Competition in the specialty segment of the coffee industry intensified as companies attempted to gain market share in this profitable and rapidly growing segment through acquisitions and by other means. This was particularly true in the single-serve coffee segment of the market. Several companies were taking greater interest in this segment and moved to acquire other companies or introduce their own brewer and K-Cup technologies. In October 2008, Green Mountain settled a lawsuit against Kraft Foods Global for patent infringement that violated its intellectual property rights, with Green Mountain asserting that Kraft infringed on Keurig’s brewing and K-Cup technologies. Kraft paid Green Mountain $17 million to settle the suit. As part of the settlement Green Mountain licensed its brewer and cartridge technologies to Kraft.Elizabeth Fuhrman, “Green Mountain Coffee Roasters Gives a One-Two Punch,” Beverage Industry, March 2009, 32.
In September 2012, two patents on Green Mountain Coffee Roasters’ (GMCR) K-Cups and Keurig brewer expire. These key patents are related to technology that maintained a precise amount of coffee in each pod and the means to extract its liquid. Copying the technology will not be difficult as the patents protect relatively simple inventions.
In anticipation of the patent expirations, GMCR launched new products (see more in the discussion that follows) and also aggressively pursued licensing of its K-Cup technology. Notable licensing agreements were made with Caribou, Folgers, Dunkin’ Donuts, and Starbucks. However, Green Mountain Coffee Roasters’ stock price plunged 16 percent after Starbucks said it would soon start selling the single-cup coffee machines. Market investors believed that this move by GMCR’s main competitor would deflate demand for Green Mountain’s Keurig machines. Shares of Starbucks on the same day rose by 3 percent.
In the company’s 2008 corporate social responsibility report, GMCR management stated that their top challenge was the environmental impact of their coffee packaging materials and brewing systems. To address this challenge management engaged in an in-depth life cycle assessment to understand and compare single-cup brewing versus drip brewing from a systems standpoint. Mike Dupee, Green Mountain’s vice president of corporate social responsibility, in his letter in the 2008 Corporate Social Report, wrote,
Growth, as with any change in the status quo, generally triggers some amount of self-examination. How did we get here? Where are we going and how are we going to get there? As a values-based business, we ask these same questions—and our commitment to social and environmental responsibility adds another layer to the process. How do we address the management of our ecological footprint while growing at these rates? How do we manifest our commitments across a growing family of brands? How do we maintain the best aspects of our corporate culture and welcome new ideas as we spread out across new geographies and welcome more and more people into our enterprise? It is more apparent than ever that we must continue to prioritize key sustainability opportunities and challenges alongside the demands of a fast-growing business.Green Mountain Coffee Roasters, Inc., Annual Report on Form 10-K for Fiscal Year Ended September 26, 2009.
In the 2009 CSR report, management reported on the results of their life cycle analysis. The life cycle assessment showed that the disposal of a K-Cup’s packaging represented a relatively small fraction of the total environmental impact of GMCR products—the most significant environmental impacts occurred in the cultivation of coffee beans, the use of brewing systems, and the material used in the products’ packaging. One area of concern with the single-serve coffee was the manufacturing requirements of the K-Cup pack, which made recycling difficult. The K-Cup pack was made up of three main elements: the cup itself, a filter, and an aluminum foil top. The pack’s components were deemed as required to prevent oxygen, light, and moisture from degrading the coffee. To offset the environmental impact of the K-Cup brewing system, GMCR introduced a new line of more environmentally friendly brewers under the Vue brand name. The plastic used in Vue pack cups can be recycled wherever polypropylene / number five plastic is accepted. The Vue brewing system was viewed as another step on GMCR’s long journey to reduce the environmental impact of their products.Green Mountain Coffee Roasters, Inc., Annual Report on Form 10-K for Fiscal Year Ended September 26, 2009.
Can Disposable Single-Cup Coffee Be Sustainable?
