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Can Green Mountain Coffee Hold Onto its Lead?

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Green Mountain Coffee Roasters  (UNKNOWN: GMCR.DL  ) is the company behind Keurig, maker of home-based coffee machines estimated to be present in at least 12.5 million American homes, and it plans to get that to 16 million or so homes by the end of the year.

Green Mountain is the leading company in the home-based coffee brewing market. It has cornered the market thanks to its K-cup technology, those little patented, single-serve coffee pods seen in offices and homes. This unique technology eliminates the need for traditional filters or clean-up.

The problem is, now that most of Green Mountain's K-cup patents have run out (starting in 2011), the $1 billion dollar K-cup market has seen quite a few new entrants. The company does hold, however, one still-active patent, and it's not set to expire for another 8 years.

Experimenting with retail
Green Mountain's going in interesting directions with its business. It's opening its very first retail store in November in a Massachusetts mall. Up until now, Green Mountain Coffee had no physical retail locations, unlike Starbucks (NASDAQ: SBUX  ) .

Jumping into brick-and-mortar retail and serving coffee at its own stores would place Green Mountain directly in competition with Starbucks. Starbucks enjoys fairly good margins (11%) and almost no real major competitors (if you don't count McDonald's or Dunkin' Donuts). Deciding to compete with Starbucks on its own turf could also jeopardize Green Mountain's current licensing partnership, as well as the revenue stream it captures.

However, the purpose of Green Mountain's new store seems to be to gather more feedback on its customers, not to serve them directly. The store will demonstrate products, offer special promotions, and offer Keurig accessories. Along the way, Green Mountain contends that this will provide the company with further insights about its customer base.

This is not to say that this approach could change. At the moment, it doesn't seem as if Green Mountain is looking to jump into the fray as a Starbucks competitor anytime soon.

Battle of the K-Cups
For Green Mountain Coffee, K-Cup sales are its bread and butter. The company's single-serve pack revenue is at $2.4 billion, or 73% of its total revenue. Up until 2011, when two of Green Mountain's K-Cup patents expired, it had an almost complete monopoly on the single serve coffee market. This has changed recently, as people have started dallying with other (often cheaper) K-cup brands. 

The competition appears to be heating up. Other (generic) manufacturers have managed to capture 8% of the overall market.

Competitors have started flooding into the market, and they have begun efforts to differentiate themselves. Canterbury Coffee just launched a biodegradable cup in an appeal to environmentally-conscious customers. Wegmans, the popular family-owned grocery chain, has also jumped into the K-cup market with its own, cheaper brand of pods. There's also "OneCups" from Rogers Family Co. and "Grove Square" cups from Sturm Foods.

New licensing strategy
How does Green Mountain plan to protect its market share in the face of ever growing competition in a rapidly growing segment of its overall business? Simple: it plans to change competitors (which it calls "unlicensed") into "licensed partners," as the company referred to these competitors in a recent conference call. Basically, Green Mountain plans to work with competing brands, forming partnership deals where the company can leverage its distribution to market its Keurig brand and brewing system. An interesting plan.

One major licensing partner is Celestial Seasonings, owned by Hain Celestial Group (NASDAQ: HAIN  ) , an organic product company. The company has a line of tea-based K-cups. The size of the US tea market is reported to be around $27 billion, while worldwide, the market when combined with coffee reaches $67 billion, so this could pretty easily be a growth direction for Green Mountain. From this perspective, the company's indirect licensing strategy could pay large dividends down the road.                

Foolish Take
Though competition in the single-serve coffee market is increasing, there is no fundamental reason why Green Mountain won't continue to hold a significant lead in the market. The company seems to be adapting well to the change by finding new strategies to reach customers and building out new partnerships with vendors. Added to this is the company's continuing dominance in terms of the sheer presence of its Keurig branded coffee machines and the projected growth in the number of households carrying them. Ultimately, Green Mountain should remain a good investment for the foreseeable future.      

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