Keurig At-Home Case Analysis

MKTG 621
Summary

In order to successfully enter the at-home market, Keurig should use the one-cup system but revise its
channel of distribution. Keurig should provide incentives to Keurig authorized distributors (KADs) to
push the at-home system and advertise to gourmet coffee drinkers who drink more than one cup per day.

Situation Analysis

Context
Keurig is aiming to leverage its success in the office coffee service (OCS) market to enter the larger and
more competitive at-home market. In 2000, the at-home gourmet coffee market was $3.1 billion and the
away-from-home gourmet market was $3.9 billion. Keurig is currently evaluating a one-cup system
versus a two-cup system, as well as pricing strategies for each. While Keurig has already invested
$700,000 in the development of the two-cup system, the roasters prefer the one-cup system. Changing
back to the one-cup system at this point, however, would require Board approval and likely delay the
system launch.

Company
Keurig was founded in 1992 to develop a brewing system that would allow coffee lovers to brew “one
perfect cup of coffee at a time.” With its single-portion pack and new coffee brewer, the company
quickly penetrated the single-cup brewing market, attaining a leading sales position. Keurig is owned by
three majority shareholders: Green Mountain Coffee Roasters (GMCR), Van Houtte, and Memorial Drive
Trust.

Collaborators
Keurig relies on a multi-roaster strategy, which is selective but nonexclusive. Currently, Keurig is
partnered with five different roasters, two of which are majority stockholders of the company. The
roasters act as manufacturers of the K-Cups, and a network of 180 KADs work directly with office
managers to place and maintain brewers and K-Cups in their offices.

Competition      
There are two key competitors in the away-from-home market, Filterfresh and Flavia, and a variety of
other competitors in the at-home market, including Procter & Gamble, Kraft, Salton, Sara Lee and Nestlé.
These players have deep experience in the consumer market and well-established mass market
distribution channels. A key part of Keurig’s strategy is to be a first entrant in the at-home market;
Keurig believes a large number of its competitors are preparing to enter this market and is anxious to
quickly launch its new system.

Consumers
While Keurig’s current consumers are office drinkers, its new at-home system targets regular drinkers of
gourmet coffee, including coffee from whole beans, gourmet roasters, and premium cafés such as
Starbucks. Market research shows there is a strong appeal for an at-home system and a growing
popularity of whole-bean coffee among these consumers. As of 2003, an estimated 20 million Americans
were regular drinkers of gourmet coffee.

Market Size

Exhibit 1 shows the projected size of the U.S. gourmet at-home market and away-from-home market to
be $3.36 billion and $4.22 billion in 2003, respectively.

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Alternatives

Launch the Two-Cup system – Disagree. Launching a Keurig-Cup will result in increased
manufacturing and inventory costs for the roasters, two of which own a significant percentage of Keurig
(GMCR and Van Houtte own 42% and 28%, respectively). Keurig would need to incentivize the roasters
to adopt this strategy either by decreasing its royalties, which its shareholders would not favor, or passing
through increased costs to the KADs, which is likely to cause dissatisfaction. Furthermore, a two-cup
system may also create dissatisfaction among customers if the wrong cup is used in at-home brewers.
While a two-cup system would enable Keurig to maintain increased price control, Keurig can also
achieve this by changing the distribution channel.

Continue with One-Cup system – Agree. Although Keurig already incurred design and manufacturing
costs to create the Keurig-Cup, those are sunk costs. Furthermore, continuing with the single-cup system
is consistent with the roaster partners’ strategy and will reduce manufacturing costs for roasters going
forward compared to the two-cup system. While it will be challenging to convince the Board of this last
minute change, the company will be stronger in the long-term by launching the right products at the right
prices.

Revise Distribution Channel – Agree. We recommend that Keurig revise its distribution channel to
prevent the roasters from selling directly to the KADs. Keurig should purchase K-Cups from roasters at
$0.21/cup (net) and sell to KAD at $0.25/cup in the OCS market. Additionally, Keurig should sell
directly to end-users at $0.54 cents in the at-home market [see pricing strategy in Marketing Plan]. Under
this revised distribution system, roasters and KADs would receive and pay the same amount of money as
before; however, this strategy will enable Keurig to maintain price control [see Exhibit 2]. For example,
if the KADs tried to undercut Keurig’s K-Cup prices, they could simply increase the prices they charge
the KADs, forcing them to raise their prices.

