Cafe Americano

Keurig, Nespresso and the Rich Blend of the Capsule Coffee Market

Cafe Americano

Quietly, almost secretively, Keurig Green Mountain entered its first market outside of North America last year: Britain.

Keurig’s European debut looked restrained for a $14 billion company that dominates the US market for pod (or capsule) coffee machines. “Keurig” has become a byword for any kind of American coffee machine that works by inserting a plastic capsule of ground coffee into the machine’s receptacle and pressing “brew.” Chances are that it is a Keurig. The company sells over 70% of capsule-based coffee machines in the US, according to several estimates, and 57% of coffee capsules sold in the US are Keurig’s “K-Cups,” according to Euromonitor.

British coffee drinkers cannot buy Keurig’s range of counter top coffee brewers, which are ubiquitous in suburban America. A year after its UK “launch,” the only two models on offer in Britain are machines designed for offices. These are only available for purchase on the distributor’s website.

But make no mistake: Keurig has bigger plans for Europe, whose addiction to coffee predates the formation of the United States. And Britain, Keurig’s entry point, is not a mere foothold on the continent. It is a booming market for Keurig-style coffee machines and a lucrative prize in its own right.

Keurig. Brew what you love, simply.

Keurig. Brew what you love, simply

UK sales of pod coffee machines rose from 195,000 in 2009 to 2 million machines by 2014 – a ten-fold increase in sales volumes over the space of five years – according to Euromonitor. That compares to 12.9 million machines sold in the US in 2014, a four-fold increase on 2009 volumes. The percentage of British consumers buying capsules to make coffee at home rose from 12% of respondents in 2010 to 27% in 2014, according to Allegra Strategies, a London consultancy and coffee market specialist. Its ProjectCafe 2015 report estimates the value of the British pod coffee market at £2.5 billion ($3.8bn).

“Capsules have captured the imagination,” says Jeffrey Young, chief executive of Allegra Strategies. “There’s only one direction for capsule systems, and it’s upwards. It’s becoming the UK’s new instant coffee.”

“The booming British coffee market offers a fresh and encouraging perspective on Keurig’s prospects in a year that has become its annus horribilis”

With sales growth rates in the UK outstripping those in the US, Keurig’s late and low-profile market entry seems more perplexing. The booming British coffee market, however, also offers a fresh and encouraging perspective on Keurig’s prospects in a year that has become its annus horribilis.

Nespresso’s VertuoLine coffee machine, only available in the US

Nespresso’s VertuoLine coffee machine, only available in the US

Keurig’s shares have fallen 30% this year after two next-generation products fell short of expectations. The Keurig 2.0 machine was designed to reject non-Keurig-licensed coffee capsules and therefore maximize earnings from Keurig capsules, the driver of earnings from a Gillette razor blade-style business model. Investors loved the prospect of Keurig combatting counterfeit capsules through a technologically improved product. But consumers resented being forced to buy one type of pod. Many users were accustomed to buying generic compatible pods that were cheaper and tasted fine. Sales for the 2.0 disappointed.

In May the company revealed commercial details about Keurig Kold, a counter top cold-drinks machine that makes Coca-Cola, Nestea, Gatorade, and other branded drinks from capsules. Analysts perceive Keurig Kold as even more important to Keurig’s long-term growth, because it diversifies earnings away from coffee. Analyst consensus, however, judged Keurig Kold too expensive ($300) and too slow to market (the rollout will take 18 months) at a time when US consumers’ interest in carbonated drinks machines such as SodaStream seems to be moderating.

Keurig’s long-term growth may depend on expanding its coffee capsule systems beyond its home market

Keurig’s business is under strain. But growth in Britain and across Europe reinforces the power of its core proposition. Keurig captured a dominant market share by giving US consumers a way to make café-quality coffee at home. A caffeine-culture country warmed to a technology that let it drink coffee that tasted better than instant, was more convenient than driving to a coffee shop, and brewed a single cup instead of a pot. The cost of the device and the pods proved secondary to the appeal of reliably good-tasting coffee at home.

European coffee drinkers have warmed to the same proposition since 1986, when Nestle’s Nespresso invented the capsule coffee machine. Indeed continental Europeans have accepted these machines for so long that Britain lags far behind its neighbours. Last year 47% of French people and 42% of Germans said they had drunk coffee from a pod system at home, compared to 27% of British people, according to data from Mintel, the market research firm. Keurig’s long-term growth may depend on expanding its coffee capsule systems beyond its home market more than diversifying into other areas of the beverage sector. In Europe – and particularly Britain – it finds a market that is accustomed to pod machines yet is growing at a rate that accommodates multiple players. Keurig can take advantage of the fact that consumers are more alike in terms of their physiological need for caffeine and their desire for convenience than they are different in terms of their American and European cultural preferences.

