Coffee for One

by KJ Fallon

  This certainly helped generate tangible interest in the system. “Once we got the door open and the demonstrations were done, we did have a really neat technology that let people enjoy the coffee variety they wanted. It allowed the employer to enjoy the benefits of people staying in the office as opposed to going out to get their gourmet coffee, etc.”

  This was a big part of Keurig’s appeal in the workplace. Sure, having a variety of recognizable and loved coffees available in K-Cups whenever an employee wanted a fresh cup of coffee would help to keep workers more content. But having the single-serve gourmet coffee option right there in the office also meant that workers would likely make fewer trips outside of the office to trek to the closest specialty coffee shop. In theory, both management and employees would be happy. Employees would have access to gourmet coffee right there in the office so they would spend more time in the office, which would please employers. Office managers would also have less coffee preparation mess to delegate for clean up.5

  Keurig’s business model really affected their long-term growth. Keurig became, as Lazaris pointed out, a platform technology for gourmet coffee roasters to be able to offer their coffee into a channel that they really didn’t have distribution in, which was office coffee. The reason they didn’t have distribution is they hadn’t wanted it in the past. Having their coffee available for brewing in the usual office coffee system could leave their brand image vulnerable, as Lazaris explained. Let’s say, for example, that Green Mountain coffee had been available for employees to brew using the old coffee systems. This could leave Green Mountain’s brand vulnerable because when people brewed coffee and left that quarter or half pot of coffee burning on the coffeemaker, the taste of the coffee was ruined. People would then say, “Boy, that Green Mountain coffee doesn’t taste good,” when the reason it didn’t taste good was because it had been stewing into a sludge for hours.

  The coffee rosters wanted to be in the channel, but they didn’t have an effective way of doing it until Keurig came along and made office coffee available for, first Green Mountain and, then, a number of coffee roasters across the country. “That’s how we went after the office coffee market,” he said, “obviously picking the right distributors, training them on how to sell and how to service, all that was very important.”

  There were some problems getting distributors interested in putting the Keurig in offices. Lazaris recalled that the distributors did not like Keurig’s economic model. In the first place, Keurig did not want to give anybody an exclusive. Keurig had a couple of competitors in the market at the time. Keurig was not the first in the offices or in the homes with what was technically a single-serve version. The first was a company called FilterFresh. The FilterFresh system worked with one or two coffee hoppers into which the coffee was poured, and with the press of a button, the machine would meter the coffee into a chamber, provide hot water, and pump the coffee through filter paper, and you’d have a freshly brewed cup of coffee. Lazaris said, “We would call that coffee ‘fresh brewed stale coffee’ because when the coffee’s in the hopper, it gets stale and there wasn’t much in the way of selection.” That passed for single serve at the time.6

  There also was that other single cup competitor—MARS DRINKS™ FLAVIA®.

  They were in the market two years ahead of Keurig with a single-cup system that used a different patented technology that works with packets instead of little cups. The basic concept was the same; pressurized hot water, puncturing a packet, putting that pressurized hot water in the packet to brew the coffee, and pushing it through a filter into your cup. There are some differences though. Flavia’s brewing system prevents cross- contamination of flavors since whatever is in the packet—coffee, tea, hot chocolate—never comes into contact with the machine.7

  So Keurig had competitors in the market already, and those competitors had, at the time, a set of exclusive distributors, meaning there was one in each geographical territory. Keurig went to market with a different idea: a ‘select but nonexclusive’ relationship with distributors. When Keurig launched on January 19, 1998, in New York City, they had two, and pretty soon three, distributors in New York, two in Boston, and two in Rhode Island. “We did not believe that there should be one distributor in any city because we thought the market was too big. Having more than one distributor was good for both distributors because it would help build the awareness of the product. That was number one,” Lazaris said.

  According to Lazaris, the distributors were used to making 50 percent or more gross margin on any coffee product they sold. He said, “With Keurig, their gross margin was more like 33 percent, 35 percent. They said, ‘This doesn’t satisfy our business model.’ To which we responded, ‘When you go to the bank, you don’t take percent, you take cents. If you place a Keurig brewer, you will earn three times per cup what you’re making today. You’ll earn 15 cents a cup instead of five cents a cup. If all you do is place Keurig in offices and don’t increase the number of cups, it’s the same number of cups, you’ll triple your profit. You won’t make 50 percent gross margin because if you did, the price would be too high.’ Of course they set their own prices, but when there’s more than one distributor, there’s a bit of competition and it keeps prices from getting so high there’s no market.”

  Keurig found the right distributors, said Lazaris, and they were generally smaller single-owner distributorships and were more entrepreneurial. They used the Keurig product for new account generation, and they did very well: “As soon as they were making money, other people wanted to be a distributor of ours. In a few years, we were bringing on board regional distributors who covered more than one city and had multiple offices. Probably three or four years after we launched, we were now working with national distributors like Aramark, together with regional and local mom and pops.”

