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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.