Technology

Encapsulated: Coffee capsules are showing the best potential for growth in the coffee industry

It’s not often that a coffee roaster makes regular headlines as one of the top performing stocks on the Nasdaq stock exchange. In the last year, however, Green Mountain Coffee Roasters (GMCR) have consistently found themselves topping Bloomberg news briefs. On 5 May, the company soared 21 per cent, the second biggest gain in the Russell 1000 Index. In the last year, their stocks surged over 200 per cent, including an astounding 41 per cent hike that came after the company announced a distribution deal with Starbucks. The hype around the deal and its ensuing aftermath was not just about the pairing up of two of America’s largest players in coffee, but weighed heavily on the product they were pairing up on: the announcement that GMCR’s Keurig single serve system would be available with Starbucks’s brew, and be available in the coffee chain’s outlets and websites by 2012. In the last year, any news around GMCR and coffee capsules has led to jump after jump in the company’s stock and with good reason: coffee capsules alone generated almost US$2 billion in sales for GMCR, who are currently sitting as American market leaders. In an industry looking for the next area of growth, coffee capsules are clearly coming out ahead. GMCR are not alone in benefitting from their coffee capsules endeavours. Over the last few years, major players around the world have identified coffee capsules, also known as single-serve or portioned coffee, as the next big thing in the industry.  “The portioned coffee market is booming and continues to be the fastest growing part of the coffee market, by both value and volume,” says Julien Liew, Corporate Public Relations and Public Affairs Manager for Nestlé Nespresso SA, who are market leaders in Europe and around the world in coffee capsules, having refined their own system over the last 25 years. In 2010, Nespresso sales exceeded US$3.4 billion, with organic growth of more than 20 per cent. While the overall pre-portioned coffee segment represents 8 per cent of the total coffee market in terms of volume, Nespresso has shown double digit increases in all markets across the globe. Liew points out that in 2010, the number of Nespresso cups consumed every minute worldwide increased from 10,000 in 2009 to 12,300. Liew credits much of this success to Nespresso’s competitive advantage in concentrating on both a direct-to-consumer and a business-to-business approach that it has held for the last two and a half decades. Comparatively, other market leader Lavazza extended its strategy of providing to the home sector in 2007, says David Rogers, sales and marketing director for Lavazza’s retail division. While the company has been in the coffee machine business for over 20 years, he notes that when they first entered the market in 1989 they focused more on away-from-home systems, in offices and shops. Four years ago, however, they adopted an aggressive strategy into the home sector with their A Modo Mio systems. Like the other major players who have launched into the capsule market, Lavazza has experienced remarkable success. Last year the company sold 2 billion capsules worldwide and expects 20 per cent year-on-year growth for 2011.   The potential growth that Rogers envisions in the coffee capsule market is so strong, that he recently called this sector “the capsule revolution” in a presentation at the latest Allegra UK Coffee Leader Summit 2011. Rogers notes that growth in the UK, where he’s based, is coming from the decline in tea and instant coffee consumption. “In the 1950s when instant coffee was launched, it was a natural step on from tea with a similar preparation method,” says Rogers. “Naturally the flavour quality of instant is not the level of roasted coffee, so we have been playing catch up over the years in our shift from tea consumption to coffee consumption.” As consumers switch to roasted coffee however, Rogers notes that the younger generation that has grown up in coffee shops is demanding better quality at home, but without the mess, investment or skills demanded from an espresso machine – all deliverable in the coffee capsule system. From the consumer’s end, the “no mess, no fuss, no wastage” advantages to making great coffee at home is evident, but the tremendous opportunity for business growth doesn’t solely sit there. In addition to the technology’s advantage from the consumption end, coffee capsules also create possibly an unprecedented market advantage in the coffee industry – because certain capsules are only compatible with certain machines. By selling customers a machine, companies can then lock them into their systems and keep them buying their own capsules. Coffee Bean & Tea Leaf (CBTL)’s Jay Isais calls it the “razor: razor-blade” model, and CBTL is keen to enter this arena. A roaster and retailer based out of LA with 190 franchise stores across the United States, CBTL started dealing in coffee capsules and machines in December 2010. “We wanted to get in before the mainstays became entrenched,” he notes. The company had been doing research for the last few years, and found that in the United States of the 160 to 180 billion cups of coffee that are consumed, 86 per cent are consumed at home. In the United States, Isais notes, Nespresso only sells its capsules either online or in boutique stores. This is where Isais hopes CBTL will hold an advantage in making its capsules readily available in its stores nationwide. The company only makes a minimal margin off the machine and is looking almost entirely for its profits in the ongoing sale of capsules. Isais notes that where the Keurig system sells around 1.8 capsules a day, they are hoping to sell between 1.5 to 2.5 capsules per day per machine. Having already sold 50,000 machines barely six months after their launch, the fruits of their efforts are quickly starting to pay off.   “As the number of your machines in the market goes up, the number of capsules you sell is a steep accelerating curve,” he points out. The curve for CBTL is just starting its rise. Although the machines are currently only available in their stores, this is just the first tier of their marketing strategy. Next, they plan to sell machines in big box retailers and then in the food service and office environments. MAP Coffee is taking a similar approach in selling their own branded coffee machines and capsules in the Australian market, where Nespresso and Lavazza are current market leaders. Angelo Caruso, National Retail Sales Manager for MAP, notes that their point of difference is offering a coffee specifically designed for the Australian market, while their major competitors are more directed by European trends.  MAP is teaming up with major retailers to sell their machines, who will also sell their capsules. Different to CBTL, however, there will be a larger profit margin on the machines. “Because we’re distributing with electrical appliance chains, if they don’t get a margin, they won’t push the product,” says Caruso. “By going through retailers, we believe we will see better success long-term than going direct to market.”  Have a look at MAP and CBTL machines, and you will see some serious similarities. In fact, the machines are almost exactly the same. This is because both companies have teamed up with Caffita System to source their machines. Different to Nespresso and Lavazza’s global brands, since 2004 Caffita has partnered with local coffee roasters in around 50 countries all over the globe, offering locally branded machines and capsules.
Caffita’s founders were the former owners of Saeco espresso manufacturers. They got into the capsule business after selling control of Saeco to a private equity fund. “We saw the world was moving towards [capsules],” says Mario Muttoni, Caffita Sales Director and Board Member.  “We wanted to give roasters who would not normally have the capital to invest in these systems by themselves a chance to introduce them into the market.” They currently count around 30 to 35 major roasters in their list of partners, who can request capsules to their own specifications. The company also regularly teams up with smaller roasters who want their own branded capsules. “Our gaol is to be everywhere in the world, every year we have new countries on our list,” says Muttoni. Since their launch, they’ve sold from 4 to 5 million machines, although they count on 15 to 20 per cent of their machines going out of use every. From the sales of these machines, however, they make virtually no profit, and only hope to recover their production costs. The profit is found entirely in the sale of the coffee capsules. Although it depends on the country, for each machine being used in the home they sell an average of 400 to 750 capsules a year, with that number multiplying substantially for machines used in offices and food-service areas. The company filed early on for their patent rights, and currently hold patents allowing them to have high and low pressure. This allows their machines to brew more than just espresso, but also filter coffee, tea, hot chocolate and other hot beverages. So far, no compatible capsules have popped up on the market. With a system so heavily dependent on locking customers into their system, Muttoni notes they are prepared to protect their intellectual property. “We will do our best to protect our patents,” he says. Nespresso has filed more than 1700 patents on Nespresso capsules and machinery, according to reports, although this wasn’t enough to prevent compatible capsules from emerging on the market. Sara Lee Corp. and Ethical Coffee Co. were the first to make pre-filled Nespresso compatible capsules in 2010. Sensitivities over intellectual property were highlighted in ensuing legal battles. In March this year, a Swiss Court withdrew a preliminary ban on rival coffee capsules produced by Swiss retailer Denner, which is owned by Swiss cooperative Migros, and its manufacturing partner, Alice Allison. The ban had prevented the company from selling its own version of the Nespresso capsules, according to reports, however production of those pods are back in full swing. Alice Allison SA-owned Nexpod brand has been selling empty Nespresso compatible capsules since 2008. “The objective was to give consumers the opportunity to fill capsules [with] coffee or tea of their like, but still using their Nespresso machines,” says Nexpod’s Marketing and Communications Director, Sofia Dazio. “Thanks to the know-how acquired with these refillable capsules, we have been able to develop our second product: The NexPod filled compatible capsules.” The company confirmed its position, saying that there are no patent barriers to their products, and has filed for a patent of its own. “We are convinced that no existing patents are infringed,” says Dazio.  Eric Favre, who created the first version of Nespresso in 1976, told Bloomberg in an interview that he could see as many as 20 rivals eventually offer coffee that can be made with Nespresso machines. He noted in the interview, however, that Nespresso’s continued success would not be dependant upon this protection of intellectual property. “The Nespresso brand is more important than the patents,” he said in the interview. Discussions of patent issues with Lavazza’s Rogers elicit a similar response. “No company needs or wants to compromise other peoples’ position and we obviously want to protect our position in the market,” he says. “From my perspective, however, particularly in the UK, consumers want to be clearly able to match up a type of capsule with a machine… consumer education here is an element.” As for the future of this market, in addition to seeing the brand presence prevail, Rogers also predicts the expansion of the capsule system to other drinks. “In the future, I could see the systems would extend into total beverage solutions, imagine energy drinks, tea and other coffee,” he says. “Providing they can make a capsule for it, there is tremendous opportunity for growth.” Lavazza fact
Lavazza first extended into the at home market in 2007. A Modo Mio, the name of its capsule system, is My Way in Italian.

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