Green Mountain Coffee made the popular Keurig Single-Cup brewing system in which a bit of coffee is sealed in plastic and can be popped cleanly into a single-serve coffee maker. Does it make sense to put fair-trade coffee in a disposable petroleum-based package?
Of the coffee shipped around the world by Green Mountain Coffee (GMC), 27 percent is currently fair trade certified and that number is increasing. They have partnered with Newman’s Own Organics to widen the market for fair trade coffees and by putting fair trade coffees in their popular K-Cups they say they are popularizing fair trade and helping coffee growing communities. In some of their other products 19 percent of the bags are made from PLA (the corn-based bioplastic) and last year they cut their solid waste 19 percent by composting the organic waste from their production processes. Part of their fleet runs on biodiesel. GMC offsets 100 percent of their direct greenhouse gas emissions. They partner with nonprofits such as Heifer International and provide grants focused on poverty reduction.
K-Cups however, are petroleum based plastic, with a layer of polyethylene coating an interior filter paper and an aluminum foil top. It keeps the coffee fresh, but makes recycling impossible. Small though the cups may be they are big business, with GMC reporting that 2.5 million K-Cups® are brewed every day. K-Cups® were about ½ of their net sales last year.
On the sustainability of their operation GMC states, “we understand that the impact of the K-Cup® waste stream is one of our most significant environmental challenges.” They have commissioned a lifecycle analysis to compare drip brew to K-Cups®, but if they already know it is a significant challenge, in a product line representing half of their sales, it is notable that no other information on alternatives or reasonable goals are available except a statement that they “are working to identify the right definition of environmentally friendly.”
People have the choice to buy the reusable filter model (although it got bad reviews for durability), but assuming that their convenience-loving customers like the no fuss product, but also care about issues like fair trade, why is such a connected company not moving faster on this high impact issue?
Source: Lillian Laurence, “Can Disposable Single-Cup Coffee Be Sustainable?,” Sustainable Life Media, accessed June 25, 2010, http://www.sustainablebrands.com/news_and_views/articles/can-disposable-single-cup-coffee-be-sustainable-green-mountain-coffee.
Green Mountain management has taken many other steps in design, packaging, and energy use to reduce the environmental impact of the Keurig brewing systems, including the following:
- Introducing nested packaging for our K-Cup® packs, which was expected to reduce distribution-related greenhouse gas emissions by more than 20%, and decrease volume of packaging by 30%.
- Launching two pilot programs in its Away From Home channel that divert brewed K-Cup® packs from landfills.
- Offering the My K-Cup® product, a reusable filter assembly that can be refilled by the consumer. My K-Piloting a K-Cup® pack for tea made with paper, a renewable resource, in 2010.
- Including recycling codes in its brewers to facilitate responsible disposal of the recyclable parts of its home brewing systems and to ensure compliance with the RoHS Directive, a set of European regulations designed to reduce the effect of electronic equipment on the waste stream.
- Providing considerable energy savings through Auto-Off features for its At Home brewing systems.Green Mountain Coffee Roasters, Inc., Brewing a Better World: VOICES, accessed May 30, 2010, www.gmcr.com/PDF/gmcr_csr_2008.pdf.
Valuation and Stock Market Performance Challenges
In October 2011, David Einhorn and his hedge fund, Greenlight Capital, publically criticized Green Mountain Coffee Roasters, attacking the company’s patents and arrangement with Starbucks.David Benoit, “Here’s the Einhorn Presentation That Killed Green Mountain Shares,” Deal Journal (blog), October 19, 2011, http://blogs.wsj.com/deals/2011/10/19/heres-the-einhorn-presentation-that-killed-green-mountain-shares. Green Mountain’s stock promptly fell 10 percent.
Einhorn’s concerns included the following:
- Patent expiration: GMCR’s patent on K-Cups expires in September 2012, and it could allow competitors to make pods for GMCR’s Keurig machines, undercutting profit margins.
