Case 36: Green Mountain Coffee Roasters and Keurig Coffee*
On March 10, 2011, Starbucks and Green Mountain Coffee Roasters (GMCR) announced the formation
of a strategic relationship for the manufacturing, marketing, distribution, and sale of Starbucks and
Tazotea branded K-Cup portion packs for use in GMCR’s Keurig single-cup brewing system. The new
relationship was designed to provide owners of Keurig single-cup brewers with the additional choice of
Starbucks-branded super-premium coffees for their brewers. This strategic relationship furthered
Starbucks’s stated goals of expanding its presence in premium single-cup coffee, making its premium
coffees conveniently available to consumers whenever, wherever, and however they wanted it. Howard
Schultz, president, CEO, and chairman of Starbucks Corporation stated,
Today’s announcement is a win for Starbucks, a win for GMCR and most importantly a win for
consumers who want to enjoy Starbucks coffee with the Keurig Single-Cup Brewing system. Our
research shows that more than 80 percent of current Starbucks customers in the U.S. do not yet own a
single-cup brewer and our relationship will enable Starbucks customers to enjoy perfectly brewed
Starbucks coffee at home, one cup at a time.
Jeff Hansberry, president, Starbucks Global Consumer Products Group, added, “We are proud to be the
exclusive super-premium licensed coffee brand produced by GMCR for the Keurig Single-Cup Brewing
system, and we are looking forward to working with our colleagues at GMCR to further accelerate
growth in single-serve coffee.” Lawrence J. Blanford, GMCR president and CEO stated, “This relationship
is yet another example of GMCR’s strategy of aligning with the strongest coffee brands to support a
range of consumer choice and taste profiles in our innovative Keurig Single-Cup Brewing system.”1
GMCR appeared on a roll with the Starbucks development following similar news in February with
Dunkin’ Donuts announcing a promotion, manufacturing, and distribution agreement making Dunkin’
Donuts coffee available in single-serve K-Cup portion packs for use with Keurig Brewers.2 Beginning in
the summer of 2011, Dunkin’ Donuts will offer 14-count boxes of Dunkin’ Donuts coffee in single-serve
K-Cup portion packs exclusively at participating Dunkin’ Donuts restaurants in the United States and
Canada. GMCR will exclusively package the new Dunkin’ K-Cup portion packs using coffee sourced and
roasted to Dunkin’ Donuts exacting specifications. Nigel Travis, Dunkin’ Brands CEO and Dunkin’ Donuts
president stated,
We believe customers will be delighted to learn that ‘America’s Favorite Coffee’ will soon be able to be
prepared in America’s fastest-growing single-cup brewing system. By introducing Dunkin’ K-Cup portion
packs and making them available exclusively in our restaurants, we are giving people more occasions to
enjoy Dunkin’ Donuts coffee and more ways to enjoy using the Keurig Single-Cup Brewing System. We
believe this alliance of two brand leaders means incremental sales of GMCR, for Dunkin’ Donuts and for
our Dunkin’ Donuts franchisees.
GMCR president and CEO Larry Blanford stated,
Dunkin’ Donuts has top quality coffee, an extremely loyal customer base and impactful advertising
programs. Combine those assets with consumers’ enthusiastic response to Keurig’s Single-Cup Brewing
technology and we believe this alliance represents a truly exciting opportunity for both companies, with
the potential to strengthen Keurig brewer adoption by consumers in one of the fastest-growing
categories of the coffee industry.
According to The NPD Group/CREST, Dunkin’ Donuts served the most hot traditional and iced coffee in
America (for quick-serve restaurants, year ending October 2010), selling more than one billion cups of
hot and iced coffee every year. Dunkin’ Donuts was recently ranked number one in customer loyalty in
the coffee category for the fifth consecutive year by the 2010 Brand Keys Customer Loyalty Engagement
Index. Additionally, in 2010 Dunkin’ Donuts opened more net new locations globally than any other
quick-serve brand.
While Wall Street rewarded the stock price of GMCR on the news of the strategic relationships, Larry
Blanford could not ignore the risks related to GMCR’s Keurig business. Although GMCR was based in
Waterbury, Vermont, with a geographic footprint weighted almost exclusively to the U.S. and Canada,
several global developments posed risks to Keurig’s future growth. Blanford was concerned about
several issues. including product liability, protecting GMCR’s intellectual property, GMCR’s ability to
integrate their acquisitions, and the effect of commodity costs on Keurig brewers.
Coffee Consumption in the United States
The U.S. population consumed more coffee than soft drinks in 1969. According to Jack Maxwell of
Beverage Digest, U.S. consumption of coffee in 1969 was approximately 40 gallons per capita versus 20
gallons of soft drinks. By 1998, coffee consumption had fallen to 20 gallons per capita annually
compared to more than 50 gallons of soft drinks consumed. But consumer preferences can and did
change, responding to the availability of higher-quality coffee by drinking more coffee and reversing a
three-decade decline. The National Coffee Association conducted a survey revealing that 80 percent of
Americans drink coffee occasionally and over 50 percent drink coffee daily. The U.S. per capita
consumption of coffee was estimated to be 424 servings, which included in-home and out-of-home
consumption of roast, ground, instant, and ready-to-drink (bottled/canned) coffee.3 While the average
consumption per drinker rose to over three cups per day, 18- to 24-year-olds who drink coffee averaged
4.6 cups per day, whereas those over 60 years old averaged only 2.8 cups per day.4
The total coffee market in 2010 was estimated to be 105 billion cups or $34 billion (see Exhibit 1).5
Specialty coffee has become a mainstream staple as younger drinkers have come of age with Starbucks
virtually omnipresent. Given the proliferation of specialty coffee and a palate less tolerant of Robusta
coffee from a can, the Millennial Generation provides a robust outlook for specialty coffee demand (see
Exhibit 2).
