The Brewing Single-Cup Coffee War

The eye-opening fact for coffee drinkers is that coffee prices are up about 90 percent over the past year and are at 34-year highs.

This dramatic increase in the cost of beans sent the world of coffee shops, along with the likes of Dunkin Donuts and Starbucks for a loop.

In addition to raising prices on a cup of its coffee, Starbucks was forced to raise the price of its packaged coffee by 12 percent.

Management at Starbucks and others know that rising coffee bean prices are threatening their profitability. They can't keep raising the price of a cup of java...coffee drinkers will eventually say “Enough!”.

So they have hit upon a brilliant solution. One that promises higher profit margins than the companies' branded stores. Firms like Starbucks plan to move into the home, single-cup coffee market in a big way.


Single Cup Future


Two of the major chains – Dunkin' Donuts and Starbucks – are racing to roll out a premium coffee product for home machines that brew single cups.

Dunkin' Donuts says it is the country's biggest coffee merchant. It claims it sells more 1 billion cups from its stores every year. And it believes that its customers are thirsting for its brew at home in the evening too.

So it is the first company to make a deal with Green Mountain Coffee Roasters. Green Mountain makes the nation's most popular single-cup coffee machines, with a 70-80 percent share of the US single-cup market.

Green Mountain's business is built on proprietary technology that merges together home coffee makers and its K-cup pods. The company sells the machines at cost, for as little as $100. It makes its profits on the individual pods, which retail for 60-80 cents each.

The Dunkin' Donuts deal with Green Mountain was announced in February, with the company planning to launch its pods nationwide this summer. This will put it ahead of Starbucks whose deal with Green Mountain calls for an autumn launch.

Both Starbucks and Dunkin' Donuts are betting that US consumers will be attracted by the ease of using single-serve pods. As well as their lack of waste compared with traditional drip coffee machines that make whole pots.

In fact, Starbucks is so confident in its new business that it says it expects its own single-cup packaged coffee business to generate $1 billion of sales in the future.

However, there may be clouds in that coffee. Green Mountain Coffee Roasters is not alone in the industry.


European Competition


In Europe, the coffee pods that are fed into single-cup machines have been popularized by another company. The popular brand is Nespresso, which is owned by the world's largest food company by sales, Nestle. And it is one of Nestle's highest profit margin businesses.

The United States is currently only Nespresso's eighth-biggest market, but has rapidly expanded its presence here. After a slow start, its sales have doubled in the past three years. The company says that advance comes on the back of good products, keen design and canny marketing.

Nestle's has decided to push further into the US market. That is because as Nespresso's chief executive, Richard Girardot, says “we know there is big potential”.


Robust Coffee Business


Despite growing competition, there should be room for everyone to grow in this industry which is in its infancy. Portioned coffee accounts for only about 8 percent of the overall global coffee market. Yet was still worth $2 billion last year and growing fast.

No wonder then that Green Mountain Coffee Roasters trades at a valuation like a high-flying technology company. It trades at 53 times its forecast earnings for the next 12 months.

And like a technology company, its stock rocketed higher by 41 percent on the day last month when Starbucks announced a partnership with it.

The single-cup coffee market should be a winner for all involved for now. As Larry Miller, an analyst at RBC Capital Markets, said “If Starbucks can chop up its packaged coffee business into smaller packets that sell at five times the price, that's great for them.”

And great for their investors if they can pull it off.