Does Keurig Green Mountain Play Fair?

Keurig Green Mountain had a marvelous March: the company revamped its name, joined the S&P 500, and broke the shackles of an exclusive licensing deal with Starbucks. However, in the wake of a lawsuit over unfair competition, investors must decide if Keurig plays fair.

Apr 17, 2014 at 5:00AM

Keurig Green Mountain (NASDAQ:GMCR), the maker of Keurig homebrew coffee machines, has been on a roll lately. A February investment from Coca-Cola, as the company took a 10% stake in Green Mountain and announced a home soda machine partnership with it, helped the stock pop 33% this year.

However, Keurig's rival TreeHouse Foods killed Keurig's buzz in February by announcing that it had filed a lawsuit over unfair competition against Keurig. By which strategy does Keurig play: fair or dirty?

The accusation 
TreeHouse Foods claims that Keurig seeks a monopoly on the self-serve coffee industry. Given Keurig Green Mountain's moves to render unlicensed K-Cup coffee pods incompatible with Keurig machines in the wake of a 2012 patent expiration, perhaps TreeHouse has a point.

Then again, TreeHouse retains a self-interested stake in the outcome of this lawsuit. Since TreeHouse sold private label K-Cups before Keurig decided to block unlicensed K-Cups, TreeHouse may be feeling bitter about lost profits.

How should investors assess the allegation? If TreeHouse's allegations of unfair competition stand, then Keurig could be headed down a rocky legal road. Visions of regulations, financial reparations, and a forcibly foregone technological advantage come to mind.

On the other hand, if Keurig is gracefully treading the line between unfair competition and an enduring competitive advantage, investors could be looking at a long-term winner. Companies with patented technology like Keurig tend to enjoy high profit margins.

Malevolent monopoly?
Here's the evidence in favor of TreeHouse. Keurig Green Mountain will launch Keurig 2.0 later this year, which by design will be incompatible with unlicensed K-Cup pods. At the same time, Keurig plans to phase out its current machines that are compatible with unlicensed pods.

This is a one-two punch by Keurig toward competitors like TreeHouse. First, it has ensured licensing profits for all future K-Cups via the license-requiring Keurig 2.0 machine; then, it has guaranteed further market share by eliminating previous machines that still work with unlicensed K-Cups.

Do Keurig's moves constitute anticompetitive behavior or smart business thinking? Since Keurig pioneered an innovative homebrew concept, it deserves to reap the rewards of that. U.S. patent laws prevent companies from exploiting their market power for too long.

Besides, the next generation Keurig 2.0 will not enjoy a monopoly position. Nestle's Nespresso machine will compete with Keurig 2.0 for coffee pod profits and licensing partnerships. Such competition should eliminate the unfair competition allegations against Keurig.

Strategic partnerships
In the wake of expired patents, Keurig has strengthened profitable strategic partnerships. By securing K-Cup licensing deals with coffee brands like Caribou Coffee and Bigelow Tea Company, Keurig allows these brands an additional revenue stream for a cut of the sales.

Perhaps the most successful K-Cup partnership has been between Keurig and Starbucks (NASDAQ:SBUX) -- with 2 billion licensed Starbucks K-Cups shipped since March 2011. Starbucks benefits because it capitalizes on cannibalized cafe sales which it would have lost to Keurig's homebrew machine anyway. Keurig wins because Starbucks sells its K-Cups in its stores while they carry the label of the global cafe chain's premium brand (and its prices).

In March, the Starbucks partnership became even sweeter for Keurig. The companies relaxed their agreement which had named Starbucks as the exclusive premium-brand K-Cup supplier. Now Starbucks can expand its K-Cup product line while Keurig licenses additional premium brands -- most recently, Peet's Coffee & Tea. Both companies stand to benefit.

Foolish bottom line
Despite TreeHouse's accusations, Keurig's coordinated technology differentiation and strategic partnerships strike this Fool not as foul play, but as smart long-term plays. Investors should decide for themselves whether Keurig's strategy will prove enduring and profitable.

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Glenn Singewald owns shares of Starbucks. The Motley Fool recommends Coca-Cola, Keurig Green Mountain, and Starbucks. The Motley Fool owns shares of Coca-Cola and Starbucks and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on 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. The Motley Fool has a disclosure policy.

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