer platform of its own.

This isn't the time for Green Mountain to panic. Starbucks is talking a big game, but let's backtrack a bit. The only reason Starbucks is brokering new distribution deals is that its multiyear exclusivity arrangement with Kraft's (NYSE: KFT  ) Tassimo ends in less than two weeks.

What's that? You've never inserted a Starbucks coffee disc into a Tassimo? Exactly. The Starbucks brand alone wasn't enough to push food giant Kraft past Keurig, and it's had years of practice. Why would Starbucks succeed on its own now?

Sure, Starbucks could use its stores to push a proprietary single-cup brewer, but it's a delicate balance. The more systems it sells, the more in-store traffic it stands to lose.

Starbucks also prices its arguably inferior VIA packets higher than Keurig K-Cups. If Green Mountain's K-Cup patents do expire, the coffee packets will get even cheaper. Is Starbucks prepared to mark down its single-serve offerings, even if it dents the perceived value of its barista-poured brews?

Scaling the mountain
Despite patents that find Green Mountain either collecting royalties on K-Cup refills or cashing in as a distributor, it's not as if the proprietary system has scared away the bean-smiths.

Caribou (Nasdaq: CBOU  ) , Hain Celestial's (Nasdaq: HAIN  ) Celestial Seasonings, and Folgers parent J.M. Smucker (NYSE: SJM  ) are just some of the major brands that have hopped on the K-Cup bandwagon. Green Mountain has also made several regional acquisitions to make sure it's well-stocked in single-serve grounds regardless of how the patent issues play out.

Where is Starbucks going to attack if its endgame isn't simply being the mother of all K-Cup providers?

If Starbucks starts from scratch, it will be millions of brewers behind. It if acquires Tassimo from a flustered Kraft -- a possibility -- how would that move things to the next level? After all, one of the reasons Tassimo may have failed in the first place is that the Starbucks discs cost more than most Keurig brews. Throw in a lack of selection for Tassimo, and this is how Keurig came to rule the market.

I guess this leads us to another question: How open would a Starbucks brewer be to rival brands?

It would seem self-defeating for Starbucks to create a system -- especially an open royalty platform as it points out is the case with Germany's top dog -- if it's rich with third-party beans. If it weans java junkies from its stores through cheaper and more convenient premium single-serve brews and follows that up with a plethora of rival refills, that would be the beverage giant's dumbest move since nixing Chantico.

Starbucks isn't that stupid.

Schultz's memo? Leaked on purpose. The Starbucks threat? Minimal. It's just negotiating in public.

A second cup
The allure of Green Mountain is obvious. The company grew net sales by 67% in its latest quarter. Adjusted earnings grew even faster!

There's also something to be said about a proprietary platform where the consumables are higher margin than the initial system purchase. Green Mountain in coffee and SodaStream (Nasdaq: SODA  ) in carbonated soft drinks have enviable ecosystems.

However, just as Coca-Cola would have more to lose than gain by tackling SodaStream head-on, Starbucks has more to lose if it approaches Green Mountain as an adversary instead of an ally for incremental sales.

Starbucks may want everyone to sense an opportunity when it points out that only 20% of its customers have Keurig-esque solutions waiting for them back home, but maybe that's also by design. Would comps hold up if half of Starbucks' regulars were a push of a button away from a $0.50 cup of premium home-brewed coffee?

If rattling Green Mountain Coffee executives and shareholders was the purpose of this memo, Starbucks succeeded. Now it better strike a sweet deal before the market calls its bluff.

Is Starbucks a threat to Green Mountain Coffee or the other way around? Share your thoughts in the comment box below.

Green Mountain Coffee Roasters is a Motley Fool Rule Breakers pick. Starbucks is a Motley Fool Stock Advisor recommendation. Motley Fool Alpha has opened a short position on Green Mountain Coffee Roasters. The Fool owns shares of Starbucks. Coca-Cola is a Motley Fool Inside Value pick. Coca-Cola is a Motley Fool Income Investor recommendation. The Fool owns shares of Coca-Cola. 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.

