Keurig Case
Keurig Case
Keurig Inc. has been profitable and popular in the office coffee
service (OCS) market since the B2000 brewer in 1998. They continue
to expand their relationships with roasters, resulting in the
largest variety of single-cup system coffees. In 2002, Van Houtte
Inc. purchased stock, resulting in nearly $10 million to launch the
at-home single-cup system. This system differentiates itself from
other brewing systems because of its convenience, easy clean-up,
and variety of high-quality K-Cups, with over 75 flavors produced
by five roasters. For each K-cup sold, roasters paid Keurig a
royalty of $0.04. The variety of flavors is important to compete in
a market of gourmet coffees, like Starbucks; only Keurig focuses on
creating a consistent flavor every time outside of the coffee shop.
Keurig quickly penetrated the OCS market, shipping over 33,000
brewers, and over 340 million K-Cups by roasters, by 2002. The 180
Keurig authorized distributors (KADs) covered a network of offices
in North America, placing brewers, costing them $500-$1,000, into
offices free of charge or for a low monthly rental, and selling
K-Cups which cost $0.25, to managers for $0.40-$0.50 in order to
make a profit.
The value of the OCS market to Keurig is less than the value
that the KADs provide through their services, research, and network
of consumers. KAD satisfaction is more important than worrying
about the office managers when deciding between the two-cup or
one-cup system for the individual markets. Keurig should implement
the one-cup system but accommodate the pricing so they do not take
market share from the office market. This can be accomplished by
pricing the K-Cups the same in both markets, so office managers
wont purchase them directly from Keurig, reducing KAD profit, and
it will reduce likelihood of theft in the office. In the future,
retailers can purchase through KADs or directly, either way Keurig
gets $0.04 royalty per K-Cup. Keurig should not invest in the KAD
referral program but still use the office environment to promote
at-home purchases. With the price accommodation, the KADs should
not feel threatened by the promotion.
In the at-home market, for the heavy gourmet coffee drinker, the
B100 Keurig coffee brewer is the highest quality, fastest, and most
convenient brewing appliance because it results in a cup of coffee
ready in 30-seconds with the greatest variety of fresh, gourmet
flavors. The key qualities of the B100 are similar to the office
market appliance: it makes coffee quickly, has no waste, minimal
clean-up, and a variety of flavors. Keurig is capable of capturing
market share from other gourmet coffee makers by targeting the
upscale, whole-bean type of consumer; a growing segment due to the
popularity increase of whole-bean coffee. The target segment size
now is 15 million gourmet coffee drinkers that are likely to
purchase the product, including Keurig-aware and Keurig-unaware
consumers (Exhibit 4).
Keurig should create a luxury good, more-for-more positioning,
so they can charge premium prices to the heaviest, most valuable
drinkers. The heavier drinkers have a higher willingness to pay for
the brewer and will purchase more K-Cups. Based on market research,
the brewer should be priced at $199. Although there is no initial
profit, the lower price will acquire more lifelong customers that
will continue to purchase K-Cups and increase the total future
profit (Exhibit 1). K-Cups should be sold for $0.50, resulting in a
$3.3 million profit in the first year through direct sales alone
(Exhibit 2). This model is a mild razor-razor blade strategy; where
the pricing of two compatible goods is higher for one good to make
up for the discounted price of the other (Exhibit 6). This is also
how KADs profited from sales in the OCS market.
Keurig can price the K-Cups higher to show higher quality and
compete in a separate market from the other single-cup brewers.
They compete with the gourmet coffee shops that also offer
more-for-more propositions, rather than brands such as Salton or
Sara Lee, which are releasing lower-quality single-cup systems at
lower prices. It is expected that these companies, and possibly
P&G, will use mass-channel distribution of brewers and pods.
Although Keurig does not have the resources currently to launch its
B100 brewing system through the retail channel, in the near future
they will want to penetrate the retail market to increase awareness
of their product but will not need to compete with the lower priced
systems. Traditional distribution of at-home coffee has two
sources, one for brewers and one for coffee. Since Keurig has
exclusively compatible products and competes with specialty coffee
stores, they should create their own store-front through the
e-commerce-enabled website to sell both the brewer and K-Cups. They
shouldnt focus on rushing into the mass-retail channel in the next
6 months because their sales will not be affected significantly by
other single-cup brewer systems. The online store should be the
priority to create the pioneer image and will allow for maximum
profits from K-cups (Exhibit 2).
