Keurig Green Mountain (GMCR.DL) and Starbucks (SBUX 0.53%) receive the lion's share of the press regarding single-serve pods -- and rightly so. Green Mountain is the U.S. market leader, with a 36% share of the pod market compared to Starbucks' 16% share. The two may be credited with jump starting the at-home brewing trend in North America.
The cabal looks like a pretty sweet deal for U.S. coffee giants until you consider the broader market. Nestle (NSRGY 2.15%) and other competitors pose a legitimate threat to the coffee hegemony in the U.S. and abroad. Although the ultimate outcome is far from certain, it is safe to say that dominance of the pod market is far from settled. In all likelihood, there is only one clear winner in the coffee pod wars.
Massive growth ahead
There are three basic ways to consume coffee: single-serve in a retail location, multi-serve (carafe/coffee pot) at home or at work, and single-serve at home or at work. For years, at-home multi-serve was the preferred method for most consumers. For many, firing up the drip coffee maker is still part of a long-established morning routine. Regular visits to retail coffee chains are increasingly popular as well, as Starbucks can attest.
However, single-serve home-brewed coffee is the hottest of the three segments. Although Nestle's Nespresso has long had a presence in Western European homes, Green Mountain's Keurig brewer is riding the recent explosion in North American consumers' interest in single-serve brewers. As a result of the fanfare, Green Mountain's home market, North America, experienced 80% growth in pod sales from 2011 to 2012.
Market fragmentation
Single-serve pods' stratospheric growth has caught the attention of coffee companies everywhere, with everyone moving in to capture a share of the pie. Green Mountain and Starbucks want to expand internationally, while Nestle wants to expand in North America. Taken together, Western Europe and North America account for more than 90% of the single-serve pod market.
However, the U.S. and international markets are quite different from one another. For instance, Nestle's Nespresso, which has a 26% share of global pod value, dominates Europe. European customers favor espressos rather than the large cups of coffee preferred in the U.S. Green Mountain captures the no. 2 global single-serve share by dominating the North American market. Its Keurig brewer has achieved 13% household penetration in the U.S., a figure that will likely increase when it introduces its next-generation brewer that brews both single-serve and multi-serve portions.
The differences in customer preferences and the establishment of clear market leaders in North American and Western Europe make it unlikely that massive overseas growth is in store for either company. Even with brewers tailored to Western Europeans' preferences, Keurig faces an uphill battle against the well-established Nespresso. The same goes for Nespresso in North America. As a result, both companies' future growth largely relies on pod sales in their current markets.
Pod prices falling
Relying on pod growth alone may not be the most secure position. Although North American pod sales continue to surge, prices are falling. Overall U.S. pod prices declined 5.4% last December, while Green Mountain's prices declined 6.4% and Starbucks' declined 5.9%. The declines are due to increasing competition in the competitive market. With companies from McDonald's (MCD 0.37%) to Panera Bread (PNRA) entering the single-serve coffee market, prices are bound to fall even more.
This presents an interesting scenario in which unit sales are surging but unit prices are falling. This should ultimately benefit premium brands like Starbucks because the spread between discounted brands and premium brands will shrink. As a result, more consumers will trade up to the premium brand.
However, Green Mountain has the most to benefit from reversing the current arrangement. If its next-generation Keurig brewer can effectively shut private labels out of the market, prices will rise once again – with Green Mountain reaping most of the gains.
Nestle, on the other hand, is stuck in the slow-growing European market. Unless it can make an unlikely surge in North America, it will have to place its hopes in smaller markets, like Brazil.
Who's the big winner?
Single-serve pods are taking over the developed world. Nobody knows exactly how it will shake out, but the current landscape suggests that pod prices, and thus margins, will continue to decline unless Green Mountain can reestablish a near-monopoly position in the market. However, with more and more entrants joining the market, it seems likely that consumers will be the biggest winners in the single-serve frenzy.
