by KJ Fallon
Another person familiar with Keurig’s expansion, although he was not part of the development team, is Jeff Hovis, who was the director of Business Development at Product Genesis at the time.
Keurig partnered with regional coffee roasters who already had a presence in their local markets, Hovis notes. These partnerships with regional roasters were the way for Keurig to get the attention of the big national players. So while Green Mountain Roasters was the obvious first partner and investor, with coverage in the Northeastern States, they realized that they could only provide so much market access. So they allowed Keurig to pursue other regional players like Van Houtte in Canada, Caribou in the Western United States, Tully’s on the West Coast, Diedrich in the Rocky Mountain region, and Timothy’s in Ontario Canada.8
An engineer who worked on the commercial brewer even before Product Genesis came onboard, Rick Beaulieu was one of the original people Keurig hired to work on the design. While there were two basic arms of activity, he said, one being the brewer and the other the packaging line—he ended up working on both—the brewer was his primary responsibility. He was involved in redesigning the original prototype into what became the B2000.9
There were, understandably, difficulties along the way. As with most start-ups, there was the challenge of getting everything done by a specified date. Product development is problematic when it comes to a timeline because it really does not lend itself to a predictable schedule. Unforeseen issues can come up. “You’re struggling to overcome these problems that aren’t really clear when you first discover them,” Beaulieu said, “and you don’t exactly know what the right answer is until you’ve actually tried and tested it, etc.”
At the root of everything—because of the nature of the business—is that those who have a financial stake don’t really care about problems; they just care about having the product ready by the date they were promised. Another element of this particular project that was significant was the disposable component that had to be consistently manufactured.10
And the brewer had to accommodate both: “The brewer and all its variants have to accommodate all the variations that can come out of the packaging line.” This was the kind of design problem that Keurig’s early developers had to wrestle with and manage.
Some pieces of the puzzle that were especially complicated were getting the brewing time as short as possible so that no one waited too long for their coffee, as well as preventing carryover between different coffees, particularly complex if somebody is trying to brew a flavored coffee and the next person wants regular coffee.
Precise temperature control was critical to getting a small amount of coffee to brew properly in a fast timeframe. Engineering tests were performed as well as quite a few tests to find the balance between brewing coffee and creating a successful and fast single serve.
To ensure that there was no carryover of flavors from one brew cycle to the next, in the original Keurig brewer, an air blast occurred between servings. It was like a slug of air clearing out the line so that fluid would not continuously sit in the line.
The number one priority for the first commercial Keurig brewer was that it had to brew coffee fast. There was a lot of perception testing with potential users to get a sense of “Is this brewing fast enough to be credible? Will somebody wait this long for a cup of coffee rather than pouring it out of a pot?” Getting that cycle time down to what was within people’s perception of “That’s a reasonable amount of time to wait for a cup of coffee” was critical.
The original B2000 was an amazingly durable product. Hovis says they actually had that unit in their office up until about 2013, so the machine was about fifteen years old.
Something that still stands out in Hovis’s mind is that no one had a clue how big single-serve coffee would be: “The original concept was ‘Oh, could we knock off office brewers’ and in a big office environment, people will pay for this.” People in the office wouldn’t have to think about how long the pot of sludge that once was coffee was sitting on the burner. Office workers could have coffee that was always fresh, no matter what time it was. The idea that single-serve brewers, and Keurig brewers in particular, would get to the point of being a major consumer appliance and that a huge fraction of the population would get their coffee this way, was pretty much inconceivable. Product Genesis was not involved with the manufacture of the consumer brewer.
Money
Finding investors to fund the operation was not easy. According to Dick Sweeney, the operation was self-funded from 1993 until 1995. They had an initial patent for the K-Cup so that gave them something tangible to bring to investors along with prototypes that sometimes would work and sometimes would spill hot water all over conference room tables.
But they weren’t getting the investors they needed to fund the new product. Things were getting tense, with money drying up and an uncertainty about the future of the invention growing, no matter how innovative it was.
And it wasn’t for lack of trying or commitment. They took the product on road shows, not knowing whether the prototype pods would brew a stellar cup of coffee or a cup of coffee grounds-laden liquid, or whether the pods would rupture and leak all over the furniture of the venture capitalists being courted. They were met with a lot of negative reactions—they were told it would never take off, that no one would buy it.
At the eleventh hour in 1994 they found an investor, the Food Fund, and the very long slog resulted in Keurig, the company that set the standards for the single serve with their brewers and K-Cups. What led the first investor to invest in the nascent single-serve coffee start-up? John Trucano was with Food Fund at the time. He said that the main thing was that most people were dissatisfied with their office coffee—it sat on a burner all day and people could not get what they wanted, a good-tasting, keep-me-going single cup of fresh coffee. He thought that because each person could have whatever individual type of coffee they wanted, this made a lot of sense. He hadn’t realized all the technical hurdles that had to be overcome, and it was not easy.11
But Trucano knew a product like this had what it took to do really, really well. “I think the main thing was I just talked to enough people [who] were very unhappy with their office coffee,” he said. “This was about the time when Starbucks and Caribou and all these were developing these stores with gourmet coffee, and more and more people were stopping there and bringing a cup into their office rather than having the office coffee that they didn’t like.”
