Keurig Case

Keurig Inc. has been profitable and popular in the office coffee service (OCS) market since the
B2000 brewer in 1998. They continue to expand their relationships with roasters, resulting in the
largest variety of single-cup system coffees. In 2002, Van Houtte Inc. purchased stock, resulting
in nearly $10 million to launch the at-home single-cup system. This system differentiates itself
from other brewing systems because of its convenience, easy clean-up, and variety of highquality K-Cups, with over 75 flavors produced by five roasters. For each K-cup sold, roasters
paid Keurig a royalty of $0.04. The variety of flavors is important to compete in a market of
gourmet coffees, like Starbucks; only Keurig focuses on creating a consistent flavor every time
outside of the coffee shop. Keurig quickly penetrated the OCS market, shipping over 33,000
brewers, and over 340 million K-Cups by roasters, by 2002. The 180 Keurig authorized
distributors (KADs) covered a network of offices in North America, placing brewers, costing
them $500-$1,000, into offices free of charge or for a low monthly rental, and selling K-Cups
which cost $0.25, to managers for $0.40-$0.50 in order to make a profit.
The value of the OCS market to Keurig is less than the value that the KADs provide through
their services, research, and network of consumers. KAD satisfaction is more important than
worrying about the office managers when deciding between the two-cup or one-cup system for
the individual markets. Keurig should implement the one-cup system but accommodate the
pricing so they do not take market share from the office market. This can be accomplished by
pricing the K-Cups the same in both markets, so office managers wont purchase them directly
from Keurig, reducing KAD profit, and it will reduce likelihood of theft in the office. In the
future, retailers can purchase through KADs or directly, either way Keurig gets $0.04 royalty per
K-Cup. Keurig should not invest in the KAD referral program but still use the office
environment to promote at-home purchases. With the price accommodation, the KADs should
not feel threatened by the promotion.
In the at-home market, for the heavy gourmet coffee drinker, the B100 Keurig coffee brewer is
the highest quality, fastest, and most convenient brewing appliance because it results in a cup of
coffee ready in 30-seconds with the greatest variety of fresh, gourmet flavors. The key qualities
of the B100 are similar to the office market appliance: it makes coffee quickly, has no waste,
minimal clean-up, and a variety of flavors. Keurig is capable of capturing market share from
other gourmet coffee makers by targeting the upscale, whole-bean type of consumer; a growing
segment due to the popularity increase of whole-bean coffee. The target segment size now is 15
million gourmet coffee drinkers that are likely to purchase the product, including Keurig-aware
and Keurig-unaware consumers (Exhibit 4).
Keurig should create a luxury good, more-for-more positioning, so they can charge premium
prices to the heaviest, most valuable drinkers. The heavier drinkers have a higher willingness to
pay for the brewer and will purchase more K-Cups. Based on market research, the brewer should
be priced at $199. Although there is no initial profit, the lower price will acquire more lifelong
customers that will continue to purchase K-Cups and increase the total future profit (Exhibit 1).
K-Cups should be sold for $0.50, resulting in a $3.3 million profit in the first year through direct
sales alone (Exhibit 2). This model is a mild razor-razor blade strategy; where the pricing of
two compatible goods is higher for one good to make up for the discounted price of the other
(Exhibit 6). This is also how KADs profited from sales in the OCS market.

