ONLINE BUSINESS

Taking a Niche Player Big-Time

Keurig Inc. has transformed office coffee with its unique, one-cup-at-a-time system. Can it do the same for the at-home market--with machines that cost $250 each?
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One of the basic rules of office life is this: The coffee sucks. It's either too hot or too cold or too weak or too strong. Someone makes a big pot of decaf, while others crave a jolt of caffeine. Or the pot sits on the warmer all day, slowly cooking the liquid into a thick, burnt sludge.

Keurig Inc. is working hard to change that. In 1998, after eight years of development, the Wakefield, Mass., company released an industrial-strength, single-serving coffee machine that delivers a perfect cup of coffee or tea each time. Every day, office workers in the U.S. and Canada make about 800,000 cups of Keurig-brewed coffee. Sales are expected to top $25 million in 2003, up from about $7 million in 1999.

Impressive? To be sure. But despite the countless cups of joe chugged down in cubicles, the workplace represents just a fraction of the overall coffee market. Most coffee--82%, according to the National Coffee Association--is still brewed and consumed at home. Keurig CEO Nick Lazaris longed for a piece of that market. The problem was one of translation. Could his product and business model, which specifically target the office suites of corporate America, compete in the consumer marketplace? Could Keurig really go head-to-head with Mr. Coffee?

Keurig's founders, Peter Dragone and John Sylvan, never really pondered such questions when they launched the company in 1990. After years of drinking lousy office swill, they just wanted a good cup of coffee. Neither knew how to build a coffee machine. But it seemed obvious that if they could design a system that could brew a perfect cup of coffee, one cup at a time, the sky was the limit. They named their company Keurig (derived from the Dutch word for "excellence") and got to work.

Four years later, they secured a patent and came up with a prototype. Two venture capital firms kicked in $1 million and gave the pair a year to prepare a model for mass production. When they missed that deadline, the VCs offered more money but demanded that Lazaris, a veteran executive who once served as chief of staff to West Virginia Governor (now Senator) Jay Rockefeller, be brought on. (The two founders have since left.) The first model debuted in January 1998. PricewaterhouseCoopers was among the first customers and other accounting and law firms soon followed. "These people need to be caffeinated and when they left the office to get coffee, it was lost billable hours," says Lazaris, 53.

Keurig's system eliminates the need to measure either water or coffee--the two things that trip most people up--so it's virtually impossible to screw up. Pressurized hot water is filtered through a small plastic cup, called a K-Cup, that combines both coffee and filter. The company makes money by selling the machines to corporations and licensing its technology to a number of coffee roasters--including Vermont-based Green Mountain, which owns about 40% of Keurig--which pay a royalty fee for each K-Cup shipped. "It's fast, simple, and it does a really good job," says Ken Davids, co-founder of CoffeeReview.com, an online coffee-rating service.

In fact, people liked Keurig's system so much that many of them began asking for a home version; the company has received more than 12,000 such inquiries over the past two years. "I was willing to pay to have one custom-made," says one fan, Gloriana Tardie, who runs P.C. Metals Inc., a recycling business in Bridgeport, Conn., who was wowed by a Keurig machine at a convenience store near her home.

There was no denying that the company had struck a chord, nor that the large, at-home coffee market offered lots of potential. But such a move also posed untold challenges. For one thing, most Americans who drink coffee at home already own a coffeemaker. Consumers interested in trying Keurig's products would have to purchase an entirely new system. What's more, the business model didn't exactly make sense for the consumer market. One of the ways that Keurig was able to gain a toehold in the office market was by selling its machines to distributors who are encouraged to give them away or lease them for a small fee. That made sense because the real money is in the K-Cups. If an office went through 30 or 40 K-Cups a day, it didn't matter that the distributor wasn't making money on the machine. But it couldn't afford to give away machines to home users, who are unlikely to go through more than a few cups a day. Moving into the consumer market would require an entirely new approach to the business.

The Decision

Keurig began selling a consumer model of its coffeemaker in September, marketing the machines to existing office customers. In October, the first full month that they were available, the company shipped about 5,000 home brewers, either directly on the Keurig website or through roasters and distributors, and Lazaris anticipated sales of 20,000 home brewers by year-end. To entice office customers, Keurig is offering them $50 off the price of a home brewer--which retails for $250. The company is also offering all home users $20 worth of free K-Cups (about 40 of them).

Lazaris admits that's a lot to spend on a coffeemaker--nearly four times more than a new single-serve machine released by Melitta in September, for example. Meanwhile, other large companies, including appliance maker Applica, in partnership with consumer products giant Procter & Gamble, are also expected to introduce single-serving systems. Lazaris says he actually welcomes their arrival. "These multibillion-dollar companies will spend a lot of money to educate the mass market," he says. "We hope to piggyback on this and provide an upscale alternative." At the same time, however, Keurig is working hard to introduce a new model that will cost about $150 and be produced in Asia. Keurig's also struggling to solve distribution problems. Currently, neither the machine nor the K-Cups are available at retailers and Lazaris says they are unlikely to be until the price of the machine comes down. "We're talking with a major retailer right now that says if we can get the product down to $149, it will fly off the shelves," says Lazaris. Once that happens, Lazaris hopes to get supermarkets, where the overwhelming majority of people buy their coffee, to start selling K-Cups. To do that, he'll be relying on help from Green Mountain and his other roasting partners, which already have their own stores or space on supermarket shelves.

Of course, ultimately, what Keurig really needs are more enthusiastic customers like Tardie. "Whenever people come to my house, I show off the machine like it's a new piece of furniture," she says. "My friends know that when they come to my house, they get the coffee show."

The Experts Weigh In

Daniel Cox

Coffee Enterprises Inc., Burlington, Vt.
President

Keurig has two big concerns: The price of the machine is well beyond the range of the average consumer and the only way to buy the K-Cups is through mail order--something very few customers are likely to do. It should go to a coffee-producing country like Honduras or Guatemala, make the machine in a free-trade zone, and pay more than the going rate but get the price down to $99. Keurig also needs to get the cost of the cup down because it's about four times more expensive than what the typical at-home user spends.

David Oreck

Oreck Corp., a New Orleans-based vacuum-cleaner manufacturer and retailer
Founder and Chairman

Small companies need to be very careful about taking giant steps. Keurig should spend more time expanding the commercial side of the market before branching out. Since there are some really big players in the coffee business, it makes more sense for Keurig to continue being a niche player. Pursuing retailers is definitely not the way to go--Keurig will lose control of pricing, and the retailers will want a significant margin. What's more, once it's on the shelf with a bunch of other products, it's going to need someone to explain to a customer why its product costs so much more, and that's hard to find at most retailers.

Sanjay Sood

The Anderson School at UCLA
Assistant Professor of Marketing

Clearly, Keurig will get something of a free ride from larger competitors like Melitta and P&G. The problem is that once consumers are educated, they have to find their way to Keurig's website, which without a significant advertising budget is pretty unlikely. Keurig might want to consider pairing with a strong upscale retailer that sells a lot of kitchen appliances, like a Macy's or a Bloomingdale's, and offer it incentives to educate consumers about the product. Whatever it does, it definitely needs to lower the price. It's in dreamland if it thinks it can go up against a big company like P&G with a more expensive product.

Last updated: Jan 1, 2004




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