Market research is needed to track the success of the online
store. Keurig should monitor which products are purchased, how many
are purchased at once, and the demographics of the typical
consumer. If they figure out the demographics of their most
valuable online consumer they can decide what approach to take when
entering the retail market; whether they want to go into the
mass-channel distribution or the more specialized retail stores. A
recent trend in gourmet coffee sales is the transition from upscale
outlets to the mass-retail outlets.
Keurig can promote this B100 product and K-Cups online as a
pioneer company to the upscale gourmet consumer through
advertisements, they can also use the roasters. They can also
increase their reaction rates with other promotional ideas once
they enter the retail market. (Exhibit 5).
Overall, the online store should be created for the September
launch. The cost of the e-commerce-enable Web site is unknown, but
it can be assumed that the $10 million acquired from Van Houtte
Inc. will cover the initial costs and maintenance. If costs exceed
that, they can increase spending money for advertising and
promotion by taking advantage of their close relationship with the
roasters, especially GMCR and Van Houtte Inc. As shareholders,
their revenue is directly affected by Keurig brewer sales. More
market research would be necessary to prove the effects of an
increase in brewer sales on the increase in K-Cup sales in the
at-home market. If proven to be significant, GMCR might provide
working capital for the company instead of just equity through
stocks. Keurig should try to enter the retail market after the
first 6 month period with help from roasters for advertising. The
initial profit loss will be compensated for in K-Cup sales and the
retail market will increase the target segment through promotion
and increasing awareness, relying less on the KADs (Exhibits
3&5). This will result in less competition between the OCS
market and at-home market, reinforcing the one-cup system.
Exhibit 1: Target Segment Purchases Assumption 1: There are 20
million gourmet coffee drinkers and all gourmet drinkers have
similar demographics - similar to whole bean consumers, up-scale
coffee drinkers.
Assumption 2: From previous market research, assume that 75% of
the total gourmet drinker segment would be likely to purchase the
proposed Keurig B100 system.
Therefore: 20 million * .75 = 15 million gourmet coffee drinkers
likely to purchase product
Assumption 3: Assume the 1 million consumers Keurig was focusing
on in case are Keurig-aware - Realistic because if there have been
33,000 brewers sold in OCS market converting people into
Keurig-aware customers in a given office and therefore increasing
their likelihood to purchase because they have seen the product
demonstrated in the office environment.
Assumption 4: Assume the other 14 million consumers are
Keurig-unaware
Assumption 5: Through promotion and roaster advertising, assume
to capture 6% of Keurig-aware consumers and 1% of Keurig-unaware
consumers at a brewer price of $199 or more(from previous market
research)
Assumption 6: The cost of K-Cups would not affect these
purchases
Therefore: Total Eventual Purchases via online website from
current target segment:
Aware Purchases: 1 million * .06 = 60,000 brewers
Unaware Purchases: 14 million * .01 = 140,000 brewers
Assumption 7: Assume they are online purchases on Keurig
website, no retail margin
Assumption 8: Assume cost of producing a B100 was reduced to
$200 and approximate profit per appliance is $0, resulting in no
initial gain
Conclusion: Need to sell K-Cups in order to make a profit at a
realistic premium price (Brewer, $199). Even though they are not
making an initial profit they are following a model like the KADs;
they installed brewer for free, or for low monthly fee, after the
initial $500-$1000 cost and sold the K-cup at a higher price to
compensate and make a profit in the office setting.
Exhibit 2: K-Cup Consumption and PricingAssumption 1: Assume
roasters would be willing to sell their K-Cups for distribution via
online Keurig store for a cost of $0.25/cup, same as KADs to
eliminate competition between the two markets.
Assumption 2: Assume roasters would still pay a $0.04 royalty in
both markets
Profit to Keurig/ K-Cup: (Price - Cost) + .04
Therefore: price of $0.50 -- Profit= (.50 -.25) +.04 =$0.29
Assumption 3: Assume that if K-Cups were sold at $0.50, they
would follow same trend as predicted in market research for the
target segment of gourmet coffee drinkers likely to purchase
product (15 million)
Therefore:
At $0.50:
16.7% of 1-cup drinkers would be willing to pay = 2.5
million
30.7% of 2-cup drinkers would be willing to pay = 4.6
million
Assumption 4: Assume 2-cup drinkers include the aware and
unaware customers that would be the most likely to purchase the
at-home system in the first year and assume that we capture 3%
directly on our website. Realistic because the original plan
forecasts 20,000 shipments in the first year; 66% of sales expected
to be direct Keurig sales activities.