Exhibit 1: Total U.S. Coffee Market Value
Exhibit 2: Coffee Preference Percentages by Age
The Keurig K-Cup Single-Serve Brewing System
Keurig single-serve systems are designed to quickly brew a single cup of coffee, tea, hot chocolate, or
other hot beverage such as apple cider. The coffee grounds or other brew material are supplied in a
prepared, single-serving unit called a “K-Cup.” Once the brewer has warmed up, the Keurig user inserts a
K-Cup into the brewer, places a mug under the spout, and invokes the brew feature. Within 20 to 60
seconds, the beverage is brewed. Keurig machines brew by piercing the foil seal on top of the plastic KCup with a spray nozzle, while simultaneously piercing the bottom of the K-cup with a discharge nozzle.
Grounds contained inside the K-cup are embedded within a paper filter. A measured quantity of hot
water is forced through the K-Cup, passing through the brew material and the filter into a cup or mug. A
brewing temperature of 192 degrees Fahrenheit (89 Celsius) is the default setting, with some models
permitting users to reduce the temperature per preference.
“Pod” Brewing Market
The Keurig brewer utilizes patented, innovative brewing and single-cup technology to deliver a freshbrewed cup of coffee, tea, or cocoa at the touch of a button. Brewers with Keurig Brewed technology
were the top five selling coffeemakers in the United States on a dollar basis for the period of October
through December 2010 and represented 49 percent of total coffeemaker dollar sales for that period
according to the NPD Group. At the KeyBanc Capital Markets investor presentation, Larry Blanford
reported that Keurig brewer and accessories sales increased 58 percent in the first quarter of 2011
versus first quarter 2010. During this same time period, K-Cup portion pack net sales increased 89
percent to $332.9 million. As a percentage of total coffeemaker dollar sales, Keurig’s percentage has
increased quarter on quarter every quarter since 2007 (see Exhibits 3-6).
Exhibit 3: GMCR Keurig Percentage of Total Coffeemaker Dollar Sales, 2007-2010
Exhibit 4: Green Mountain Coffee Roasters Income Statement
Exhibit 5: Green Mountain Coffee Roasters Balance Sheet
Exhibit 6: Segment Summary
Specialty Coffee business unit(SCBU): Sources, produces, and sells more than 200 varieties of coffee,
cocoa, teas, and other beverages in K-Cup portion packs and coffee in more traditional packaging,
including whole bean and ground coffee selections in bags and ground coffee in fractional packs, for use
both at-home (AH) and away-from-home (AFH). In addition, SCBU sells Keurig single-cup brewers and
other accessories directly to consumers and to supermarkets.
Keurig: Sells AH single-cup brewers and accessories and coffee, tea, cocoa, and other beverages in K-Cup
portion packs produced by SCBU and other licensed roasters to retailers by principally processing its
sales orders through fulfillment entities for the AH channels. Keurig sells AFH single-cup brewers to
distributors for use in offices. Keurig also sells AH brewers, a limited number of AFH brewers and K-Cup
portion packs directly to consumers via its website, www.keurig.com.
While the coffeemaker category sales excluding Keurig declined over 5 percent in 4Q 2010 versus 4Q
2008, sales of the Keurig brewers actually increased over 400 percent during the period, fueling total
category dollar sales growth in excess of 53 percent for the period. As of year-end 2010, Keurig and
Keurig-licensed brewers were approaching the point where sales would account for over 50 percent of
total coffeemaker category sales (see Exhibit 7).
Exhibit 7: Total Coffeemaker Dollar Sales, October–December 2008 through October–December 2010 (in
millions)
Note: Data include third-party brewers. “Total coffeemaker” category includes all coffeemakers and
espresso makers. NPD data do not include all retailers and are estimated to represent 35 percent to 40
percent of the total marketplace.
During the first quarter of 2011, Keurig-branded brewers continued to gain market share in the
coffeemaker category. According to NPD, in GMCR’s fiscal first quarter, Keurig-branded brewers
(without third-party brewers) remained the number one dollar-share leader in the U.S. coffeemaker
category, with the four top-selling brewers and over 45 percent dollar share, compared to 36.4 percent
a year ago. For the same fiscal first quarter 2011 period, NPD estimated that, including third-party
Keurig-branded brewer sales, Keurig brewers represented 49.3 percent of total coffeemaker dollar sales.
In Canada, Keurig brewers (without third-party brewers) were the second leading dollar-share leader of
all coffeemakers, with the brand increasing its dollar share to 14.6 percent in GMCR’s fiscal first quarter
2011 from 8.1 percent in 2010. On a unit basis, Keurig-branded brewers (without third-party brewers)
gained ground, increasing share to 6.8 percent in 2011 from 3.2 percent in 2010 for all coffeemakers.
