Keurig Green Mountain (UNKNOWN:GMCR.DL) has so thoroughly dominated the single-serve home-brew coffee market that Starbucks (NASDAQ:SBUX) supports its K-cup machines even though it's trying to establish its own Verismo single-cup system.
Starbucks not only pays Keurig a royalty in order to sell licensed K-cups, it also features them in its stores -- often more prominently and with more shelf space than it gives Verismo and its proprietary pods. That's likely because the market for K-cups dwarfs the one for Verismo pods. It's a bit of a conundrum for the coffee retailer as building an audience for its brewer is a better long-term strategy, but pushing K-cups offers more sales for the foreseeable future.
Starbucks' Verismo has struggled despite the fact that its ability to make lattes and espresso shots makes it more versatile than Keurig's K-cup line. Part of that simply comes from Starbucks being late to the party. By the time the Seattle-based chain launched Verismo during the 2012 holiday season, Keurig brewers were already the in-home standard. Starbucks may have had a better product, but it wasn't such a vast improvement that people would replace a working Keurig machine with a Verismo.
Starbucks also hurt itself by launching the line with the first machines having a $199 price tag. The company has brought that number down and the entry-level Verismo now costs $99, but for consumers the cost is a tough one to justify if they already have Keurig machines at home. Starbucks seems aware of that and ran a $59 special on the $119 "Champagne" model during the Black Friday and Cyber Monday shopping period, but even that is not cheap enough to take significant market share away from its well-established rival.
If Starbucks really wants to compete with its frenemy Keurig, it should find a way to give Verismo to its most loyal customers for free.
How big is this market?
Keurig, which makes almost all of its revenue in the United States, had $4.7 billion in sales in its fiscal 2014, according to S&P Capital IQ data, up 8% from the previous year. Of that $4.7 billion, $3.6 billion came from portion packs sales (nearly all K-cups, but some for its other brewers). The company sold nearly 10 billion portion packs for the year along with just under 11 million brewers.
Though the company does not break this data out, it is generally believed that selling brewers is a low-margin business at best while selling portion packs is where the real money is. To sell portion packs, you need to have an established base of people using your brewers. Keurig does and Starbucks doesn't.
Starbucks is committed
Starbucks does not release Verismo sales and hasn't even publicly hinted at them aside from CEO Howard Schultz claiming during a January 2013 earnings call that it had sold 150,000 brewers in the first quarter of FY 2013 during. At the time, he seemed to believe in the line.
"We remain committed to attaining leadership in the single-serve category, and I can tell you today that with Verismo we are in the nascent stage of building a multi-billion-dollar platform for Starbucks over the long term," said Schultz at the time. "And we are in it for the long term."
Giving away Verismo is a radical option, but it could open up billions in potential pod sales. Starbucks could do it without simply handing out brewers to whoever wants one. The company could leverage its loyalty program to make sure the brewers got into the hands of the people most likely to actually use them (and buy pods). Perhaps a brewer could be offered after a customer forgoes a number of free beverages earned through the loyalty program or maybe Starbucks could require a gauntlet of purchases. That might require a customer to buy a certain amount in-store, online, and through third-party grocery channels during a particular time period.
The mechanics aren't that important, but the revenue from the required sales would likely offset some of the cost of handing out free brewers. Starbucks already does this type of promotion where it awards premiums (usually free drinks) if a customer earns a certain amount of stars during a set period of days. This would just be an expanded version of that type of offering.
It's a simple equation. Put Verismo in people's homes who already like Starbucks and they will use it. That will lead to pod sales and that, over time, will deal a blow to Keurig.
Daniel Kline has no position in any stocks mentioned. The Motley Fool recommends Keurig Green Mountain 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.