Therefore:
Price of Brewer ($199)
For 2-cup drinkers, 10.1% would be willing to purchase a brewer
priced over
$130 = 465,105 willing to purchase
465,105 potential consumers * .03 = 13,953 brewers sold through
website in the
first year (market:18 million purchased annually)
Given: Average consumption is 2.25 cups a day
Therefore: Profit per brewer in K-Cups (Year 1):
13,953 brewers * 2.25 K-Cups/day * 365 days * $0.29/K-Cup = $3.3
million profit in first year
Conclusion: From online-sales only there will be a $3.3 million
profit in the first year to the realistic proportion of the
targeted segment. In office market with KADs, Keurig profit in the
fifth year = 125 million K-Cups * .04 royalties = $5 million, not
much larger. It will expect to increase with awareness, and as the
number of brewers purchased increases. If it reaches the totals
predicted in Exhibit 1 with all else equal, profit from K-Cups
would equal: 200,000 brewers * 2.25 K-Cups/day*$0.29/K-Cup =
$130,500/day.
Exhibit 3: Retail Profit
Assumption 1: Assume the rest of the forecasted 20,000 brewers
were sold through retailers instead of KADs. Resulting in
approximately 6,000 brewers at the retail price of $199; the costs
of brewer remains the same, therefore there is a deficit of -$100/
brewer for Keurig.
Assumption 2: Since we want compatibility - but dont want to
lower profit on K-Cups, we can sell K-Cups solely through our
specialty store. Consumer must purchase online for $0.50. Profit
for Keurig =$0.29/K-Cup
Assumption 3: Consumers drink 2.25 cups a day on average
still
Therefore: -$100 *6000 brewers = $600,000
Break Even: Days of coffee consumption to BE = 600,000 / (6000
brewers *2.25 cups/day
*$0.29/cup) = 153 days
Approximately 7 months for costs to be covered, not including
the online profit.
If K-Cups were sold through retail market with .5 retail margin,
Keurig profit/K-Cup would be $0.04 and break even would be:
Days = $100/ (2.25 *.04) = 1,111 days = approximately 3
years
BUT Assumption: Behavior of purchasing K-Cups and brewers would
increase with easier accessibility in retail stores so profit would
take less time in reality.
Conclusion: Keurig should penetrate retail market to increase
sales, but use promotion to keep the K-Cup sales online even if
they are offered for sale in stores because that will allow for the
fastest and greatest profit gain. Which particular retail market
has to be determined through market research.
Exhibit 4: Percentages from previous market research (Next
page)Gourmet Coffee Drinkers% Interested % Likely to purchase
20 million88%75%
#15 million: Aware =1 million
Unaware = 14 million
Exhibit 5:PromotionPotential CaseOptimal Case
Option 1: Market discounted brewer to the 12,000 OCS market
users: Brewer for $149 if purchased directly on online-store.
Costs: Market directly through emails - little to no cost
Benefit: Gain loyal customer and increase K-Cup sales
*First 6 monthsIf Reaction Rate = 20% in first 3 months
Brewer Sales = 2400
Profit per brewer: ($149-$200) = -$50
Profit per K-Cup: 2400*2.25*.29= $1566/day after three months
from this alone
Reaction Rate = 50% in first three months
Brewer Sales = 6000
Profit per brewer = -$50
Profit per K-cup = $3915/ day after three months
Option 2: Give discount coupon with retail-store brewers for
online K-Cup purchases
Cost: Distribution, covered for brewers
Benefit: Takes away retail margin for K-Cups when purchased
online directly
*After first 6 monthsReaction Rate = 10% of the 6000 purchases
use coupon
Assume new profit= $0.20
K-Cup profit: 600*2.25*.20 = $270/day
Compared with retail K-Cup Profit: 600*2.25*.04= $54/day
Reaction Rate = 50% use coupon
Assume new profit = $0.20
K-cup profit: 3000*2.25*.20=$1350/day
Compared with retail K-Cup profit: $270/day
Option 3: Demonstration in retail stores set-up next to Keurig
displays
Cost: construction
Benefit: Increase likelihood of purchase Increase by 70%
Positively affect sales
Convert more unawares to aware
*After first 6 monthsIncrease by 90%
Positively affect sales
Convert more unaware to aware
Exhibit 6: Razor-razor Blade Example: The cost of a video game
consul might result in an initial loss for the company, but the
continuous purchase of games, priced higher, results in overall
profit and consumer loyalty because they have two exclusively
compatible products.11