Longtime Fool contributor Rick Munarriz can actually walk to three Starbuckses from his home, but he's still not much of a coffee sipper. He's had a Keurig brewer in his home since Christmas 2007. He does not own shares in any of the companies in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 18, 2011, at 3:28 PM, emphature wrote:

    I think you are spot on in this assessment. GMCR really has the foot in the door. It's a good investment regardless of what Starbucks does. But Starbucks is used to those high margins, getting into this would lower them as a competitor. I would think they have bigger fish to fry and should look for the chance to add to their income, not their infrastructure.

    I think Sodastream is already in this mode of talking with either Coke or Pepsi (no proof, just speculating) since they have been doing this for so many years and are now really taking off.

    It would give either a quick leg up against the other in penetrating this market. That being said, even if one or the other did start to compete, the other would probably just catch up by buying Sodastream (again, speculating).

    However, Sodastream is already distributing in 41 countries and over 40,000 store locations (many of which do not carry carbonated beverages - i.e Bed Bath and Beyond, Crate and Barrel, Williams-Sonoma, etc.). So yes, this would be good incremental for Coke or Pepsi and they could let Sodastream worry about the mechanics of distribution and relationships...especially because of the additional CO2 refill exchange program. That is also a reason to partner with Sodastream instead of compete.

    Huh...you (I) just talked me into buying more of Sodastream.

  • Report this Comment On February 18, 2011, at 3:30 PM, emphature wrote:

    Forgot Full Disclosure: I have KO and SODA and GMCR in my portfolio (and my CAPS).

  • Report this Comment On February 18, 2011, at 4:22 PM, 1Lolly wrote:

    I believe GMCR products quality to be far superior to starbucks and they are more concerned of the health and civic matters involved in the food industry!

    they also price well!

    I

  • Report this Comment On February 18, 2011, at 5:29 PM, artistx wrote:

    Starbucks IS creating a Keurig Kcup, beyond that I can't say more.

  • Report this Comment On February 19, 2011, at 1:12 PM, NHWeston102 wrote:

    Fascinating discussion, friends, but I'd like to add a cautionary note from a very-long-time GMCR holder whose been phasing out lately. I have read a lot of traffic lately about Keurig-owners having repeated problems with their coffee-brewer. Now all these folks praise the service GMCR gives - and they ARE great people. My concern is threefold. First, all this repair and servicing eats at the bottomline of a company rapidly becoming one of the most over-valued and debt-carrying stocks on the market. Second, consumers have just so much patience. Third, this technical flaw creates a space for competitors not willing to wait for patent-expiration to rival the Keurig. By fixing the flaw, a competitor can claim that [a] our product IS not a patent-infringement `cause we fixed GMCR's screw-up with a different system (even if our machine is a Keurig in all other respects) and (b) we can market as more efficient, up-to-date, and maybe cheaper (to operate, if not too buy). I'm hoping when the "dance-of-the-angry-sumo-toads" ends, SBUX and GMCR will make a deal. I just don't see SBUX needing or profiting on going head-to-head with GMCR. Good article, mates!!

  • Report this Comment On February 21, 2011, at 12:37 AM, LQM2 wrote:

    Really good article Rick, one of the most insightful I've ever read on MF. As much as Schultz wants his jaw flapping about "early days" to be true, it isn't. SBUX is playing a weak hand in single cup. If they go it alone they are capitulating and saying "we're gonna lose our customers to GMCR so we might as well try and keep em in our single cup at lower margins". If some kind of massive advertising campaign by SBUX expands concept acceptence, GMCR could end up the winner with slightly less share of a much bigger pie. GMCR in a good spot here...maybe takeover bait for KFT who would love to stick it to SBUX.

  • Report this Comment On February 23, 2011, at 7:25 PM, artistx wrote:

    Note to the author:

    You can't really compare Via packets to Kcups. One is portable/instant the other is not.

    As a general comment, I'm not sure why anyone buys Kcups, they're such a waste of resources/packaging, cost more and save only a few seconds of time compared to whole beans.

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