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What Keurig's New Stance On DRM Means for Unlicensed K-Cups

By Daniel B. Kline - May 11, 2015 at 3:00PM

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The company is loosening its control in some ways, but maybe not enough to get the public to buy its struggling 2.0 brewers.

When Keurig Green Mountain (GMCR.DL) introduced its 2.0 brewing system -- the successor to its first generation of wildly popular K-Cup brewers -- it tried to sneak in a feature that many consumers did not like.

Alongside the ability brew full carafes as well as single cups, the coffee company added digital rights management, or DRM, software. This technology made it so owners of the new brewer could only used coffee pods licensed by Keurig. 

That made tremendous financial sense -- in its most recent quarter the company took in nearly $1 billion in pod sales, which dwarfed the $106.4 million of revenue from brewers, its second-biggest category. Any sales of unlicensed pods threaten to cut into that cash cow, and companies including Treehouse Foods (THS -2.62%) and a number of supermarket chains have produced unlicensed pods since Keurig's patents on the technology expired.

Treehouse and other unlicensed pod makers have damaged Keurig by taking an estimated 14% of the $3.7 billion K-Cup market as of June 2014, wrote fellow Fool Ted Cooper.

Stopping this practice -- and no longer offering a reusable K-Cup that made it possible to use any brand of ground coffee in the popular brewer -- seemed like a good idea for Keurig. In reality, it caused a consumer backlash that forced the company to reverse course.

Keurig makes its own K-Cups and licenses other companies to do so. Source: author.

Keurig offers a mea culpa
It's worth noting that while locking out unlicensed cups was an important feature in the 2.0 brewers -- at least for investors -- it was not a particularly successful one. Treehouse trumpeted its ability to bypass the lockout not long after the brewers were launched, and anyone with the ability to do an Internet search can get around the protection fairly easily.

Because of that, the company has little to lose by backtracking on its DRM efforts and opening the doors at least somewhat to unlicensed pods and reusable K-Cups. That makes what CEO Brian Kelley said during the company's second-quarter earnings call largely an attempt to get some good public relations out of a failed attempt to keep the system closed.

He acknowledged "our transition to 2.0 was particularly complex. Point of sale results were not as strong as anticipated, which led to higher levels of brew inventory of retail and on our balance sheet." He even acknowledged that the DRM technology -- though he spoke around those words -- contributed to the problem.

"Some of this was due to consumer confusion around pod compatibility which we've mentioned in the past," Kelley said. "Although we are seeing improvement as we transition more formally unlicensed brands into our manufacturing system."

That's an investor-friendly way of saying the company made a mistake and angered some of its customers. Overall, Keurig is not abandoning DRM, but it certainly is stepping back. 

What else is Keurig doing?
In addition to seeking licensing deals with some of the pod rogues, the company is also working hard to clear up a common customer misconception. One byproduct of the DRM technology has been some customers' belief that no third-party pods worked with the system; the company plans to address that, Kelley said:

Beginning in June of this year 2.0 brewer packaging will more prominently communicate the fact that the Keurig 2.0 brew is more than 500 varieties across more than 70 brands, including the top 10 brands. We expect this to help clear up the misperception the system only brews Green Mountain or Keurig-owned brands.

The company, its CEO added, also plans to bring back the My K-Cup accessory for the upcoming holiday season. This is the reusable device that allows allow consumers to brew any coffee they want in their Keurig brewer.

"Our new My K-Cup will work with the Keurig 2.0 and more importantly respond to the small but passionate number of consumers to express their strong desire to see it in the Keurig 2.0," according to Kelley.

Is it enough?
The My K-Cup concession is a major one as it completely frees users of the brewer from buying pods. Of course, it's only for cost-conscious users given that the reusable device has to be packed with coffee for reach brewing and then cleaned after each use, which eliminated much of the convenience that most people want from single-cup brewers.

On the DRM side, the company is making some more deals, likely at better terms to entice unlicensed pod makers to join up, but that's not the same as removing the DRM technology. Buying pods in the marketplace remains confusing, as the ones which won't work in the 2.0 (at least without those very simple workarounds) are not marked as such.

While the company has loosened its stance, it still faces potential consumer backlash and it may not have done enough to remove people's fears about buying the new system. It's a start -- and it still attempts to protect the company's licensed sales -- but it could be too small a measure to turn things around for the 2.0.

 

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Stocks Mentioned

Keurig Green Mountain, Inc. Stock Quote
Keurig Green Mountain, Inc.
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Treehouse Foods, Inc. Stock Quote
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