Keurig Case

Keurig can price the K-Cups higher to show higher quality and compete in a separate market
from the other single-cup brewers. They compete with the gourmet coffee shops that also offer
more-for-more propositions, rather than brands such as Salton or Sara Lee, which are releasing
lower-quality single-cup systems at lower prices. It is expected that these companies, and
possibly P&G, will use mass-channel distribution of brewers and pods. Although Keurig does
not have the resources currently to launch its B100 brewing system through the retail channel, in
the near future they will want to penetrate the retail market to increase awareness of their product
but will not need to compete with the lower priced systems. Traditional distribution of at-home
coffee has two sources, one for brewers and one for coffee. Since Keurig has exclusively
compatible products and competes with specialty coffee stores, they should create their own
store-front through the e-commerce-enabled website to sell both the brewer and K-Cups. They
shouldnt focus on rushing into the mass-retail channel in the next 6 months because their sales
will not be affected significantly by other single-cup brewer systems. The online store should be
the priority to create the pioneer image and will allow for maximum profits from K-cups
(Exhibit 2).
Market research is needed to track the success of the online store. Keurig should monitor which
products are purchased, how many are purchased at once, and the demographics of the typical
consumer. If they figure out the demographics of their most valuable online consumer they can
decide what approach to take when entering the retail market; whether they want to go into the
mass-channel distribution or the more specialized retail stores. A recent trend in gourmet coffee
sales is the transition from upscale outlets to the mass-retail outlets.
Keurig can promote this B100 product and K-Cups online as a pioneer company to the upscale
gourmet consumer through advertisements, they can also use the roasters. They can also increase
their reaction rates with other promotional ideas once they enter the retail market. (Exhibit 5).
Overall, the online store should be created for the September launch. The cost of the ecommerce-enable Web site is unknown, but it can be assumed that the $10 million acquired from
Van Houtte Inc. will cover the initial costs and maintenance. If costs exceed that, they can
increase spending money for advertising and promotion by taking advantage of their close
relationship with the roasters, especially GMCR and Van Houtte Inc. As shareholders, their
revenue is directly affected by Keurig brewer sales. More market research would be necessary to
prove the effects of an increase in brewer sales on the increase in K-Cup sales in the at-home
market. If proven to be significant, GMCR might provide working capital for the company
instead of just equity through stocks. Keurig should try to enter the retail market after the first 6
month period with help from roasters for advertising. The initial profit loss will be compensated
for in K-Cup sales and the retail market will increase the target segment through promotion and
increasing awareness, relying less on the KADs (Exhibits 3&5). This will result in less
competition between the OCS market and at-home market, reinforcing the one-cup system.

Keurig Case

Exhibit 1: Target Segment Purchases

Assumption 1: There are 20 million gourmet coffee drinkers and all gourmet drinkers have
similar demographics - similar to whole bean consumers, up-scale coffee drinkers.
Assumption 2: From previous market research, assume that 75% of the total gourmet drinker
segment would be likely to purchase the proposed Keurig B100 system.
Therefore: 20 million * .75 = 15 million gourmet coffee drinkers likely to purchase product
Assumption 3: Assume the 1 million consumers Keurig was focusing on in case are Keurigaware - Realistic because if there have been 33,000 brewers sold in OCS market converting
people into Keurig-aware customers in a given office and therefore increasing their likelihood
to purchase because they have seen the product demonstrated in the office environment.
Assumption 4: Assume the other 14 million consumers are Keurig-unaware
Assumption 5: Through promotion and roaster advertising, assume to capture 6% of Keurigaware consumers and 1% of Keurig-unaware consumers at a brewer price of $199 or
more(from previous market research)
Assumption 6: The cost of K-Cups would not affect these purchases
Therefore: Total Eventual Purchases via online website from current target segment:
Aware Purchases: 1 million * .06 = 60,000 brewers
Unaware Purchases: 14 million * .01 = 140,000 brewers
Assumption 7: Assume they are online purchases on Keurig website, no retail margin
Assumption 8: Assume cost of producing a B100 was reduced to $200 and approximate profit
per appliance is $0, resulting in no initial gain
Conclusion: Need to sell K-Cups in order to make a profit at a realistic premium price
(Brewer, $199). Even though they are not making an initial profit they are following a model like
the KADs; they installed brewer for free, or for low monthly fee, after the initial $500-$1000
cost and sold the K-cup at a higher price to compensate and make a profit in the office setting.

Exhibit 2: K-Cup Consumption and Pricing

Assumption 1: Assume roasters would be willing to sell their K-Cups for distribution via
online Keurig store for a cost of $0.25/cup, same as KADs to eliminate competition between the
two markets.
Assumption 2: Assume roasters would still pay a $0.04 royalty in both markets
Profit to Keurig/ K-Cup: (Price - Cost) + .04
Therefore: price of $0.50 -- Profit= (.50 -.25) +.04 =$0.29
Assumption 3: Assume that if K-Cups were sold at $0.50, they would follow same trend as
predicted in market research for the target segment of gourmet coffee drinkers likely to purchase
product (15 million)
Therefore:
At $0.50:
16.7% of 1-cup drinkers would be willing to pay = 2.5 million
30.7% of 2-cup drinkers would be willing to pay = 4.6 million
Assumption 4: Assume 2-cup drinkers include the aware and unaware customers that
would be the most likely to purchase the at-home system in the first year and assume that we
capture 3% directly on our website. Realistic because the original plan forecasts 20,000
shipments in the first year; 66% of sales expected to be direct Keurig sales activities.
Therefore:
Price of Brewer ($199)
3

