Keurig Green Mountain Is About to Drastically Alter the Single-Serve Beverage Industry

Keurig Green Mountain’s latest generation of brewing technology promises to have major industry-wide implications.

Jul 15, 2014 at 3:48PM

The last real major change in the single-serve beverage industry came back in September 2012. That's when Keurig Green Mountain's (NASDAQ:GMCR) patent on its revolutionary K-Cup technology expired, and, as a result, unlicensed competitors were, for the first time, allowed to infiltrate the market.

This period of relative stagnation is about to come to an abrupt end, however, as Keurig is slated to release the next generation of its brewing technology this fall. While there is still a good deal of uncertainty regarding the specifications of Keurig 2.0, one thing is certain: its release is going to have major industry-wide consequences.

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Source: Keurig Green Mountain

Keurig is about to completely change the game
Up until this point, Keurig brewers have only been able to make single servings of the desired beverage, something that Keurig has identified as being a common customer complaint. Keurig 2.0 solves this problem by not only being capable of pumping out single servings but by being equally capable of making entire carafes of the beverage.

The real importance of Keurig 2.0, however, comes in the proprietary technology that will be embedded in new brewers. This technology will allow Keurig 2.0 brewers to identify and brew only Keurig packs.

In September 2013 79% of K-Cup sales in the U.S. were credited to Keurig-licensed brands. The remaining 21% was comprised of a collection of unlicensed brands, most notably Kraft Foods(NASDAQ:KRFT) Maxwell House, Peet's Coffee and Tea, and TreeHouse Foods (NYSE:THS). In Keurig 2.0 brewers none of these companies' pods will work, which effectively restores the monopoly Keurig held over the industry before its patent on the original K-Cups expired in September 2012.

Not so fast, says TreeHouse
Understandably, these "unlicensed brands" are none too happy that they are going to be shut out from Keurig 2.0 machines. TreeHouse has even taken it so far as to sue Keurig for "anti-competitive practices."

The suit was brought against Keurig in February, yet at this point there is no definite indication of which way the judge will rule. Therefore, both scenarios have to be given equal consideration.

If TreeHouse's claims are dismissed, Keurig effectively will hit the refresh button on its expired patent. As Keurig plans to eventually faze out its existing models of original Keurig brewers as time progresses, with time unlicensed brands will dwindle in market share until eventually they become irrelevant.

If TreeHouse wins, however, a much gloomier situation arises for Keurig. While Keurig would likely appeal and stretch the court case out longer, and thus allow for a successful launch this fall, eventually these unlicensed brands would be allowed to continue making pods for Keurig brewers, which would place the industry, in essence, where it is today. Keurig would still control the lion's share of the K-Cup market yet would have to continue to deal with these unlicensed brands.

In this scenario Keurig would also have to rely more on its strategic partnerships with key players like Starbucks, Dunkin' Donuts, and Snapple. There is a remote possibility that some time down the road these partners could jump ship in order to evade having to pay Keurig's licensing fees. For Keurig this would be catastrophic. Starbucks alone accounted for 14.2% of overall U.S. K-Cup sales in September 2013. Without these key partnerships, Keurig's market share would dramatically decrease, while its licensing pricing power would also be crippled.

Again, however, it is important to recognize that this possibility is remote. Any one of these partner companies could theoretically, depending on their contracts with Keurig, jump ship today. Despite its lack of an exclusive patent since 2012, Keurig has only expanded its partner base during this time and likely will continue to do so.

For Treehouse, Kraft, and the other companies that currently produce unlicensed pods for Keurig machines being allowed access into Keurig 2.0 brewers would effectively put them where they are today, while being shut out would be bad, but not catastrophic. For Kraft and Treehouse especially, these pods only account for a small portion of overall company sales. Worst case scenario, these companies would have to make licensing agreements with Keurig, trimming their margins. A small margin haircut, however, is something both of these companies would happily receive to keep their hands in the rapidly growing, Keurig-driven beverage industry.

The Foolish takeaway
Keurig still hasn't released any detailed information on Keurig 2.0, but already we know it will be a game changer. Standing in the way of Keurig 2.0 reaching its full potential, however, is TreeHouse's legal action, which may eventually open the 2.0 market to the unlicensed brands that have proven relatively successful in capturing market share from Keurig.

On Aug. 7 we will get more information on the progress of Keurig 2.0 when the company reports third-quarter earnings.

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Ryan Guenette has no position in any stocks mentioned. The Motley Fool recommends Keurig Green Mountain. 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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