Approximately 18.5 million coffee brewers were sold each year in the United States, and Keurig’s goal
was to convert over half of the 90 million American homes with coffee brewers to Keurig.6 As recently
as 2007, research by the NPD Group indicated that the single-serve proposition wasn’t compelling
enough for consumers to replace their existing coffeemakers with pod machines. NPD’s research
indicated that a significant proportion of purchasers were unsatisfied and cited unreliable machines as a
problem as well as the coffee itself. The pods available, consumers complained, were pricey, often hard
to find, and limited in terms of flavor and blends. In their survey, the NPD Group found some consumers
were dissatisfied with the performance of pod machines, with 17 percent of machines returned, thrown
out, or given away. John Block, director for the NPD Group, said, “Manufacturers and retailers have a
great opportunity to improve their position in the marketplace by listening to consumer feedback, and
integrating all three attributes that customers want most into their product offering: a reliable pod
machine, easy-to-find refills, and a variety of coffee flavors.
A Multichannel Strategy for the Away-from-Home (AFH) Market
Keurig initially focused on the AFH commercial segment of office users. Increasing demand and brand
awareness enabled Keurig to pursue a multichannel strategy, providing widespread exposure to
consumer trial. Starbucks and other specialty coffee purveyors laid the groundwork for launching into
the AFH office coffee service (OCS) market by educating consumers about gourmet coffee and moving
coffee beyond a commodity. Starbucks may be responsible for a paradigm shift regarding the price
elasticity for coffee. The paradigm that applied to price elasticity affecting consumer purchases of
Robusta coffee by the can shifted with the proliferation of fresh-ground Arabica beans served in a
coffeehouse, often for $2 or more per cup. This paradigm shift enabled Keurig to offer a single-cup
brewing system into offices, capitalizing on consumer demand to replicate their coffeehouse quality java
in the office.
There were approximately 2.6 million coffee brewers in offices nationwide serviced by a network of
approximately 1,700 distributors. Of those offices, GMCR estimated that 12 percent had single-cup
brewers, and about half of those were Keurig brewers.8 While Keurig brewers were estimated to be in
30 percent of offices in New England, national penetration in the office channel was only about 6
percent.
Keurig continued working with its network of Keurig Authorized Distributors (KADs) to execute office
acquisition plans, conduct lead generation, demonstrations, and sampling programs to build Keurig’s
office coffee business. In addition to Keurig’s traditional distributor network, customers such as Office
Depot and Staples were helping Keurig grow through their business-to-business solutions for both large
and small office applications.
Another AFH single-serve opportunity Keurig identified was the hotel market. There were approximately
five million coffeemakers in hotel rooms across North America. Keurig believed that 40 percent of these
rooms catered to travelers who would appreciate the benefits of single-serve brewing. The Keurig team
went through a rigorous process to develop new brewer concepts for the market. The development of a
new “hotel in-room” brewer was one example (see Exhibit 8).
Exhibit 8: Keurig “Hotel In-Room” Brewer
Single-Cup Brewer System Competition
Consumers had many options of single-cup brewing systems to choose from in North America and
internationally. Competition in the single-cup brewing system market was increasing, as relatively low
barriers to entry encouraged new competitors to enter the market, particularly with typically lower-cost
brewers that brewed coffee packaged in nonpatented pods. Many current and potential competitors
had substantially greater financial, marketing, and operating resources versus Keurig. According to
Keurig, their primary competitors were Flavia Beverage Systems (manufactured by Mars), the Tassimo
beverage system (manufactured and marketed by Kraft), the Senso brewing system (manufactured and
marketed by Philips and Sara Lee), and a number of additional single-cup brewing systems and brands.
Kraft’s Tassimo system was made primarily for at-home use, while the Mars’s Flavia system targeted
offices.
A January 2009 Consumer Reports article on coffeemakers covered pod machines. The article stated,
“With pod machines, you simply drop in a sealed packet of coffee—no grinding, no scooping, and no
mess. But many lock you into the company’s coffee, which tends to be pricey, and the results have been
unimpressive.” According to Consumer Reports, “Cuisinart’s Cup-O-Matic SS-1, $200, did best among
the pod models tested. It took standard pods or your own grind and lets you pick regular or bold in five
cup sizes. It was reasonably quick: about three minutes for the first cup, one minute thereafter. But the
model occasionally leaked extra water into the cup, diluting the coffee.” Consumer Reports also tested
the Keurig Breville BKC600XL, $300. Consumer Reports commented that the Keurig machine, “accepts
any K-cup as well as loose coffee grounds. It was fairly quiet but that first cup takes almost four
minutes.” Consumer Reports recommended, “If you want coffee for one in a hurry and you insist on the
neatness and convenience of a pod machine, consider the Cuisinart for its flexibility and speed.
Otherwise, we recommend our top-scoring to-go model, the Melitta Take2 ME2TM. It’s quick, brewed
superbly, and costs just $25.”
The History of Keurig
Named for the Dutch word for excellence, Keurig was launched in 1990 by Peter Dragone and John
Sylvan, with the belief that coffee should always be served fresh, whether at home or at the office, just
as in a gourmet coffeehouse. Dragone and Sylvan noticed that people were leaving the office in search
of a fresh cup of coffee and asked themselves, “Why do we brew coffee by the pot when we drink it by
the cup?” From this question, the revolutionary concept of Keurig K-Cup portion pack brewing was born.
