How Will Higher K-Cup Prices Affect Keurig Green Mountain Sales?

The company is raising prices on its popular single-serve coffee products by 9%.

Aug 15, 2014 at 10:39AM

Keurig Green Mountain (NASDAQ:GMCR) dominates the single-serve coffee market in the United States, and raising the price of K-Cup portion packs is unlikely to change that.

The move could crack open the door for Starbucks (NASDAQ:SBUX) and its Verismo single-serve system. It's also possible it might send a few more people to Nestle's (NASDAQOTH:NSRGF) Nespresso machines, but those numbers will be small. The real threat to Keurig's business is that people will drink less coffee, brew more cost-effective full pots, buy more unlicensed pods, or decide that if the cost of a K-Cup is this high, they might as well go out for coffee.

A price hike also has the potential to be a boon for Keurig's business if customers keep buying K-Cups in the same numbers at the higher price. The increase has its risks, but the coffee-maker appears well-positioned to pass on rising costs to customers. 

What is Keurig doing?
The company announced a price increase of up to 9% on all portion packs sold by Keurig for use in its brewing systems and on all its traditional bagged, fractional packs, and bulk coffee products, effective Nov. 3.

This price increase is in direct response to several factors affecting the cost environment in the coffee and consumer packaged goods industries, Keurig said in a press release. Those include a sustained increase in the price of green coffee and cocoa, along with increases in packaging materials, energy, and transportation costs. Over the past year, green coffee prices alone have increased approximately 55%, according to the company.

"Many of our competitors already have implemented price increases in light of the reality of sustained input cost increases," said Keurig President of U.S. Sales and Marketing John Whoriskey. "After careful review, we determined that it is necessary for us to adopt a small price increase in light of these higher costs. We understand that consumers have many beverage options, and we will continue to innovate and price competitively to win consumers' business."

Is Keurig vulnerable?
A 9% price hike is a steep one, but the underlying costs that impact Keurig are industrywide. That does not mean single-serve rivals Starbucks and Nestle have to raise prices -- and neither has, yet. Starbucks dominates the U.S. out-of-house coffee market, and Nestle's Nespresso is the dominant single-serve player in Europe. Both companies could decide to sacrifice short-term margins in order have their machines look more attractive next to Keurig's K-Cup brewers.

That shouldn't matter much, however, as Keurig has a huge user base of K-Cup machine owners. If price is a driving factor, then those customers are unlikely to spend at least $149 for a Verismo or more than $200 for the entry-level Nespresso.

While full pots are more cost-effective, they are less convenient than cup-at-a-time machines, so that is unlikely to have a material impact on Keurig's business.

Unlicensed K-Cups, however, represent a potentially huge problem. These are pods that work in K-Cup brewers, but for which Keurig does not receive any money. These fake K-Cups already cost less than licensed ones and they could become an even more attractive option for customers. The new Keurig 2.0 brewers, which launch this fall, have technology that prevents these portion packs from working, but it's unlikely a large percentage of Keurig customers will buy the new brewers immediately upon release.

It seems likely that if the supermarket chains that make and sell unlicensed K-Cups keep prices flat, then they will gain some market share. The number is still likely to be small, however, as part of the appeal of licensed K-Cups is the huge variety of brands offered. The people who buy store-brand K-Cups will continue to do so, and those who insist on Starbucks, Dunkin' Donuts, and Keurig's own Green Mountain brand will likely continue to buy the way they always have. 

Customers could, of course, go out for coffee, but that was always an option. Rising K-Cup prices will make it more costly per ounce to brew at home than to buy at some convenience store chains or fast food restaurants. But if Keurig's customers were going to stop buying K-Cups because McDonald's offers $1 coffee, they likely already would have done so.

How dominant is Keurig in the U.S.?
The products Keurig is raising prices on represent nearly all of its business. In 2013 the company did approximately 92% of its sales through the combination of portion packs and Keurig Single Cup brewers and related accessories. The coffee seller had $4.3 billion in total sales, with $3.1 billion of that coming from portion pack sales and $827.6 million coming from Keurig Single Cup Brewer and accessories net sales. Almost all of that revenue came from the United States and Canada.

In the U.S., Nespresso only does $300 million in sales in what the company estimates is a nearly $5 billion market for coffee pods/capsules. Starbucks does not release sales for its Verismo brewers or its Via instant coffee line, but they remain a minor player in the at-home single-serve market.

Despite the many threats to Keurig's market dominance, it seems unlikely that a 9% price increase is going to change people's coffee-drinking habits -- even if competitors keep prices flat. More customers will buy unlicensed portion packs, but only a tiny number of them. The price increase will not harm Keurig's bottom line and could actually improve profitability if the increase more than fully offsets rising prices. 

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Daniel Kline has no position in any stocks mentioned. He is drinking Starbucks coffee made in a Keurig brewer as he writes this. The Motley Fool recommends Keurig Green Mountain, McDonald's, and Starbucks. The Motley Fool owns shares of Starbucks. 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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