The K-cup Phenomenon

by Sam Kornell

Oné autumn day in 1992, a man named Nick Lazaris came to visit Donald Schoenholt. Schoenholt is the pro­pri­etor of Gillies Coffee, the country’s old­est cof­fee mer­chant, and Lazaris was a young engi­neer, recently grad­u­ated from MIT. They sat down at a table on the floor of Schoenholt’s fac­tory, in Brooklyn, and for the next two hours Lazaris attempted to con­vince Schoenholt to invest in a sin­gle serve cof­fee machine he and a fel­low engi­neer at MIT had invented. Schoenholt was inter­ested, but after care­ful con­sid­er­a­tion he decided to pass.

Not long ago I spoke with Schoenholt, and asked him about his deci­sion to turn Lazaris down. Only a few days before our con­ver­sa­tion Green Mountain Coffee Roasters, the Vermont out­fit that bit when Lazaris came call­ing, had reported its eleventh con­sec­u­tive quar­ter of bet­ter than 40 per­cent net sales growth—mostly on the back of its K-Cup sales. Here is Schoenholt’s response:

If you visit my home in Long Island, and you walk down to the garage, there’s a brick wall. If you then walk to the area right in front of my car, you’ll notice that there’s a dent in the brick. That’s where, for the last twenty years, I’ve been bang­ing my head.

Schoenholt isn’t the only spe­cialty roaster in the U.S. who may feel like bang­ing his head against the wall when the sub­ject of Keurig arises. In 1996 Green Mountain agreed to make a con­sid­er­able invest­ment in Keurig, and for the next decade the two com­pa­nies worked closely to refine the Keurig tech­nol­ogy; in 2006, Green Mountain bought Keurig out­right. It was a good deci­sion: Today, Green Mountain is expand­ing extra­or­di­nar­ily rapidly—for the last nine months it has pro­duced net sales growth of sev­enty per­cent over the prior year. These amaz­ing fig­ures have come mostly on the strength of its dom­i­nance of the sin­gle serve cof­fee mar­ket in the United States. In late August, Fortune placed Green Mountain sec­ond on the their list of the world’s 100 fastest grow­ing companies.

But some roast­ers aren’t bang­ing their heads – they’re bang­ing their fists. In recent years, Green Mountain has bought up the last remain­ing licensees of the Keurig tech­nol­ogy in the United States. There is still one remain­ing K-Cup licensee in Canada (Van Houtte), but at this point Green Mountain’s posi­tion in the sin­gle serve cof­fee mar­ket in the U.S. is, as one ana­lyst recently put it to me, “dominant—very dom­i­nant.” This has led many spe­cialty cof­fee roast­ers to grum­ble about Green Mountain effec­tively lock­ing them out of the fastest grow­ing cof­fee mar­ket in the U.S. “Just because you were first to mar­ket doesn’t mean you should have the right to shut out the rest of the world com­pletely,” said Tom Oliver, co-owner of Coffee Roasters of New Orleans.

In the last few years, as the econ­omy has steadily imploded, more and more Americans have been sav­ing money by eschew­ing cof­fee shops – accord­ing to the lat­est fig­ures, about 85 per­cent now make their cof­fee at home – mak­ing the arrival of a clean, effi­cient, sin­gle serve cof­fee machine ide­ally timed. For the right cus­tomer, the virtues of the K-Cup, the cof­fee pod Green Mountain pro­duces for use in the Keurig machine, are legion. The cof­fee is supe­rior to sim­i­lar qual­ity cof­fee pur­chased ground from the super­mar­ket, and requires vir­tu­ally no cleanup. This makes it par­tic­u­larly attrac­tive to com­muters and offices, as well as busi­nesses with recep­tion areas, and it means that for roast­ers with direct mail order busi­ness, and also roast­ers who sup­ply office build­ings, the K-Cup mar­ket is a poten­tially huge source of new revenue.