In 1994 Keurig secured a patent and came up with a prototype. Two venture capital firms kicked in $1
million and gave Dragone and Sylvan one year to prepare a model for mass production. When they
missed that deadline, the venture capitalists offered more money but demanded that Nick Lazaris, a
veteran executive who once served as chief of staff to West Virginia Governor (now Senator) Jay
Rockefeller, be brought on. In 1998, after eight years of development, Keurig released an industrialstrength, single-serve machine that delivered a perfect cup of coffee or tea every time.
Keurig was a technology company in the coffee industry. Keurig brewers represented a fusion of
technology and design. To maintain and enhance its position as a leader in the gourmet single-cup
market, Keurig invested significant resources and capital in engineering and research and development.
This led to a strong and growing portfolio of market-leading, proprietary technology. Keurig’s integrated
engineering team drove fast and innovative product development in all three areas that supported
Keurig’s single-cup system: brewers, portion packs, and high-speed packaging lines that manufactured
the portion packs. Keurig’s integrated approach to new-product development resulted in accelerated
new-product launches since 2004. Keurig employed over 30 degreed engineers from varied disciplines.
The engineering team at Keurig included mechanical, software, and nutritional science, as well as quality
assurance and industrial engineering. As of 2007, Keurig held 26 U.S. and 65 international patents
covering a range of its portion packs, packaging line, and brewer technology, and Keurig had additional
patent applications in process. Of these, 72 were utility patents and 19 were design patents. The Keurig
system was based on three fundamental elements:
1. A patented and proprietary portion-pack system (“K-Cup”) using a specially designed filter,
sealed in a low-oxygen environment to ensure freshness (see Exhibit 9).
Exhibit 9: The Keurig K-Cup
2. Specially designed, proprietary high-speed packaging lines that manufactured K-Cups at the
coffee roaster’s facilities using fresh roasted and ground coffee (or tea)
3. Brewers that precisely controlled the amount, temperature, and pressure of water to provide
a consistently superior cup of coffee or tea in less than a minute when used with K-Cups.
Keurig’s patented system eliminated the need to measure coffee or water—the two primary
culprits for suboptimal java. With the Keurig system, pressurized hot water was filtered through
a small plastic pod, called a K-Cup, that combined both filter and coffee (see Exhibit 10).
Exhibit 10: Normal versus Injection Brewing Process
Keurig maintained a sizeable quality control team to assist engineering in establishing quality
standards; to communicate standards to all manufacturing partners, roasters, and suppliers; and
to audit compliance with Keurig’s established standards. This emphasis on quality products,
easy-to-use features, and innovative technologies earned Keurig high marks in customer
satisfaction, with 94 percent customer satisfaction from tracked brewer purchasers.
A licensing agreement enabled Green Mountain Coffee Roasters to package its high-quality
Arabica beans in Keurig’s patented container, the K-Cups. GMCR started distributing the new
single-cup Keurig Premium Coffee System to office-coffee-service (OCS) and food-service
providers in 1998. GMCR and Keurig sold the system through select distribution channels. The
system featured the single-cup Keurig brewer and eight varieties of Green Mountain coffee,
including blends, flavored, decafs, and estate coffees. Keurig’s K-Cup packaging guaranteed that
each cup of coffee was as fresh as “the first cup of every pot.” Keurig’s strategy to gain market
share in the office market was to sell machines to distributors and encourage them to give the
machines away or lease them for a small fee. The economics of the strategy worked for
distributors, because the real profit was in selling K-Cups. If an office went through 30 or 40 KCups per day, a distributor recouped the cost of the machine in less than six months of K-Cup
sales.
When Keurig launched its first single-cup brewer for the office market in 1998, it partnered with
Green Mountain Coffee to manufacture and sell Keurig’s patented K-Cups. Although Green
Mountain Coffee was the first roaster to sell its coffee in Keurig’s single-cup brewing system, by
2003 GMCR was competing for Keurig’s sales with three other North American roasters:
Diedrich Coffee, Timothy’s, and Van Houtte, a vertically integrated roaster and office coffee
distributor in Canada and the United States. Since 2003, Keurig had licensed several additional
coffee roasters to package gourmet coffee and teas into K-Cups, all of whom paid royalties to
Keurig based on the number of K-Cups shipped. For each K-Cup shipped, roasters paid Keurig a
royalty of approximately $.04. This unique licensing agreement system enabled Keurig to offer
the industry’s widest selection of gourmet branded coffees and teas in a proprietary single-cup
format. This wide coffee selection proved to be a key differentiator for Keurig’s brewing system.
