The recall of over 7 million defective coffee brewers could hurt Keurig Green Mountain (NASDAQ:GMCR) worse than the proliferation of simple hacks that defeats the technology protecting its new coffee systems.
Just as it's trying to convince consumers to pay up for the new brew machine, a defect in an older system that can lead to scalding burns may raise quality control concerns that could dampen sales.
Step away from the coffee brewer
The Consumer Product Safety Commission announced just before Christmas the recall of 7.2 million Keurig MINI Plus Brewing Systems due to the potential for scalding burns caused by overheated water. Keurig has received about 200 reports of hot liquid escaping from the machines, including 90 reports of burn-related injuries.
These are single-serve machines that brew coffee in three different sizes: 6 oz., 8 oz., and 10 oz. Keurig says hot water can spray out, particularly if you try to brew more than two cups in quick succession.
There's a free repair kit customers can get by contacting Keurig, and though you can still use your brewer while you await the kit's arrival, the coffee maker suggests you keep an "arm's length distance" between you and your machine.
It's not the cost, but the damage to reputation
The problem for Keurig isn't the cost of resolving the problem. That's going to be relatively cheap.
In its annual report filed with the SEC last month, Keurig said it recorded a net charge for the fiscal year of $10 million after accounting for expected insurance claims, and doesn't think it will have a material adverse effect on its financial position.
Probably not. The coffee brewer generated $4.7 billion in revenues for fiscal 2014, realizing net profits of more than $597 million. The $10 million charge is pocket change, though returns of the MINI Plus in the fourth quarter caused a $22 million impact to brewer sales. That turned a 7% gain in brewer and accessory sales into a 5% decline for the quarter.
What will be worse is if the recall damages sales of the new Keurig 2.0 brewing system that it launched in August. Lower machine sales would mean lower K-cup sales, and that would pinch profits.
The razor-and-blade theory
The company is counting on the new system to revive profit margins. They evaporated after patent protection on its older K-cup coffee pods expired.
It's the pods, of course, where Keurig makes its money. In true razor-and-blade fashion, the brew machines are given away at cost and the margins are made up with the consumable pods. Following patent expiration, though, third party pod makers like Treehouse Foods (NYSE:THS) entered Keurig's market and the cash cow dried up.
The 2.0 system is an attempt to reclaim those profits. Keurig used technology to build a moat of sorts to protect the new machine.
A reader in the new brew system will only allow use of pods containing a chip embedded in the cap to brew coffee. Older pods or white label ones get an error message.
A simple solution
Unless, that is, you use a simple hack to work around the technology. Some users, for example, have permanently taped a new cap to the reader to resolve the error message and use older, cheaper K-cups.
How many people will actually use the hacks is debatable -- I like to think most people are honest -- so a potential reputation-damaging recall is a much bigger concern.
Individually these issues aren't fatal for Keurig, but coming in quick succession as they have (not to mention if defects are found in the new brew system) they have to burn and could end up leading to much bigger problems for the coffee brewer.
Follow Rich Duprey's coverage of all the most important news and developments in the leading brand name products you use. He 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.