K-Cups: The New Growth Driver For Starbucks?

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America’s biggest players in terms of coffee sales, Starbucks (NDAQ: SBUX) and Dunkin’ Donuts (NDAQ: DNKN), have been focusing their energies on growing their consumer manufactured goods (CMG) segment, which is dominated by the single serve container, more popularly known as K-Cups. A single-serve coffee container is a method for brewing enough coffee for a single portion. These containers or pods, containing grounds, are usually incompatible, and not interchangeable, between different systems.

Although single-serve systems have been in existence for over 40 years, they became a rage only recently with the introduction of Keurig Green Mountain’s K-Cups. Coffee pods’ share of total coffee sales in 2000 was almost negligible. But, with the launch of K-Cups, this market was taken by storm, commanding a strong 34% share of total coffee sales in 2014.

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Source: Euromonitor

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A recent study conducted by the National Coffee Association (NCA), showed that 25 percent of American coffee drinkers used single-serving coffee machines in 2015. Furthermore, coffee pods make up for about one-third of all coffee sold in the U.S. This is despite the fact that a unit of K-cups costs nearly 20 U.S. dollars more than a unit of traditional roast-and-ground coffee. This trend is likely seen due to the efficiency, quality, and array of choices offered by the single-serve machine, as opposed to the local coffee shop. Further, market-research firm Mintel, expects consumers to spend nearly as much on coffee pods as they do on bulk coffee by 2020.

After the expiry of Keurig’s K-Cup patent in 2012, innumerable cheaper copies of these pods and machines emerged in the market. Although Keurig still commanded the majority share of the industry, its sales growth slowed down significantly.

IRI

Source: www.iriworldwide.com

Keurig responded to the increased competition by partnering with retail giants, like Starbucks and Dunkin’ Donuts, allowing them to manufacture their own, cheaper K-Cups. Moreover, it came up with a new model of the single-serve coffee machine, which would only be compatible with licensed pods. As a result, today, Starbucks can lay claim to almost 15% share of the single-cup coffee market in the U.S.

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On the back of expectations of continued growth in the market, Starbucks entered a new agreement to sell coffee pods compatible with Nespresso, the  most popular single-cup brewer in Europe. In addition, it inked a new deal with Keurig Green Mountain to sell K-Cups in more channels in North America. At an operating margin of about 38%, the channel development or consumer manufactured good segment was Starbucks’ most profitable line of business last year. The company said that it expects this segment to be an important driver of its long-term growth. Starbucks has also launched a line of hot-cocoa and tea pods.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Starbucks

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