Revise Proposed KAD Referral Program – Agree. A primary target for Keurig’s at-home brewers are
current users of its office system; Keurig already received 12,000 unsolicited emails from office users
inquiring about the availability of a home system. Therefore, having KADs market Keurig’s at-home
product to office users will be essential for success. We recommend that Keurig create an incentive
program for KADs in which KADs receive $15 for each B-100 sale they generate, and $0.04/cup of
coffee sales to those customers for the subsequent 3 years [see Exhibit 5].

Marketing Plan

Segmentation and Targeting: Gourmet coffee sales increased over 40% ($2.2 to $3.1 billion) from 1996
to 2000 and are expected to reach approximately $3.4 billion by 2003. Gourmet coffee drinkers have a
higher willingness to pay and we recommend targeting this segment. More specifically, Keurig should
target Keurig office-users, who are already familiar with the product, particularly the 12,000 users that
emailed the company about developing an at-home system, and serious coffee drinkers (people who drink
2+ cups/day).

Positioning Statement: Keurig should position its brewers and K-Cups as high quality, great tasting, yet
convenient products that offer a selection of coffee unparalleled by competitors. It should position itself
as a convenient, more affordable alternative to coffee shops such as Starbucks [see Exhibit 6] and a
premium brand with better taste and variety in comparison to other at-home systems.

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Product: Keurig’s products offer the ultimate in convenience – quick brewing, ease-of-use and minimal
clean-up. Test users commented that the coffee was consistently great-tasting and 88% of interview
respondents indicated an interest in the Keurig at-home system.

Price: We recommend that Keurig set the retail price of its at-home brewer at $249 [see Exhibit 3]. If it
sets its brewer price at $149 or $199, Keurig would need to generate revenue from K-Cups of $4.8
million and $1.8 million in the first year to offset losses on equipment sales. Alternatively, a price of
$299 alienates many customers, and the higher margin does not make up for the loss in unit sales.

Keurig should set a retail price for K-Cups that is higher than the price office managers receive ($.040-
0.50). If the retail price is less than or equal to the wholesale price, Keurig will be competing directly
with the KADs and office managers will be able to purchase K-Cups online. This could strain the
relationship Keurig has with its KADs and not give KADs a very good incentive to push the Keurig at-
home system. Market research indicates over 30% of consumers are willing to pay over $0.50 for a K-
Cup; therefore, we recommend that Keurig set a retail price of $0.54/cup for direct sales [see Exhibit 4].
While there is a risk that at-home users may steal K-Cups from the office, we believe that $0.54/cup is
within the price range of our target customers who are willing to pay more for K-Cups anyway.

Place: Because it cannot currently target the retail channel, Keurig should direct sales of its at-home
products through the Keurig website. Keurig should advertise the system’s ease of use [see Exhibit 7]
and in mediums where it is easy to demonstrate the product (i.e. television and internet); KADs should
market to current office-users through point-of-sale advertising in return for royalties. Combined, these
methods should eventually pull the products into new retail channels.

Promotion: The Keurig system is a “demonstration-driven product.” Over 90% of interview

respondents indicated that a product demonstration increased their likelihood of buying the product. As
such, we recommend Keurig offer $50 rebates to the first 1,000 customers who purchase the B-100
brewer, referral incentives for first-time buyers, and product demonstrations in selected venues. These
customers should help increase product awareness through word-of-mouth.

Potential Risks: Risks include the following: incurring more costs by selling directly to at-home users
(will likely need increased personnel to manage customer relationships), cannibalizing OCS sales, and
inability to convince the Board to adopt the single-cup strategy.

Conclusion

Adopting our proposed strategy will enable Keurig to make a strong entrance into the at-home market
while satisfying both roasters and KADs. Roasters will receive the same price for K-Cups and benefit
from the single-cup strategy, and KADs will pay the same price for K-Cups and receive incentives to
push the at-home system. Both will benefit from increased sales in the at-home market.