At the moment, sin­gle serve cof­fee com­prises about five per­cent of the total U.S. cof­fee mar­ket, and some ana­lysts believe it could grow to a ten or even fif­teen per­cent mar­ket share. In an indus­try as old as the cof­fee busi­ness, it is highly unusual for one com­pany to so com­pletely con­trol such a rapidly expand­ing mar­ket, and it has led to dark mur­mur­ings within the indus­try about Green Mountain hav­ing a monop­oly, or at least some­thing like it. “I don’t know if they have a legal monop­oly, but they have cer­tainly shut every­one else out of the mar­ket,” Tom Oliver told me.

Last win­ter Green Mountain bought the last remain­ing K-Cup licensee in the U.S., San Jose-based Diedrich Coffee, for $290 mil­lion, best­ing Peet’s in a bit­ter bid­ding war. Before Green Mountain could com­plete the pur­chase, how­ever, the Federal Trade Commission con­ducted an inves­ti­ga­tion to deter­mine whether the acqui­si­tion would give Green Mountain a monop­oly over the sin­gle serve mar­ket in the U.S. The FTC con­cluded that it would not. But when I recently asked an indus­try ana­lyst which com­peti­tors are likely to offer a cred­i­ble chal­lenge to Green Mountain in the fore­see­able future, he couldn’t name any. Last year Green Mountain made $803 mil­lion in sales, and this year it expects to sell nearly three bil­lion K-Cups. Even if what Green Mountain has does not con­sti­tute a legal monop­oly, might it be a “func­tional monop­oly,” as Oliver put it?

Donald Schoenholt, for one, isn’t buy­ing it. “The Keurig tech­nol­ogy pro­duces sin­gle serve cof­fee, and there are other sin­gle serve cof­fee prod­ucts,” he said. “The cat­e­gory we’re talk­ing about here is sin­gle serve cof­fee, not K-Cup cof­fee.” I asked Schoenholt how smaller roast­ers such as Gilles could get into the mar­ket. “You can’t,” he replied. “The world isn’t fair, and the cof­fee world isn’t fair. That’s the way things are in real life.”

There is a cer­tain irony that Green Mountain is being crit­i­cized by smaller roast­ers for stream­rolling the rest of the spe­cialty cof­fee indus­try. Another way to look at its suc­cess with the K-Cup is to con­sider that in the last five years it has, as a mid-sized spe­cialty roaster from Waterbury, Vermont, out­ma­neu­vered Starbucks—a $17 bil­lion company—and Kraft, a $100 bil­lion com­pany, and come to dom­i­nate a highly cov­eted sec­tor of the cof­fee econ­omy. From a busi­ness per­spec­tive this is impres­sive, par­tic­u­larly con­sid­er­ing that Green Mountain invested in Keurig’s tech­nol­ogy long before it was clear that there would be a pay off. But one of the con­se­quences of the extra­or­di­nary way in which Green Mountain has vaulted itself up into the big leagues is that it has had to endure stress on its ideals.

From the begin­ning the founders of Green Mountain defined their com­pany as a socially and envi­ron­men­tally pro­gres­sive spe­cialty roaster whose atti­tude was fun­da­men­tally local in nature – much like another famous Waterbury, Vermont com­pany, Ben and Jerry’s. But they are cur­rently trav­el­ing out­side of their tra­di­tional precinct as a large spe­cialty out­fit, becom­ing a straight-up national cof­fee power. Awkward ques­tions often accom­pany this kind of growth, and Green Mountain is no excep­tion. “Green Mountain was among the very first roast­ers into being peo­ple sen­si­tive and envi­ron­men­tally sen­si­tive,” Donald Schoenholt told me. “They did it very early, and they’ve done it very, very well. Green Mountain is, in my opin­ion, really the model for the cof­fee indus­try in envi­ron­men­tal and peo­ple sen­si­tiv­ity.” He paused.

Now, why am I going to pains to say all of this? Because the K-Cup is the most anti-environmental item made in the cof­fee indus­try today, with the pos­si­ble excep­tion of the Nespresso cup, which is alu­minum. The K-Cup is not biodegrad­able plas­tic – it’s the stuff you hate putting in land­fills. So here is this com­pany with this won­der­ful track record of sen­si­tiv­ity mak­ing its pri­mary liv­ing today from an item that is an envi­ron­men­tal nightmare.”