Consumers could choose from 11 gourmet brands and over 130 varieties of coffees and teas in
K-Cups. Of the more than 2 billion cups of Keurig brewed coffee and tea that had been
consumed since Keurig launched in 1998,9 Green Mountain Coffee continued to be the leading
K-Cup roaster, representing 57 percent of K-Cups shipped in fiscal 2008.10
In 1998 GMCR held a minority investment of less than 5 percent in Keurig Inc. This partnership
with Keurig developed into an important growth driver in fiscal 2000, as the unique Keurig onecup brewing system gained momentum in the marketplace. K-Cup sales made up 15.7 percent
of total sales at GMCR in fiscal 2000. GMCR’s partnership with Keurig Inc. continued to be an
important growth driver in fiscal 2001, with K-Cup sales comprising 20.4 percent of total
revenue for GMCR. Keurig’s ownership structure changed in 2002 as a result of agreements with
GMCR and Van Houtte. Keurig sold stock to Van Houtte, raising $10 million to seed Keurig’s athome business launch. The investment secured Van Houtte a 28 percent ownership position in
Keurig. Simultaneously, GMCR invested $15 million, by acquiring and executing stock options, to
purchase 42 percent of Keurig. These strategic moves resulted in GMCR and Van Houtte joining
Memorial Drive Trust (MDT) as the top three shareholders of Keurig. MDT, an investment
advisory firm, had been the primary venture investor in Keurig since 1995 and led Keurig’s board
of directors. Separate shareholder agreements with MDT, however, restricted both GMCR and
Van Houtte from holding a seat on Keurig’s board of directors. However, in June 2006, GMCR
completed its acquisition of Keurig for $104.3 million.
Expanding Keurig’s Family of Brands
In addition to Green Mountain Coffee and GMCR’s affiliated Newman’s Own Organics and
Celestial Seasonings Tea brands, which were packaged and sold by Green Mountain Coffee,
Keurig’s other North American K-Cup brands offered as of year-end 2006 included Diedrich,
Gloria Jean’s, Coffee People, Timothy’s, Emeril’s, Van Houtte, Bigelow, Tully’s, and Twinings.
In January 2007, Keurig Inc. and Caribou Coffee, the second largest publicly traded gourmet
coffee company in the United States in terms of number of retail stores, announced a
partnership to market Caribou’s gourmet coffees in Keurig K-Cups. “We are proud to welcome
Caribou to the Keurig family,” stated Nick Lazaris, former president of Keurig. “Caribou is an
exceptionally strong brand with a loyal following among gourmet coffee lovers. Our office and
home Keurig users will be delighted with Caribou in K-Cups.”11 Under license from Caribou
Coffee, Keurig served as the wholesale distributor and a direct retailer for Caribou Coffee KCups. In addition, many Keurig premium retail partners added Caribou Coffee K-Cups to the
selection of K-Cups already carried in 6,700 stores coast to coast. For the office coffee channel,
Caribou Coffee K-Cups were offered through Keurig’s authorized distributors for marketing to
offices where Keurig brewers were installed. Caribou marketed both Caribou Coffee K-Cups and
Keurig brewers in many of its coffeehouses.
As Keurig gained momentum across the United States, the diversity of the K-Cup brand portfolio
increased in importance because regional preferences could not be underestimated as national
penetration progressed. The addition of Caribou Coffee, a strong Midwest brand, helped build
K-Cup sales and introduce Green Mountain Coffee to areas beyond its core market.
In September 2008 GMCR announced an asset purchase agreement to acquire the Tully’s coffee
brand and wholesale business. Tully’s was a well-respected specialty coffee roaster with Pacific
Northwest roots and heritage. The Tully’s wholesale business division distributed coffee to over
5,000 supermarkets, located primarily in the western states, and also sold coffee in K-Cup
portion packs. The Tully’s acquisition was designed to provide GMCR with a complimentary
West Coast brand and business platform to facilitate future geographic growth and brand
expansion. In March 2009 GMCR completed the acquisition of the Tully’s Coffee brand and
wholesale coffee business from Tully’s Coffee Corporation for the purchase price of $40.3
million. GMCR financed the purchase through its existing $225 million senior revolving credit
facility. Larry Blanford stated, “This acquisition strengthens our leadership in specialty coffee
and will support our plans to establish our proprietary Keurig Single-Cup system as the preferred
way to enjoy coffee throughout North America.” Tully’s retail locations continued to operate
under license and supply agreements with GMCR. Tully’s retail and international business
remained an independent company, operating under the name of TC Global Inc., owned by its
existing shareholders and managed by its existing management team.
In November 2009 GMCR announced the acquisition of Timothy’s Coffees of the World Inc. for a
cash purchase price of approximately $157 million, in U.S. dollars. The acquisition included the
Timothy’s World Coffee brand and wholesale business (but did not include retail operations)
and was maintained as a wholly owned Canadian subsidiary, with operations integrated into
GMCR’s Specialty Coffee Business Unit. Headquartered in Toronto, Ontario, Timothy’s was a
premium coffee company that produced specialty coffee, tea, and other beverages in a variety
of packaged forms. Additionally, Timothy’s produced K-Cup portion packs for the Keurig singlecup brewing system sold under the Timothy’s World Coffee, Emeril’s, and Kahlua Original K-Cup
brands. Timothy’s became a licensed roaster of Keurig Inc., a wholly owned subsidiary of GMCR,
in 2000. Regarding the acquisition, Larry Blanford stated,
Timothy’s is a great addition to GMCR’s family of brands. We have been collaborating together
since they became a Keurig licensee and know the company is a great strategic and cultural fit.
