KEURIG: ECOSYSTEM
EIS: Professor Adner, 10-11-2010
Francisco Dondo
Nicole Dotts-Wright
Jon Gilman
Coffee Industry: Background
The coffee industry in the United States is valued at about $19 billion each year. Gourmet and
Premium Coffee account for about half of that industry value. The industry will continue to grow as
food enthusiasts are trying to increase this value even more by promoting new coffee-industry trend:
paring specific coffee blends with food to enhance the flavor of both items, much the same way as
particular wines are matched with particular foods. According to the Coffee Research Organization and
the National Small Business Development Support Center Clearinghouse, more than 400 billion cups of
coffee are consumed each day, making it the most popular beverage in the world. Statistics estimate that
Americans consume 400 million of those cups of coffee daily (which equals about four-and-a-half
thousand cups of coffee each second), making the United States the leading consumer of coffee in the
world. The average American drinks 3 cups of coffee a day with 69% consuming coffee during the
morning and/or breakfast. Even though coffee shops make up the fastest growing part of the ‘restaurant
coffee business’, 74% coffee drinkers prefer to consume coffee at home, while 17% prefer to drink
coffee at work (62% inside the work place).
Keurig Inc
Keurig was founded and launched through the strategic combination of engineering intelligence
and business savvy. In 1992, Ian Greenwood, an engineer in the electronics industry and Peter Dragone,
an MBA graduate from Harvard, came together to form their new company, “Keurig”- Dutch for
“excellence”. The modified yogurt cup in which single serving coffee would be held was named the “KCup”. After a number of failures in attempting to find VC funding or an experienced manufacturer with
strong distribution channels who might be interested in collaborating with them, they finally received a
small investment from the Food Fund, a small VC firm specializing in food-related products. The
company used the money to create a few higher quality brewer prototypes allowing them to gain some
momentum. However, with momentum soon falling and a lack of leadership within the company, there
was a need for new management; Nick Lazaris was soon made President and CEO of Keurig. Lazaris
decided to continue with the previous segmentation strategy for Keurig: pursuing the two commercial
segments, office coffee services and food-service establishments first and later the consumer market
segment. With additional funding from Food Fund, new funding through MDT Advisers (a financial
management company), and an R&D and investment partnership with Green Mountain Coffee, Keurig
had one last shot to enter the market. Thus, it was now imperative that Nick Lazaris map out the Keurig
innovation ecosystem to ensure all actors within the ecosystem are on the same page, he understood
where potential delays (risks) in getting the Keurig system to market might come from, and ensure that
these co-innovation, adoption, and initiative risks are mitigated.
Value Vision
The value that Keurig delivered to the office coffee ecosystem was significant but certainly not
evenly spread among the actors. Most of the value delivered was to the office manager and office
employees. The existing office coffee offering was fraught with bad-tasting coffee and waste. Coffee
was manually brewed by employees, which inherently led to an inconsistent taste and often an
inconsistently bad taste. Additionally, employees would have to make a full pot of coffee even if they
were only going to drink one or two cups. At the end of the day, the office manager had to discard
leftover brewed coffee and saw his budget literally being washed down the drain.
Keurig provided many benefits to office managers: less waste because it only produces single
servings, less coffee theft because employees couldn’t take the K-cups home and use them, easy cleanup and maintenance because there were no filters to change, and finally more flavor variety because
office managers didn’t have to order a five-pound bag of each variety. Office employees were similarly
happy because they could actually enjoy a decent cup of coffee in the office that fit their taste profile.
The value delivered to the office coffee distributor was less clear. The most negative aspect
from the distributor’s perspective was that less waste was a benefit to the office manager but in the end,
meant less coffee purchased from the distributor. There was no guarantee that office coffee distributors
could make more money selling less coffee in the form of K-cups. Another hindrance was that office
managers were likely to order less coffee because they no longer had to buy in bulk. Once a bag of drip
coffee was opened, it had a limited shelf life, which drove reorder business to the distributors. On the
other hand, the K-cups could sit on the shelves for months and still taste like freshly brewed coffee.
Finally, the Keurig brewing machine was initially much more expensive than traditional brewing
equipment, which raised the profitability hurdle for distributors who wanted to adopt the Keurig system.
Packaging line
supplier
Brewer
supplier
KEURIG
ECOSYSTEM
Initiative Risk
KEURIG
Adoption Risk
Coffee
Roasters
Co-innovation
Risk
Coffee
distributors
“Office coffee
system”
Office
managers
Consumers
Ecosystem: Adoption Chamber & Risks
Traditionally, coffee was sold directly from the coffee roasters to regional distributors, who then
in turn serviced office managers with a complete office coffee system. The regional distributors were
additionally responsible for procuring the coffee brewers, coffee making supplies (e.g. filters), and
replacement parts as needed. These distributors typically locked up its customers by providing the
brewers free of charge to the office manager in exchange for an office coffee service contract. All in all,
distributors had a pretty stable situation in this ecosystem.