Keurig Case

For 2-cup drinkers, 10.1% would be willing to purchase a brewer priced over
$130 = 465,105 willing to purchase
465,105 potential consumers * .03 = 13,953 brewers sold through website in the
first year (market:18 million purchased annually)
Given: Average consumption is 2.25 cups a day
Therefore: Profit per brewer in K-Cups (Year 1):
13,953 brewers * 2.25 K-Cups/day * 365 days * $0.29/K-Cup = $3.3 million profit in first year
Conclusion: From online-sales only there will be a $3.3 million profit in the first year to the
realistic proportion of the targeted segment. In office market with KADs, Keurig profit in the
fifth year = 125 million K-Cups * .04 royalties = $5 million, not much larger. It will expect to
increase with awareness, and as the number of brewers purchased increases. If it reaches the
totals predicted in Exhibit 1 with all else equal, profit from K-Cups would equal: 200,000
brewers * 2.25 K-Cups/day*$0.29/K-Cup = $130,500/day.

Exhibit 3: Retail Profit

Assumption 1: Assume the rest of the forecasted 20,000 brewers were sold through retailers
instead of KADs. Resulting in approximately 6,000 brewers at the retail price of $199; the costs
of brewer remains the same, therefore there is a deficit of -$100/ brewer for Keurig.
Assumption 2: Since we want compatibility - but dont want to lower profit on K-Cups, we
can sell K-Cups solely through our specialty store. Consumer must purchase online for $0.50.
Profit for Keurig =$0.29/K-Cup
Assumption 3: Consumers drink 2.25 cups a day on average still
Therefore: -$100 *6000 brewers = $600,000
Break Even: Days of coffee consumption to BE = 600,000 / (6000 brewers *2.25 cups/day
*$0.29/cup) = 153 days
Approximately 7 months for costs to be covered, not including the online profit.
If K-Cups were sold through retail market with .5 retail margin, Keurig profit/K-Cup would be
$0.04 and break even would be:
Days = $100/ (2.25 *.04) = 1,111 days = approximately 3 years
BUT Assumption: Behavior of purchasing K-Cups and brewers would increase with
easier accessibility in retail stores so profit would take less time in reality.
Conclusion: Keurig should penetrate retail market to increase sales, but use promotion to keep
the K-Cup sales online even if they are offered for sale in stores because that will allow for the
fastest and greatest profit gain. Which particular retail market has to be determined through
market research.

Exhibit 4: Percentages from previous market research (Next page)

Gourmet Coffee
Drinkers

%
Interested

% Likely to purchase

20 million

88%

75%

15 million: Aware =1 million

Unaware = 14 million

Exhibit 5:
4

Keurig Case

Promotion

Potential Case

Optimal Case

Option 1: Market
discounted brewer to the
12,000 OCS market users:
Brewer for $149 if
purchased directly on onlinestore.
Costs: Market directly
through emails - little to no
cost
Benefit: Gain loyal customer
and increase K-Cup sales
*First 6 months

If Reaction Rate = 20% in

first 3 months
Brewer Sales = 2400
Profit per brewer: ($149$200) = -$50
Profit per K-Cup:
2400*2.25*.29= $1566/day
after three months from this
alone

Reaction Rate = 50% in first

three months
Brewer Sales = 6000
Profit per brewer = -$50
Profit per K-cup = $3915/ day
after three months

Option 2: Give discount

coupon with retail-store
brewers for online K-Cup
purchases
Cost: Distribution, covered
for brewers
Benefit: Takes away retail
margin for K-Cups when
purchased online directly
*After first 6 months

Reaction Rate = 10% of the

6000 purchases use coupon
Assume new profit= $0.20
K-Cup profit: 600*2.25*.20 =
$270/day
Compared with retail K-Cup
Profit: 600*2.25*.04=
$54/day

Reaction Rate = 50% use

coupon
Assume new profit = $0.20
K-cup profit:
3000*2.25*.20=$1350/day
Compared with retail K-Cup
profit: $270/day

Option 3: Demonstration in
retail stores set-up next to
Keurig displays
Cost: construction
Benefit: Increase likelihood
of purchase

Increase by 70%
Positively affect sales
Convert more unawares to
aware

Increase by 90%
Positively affect sales
Convert more unaware to
aware

*After first 6 months

Exhibit 6: Razor-razor Blade Example: The cost of a video game consul might result in an
initial loss for the company, but the continuous purchase of games, priced higher, results in
overall profit and consumer loyalty because they have two exclusively compatible products.