We believe that Timothy’s, along with our Green Mountain Coffee brand, will contribute
meaningfully to our future success in Canada and throughout North America. It will accelerate
GMCR’s geographic expansion with a Canadian brand platform that includes manufacturing and
distribution synergies. The retail portion of the Timothy’s business has been purchased by
Bruegger’s Enterprises, Inc. and will continue to support the Timothy’s brand across Canada. Our
acquisition includes a five-year coffee supply agreement with Bruegger’s Canadian affiliate and
we look forward to our expanding relationship with them as we already supply all of their 290
locations in the U.S.… Timothy’s wholesale business and brand is a landmark international
acquisition for GMCR—representing the accomplishment of a key goal: to further optimize the
Keurig opportunity and our family of brands across North America.
In May 2010 GMCR announced that it had acquired Diedrich Coffee Inc. for $35 per share of
common stock in cash, pursuant to a cash tender offer and a “short form” merger, in a
transaction with a total value of approximately $300 million. Diedrich Coffee became a wholly
owned subsidiary of GMCR and was integrated into GMCR’s Specialty Coffee business unit.
Diedrich Coffee specialized in sourcing, roasting, and selling the world’s highest quality coffees.
The company marketed its three leading brands of specialty coffees, Diedrich Coffee, Coffee
People, and Gloria Jean’s Coffees, through office-coffee-service distributors, restaurants, and
specialty retailers and via the company’s web stores. Diedrich Coffee was one of the few
roasters under license to produce K-Cups for Keurig’s top-selling single-cup brewing system.
Regarding this acquisition, Larry Blanford stated, By taking the next logical step beyond our
already successful licensing agreement with Diedrich Coffee, we are bringing in house three
strong, complementary brand platforms—Diedrich, Gloria Jean’s and Coffee People—and
augmenting the growing GMCR beverage brand portfolio. In addition, we are gaining
manufacturing and distribution facilities in California, which will enable us to more effectively,
reach consumers in this region.
The combined company operated manufacturing and distribution facilities in Waterbury and
Essex, Vermont; Castroville, California; Knoxville, Tennessee; Sumner, Washington; and Toronto,
Ontario. GMCR also announced that it amended its Amended and Restated Revolving Credit
Agreement to provide for a new term loan for $140 million, a new uncommitted revolver
increase option of up to $100 million, and increases in the permitted amounts of certain forms
of indebtedness and investments. In connection with the closing, GMCR executed the $140
million new term loan to pay for a portion of the Diedrich Coffee acquisition purchase price.
In December 2010 GMCR announced that it had successfully completed its acquisition of LJVH
Holdings Inc. (“Van Houtte”) for an aggregate cash purchase price of CAD $915 million, or USD
$905 million, subject to adjustment for final exchange rate and future adjustment based on Van
Houtte’s working capital, net indebtedness, and pre-closing taxes as of immediately prior to the
acquisition’s closing. Headquartered in Montreal, Quebec, Van Houtte was a leading gourmet
coffee brand in Canada in the home and office channels. Van Houtte’s last 12 month’s net sales
were CAD $445 million as of August 21, 2010, or approximately USD $433 million based on the
exchange rate as of September 13, 2010. Van Houtte roasted and marketed gourmet coffee for
home and office consumption and distributed it through Van Houtte’s direct-to-store delivery
and coffee-services networks in Canada and the United States. GMCR expected to continue
operations from Van Houtte’s location in Montreal, Quebec, under the leadership of Gerard
Geoffrion, Van Houtte’s president and CEO. Van Houtte’s Canadian brands included Van Houtte,
Brûlerie St. Denis, Les Cafés Orient Express Coffee, and Brûlerie Mont Royal. Van Houtte also
produced K-Cup portion packs for the Keurig single-cup brewing system under the Van Houtte,
Bigelow, and Wolfgang Puck K-Cup brands. Regarding the acquisition, Gerard Geoffrion, Van
Houtte president and CEO stated, “As a result of our long-term relationship as a Keurig licensee,
we know there is a strong cultural and strategic fit between GMCR and Van Houtte. We believe
the combination of our brands, employees and our respective geographic strengths makes for a
stronger overall company and will enable us to continue to grow our presence in Canada.” Larry
Blanford stated, “We are very pleased to welcome Van Houtte and its approximately 1,800
employees into the GMCR family. We are confident that Van Houtte, with its well-known
portfolio of brands and strong management team, will help drive GMCR’s future success in
Canada and throughout North America.” GMCR financed the Van Houtte acquisition through a
combination of cash on hand and new debt financing. GMCR entered into $1.45 billion in senior
credit facilities, consisting of:
1. A term loan A facility in an aggregate amount of $250 million,
2. A term loan B facility in an aggregate amount of $550 million,
3. A U.S. revolving-credit facility in an aggregate amount of $450 million, and
4. An alternative currency revolving credit facility in an aggregate amount of $200 million.
GMCR used a portion of the proceeds from these senior credit facilities to repay GMCR’s
borrowings under its former credit facility and to pay the Van Houtte acquisition purchase price.
GMCR also planned to use a portion of the proceeds from these senior credit facilities to
support GMCR’s ongoing growth.
Subsequent to the closing of the transaction, GMCR anticipated conducting a strategic review of
Van Houtte’s U.S. coffee-services business, Filterfresh, in contemplation of a potential
divestiture of Filterfresh, given GMCR’s current sales and marketing structure and its existing
network of independent Keurig authorized distributors throughout the United States. The
proceeds from any divestiture would be used to reduce GMCR’s outstanding indebtedness.