The real pain point in this ecosystem came from the responsibilities of the office manager.
Office managers are responsible for making sure everything is running smoothly at the office. If the
printer’s broken, there are no more pens, or the toilet clogs, the office manager has to put out these fires.
The office coffee system is just another daily headache he or she has to deal with. There may be
complaints that the coffee is too strong, not strong enough, has too many coffee grinds in it, isn’t fresh,
and so forth.
The last piece of the office coffee system is the coffee drinking employee. This group of actors
is generally dissatisfied with the current office coffee system but has a number of options available to
them. For one, many employees brought their own brewed coffee to work to ensure that they actually
like the coffee they drank. The second group of employees went to premium coffee retailers such as
Starbucks and Dunkin Donuts to buy their coffee. Lastly, the minority of employees actually drank the
office coffee provided for free.
Ecosystem: Focal Initiative & Risks
By 1992, Ian Greenwood wished to turn into a business centered on creating portion packs of
premium coffee. The coffee inside would stay fresh because nearly all the oxygen would be removed
through special packaging techniques. The concept held the promise creating a way to brew coffee much
more precisely and consistently than any method available at the time. The initiative would then involve
two revolutionary developments: a special coffee brewing machine and the mentioned special packages.
Once the idea was in place, the different partners behind the concept sought to find, first, an
experienced manufacturer with strong distribution channels but this was one of the first barriers they
faced as no manufacturer believed that they could create a real coffee maker that would deliver the
promised coffee. One of them even mentioned: “their machine leaked all over the conference table…”
Following the natural development of their idea, they meet with different appliance and coffee
roasters but they hit another wall. The appliance guys were convinced that the Keurig team could never
produce large quantities of individual packs economically and the roasters were convinced that they
would never get the coffee-maker to work flawlessly.
Several missteps and missed deadlines caused some to doubt if Keurig’s system would ever be
rolled out in a major way. In early 1997, after continuous lost efforts, Keurig decided to outsource more
of the development work on both the brewer and the packaging line. This would enable the team to
focus on customer, channel and distribution development. But how would they do this without a real
product to show and test?
The team was so convinced about the idea that they ordered several prototypes of a flawed
brewer design, corrected the defects in a few and basically started to make the individual coffee cups in
the back of their office. They needed to gain more information on how end customers would receive the
product.
They placed units in office environments around the city of Boston and would frequently discuss
the system’s performance with the office/facility manager in charge of coffee service. With this
information, they would go to their brewer and packaging line and implement all the required changes to
their developments.
Part of the risks were mitigated but did outsourcing the developments and focusing exclusively
on customer, channel and distribution development solved the problems faced in the past?
Development of the K-Cup packaging line
Manufacturing Technology Services was the company in charge of developing the packaging
line for the mass production of the cups. After it finished the first development and when ready to ship
the line, the company advised Keurig that because of the increased costs caused by design modifications
during development, it would not ship it until an additional $180,000 payment.
Although the original Keurig-MTS contract made all intellectual property associated with the
development of the packaging line property of Keurig, any new vendor would still have to conduct a
great deal of reverse engineering of the first packaging line in order to successfully execute the project.
Keurig management assessed sourcing options going forward but they knew that they could not
afford any delay in the rollout of its packaging system. Although very concerned, they agreed to MTS
requirements and put in place a new contract for future line developments.
Development of brewers
As the first cups rolled off of the first packaging line, Keurig became very concerned about the
quality of the brewers its supplier was producing. Keurig had estimated that each packaging line could
support around 1,500 brewer placements and as such, the rollout for brewing units was totally linked.
The timetable had to be maintained if Keurig wanted to continue to develop its network of distributors
and premium roasters.
On the initial order of 1,000 brewers that the vendor passed through its quality control system,
some were with “loose screws and parts literally falling out”. Keurig had difficulty identifying
alternative packaging line vendors and was now searching for a new contract brewer manufacturer.
Again, they knew that if they changed suppliers, a great deal of time would be lost as the new company
came up the learning curve.