  Over the course of two to three years, Keurig expanded distribution from the East Coast all the way across the United States and then across the border into Canada. New distributors came on board as time went on, including bottled water distributors and office products distributors in addition to office coffee distributors. “There were many ways for people to make money selling Keurig,” he says, “and for office employees to enjoy having the Keurig option. People really did like our product.”

  Then came the dot-com implosion in March 2000, where the Nasdaq dropped 78 percent over thirty months, and a lot of companies started cutting back. Keurig had a good position with a lot of technology companies, and with the dot-com bust those companies were cutting back on employees, as well as employee benefits. Lazaris heard stories about the Keurig brewer starting to be wheeled out of an office and the employees subsequently complaining. The employees felt that since there were fewer of them and they would be working a lot harder, they needed good coffee nearby now more than ever and they wanted the Keurig. Keurig managed to hold their position in the marketplace and came back even stronger as the economy recovered.8

  Not only did the brewer have to be great, but so did the coffee in the single-serve pods. Green Mountain Coffee, which had been lusting after a bigger share in the premium coffee market, invested a 35 percent stake in Keurig in 1996.9

  Summing up, Keurig’s number one challenge was getting the product right. The number two challenge was getting their go-to market strategy right, and the third challenge was training their distributors to go out and sell, and also developing their distribution structure. By their third year, Keurig was a profitable enterprise with great prospects, and that’s when they started to take a good look at the consumer market.10

  A Home Version of the Keurig Takes Shape

  Keurig was getting close to having a brewer ready for home use. While this would be a new market, the idea to get the Keurig into the home had been there for a while. When Nick Lazaris was interviewing with the venture capital firm in late 1996, it was obvious that they had a product that “fundamentally, even though it was targeted for offices, was going to be used by coffee drinkers. Consumers.”
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  There were a few reasons for the expansion into the consumer market. One reason, of course, had to do with the management of the business. But another reason for going over to the consumer side was that it would please the employees of offices that used the commercial Keurig.

  “We always understood there was a consumer market potential,” said Lazaris, “but I’ll have to say that early on, it was clear that significant accomplishments had to occur before we could ever get in the consumer market. One of them was the size and cost of the brewer.”

  The original Keurig commercial brewer cost over $700. They knew that a brewer needed to be, at most, a couple hundred dollars in the consumer market, so they needed a revolution in their thinking for a different generation of machine. Then they needed to figure out how they were going to create consumer awareness and traction so that people would try their product and then buy the brewer for home use. Would consumers be willing to pay 50 cents or more per cup of coffee to have fresh brewed coffee at home? Coffee in the office is generally free, so these were really significant hurdles.12

  When they were ready to move into the consumer market, Keurig needed to get a brewer manufactured and have the retail cost be around $150. At that point there were a few well-heeled competitors, including Phillips’ and Sara Lee’s Senseo, for instance, which used a plastic-free coffee pod in its brewer and was launched in the Netherlands in 2001. Philips made the brewer while the coffee pods were distributed by Sara Lee.13

  The concept of single cup was already present in the commercial market for filtered coffee, and already present in the consumer markets for espresso, and then came the Philips-Sara Lee Senseo system, which followed the initial launch in the Netherlands with promotion in Belgium, France, Germany, Austria, Denmark, United Kingdom, United States, and Australia, in that order.14 A lot of US companies kept a close eye on the Senseo, which came to the United States in 2005. “What happened,” said Lazaris, “was the product was very well received by consumers in [the Netherlands], and the structure that Douwe Egberts [Philips’ coffee brand] and Sara Lee set up for pod distribution through grocery made the pods easily available.”

  So the Senseo had easy availability of the pods, the price of the brewer was agreeable to consumers, and people liked the machine. The launch of the Senseo attracted a lot of attention in the US market. Procter and Gamble started looking at developing a pod system for the United States and in 2004 launched a single-serve brewer, Home Café, which used soft pods not unlike the Senseo’s.15 Sara Lee and Philips, in the meantime, focused on European distribution.

  The idea for single-serve coffee was so well-timed that a lot of other companies jumped into the market for making pods. The way it usually works is that the company has to sell the coffee brewer at a loss but make it up by selling the pods for the brewer. In any case, the market for single-serve coffee was getting a little messy. While the Senseo grew very quickly, the brewer wasn’t launched in the United States right away. The first single-cup pod coffee machine for home use in the United States was brought out by Salton.

  Salton Leads the Way

  Nick Lazaris views Salton’s release of a single-serve brewer as a good thing, a very good thing for Keurig. Why, when it would seem that Salton beat Keurig to the single-serve punch? If it wasn’t for Salton, he explained, Keurig could never have opened those doors with the retailers; Keurig was just not that known. But when somebody like Salton says this is the next big thing and they are behind it, and they can point to its success in Europe, that is different. Salton also told the retailers that this appliance would have to be marketed differently. “They could say that to the people who could make the changes in those retail organizations so as to support the launch,” he pointed out.