One challenge Keurig faces is the European preference for espresso over filter coffee. Nespresso’s dominance in Europe symbolizes this preference. But if Keurig can adapt and find a footing in Europe, it may recover the growth it is losing in the US. It has the funds to develop a machine tailored to the European market: perhaps one that makes espresso as well as filter coffee. In Britain instant coffee is the leading type of coffee made at home, meaning that consumers are accustomed to drinking mugs of coffee rather than shots of espresso. So Keurig could even turn its expertise in filter coffee to its advantage in the UK.

“They can’t take it for granted that they can make it work in the UK,” says Jeffrey Young of Allegra. “There’s already a number of coffee capsule systems in the market.”

“But Nespresso has not completely dominated the UK market like it has in Europe,” he adds. “Frankly Nespresso has not done as well here as you might expect. So potentially there’s an opening for Keurig. It all depends on the funds they put into the effort. There are plenty of machines out there, so Keurig would need to convince people that ultimately it was the right one, and that comes down to taste – getting the taste exactly right for the British consumer.”

Nespresso Variations 2009

Nespresso Variations 2009

When Keurig introduces its range of home brewers to the UK, they will compete more with mid-range machines like Mondelez’s Tassimo and Kenco’s Senseo than with Nespresso, Jeffrey believes. “They’ll be competing on the supermarket level. It’s not necessarily second tier. It’s just mainstream, whereas Nespresso is an elite system. It’s aspirational in terms of its brand perception and distribution. It’s premium. It’s George Clooney. Even the aluminium capsules make it feel more premium.”

Nespresso calls its coffee pods “Grand Crus” and its flavours include “Arpeggio.” Keurig calls its coffee pods “K-Cups” and its flavours include “Dunkin’ Donuts Dunkin’ Dark Roast.” The elite, European, espresso-only identity of Nespresso helps explains why its coffee pods account for only 4% of US pod sales versus Keurig’s 57%.

Keurig can be confident that its US market leadership is intact. Despite the mixed reaction to its newest systems, it continues to supply hundreds of flavours of coffee pods to over 20 models of coffee machines – all catering to Americans’ preferred way of drinking coffee.

But Keurig now faces a stronger challenger in its home market: Nespresso.

Nespresso released the VertuoLine coffee maker in the US around the time that Keurig entered the UK market. The VertuoLine makes both an 8-ounce filter coffee and an espresso in the same machine – helping to justify its $300 price tag. Catering to Americans’ taste for brewed coffee and also the occasional cappuccino, the VertuoLine is aimed like a fusillade of cannons against Keurig’s market share.

VertuoLine is aimed like a fusillade of cannons against Keurig’s market share

Nespresso’s launch of the VertuoLine was glamorous and media-savvy, rather like George Clooney. It was the opposite of Keurig’s quiet entry in Europe. This machine, Nestle stated, “was the most important innovation breakthrough for Nestle Nespresso since the invention of portioned coffee in 1986.”

“Designed to meet the tastes and preferences of the North American consumer,” the VertuoLine was such a “breakthrough” because it allows Nestle to capture a bigger share of the US coffee-pod market, which is the biggest prize of all. Sales of coffee pods reached $4 billion in 2014, a 32% gain on the prior year, according to data from Euromonitor.

“Pods remained the major growth driver in the US coffee market in 2014, as the convenient coffee category continues to captivate consumers,” Euromonitor analysts note. “Fresh ground coffee pods have seen colossal growth from the popularity of the Keurig brewing machine.”

The rivalry between Keurig and Nespresso is heating up, as both companies explore ways to take market share in their rival’s home territory. Their competition, however, is not a zero-sum game. Demand for capsule coffee machines is surging in Europe, the US, and in cities around the world, accommodating multiple brands in each market.

More powerful than any brand is the underlying driver of this demand. Fresh-packed capsule coffee machines are the best system yet invented for consumers to enjoy their daily dose of coffee in the comfort of their homes. The machines standardize the delivery of high-quality roasts, making coffee not only convenient to make but better tasting.

Nespresso

Nespresso

The threat to Nespresso and Keurig is not so much the destruction of one company’s market position by the other. Rather, it is the prospect of a new platform that delivers high-quality coffee in an even more efficient way. “There’s definitely a trend toward capsules, but ultimately the end goal is higher quality coffee and more coffee,” says Jeffrey of Allegra Strategies.

Coffee connoisseurs at the top of the market, he says, are graduating out of capsule coffee systems. They want something just as convenient – yet more powerful. “The problem is that those capsules don’t have enough coffee in them. If you get a taste for that lovely flat white that they make for you in your favourite café, you’re drinking 18 grams of coffee. The capsules only carry 7 or 8 grams. People are saying: ‘It’s not strong enough!”

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