Ecosystem: Complimentors & Coinnovation Risk
Focusing on the ‘Complimentor’ area of the Keurig Ecosystem, there are two different
Complimentors that play a critical role in moving the overall Keurig Innovation towards the end
consumer. The first is Green Mountain Coffee Roasters (GMC), who play a primary complimentor role
in the ecosystem as R&D and investment partners in the overall Keurig innovation and a secondary
complimentor role as a K-Cup retail partner. The second Complimentor includes all of the individual
coffee roasters (outside of GMC) who also develop licensing agreements with Keurig as K-Cup retail
partners; these coffee roasters currently include Café Escapes, Caribou Coffee, Coffee People, Diedrich,
Donut House Collection, Emerils, Gloria Jean’s, Newman’s Own Organic, Revv, Timothy’s, Tully’s,
Van Houtte, Wolfgang Puck, Ghirardelli, and Bigelow.
Keurig is reliant upon GMC in two ways: firstly, GMC is a co-innovator with Keurig to find the
best K-cup system that can work for both the Coffee Roasters and Keurig. Without GMC’s input,
Keurig would not necessarily know the best way to package coffee, keep it fresh, and make a product
that would be as attractive to Coffee Roasters as it is to the end consumer. It was just as critical to bring
the various Coffee Roasters on board as it was to convince the adoption chamber that they needed
Keurig. From Keurig’s perspective, their innovation would only be successful if it met a key part of the
value proposition: there would be a variety of coffee and non-coffee options available to the end
consumer to satisfy the individual needs and taste. Thus, the co-innovation risk is evident in that
without Green Mountain Coffee’s initial support to ensure the k-cup technology would meet both the
Coffee Roasters needs as well as Keurig’s and that the licensing agreements developed shortly after
were fair for both parties, Keurig would in the very least have had significant delays going to market and
in the most severe case, no attractive product at all. To mitigate this risk, it was imperative for Keurig to
develop an ecosystem strategy that kept all of the actors happy and satisfied.
Ecosystem Strategy
In creating a strategy to align the actors in this ecosystem, Keurig was smart and realized that
they weren’t creating equal value for all parties. Keurig knew that the office managers would consider
Keurig a slam dunk but office coffee distributors would find the Keurig system less appealing than the
existing solution. Therefore, Keurig devised the following strategy.
Keurig decided to structure the economics of the new ecosystem such that office coffee
distributors were compensated for adopting a system that would most likely reduce their sales volume.
The price of traditional coffee was about 12.5 cents per brewed cup. However, the price of K-Cups was
about 40-50 cents per serving. Assuming there are similar wholesale mark-ups for each product,
volumes for office coffee distributors could have dropped by ~70% with Keurig and office coffee
distributors would still be earning the same amount of gross profit on coffee sales. Due to the huge
value created for office managers, Keurig knew that demand for its brewing system would be high and
encouraged its distributors to arrange rental or lease programs for the Keurig brewing systems. This
rental income could help deflect the upfront cost of the brewer, which is currently incurred by the
distributors.
Keurig kept their piece of the value pie created in this ecosystem limited to encourage adoption.
Keurig took a small licensing fee from each K-Cup sold by a coffee roaster and decided to earn no profit
on the brewing system or on the packaging lines. Keurig had the foresight to realize that by opting for a
razor/razor blade revenue model, they could increase adoption near-term and share in the profits longterm as more and more systems were being installed in the office coffee ecosystem.
Further, Keurig wanted to ensure that their ‘Complimentors’ were happy as Keurig relied upon
the Premium Roasters for their prestige, channels, manpower, and marketing expertise. Without the
support of these Coffee Roasters, Keurig would have had to launch its own line of branded coffee which
would have significantly furthered the delay of success of the Keurig system (simply through time to
build coffee brand equity). To mitigate the co-innovation risk and keep all the Coffee Roasters happy,
Keurig needed to continue to work tightly with the adoption chamber as Coffee Roasters were happy as
long as their brand was penetrating more and more segments of the market. For example, GMC was
happy as long as “Keurig would help secure their place in the premium quality single brew market,
continue revenue growth for GMC, and increase geographic market penetration”.
Finally, Keurig took away two key learnings through their work with the original initiative and
development process; don’t rely only on one supplier for the development of strategic parts of your
product such as the packaging line and the brewing machine, and don’t overpromise to your strategic
partners to the extent that could damage your relationship and the flow of the whole innovation
ecosystem.
Sources
Marshall, Paul W. & Dann, Jeremy B. “Keurig”. Harvard Business School Publishing, Boston, MA,
1999.
Anderson, Eric T. “Keurig At Home: Managing a New Product Launch”. Kellogg School of
Management, Northwestern University, 2005.
Miller, Joyce. “Innovation and Renovation: The Nepresso Story”. International Institute for
Management Development, Lausanne, Switzerland, 2000.
Appendix I (Office Coffee System with Keurig)
Appendix II (K-Cup Patented Brewing System)
Appendix III (Various Contributers/Coffee Roasters)
Appendix IV (K-Cup in Keurig System)