Exhibit 1 – Market Size [A]

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 Gourmet Coffee Market
At-home [B] Away-from-home [C] Annual Growth
1996 2,200 N/A N/A
1997 2,500 N/A 13.64%
1998 2,800 N/A 12.00%
1999 3,000 N/A 7.14%
2000 3,100 3,900 3.33%
2001E 3,208 4,036 3.48%
2002E 3,289 4,138 2.52%
2003E 3,356 4,222 2.04%

[A] Assumed Keurig would focus on Gourmet Market only. The Mass Market products are sold at much lower price
points (for example, this segment includes P&G which sells Folgers).
[B] Applied a regression analysis using data provided in Exhibit 4 of Casebook to estimate market size for years 2001-
2003. At home gourmet = 2500.6656 + 439.68343*Log(Year).
[C] Assumed away-from-home market would have the same annual growth as the at-home market.

Exhibit 2 – Current and Proposed Distribution Channels [A]

Current Distribution Channel:

[A]
Transfer of tangible goods
Keurig
Transfer of services or payment
Right to produce
$0.04 royalty
K-Cups

K-Cups
Roasters KADs

K-Cups $0.40-$0.50 per

$0.25 per K-Cup K-Cup

Offices

Proposed Distribution Channel for OCS Market:

Keurig
$0.21 per K-Cup
$0.25 per K-Cup
(0.25 - .04 royalty)

K-Cups
Roasters KADs

K-Cups $0.40-$0.50 per

K-Cup

Offices

Proposed Distribution Channel for At-Home Market:

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 K-Cups

$0.21 per K-Cup $0.54 per K-Cup At-Home

(0.25 - .04 royalty) Keurig Consumers
Proportion of
sales generated
from POS ads

Roasters KADs
Advertisements
POS advertising generate at-home
on OCS brewers sales from existing
offi ce users

Offices

Exhibit 3 – Lifetime Value of a Brewer at Different Price Points (3 Years)

PROFITS FROM BREWERS
Projected Payment to Total Profit Brewer Profit
Price Point Unit Sales (1) Cost (2) KADs (3) for 4 Months in Year 1

$149 20,000 $200 $596,160 ($1,616,160) ($4,848,480)

199 16,000 200 596,160 (612,160) (1,836,480)
249 12,000 200 596,160 (8,160) (24,480)
299 8,000 200 596,160 195,840 587,520
(1) Projected sales of 20,000 from page 123 of Casebook. Assumes Keurig will lose 20%, 40% and 60% of projected
sales by increasing the price of brewers to $199, $249 and $299, respectively.
(2) Assumes Keurig is able to reduce cost to from $220 to $200 through engineering efforts, per page 123 of Casebook.
(3) Sale of 39,744 at-home brewers attributed to KADs * $15 per brewer incentive fee, per Exhibit 5.
PROFITS FROM K-CUPS
Cups Price Cost Per Cup Incentive Per Cup K-Cup Profit
Customers Per Year (1) Per Cup (2) Per Cup (3) to KADs (4) Margin in Year 1

20,000 585 0.54 0.21 0.04 0.29 $3,393,000

16,000 585 0.54 0.21 0.04 0.29 2,714,400
12,000 585 0.54 0.21 0.04 0.29 2,035,800
8,000 585 0.54 0.21 0.04 0.29 1,357,200
(1) Assumes 2.25 cups per day * 5 days per week * 52 weeks per year.
(2) Per Exhibit 4.
(3) Per Exhibit 2.
(4) Per Exhibit 5.

TOTAL PROFITS
Total
Price Point Year 1 Year 2 Year 3 3-Year Profit

$149 ($1,455,480) $2,544,750 $1,908,563 $2,997,833

199 877,920 2,035,800 1,526,850 4,440,570
249 2,011,320 1,526,850 1,145,138 4,683,308
299 1,944,720 1,017,900 763,425 3,726,045
Note: Keurig assumes it will be paying KADs percentage of at-home sales for 3 years, per page 124 of Casebook.
Also assumes 75% retention rate per year.