Trucano mentally calculated what people were paying for a cup of coffee at gourmet coffee shops. He figured that more and more people were paying $1.00, $1.50, and up for a cup (at the time . . . that would seem like a bargain now!) of Starbucks to bring to the office rather than drink a free cup at the office because they weren’t happy with the quality of the office coffee. So he reasoned that if this coffee brewer could really make a premier cup of coffee it made sense that it would do well.
Quite a few unexpected and unforeseen issues regarding investing came up with this developing product. For instance, according to Trucano, the two biggest hurdles were finding an engineering company to design a machine that could produce K-Cups at high speed. The first company that they contracted with did not work out. Trucano and Sweeney found a company in Minnesota that designed a machine that produced one hundred cups a minute. “It really took a combination of finding a machine that could make these K-Cups at high speed,” Trucano said, “and then also find all the intricacies within the brewer to make sure that we could make the brewer work, and this took several years.”
As to how they found a manufacturer that could handle churning out a high number of K-Cups at a time, Trucano says that this manufacturer had made a packaging line for a company that he knew very well in the microwave popcorn business, and so he thought they would be able to overcome the engineering hurdles to quickly make a large quantity of cups. Trucano mentioned that he and Sweeney talked to them about the need to put a filter paper inside the cup, sonic weld it
to the top, put coffee in it, and then put a top on it. “We explained it to them, and they said, ‘Yeah, we think we can do that. It will cost you $750,000, but we think we can make one that can do a hundred a minute.’ It took them about a year, but they were able to do it. Without that, we were dead.”
It would take years and a lot of money pouring in to get the whole single-serve brewing system just right. To give an idea of how difficult this process was, below is an overview of the money expended prior to the company earning any revenue:
1994—$50,000
1995—$1,000,000
1996—$1,000,000
1997—$1,000,000
1998—$4,000,00012
Trucano said that the initial $50,000 was for legal fees to file patents on the brewer process and the K-Cup design, and also a little money for the two founders to live on, since they had invested everything they had into the start-up. “These patents were issued in 1995 and were good for seventeen years until 2012 when competition was allowed to compete in the K-Cup business.”
They had limited funds and had to rely on other investors to help them or they could never have gotten this done, Trucano said. There was a venture fund in Boston that co-invested with them, but, according to Trucano: “The Food Fund itself only put about a million dollars in, but we had contacts in Minneapolis that put another seven million dollars in.”
The logistics involved in putting together the whole package of the brewer were complicated. There were a few times Trucano and the Food Fund wondered about their odds of success. He said that there were times when they came pretty close to walking away from the whole thing. At the end of 1996, they still really didn’t have a brewer that worked, they didn’t have a K-Cup line that worked, and as a group they were over two million dollars into the deal. “But I think because we still thought there was a huge potential, we decided to give it another round of financing,” Trucano said. Trucano even went along on some of the early road shows to drum up interest in this new way to make coffee.
From Trucano’s standpoint, Food Fund’s investment in Keurig at such an early stage was probably the earliest point at which he had ever invested in a company. Things were really in the research and development stage.
It was tough going at the very beginning. One time, according to Trucano, the team went to Minneapolis for a demo for some potential investors there. They put the K-Cups in the machine and the cups blew up. It turns out that on the airplane trip to Minneapolis something happened with the pressure in the K-Cups so they literally exploded in the brewer. Every time they thought they had one thing worked out, Trucano remembered, something else would crop up.
But when they finally had the office brewer ready to go, it quickly became the number one office single-serve coffee brewer. People liked the fact that they had a brand name and that the K-Cups contained well-known and well-liked named coffees. In the Northeast the K-Cups contained Green Mountain, in the Midwest, Caribou, all names of coffee purveyors that people trusted and coffee people would want to drink. the K-Cups contained exciting for coffee lovers who worked in offices.
People in offices would love and welcome a great cup of coffee at work. But would convincing office managers to install the Keurig in the workspace be an easy or hard sell? The convenience and apportionment of brewing using the single-serve system was going to cost more. That was just the way it was. Helping the decision makers in the offices understand and accept that idea was a bit of a challenge. The team had to convince office managers that they should pay forty cents for a cup of coffee, when they were making twelve-cup pots that cost between a nickel and a dime per cup, Trucano explains. But because there’s a lot of waste and a lot of cleanup with the traditional office coffee setup with glass coffee pots and loose grounds, the team was able to convince the people in charge of purchasing the coffee systems that paying forty cents was not that much because they were paying five to ten cents for a bad cup of coffee, and probably half of it was being thrown out.13
Trucano said that taking the Keurig to the next level, to the home environment, was really a decision that was made because a lot of people in the offices said they wanted to have the same appliance for their home. This meant reengineering the brewer yet again, since it had to be made smaller because it was too big for most kitchen counters. They contracted with a firm in Boston to downsize the basic machine into one that could fit on a home counter.