- Starbucks, Dunkin (DNKN) and Smucker’s (SJM) deals are less profitable than expected: GMCR earns around $0.15 per K-Cup it sells on its own, but filings show that K-Cups licensed to Smucker’s earn around $0.06 per K-Cup. GMCR has said many times that the Starbucks and Dunkin deals would be the same, so investors should expect falling profit margins.
- Valuation: At a P/E of 80, investors may begin to question that multiple as Einhorn attacks the stock.
The following points were made in favor of GMCR:
- Starbucks, Dunkin, and Smucker’s waited to strike a deal this year. If GMCR was about to collapse due to its patent expirations, why would Starbucks and Smucker’s strike a deal? Obviously they are assuming GMCR will be around to fulfill its end of their contract.
- Growth: Net sales soared 127% in the most recent quarter. Few, if any companies have that kind of growth. Not even Apple (AAPL) can match that kind of sales increase.
- Expanding market share: GMCR estimates that 25% of all coffee machines sold in the quarter were K-Cup brewers. Given that this 25% is growing far above the other 75%, we think that Green Mountain will increase its market share.
- Forward P/E: Though the P/E ratio is 80, the forward P/E is under 32, a huge fall, implying huge growth for the company. Given that the company is expected to grow earnings and revenue by 60%, is it that expensive?
- Patent expirations are a positive: The patent expirations occurring in 2012 are a net positive for GMCR, because a lack of license fees means cheaper K-Cups, expanding demand for brewers that ARE patent-protected. Furthermore, focusing on brewers will turn them into a profit center for GMCR if it cannot earn enough from K-Cups.
- Acquisitions have all been done to prepare for patent expirations: GMCR has been criticized for questionable acquisitions, such as Van Houtte and Diedrich. But, the net result of these acquisitions is that Green Mountain now owns its top selling K-Cup providers, which means that ironically Green Mountain is the prime beneficiary of its own expiring patents.
- New products: GMCR is developing new products, including an espresso machine, and a new Keurig filtering system, which will come with their own patent protections.
Source: Helix Investment Management, “Who’s Right about Green Mountain Coffee Roasters? Einhorn or the Street?,” October 19, 2011, accessed March 3, 2012, seekingalpha.com/article/300640-who-s-right-about-green-mountain-coffee-roasters-einhorn-or-the-street.
Challenges Take a Toll
On May 2, 2012, GMCR shares declined 48 percent after the company reported it had sold fewer brewers and K-cups than it had anticipated in the quarter ending in March, causing the company to lower its profit expectations for the year. The fallout came as Green Mountain faces increased competition in the fall when Starbucks plans to launch a high-end espresso brewer and two of Green Mountain's patents on K-cup technology expire.
- GMCR was able to use excellence in business sustainability as a source of competitive advantage and to help increase its profitability and market value.
- The company faces many challenges. These include continuing the following: its leadership in sustainable business practices, its strong position in the coffee industry, and its stock market performance prior to 2012.
Describe how GMCR was able to grow and increase profitability by selling single-cup coffee. Then discuss the significance of single-cup coffee packaging and how it relates to sustainability. Is single-cup brewing compatible with sustainability? Why or why not? Can GMCR maintain its leadership in sustainable business practice and continue to grow its single-cup coffee business?
Go to www.vuerecycling.com. How does the Vue support, if at all, GMCR’s claims that its new brewer technology and its packs of plastic cup are more environmentally friendly? Is GMCR doing enough to address its environmental critiques?
What happens to GMCR now that its main competitor, Starbucks, is selling single-cup brewers in their stores and after its K-Cup patent expires? Will this increase the company’s reliance on sustainable business practices with Vue and other similarly focused initiatives? Within the single-cup segment of the coffee market will GMCR be able to continue to distinguish itself by its sustainability effort and can sustainability efforts contribute to future profitability and stock price appreciation?