Corporate Social Responsibility Shaped the Organizational Culture at GMCR
Green Mountain was committed to conducting its business in a socially responsible manner. The
company believed that doing well financially could go hand in hand with giving back to the
community and protecting the environment. In their 2010 annual report, GMCR stated that their
success was supported by their long-standing commitment to social and environmental
responsibility (see Exhibit 11). That commitment, combined with GMCR’s entrepreneurial spirit
and highly engaged workforce, enhanced their competitive advantage and provided GMCR an
“opportunity to create better coffee, and brew a better world.” GMCR allocated 5 percent of
their pretax profits to support social and environmental projects every year. GMCR posted their
Corporate Social Responsibility Report at www.Brewing-ABetterWorld.com.
Exhibit 11: GMCR ’s Corporate Social Responsibility Initiatives
GMCR worked to protect the environment. Waste reduction and responsible energy use were
two of GMCR’s top priorities and had been since 1983, when GMCR began composting in their
retail coffee shops. In 1989 GMCR developed Earth-Friendly coffee filters. More recent examples
of GMCR’s commitment to protecting the environment included working with International
Paper to bring to market the world’s first to-go cup made with renewable materials, installing an
on-site biodiesel fueling station, and embracing carbon offsets.
As the single-cup coffee market and Keurig brewing systems grew in popularity, GMCR
understood that the impact of the system was one of their most significant environmental
challenges. Finding a more environmentally friendly approach to the packaging challenge
represented by the K-Cup portion pack waste stream was a big priority for GMCR. GMCR actively
researched alternatives to the petroleum-based materials that made up the majority of Keurig
K-Cup packaging. GMCR commissioned Life-Cycle Analysis in 2008 to help quantitatively
understand the environmental impact of the K-Cup portion pack as it compared to using a
typical drip-brewer and identify the best opportunities to reduce its impact. GMCR worked to
identify the right definition of “environmentally friendly” for the Keurig system and all their
packaging. Because the term “environmentally friendly” can mean many things (carbon-neutral,
biodegradable, compostable, petroleum-free, etc.), GMCR was researching what was possible
today and tomorrow, taking into account the current state of packaging technology, consumer
preferences, community infrastructure, performance requirements, and the demands of the
marketplace. GMCR continued to offer the My K-Cup product, a reusable filter assembly that
could be refilled by the consumer, was easily cleaned, and was compatible with all Keurig home
brewers currently sold. On the brewer side, all Keurig engineers had been trained on the
European RoHS directive, which restricted the use of certain hazardous substances in electrical
and electronic equipment, and all Keurig brewers were RoHS compliant.
Keurig-Fueled Sales Growth at GMCR
For fiscal 2010, the Keurig single-cup brewing system (brewers and K-Cups) were driving growth
and value creation for GMCR. Approximately 88 percent of consolidated net sales for GMCR
were derived from the Keurig Brewing System (brewers, K-Cup portion packs, and royalties).
While net sales for GMCR’s specialty coffee business rose 64 percent in 2010 to $629 million,
the Keurig business unit sales increased 81 percent to $728 million for total net sales of $1,357
for GMCR. Sales were forecast to increase by 45–53 percent in 2011 to $1,968 to $2,076. As a
reseller, Keurig placed K-Cups and brewers side-by-side in outlets such as Bed Bath & Beyond,
Macy’s, Target, and many more. Keurig merchandised brewers and K-Cups in over 19,000 retail
outlets plus 14,000 supermarket locations in fiscal 2010 (see Exhibit 12). For the 12 weeks ended
December 26, 2010, the GMCR 12-count K-Cups had penetrated 61 percent of the grocery
stores in the United States.
Exhibit 12: GMCR Sales Growth
Manufacturer and Trade Risks
Because all Keurig single-cup brewers were made by a single manufacturer in China, GMCR was
exposed to significant risks that could materially adversely affect the supply or cost of Keurig
machines. Any disruption in production or inability of GMCR’s manufacturer to produce
adequate quantities to meet consumer demand, whether as a result of a natural disaster or
other causes, would significantly impair GMCR’s ability to operate their business on a day-to-day
basis. Furthermore, GMCR faces the possibility of product supply disruption and increased costs
in the event of a number of other occurrences, including changes in the policies of the Chinese
government, political unrest or unstable economic conditions in China, changes in foreign
exchange rates, or developments in the United States that are adverse to trade, such as the
enactment of protectionist legislation.
Quality and Liability Risks
Product recalls and product liability were also potential dangers. If GMCR’s manufacturer of
brewers does not adhere to product safety requirements or quality-control standards, GMCR
might not identify a deficiency before brewers ship to Keurig customers. This could damage
Keurig’s reputation, and thus GMCR’s reputation and brands, and even lead to customer
litigation against GMCR. Of course, GMCR maintains a reserve for product warranty costs, which
is based on estimates and their knowledge of current conditions, but GMCR’s actual costs could
exceed that reserve, resulting in higher costs and a need to increase their reserve for future
warranty costs. For example, during fiscal 2010, GMCR experienced higher than expected
warranty returns for certain brewer models. (They believed a component used in certain Keurig
brewer models during late 2009 to be at fault.) To correct the issue, GMCR replaced the affected
brewers and made changes to their hardware and software. However, it is possible that GMCR
will experience warranty expenses related to this or similar quality issues in the future.