Exhibit 4 – K-Cup Pricing Based on Consumption of 2+ Cups per Day

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 % Willing to Pay % Loss
K-cup Pricing 2+ cup/Day % Revenue from Price Increase

> $ 0.55 14.6% 8.0% (8.5%)

.50-.54 30.7% 16.6% 0.1%
.45-.49 33.6% 16.5% (1.8%)
.40-.44 41.5% 18.3% (0.5%)
.35-.39 48.2% 18.8% (1.1%)
.30-.34 58.5% 19.9% (2.0%)
.25-.29 75.6% 21.9% NA
Source: Casebook page 128.

Office managers are currently buying K-Cups for $0.40-$0.50 per share. In order to ensure that they continue to
purchase through KADs and not purchase from the web site, Keurig needs to price its online K-Cups above $0.50 per cup.

If Keurig prices at or above $0.55, it will lose 8.5% revenue due to the price increase. If it prices between $0.50 and $0.54,
Keurig will gain an additional 0.1% revenue (compared to a price point between $0.45-$0.49).
Therefore, Keurig should price at the top of the $0.50 to $0.54 price point, or $0.54 per K-Cup.

Exhibit 5 – Proposed KADs Incentive Program

Incentive Program Values Sources / Assumptions

1 No of K-cups shipped in 2002 (in millions) 125,000,000 From Casebook

2 Expected percentage loss of cups from at-home 5.0% Assumption
3 Number of K-Cups lost (in millions) 6,250,000 Line 1 * Line 2
4 Mean price charged by KADs $0.45 From Casebook (range of 0.40 to 0.50)
5 Cost of K-Cups $0.25 From Casebook
6 Profit loss (in millions of dollars) $1,250,000 Line 3 * (Line 4 - Line 5)

7 No of brewers sold by KADs 33,000 From Exhibit 3 in Casebook

8 No of KADs working for Keurig 180 From page 117 of Casebook
9 No of brewers per office 1 Assumption
10 No of offices 33,000 Line 7 / Line 10
11 No of office per KAD 184 Line 10 / Line 8
12 Percentage of KADs participating 60.0% From page 124 of Casebook
13 No of offices where ads are placed 19,872 Line 8 * Line 11 * Line 12
14 At home brewer sales per office 2 From page 124 of Casebook
15 No. of at-home brewers sold b/c of KADs 39,744 Line 13 * Line 14
16 Dollar amount paid to KADs per brewer (incentive) $15 From page 124 of Casebook

17 Compensation to KADs for sale of brewers $596,160 Line 15 * Line 16

18 Remaining Loss 653,840 Line 6 - Line 17
19 No of cups per day 2.25 From page 120 of Casebook
20 No of cups per brewer sold by office sales per year 23,250,240 Line 15 * Line 19 * 5 days per week * 52 weeks
21 Incentive per cup to make up for loss $0.03 Line 18 / Line 20
22 Added incentive so they push the product 0.01 Recommendation
23 Dollar amount paid to KADs per K-Cup (incentive) $0.04 Line 21 + Line 22

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Exhibit 6 – Economic Value of the Customer
Starbucks
Coffee consumption per day 2.25 [A]
Average price of Star bucks 8oz coffee 2
Per year spend on Star bucks 1170 [B]
Keurig
Brewer price 249 [C]
K-cup price 0.54 [D]
Coffee consumption per day 2.25 [A]
Per year spend on Keurig 564.9 [E]
So Economic Value to the customer 605.1 [F]

Notes
[A] Casebook, p.120 Average coffee consumption per day at home
[B] Calculated based on consumption for 5 days, 52 weeks a year
[C] Per our recommendation
[D] Per our recommendation
[E] Price per brewer+k-cup price*coffee consumption per day*5days*52weeks
[F] Annual ammount spent on Starbucks-annual amount spent on Keurig

Assumptions
[1] Calculations based on Starbucks price as gourmet coffee market leader
[2] Average price of 8oz Starbucks coffee is $2

Exhibit 7 – Advertisement

Savor your Mornings …

One Cup at a Time

Keurig At-Home
Bring home the taste of your local coffee shop for every-
day convenience

1 2 3 4

IT’S AS EASY AS THAT!

Additional Information
The following additional information would have aided our analysis:
 Additional information related to any stated assumptions
 Detailed market share information for 2001-2003
 Detailed margin information for Keurig, Roasters and KADs

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 More specific demographic information for gourmet coffee market