Keurig Green Mountain (UNKNOWN:GMCR.DL) revolutionized home coffee brewing with its K-Cup machines. These brewers essentially created the single-serve home market in the United States, and they remain dominant despite Starbucks attempting to compete with its Verismo line and Nestle trying to increase sales for its Nespresso machines.
Keurig Green Mountain has steadily grown K-Cup sales from 1.94 billion units in 2009 to nearly 12 billion in 2014, according to Statista. Keurig also grabbed a $4.7 billion chunk of the $40 billion U.S. coffee industry in 2014.
"According to IRI, our Keurig system now accounts for 30% of the U.S. coffee business at retail," the company wrote in its annual report "Yet, with the Keurig system in only 16% of U.S. households, we are still in the very early stages of our development with new beverage categories and new geographies ahead of us."
On the surface that's all good news, but in the long run Keurig could have a problem -- consumers don't like its next-generation brewer, Keurig 2.0. Antipathy toward the new system, which was released toward the end of the company's fiscal 2014, translated to Keurig Green Mountain posting a slight decline in year-over-year brewer and accessory sales in the last quarter of FY14 (from $190 million to $181.6 million) and a larger decline in the first quarter of FY15 (from $375 to $307 million).
That latest drop is particularly troubling because the company's first quarter includes the entire holiday shopping period; this was also the first quarter in which the 2.0 was on sale for the entire three-month period. Keurig does not acknowledge weakness in its 2.0 line and even goes out of its way to blame the sales decline on other models.
"The 18% decline in Keurig's brewer and accessory net sales compared to the prior year period was due to a 12% decline in brewer sales volume, driven largely by weaker sales of MINI Plus brewers," the company wrote in its latest earnings release.
That might be true, but growing public sentiment headwinds suggest the 2.0 will not achieve the unqualified success of its predecessor. Keurig has a perception problem that could not only sink its new model but could ultimately hurt its cash cow: K-Cup sales.
Until 2012, Keurig's patent on K-Cups kept other companies from making coffee pods for its brewers. When that protection expired, a number of brands, including some supermarket chains, began producing their own nonlicensed K-Cups. These portion packs were generally cheaper than the licensed versions, and Keurig Green Mountain, of course, does not get a royalty on their sale.
To freeze out unlicensed K-Cups and take back its monopoly, the company has installed digital rights management technology in the Keurig 2.0 that in theory prevents the device from using nonlicensed pods. Specifically, a scanner looks for a special ink mark that tells the machine it is OK to use the pod.
The system has been less than foolproof, and two Keurig competitors -- Mother Parkers and TreeHouse Foods -- have publicly bragged about being able to circumvent the technology. It's also fairly easy for anyone with an Internet connection to get around the technology following a simple Web search.
Nonetheless, the presence of the DRM technology has led to the 2.0 receiving two and a half out of five stars from over 1,000 Amazon.com customers compared to the four- and five-star ratings of many earlier Keurig systems.
K-Cups are not environmentally friendly
Another byproduct of the DRM technology is that Keurig 2.0 owners can no longer use reusable K-Cups. The company thus faces an increased backlash from environmentalists who are appalled at how much waste it produces.
"Keurig, the single-serve coffee industry's leader, produced enough plastic coffee pods last year to circle the earth more than 10 times, according to one analyst's estimate," the Associated Press reported. That statistic is often cited by the company's critics, which also include companies being frozen out by the new system.
Keurig is taking action
It's hard to argue that K-Cups are environmentally friendly when every cup of coffee results in a little plastic piece of trash. Keurig is not blind to this and has a sustainability program that attempts to improve the company's environmental practices. As part of this effort, the company has pledged to make K-Cups fully recyclable by 2020.
"Designing a recyclable K-Cup pack is only one piece of the equation," according to the Keurig Web page. "We also want to be certain that the majority of our consumers can effectively recycle their used K-Cup packs. We're actively engaged with other businesses, recyclers, and industry organizations to understand the whole system and contribute to solutions."
The challenge is whether Keurig can make these changes fast enough in the face of consumers who seem legitimately angry. Poor sales for the 2.0 may be a symptom of a growing backlash against the idea of single-cup coffee among certain groups. Whether that rising tide becomes a problem depends upon how Keurig handles both the environmental issue and the concerns over the DRM technology.
It's still a solvable problem, but it's not one that can be swept aside until 2020 even if that's the earliest the company can deliver recyclable K-Cups. Keurig needs to take action now -- offering a reusable K-Cup for the 2.0 would be a start -- if it hopes to keep and grow its customer base.
Daniel Kline has no position in any stocks mentioned. He used a Keurig brewer nearly every day and never thinks much about what that may do to the environment. The Motley Fool recommends Amazon.com, Keurig Green Mountain, and Starbucks. The Motley Fool owns shares of Amazon.com and 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.