Getting the Keurig system out in the consumer marketplace was difficult without distribution in big stores like Walmart, Target, and so on. Initially, remembers Trucano, they relied on placards set up near the Keurig machines in the offices that said, “If you want one of these for your home, go on Keurig.com and you can order the machine and then you can also order the K-Cups.” No one wanted people to abscond with K-Cups from the office and take them home.
CHAPTER 6
The Nascent Keurig and the K-Cup
Nick Lazaris became president and CEO of Keurig in February 1997 and took the company to the next level. Lazaris had been recruited to be the new president and CEO by the venture capitalists who, at that point, owned a controlling interest in the company. The venture capitalists basically told the young company that they would support them for one year to get the product to market. According to Lazaris, the company was five years old at the time he joined it, and had not yet realized success with commercializing the concept of single cup.1
Lazaris said there were two venture capital firms, the larger of the two being MDT Advisors, and the other was the aforementioned Food Fund, the small company focused on food and beverage out of Minnesota.2After the initial investment, there was a second round of investment from the venture capitalists. With this second round of financing, the venture capitalists acquired majority ownership of the company and as such, were not happy with the progress being made toward commercializing the product. When Lazaris was recruited to be the new CEO there were about eight employees at the time.3
Lazaris had been the CEO of the oldest photo frame company in the United States. They sold products that were design sensitive through department stores and independent retailers, so he understood the retail channels. Before that, Lazaris was a VP of marketing with a company called Wright Line, and worked with a sales force, so he also had experience with sales, marketing, and general management in both business-to- business and in consumer products.
Keurig was, on its front end, a business-to-business product that had already been introduced to the office segment for office coffee, Lazaris recalled. From the moment he interviewed for the CEO job, the idea was, if Keurig could make it as the coffee used in the office environment, they would have a home run, and if they could figure out a way to make it into consumer products, they would have a grand slam. So, Lazaris signed on.
There were problems getting it out in the marketplace. The first thing clearly that “had to be done or nothing else follows” was the product needed to be commercialized. The Keurig is, as Lazaris explained, a system product. It’s the combination of a K-Cup and a Keurig brewer, like other system products; i.e., the Nespresso has the Nespresso capsule. This involves three things. It involves a brewer, which can work with a K-Cup and produce a controlled amount of water at a certain temperature and pressure to brew the coffee. It involves the K-Cup itself, and then the third component is the machine that makes the K-Cups. “For a startup to take on those challenges is not an easy thing,” said Lazaris.
Keurig found some outside engineering partners to help the handful of engineers the company had to work on the brewer. They redesigned the product that had been developed to date, as Lazaris explained. “We essentially wrote off, threw away, and started over.”
Keurig hired engineers to work on the new brewer, and engineers to work on the new packaging line. “Those two things,” said Lazaris, “had to come together in twelve months’ time, and of course the K-Cup that was produced on that packaging line had to work effectively with the brewer. Much like the razor-razorblade, you
needed the razorblade to go in the razor, but you needed a machine to make the razorblade. These [were] not easy challenges.”
There was much work to do before Keurig could hope to succeed as a brand and as a company. “Technically, we had a set of challenges that needed to be overcome before anything could happen,” said Lazaris. “That [was] number one. Number two was the business model.” When Lazaris arrived at the company, the business model was fundamentally oriented toward Keurig going after the office coffee market using not only its own brewer but its own brand of K-Cups. Keurig would not only make the brewer and the K-Cups, Keurig would have its own brand of coffee in the K-Cups, instead of a more recognized brand like, say, Green Mountain.
After Lazaris joined the company, he and the management team came up with a different business model. Instead of having someone manufacture the K-Cups for Keurig on a contract basis with Keurig selling them to distributors, they determined that it would be more effective and efficient to have that contract manufacturer be a branded gourmet coffee roaster and take ownership of the product. When the contract manufacturer sold the product to Keurig’s licensed distributors, Keurig would receive a royalty. It was a different structure, Lazaris observed. It eliminated the inefficiencies of Keurig having to handle and own the inventory. Secondly, it also gave them the ability to piggyback on the reputation of the brand of the coffee roaster to introduce Keurig’s technology into the marketplace. It was, he said, “Sort of like a halo effect.”4
Keurig entered the office coffee market on January 19, 1998, within twelve months of Lazaris joining the company. They launched in the Boston area as well as New York, and pretty soon thereafter, they were in the mid-Atlantic states. “That was our focus the first year,” Lazaris said. When the distributors they partnered with would call on potential offices, they could say, “We have this new technology that brews one cup at a time, and it uses Green Mountain coffee.” Green Mountain had brand recognition in that part of the country.