Proprietary Technology Risks
GMCR’s ability to compete effectively depends, in part, on their ability to maintain the
proprietary nature of Keurig technologies, which include the ability to obtain, protect, and
enforce patents and other trade secrets and know-how relating to Keurig technology. GMCR
owns patents that cover significant aspects of their products, and certain patents of GMCR will
expire in the near future. In the United States, patents associated with GMCR’s currentgeneration K-Cup portion packs will expire in 2012 and 2017. GMCR also has pending patent
applications associated with current K-Cup portion pack technology which, if ultimately issued as
patents, would extend coverage over all or some portion of K-Cup portion packs and have
expiration dates extending to 2023. These applications may not issue, or if they issue, they may
not be enforceable, or may be challenged, invalidated, or circumvented by others. Additionally,
GMCR has a number of portion-pack patents that extend to 2021 but which GMCR has elected
not to commercialize yet and may never commercialize. In addition, Keurig has continued to
invest in further innovation in portion packs and brewing technology that would enhance their
current patents or could lead to new patents. GMCR takes steps to protect all such innovation
and is prepared to protect their patents vigorously. Given the complex technical issues and
inherent uncertainties in litigation, however, there can be no assurance that GMCR would
prevail in any intellectual property infringement litigation they instituted to protect their
intellectual property rights.
Risks of Integrating Acquisitions
Integrating GMCR’s acquisitions into their business presents significant challenges and risks to
their business, including: distraction of management from regular business concerns;
assimilation and retention of employees and customers; managing the operations and
employees of those businesses, none of which have been near their current headquarters and
operation locations; or GMCR might fail to successfully integrate the acquired businesses into
their business and, as a result, fail to realize the expected benefits of these acquisitions. Diedrich
had a history of operating losses, and GMCR’s ability to achieve and then maintain the
profitability of this business line depended on GMCR’s ability to manage and control operating
expenses and to generate and sustain increased levels of revenue. GMCR might fail to grow and
build profits in business lines or achieve sufficient cost savings through integrating customer
service or administrative and other operational activities. If GMCR was not able to successfully
achieve these objectives, the anticipated benefits of these acquisitions would not be realized, or
it might take longer to realize them than expected. As a result, their operations could be
materially adversely affected.
Risks from Fluctuating Commodity Costs
Significant fluctuations in the cost of other commodities, such as steel, petroleum, and copper,
influence prices of plastic and other components used in manufacturing Keurig coffee brewers.
Approximately 96 percent of the Keurig brewers shipped in fiscal 2010 were sold to the at-home
channel approximately at cost, or sometimes at a loss, when factoring in the incremental costs
related to sales (including fulfillment charges, returns reserve, and warranty expense). With
respect to the Keurig single-cup, at-home system, GMCR continued to pursue a model designed
to penetrate the marketplace, a component of which was to sell brewers at affordable
consumer price points in order to attract new customers into single-serve coffee. Any rapid,
sharp increases in their cost of manufacturing at-home brewers would be unlikely to lead GMCR
to raise sales prices to offset their increased cost, as GMCR’s strategy was to drive penetration
and not risk slowing down the rate of sales growth as compared to GMCR’s competitors or
before realizing cost reductions in GMCR’s purchase commitments. There was no assurance that
GMCR would be able to sell at-home brewers approximately at cost when such fluctuations
occur.
Risks of Coffee Availability
Decreased availability of high-quality Arabica coffee beans could jeopardize GMCR’s ability to
maintain or expand their business. GMCR roasted over 50 types of green coffee beans to
produce more than 100 coffee selections. If one type of green coffee bean were to become
unavailable or prohibitively expensive, GMCR believed they could substitute another type of
coffee of equal or better quality meeting a similar taste profile. However, a worldwide supply
shortage of the high-quality Arabica coffees GMCR purchases could materially adversely affect
their business. Worldwide or regional shortages of high-quality Arabica coffees could be caused
by multiple factors, such as weather, pest damage, or economics in the producing countries. In
addition, the political situation in many of the Arabica-coffee-growing regions, including Africa,
Indonesia, and Central and South America, can be unstable, and such instability could affect
GMCR’s ability to purchase coffee from those regions. If Arabica coffee beans from a region
became unavailable or prohibitively expensive, GMCR could be forced to discontinue particular
coffee types and blends or substitute coffee beans from other regions in GMCR’s blends.
Frequent substitutions and changes in GMCR’s coffee product lines could lead to cost increases,
customer alienation, or fluctuations in gross margins. While the production of commercial-grade
coffee was generally increasing, many industry experts were concerned about the ability of
specialty coffee production to keep pace with demand. Arabica coffee beans of the quality
GMCR purchased were not readily available on the commodity markets. GMCR depended on
their relationships with coffee brokers, exporters, and growers for the supply of their primary
raw material, high-quality Arabica coffee beans. In particular, the supply of Fair Trade Certified
coffees was limited. GMCR might not be able to purchase enough Fair Trade Certified coffees to
satisfy the rapidly increasing demand for such coffees, which could materially adversely affect
revenue growth.