This is going down like day-old coffee. Nestle (NASDAQOTH: NSRGY ) just had its single-serve Nespresso coffee system patents revoked by a European regulatory agency, giving its biggest rival Mondelez International (NASDAQ: MDLZ ) another opportunity to take a bigger swig of the European coffee market.
According to the market researchers at Euromonitor, the single-serve market is an $8 billion global opportunity with western Europe alone accounting for $5.1 billion worth. Single-serve coffee presents a 20% cup of the entire European coffee market. Nestle, as the biggest player in the field, has long dominated its rivals with a combination of stylish Nespresso machines (it invented the first one back in 1986) and a passel of lawyers that have taken on those who would sell knock-off pods to consumers.
However, the difference between Nestle's brand and that of, say, Green Mountain Coffee Roasters (NASDAQ: GMCR ) , which also came in for a world of hurt and reduced profits when it lost patent protection on its K-cups, is the former uses a direct-to-consumer distribution model for its pods as opposed to selling them in stores as the latter does, or as most of the other companies do that have since brought single-serve machines to market.
The single-serve market is interesting for another reason: the cross-pollination that goes on between manufacturers. Mondelez, for example, has its own single-serve machine, Tassimo, that it introduced in 2005, and with $1 billion in projected sales it's the fastest growing single-serve machine on the market. Yet the former Kraft Foods division also announced plans this past summer to start producing coffee pods that were compatible with Nestle's Nespresso. Starbucks (NASDAQ: SBUX ) similarly introduced its own brewing machine, Verismo, even as it expanded its relationship with Green Mountain's Keurig K-cup.
That's because in true razor-and-blades business model form, the real money is found in the coffee capsules. Sales of Green Mountain's pods, for instance, are up 20% over the first nine months of the fiscal year even as machine sales volumes rose a more modest 5%. But with their availability everywhere and across some 45 brands, that's to be expected. Its Keurig machine is the industry leader in the U.S., and its K-cups held a 60% share of the market in 2012. Second was Starbucks at a distant 18%, while J.M. Smucker came in third with a 12% share.
Yet analysts think private label pods will see the lion's share of growth with an annual compounded rate approaching 80% through 2016.
Nestle, which has positioned itself as a premium coffee brand, wasn't willing to mix with the masses like that, preferring instead to market directly to its customer through a club and at its own branded specialty boutiques. But that model apparently was its weak link, as the European regulatory body viewed the consumer as a licensee and the U.K.'s patent protection law prohibited the sale of competing coffee capsules to anyone other than a licensee.
In short, the ruling said Nestle could no longer interfere with the rights of purchasers to use their Nespresso machines for their "normal function," which is "to make coffee from capsules." As a result, Nestle may need to rethink its customers' exclusivity. Since anyone can make a pod for the Nespresso machine, joining a high-priced club might not be as soothing as a warm cup of joe.
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