Not long ago I spoke with Dan Cox, who from 1981 to 1992 served as Green Mountain’s Vice President. Cox now runs Coffee Analysts, a cof­fee test­ing firm, and he empha­sized to me that his remarks in no way rep­re­sent Green Mountain. I asked him about the envi­ron­men­tal prob­lems asso­ci­ated with the K-Cup. “It puts them in a very awk­ward sit­u­a­tion, and they don’t like it,” he said. “They have a task force work­ing on this around the clock and they haven’t found a solu­tion.”
He con­tin­ued. “It’s more than an image prob­lem for them – they’re pretty solid on their image. They just want to do the right thing and right now they know that putting fifty cups per pound of cof­fee in the dump­ster doesn’t feel very good. But they’re going to sell two and a half bil­lion dol­lars of K-Cups this year. What? Are they going say no to the orders? That’s not going to happen.”

Cox, who has served three terms as the pres­i­dent of the Specialty Coffee Association of America, is well known for hav­ing a frank way of express­ing him­self. When I asked him about com­plaints that Green Mountain is monop­o­liz­ing the mar­ket, his response was char­ac­ter­is­ti­cally direct. “It’s a really sim­ple story: there is no monop­oly,” he said. “A monop­oly is where some­one con­trols the mar­ket so that no-one else can get in. The mar­ket is not about K-cups. The mar­ket is about sin­gle serve cof­fee. That’s the cat­e­gory, and in sin­gle serve you have mul­ti­ple players.”

According to Cox, com­plaints about the Green Mountain’s con­trol of the K-Cup amount to lit­tle more than “spilled milk. They spent years mak­ing [the tech­nol­ogy] tech­ni­cally pro­fi­cient,” he told me. “At the time, it was a huge risk. It was a gam­ble. It wasn’t on the mar­ket, and they spent a lot of money and it panned out. Whenever some­one makes some­thing new, of course all of the com­peti­tors wish they’d thought of it. But they want Green Mountain to give their busi­ness away? Come on. Grow up.”

If there’s no way for spe­cialty roast­ers to get in on the action, I asked Cox, how do they counter the grow­ing demand for K-Cups? The answer is sim­ple, he responded. The K-Cup offers con­sumers good cof­fee, but not high-quality spe­cialty cof­fee. That”, he said, “is what spe­cialty roast­ers should empha­size in their mar­ket­ing. If you like your cof­fee stronger you can’t get it out of a K-Cup – the most cof­fee you can get in one of those things is about 11 grams,” he said. “So if you’re a micro­roaster, you can say ‘Hey lis­ten, we have excel­lent cof­fees that we make fresh and you make at any strength you want.’”

Many spe­cialty roast­ers agree with Cox on this point. In an email, Paul Thornton, the roast­mas­ter at Portland-based Coffee Bean International, told me, “There is a very clear dif­fer­ence in the expe­ri­ence a con­sumer might have between auto­mated sin­gle brew from a Keurig, and man­ual sin­gle brew from a cof­fee shop. I per­son­ally feel it’s equal to the com­pa­ra­ble dif­fer­ence between truck stop cof­fee and a cof­fee shop” – two dif­fer­ent markets.

I heard a sim­i­lar sen­ti­ment from Larry Challain, the owner of Olympia, Washington based Batdorf and Bronson. “I think this is all a tem­pest in a K-Cup,” he told me. “I applaud Green Mountain for their suc­cess with Keurig and K-Cups. A K-Cup brewed in a Keurig brewer makes a good cup of cof­fee for what I would call a “gourmet” prod­uct.” However, Challain said, “I do not con­sider pre-ground cof­fee sealed in a plas­tic con­tainer that sits for months at a time on the shelf to be spe­cialty cof­fee. Batdorf & Bronson has no inter­est in this sin­gle serve mar­ket. Quite frankly I think Green Mountain should be applauded for upgrad­ing the qual­ity of the con­ve­nience sec­tor niche.”

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