  When Salton decided to bring out a single-cup brewer in the United States, recalled Lazaris, their people were able to go to the senior levels of retail executives of the big chains to talk to them. They could tell the top executives that this was the next wave and that they could be a partner but they would have to do something a bit differently than they’d done before, as explained earlier. It was a system and had to be promoted and sold as a system.

  In February of 2004, Procter and Gamble announced that it was launching its own pod system called Home Café, also to be sold to retailers.16 So, remembers Lazaris, the retailers were going to have two lines of single-serve brewers to choose from. But wait. There’s more. Sara Lee and Philips were bringing Senseo to the United States in the fall of 2004.

  So by the time one year had elapsed, three different pod systems were in the United States, and then there was a fourth—Keurig. Keurig’s head of the at-home division went out in January 2004 knowing that Salton was in the market, and knowing that Procter and Gamble and Sara Lee were coming, Lazaris said. He called on the retailers and told them that since they’d already started selling single cup brewers, they must believe that it was going to be a big industry. The idea was to convince the executives at the big stores to go with Keurig instead of their competitors.17

  Lazaris said they explained to the heads of the retail outlets that while stores were probably already considering adding one or both of the Home Café and Senseo systems, and Keurig’s brewers cost two or three times as much as the competitors and their coffee cost twice as much, they really ought to try Keurig too, because Keurig was different. Keurig had a different concept that provided a better cup of coffee that a significant percent of the store’s customers would want to upgrade to. They told the heads of the stores that every time they sold a Keurig brewer for $149, they would be making three times the gross profit dollars that they made selling a Salton brewer at $49. And the stores would be making twice as much with the coffee. They asked, “If you could just give us some stores to test in, in holiday 2004, and allow us to demonstrate our machine, you’ll see that Keurig outsells everybody else.”

  Keurig was in two hundred stores of ten retailers in 2004. This was the third generation of the brewer that used a new set of patents to lower the cost. “While we did sell at a loss, it was a small loss,” Lazaris said. They launched the product in November 2004 at select retailers, and they supported the introduction with in-store demonstrations. “The product was high quality,” he said, “so anybody that saw the packaging or better yet, touched the machine, saw the machine, saw the finish, saw the fit, let alone tasted the coffee from the machine, saw that it was superior to the alternatives and we sold through very well. The retailers liked us.”

  By the next holiday season, Keurig was in 3,500 stores.

  That is when Kraft’s Tassimo system was launched in the United States. The Tassimo system used fully encapsulated pods similar to what the Keurig used, albeit of a different shape. While the folks at Keurig might say that the coffee pillow-shaped Senseo pods were all a bit messy and allowed for taste contamination, and so on, the same could not be said of the Tassimo system. The Tassimo also offered options for making lattes and cappuccinos using the pods. “Of course we were concerned about that because they had a portion pack that had an irradiated liquid milk in it,” said Lazaris. In the end, consumers in the United States seemed more interested in having a large variety of coffees. Keurig offered sixty K-Cup varieties when they launched. Over the course of the next couple years, that increased to hundreds.

  Since there were several different types of single-serve brewers when Keurig brought out its commercial Keurig, consumers were already aware of single-serve options because of all of the advertising from the other brands. Said Lazaris, “Our strategy was, let our competitors educate the public and get them in the store, that’s where our demonstration and our packaging, and the look and feel of the product need to stand out so they buy from us, and we capture those customers.”

  An important part of the strategy of the single-serve brewing system is, of course, the coffee. Sara Lee’s and Procter & Gamble’s coffee pods were available in thousands of grocery stores across the country. Since that is where people shopped for
coffee, it seemed like a sure thing. They already had the channel for the coffee. They just needed to sell a huge number of machines through the retailers to create demand to pull those coffee pods off of the supermarket shelves.18

  Keurig at the time had no grocery store relationships, so they were able to tell the department store retailers that not only were they going to make money selling the brewer and the initial set of K-Cups, but people would have to keep returning to their store to buy more K-Cups. Keurig was offering K-Cups on the Internet as well, particularly varieties that retailers didn’t offer.19 As Lazaris said, they told the retailers, “You’ll have long term benefit from K-Cups.” He continued, “But nobody realized just how big a business the K-Cup business would be for department and specialty stores. Retailers like Bed Bath & Beyond did a huge business in K-Cups.”

  This meant that in the beginning Keurig did not have to be concerned about having K-Cups in thousands of stores; they just needed to have the K-Cups in the stores that sold the brewers so people always knew they could buy them there, or they could go on the Internet and buy directly from Keurig.20 “That allowed us to more gradually grow our in-store base, which we did, to get to the tipping point that then starts to justify grocery store distribution, which we watched,” Lazaris said. “We knew the zip codes of the people who bought our product and who shopped with us.”

  Green Mountain acquired Keurig in 2006 and was well positioned to begin putting K-Cups into stores where the company felt that the population had enough machines to make the risk worthwhile, which it did. “We had an ability to grow more slowly and deliberately. It didn’t have to be a grand slam in the first inning of the game,” Lazaris said.