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 (UNKNOWN:GMCR.DL), 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.
Fool contributor Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends Green Mountain Coffee Roasters 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.