The Big Trend in Brewing: Single-Serve Coffee

By Russ Banham

The way we brew coffee at home has changed surprisingly slowly over the past century. Your grandparents probably had a shiny chrome-and-bakelite percolator on their kitchen counter. And since the 70s, standard issue has been the automatic drip maker, which has enjoyed enormous popularity. But the ubiquitous auto drip is rapidly going the way of the percolator, thanks to a new breed of brightly enameled, sleek machines that brew a fresh cup of coffee in a matter of seconds.

Welcome to the fastest-growing business in the coffee industry: single-serve, a method of at-home brewing in which the machine makes one cup of coffee at a time from capsules or pods that contain coffee grounds. The brewing method, already popular in Europe, is now catching on in the U.S. There's no need to grind beans, measure coffee, or reheat cups, and the cleanup is minimal.

Still, there are downsides—chiefly, price and the environmental impact of all those plastic pods. While the cost of a basic machine starts at around $50, higher-end ones that can make lattes, cappuccinos, and other frothy-milk beverages can run to $800. Then there's the cost of the pods. While the price per pod (roughly 5-8 grams of coffee) is well under $1, the cumulative cost of a pound of that same coffee can be upwards of $50, nearly twice the price of the most expensive artisanal coffees.

Not that these potential drawbacks are slowing market acceptance. According to Euromonitor International, a marketing firm that focuses on industry and consumer lifestyle research, single-serve machines accounted for 20 percent of total coffee-maker sales in 2011, up from four percent in 2006. In the same period, retail sales of the machines have grown an eye-popping 523 percent.

The Preference for Pods

Some 17 percent of coffee drinkers currently prefer their coffee brewed one cup at a time, with 79 percent of these touting convenience as the reason, according to another market research firm, Mintel International. Thirty-eight percent of those same respondents also say the single-serve machines consistently produce better-tasting java than traditional coffee makers.

In France, where a demitasse of coffee is revered like a fine Bordeaux—the French drink around 30 percent more coffee each year than we do in the U.S., 395 cups per person—single-serve has overtaken fresh beans and fresh ground coffee in retail sales. "When something is perceived as high quality, Europeans generally will pay more for it," says Debra Mednick, executive director, client development, at market research firm NPD Group. "In the U.S., the machines are catching on primarily because of their ease of use and convenience."

A World of Partnerships

The single-serve coffee market is unique for another reason—the diverse partnerships between coffee roasters and kitchenware manufacturers that have formed to produce, distribute, and brand the machines. The pioneer in this regard is Sara Lee Corp., which sells branded coffee and teamed up with Dutch company Philips to launch the Senseo single-cup machine in 2001.

Other partnerships soon followed. Kraft Foods, for instance, introduced its Tassimo single-cup machines, which were initially made by Saeco and are currently manufactured by Bosch. The pods (or T-Discs, as the company calls them) contain Kraft coffee brands like Maxwell House and Gevalia, among others.

Nestlé was another early player in the market with its Nespresso machine, which brews espresso rather than American coffee. The company makes both the machines and the coffee capsules, as it calls them. However, it has arrangements with Krups, Siemens, DeLonghi, and other kitchen equipment makers for the machines to carry their brand names. Nestlé also makes the premium Dolce Gusto single-serve machine, which brews espresso, as well as lattes, cappuccinos, and hot cocoa.

The announcement by Starbucks in March 2012 that it would compete directly against Nespresso with a high-pressure brewer—said to produce a more intense flavor of espresso and coffee than competing machines—took many by surprise, as the company has been selling Starbucks-branded coffee pods for use in Keurig machines. Starbucks' Verismo machine, which is being made by German coffee machine maker Krueger, will make its debut later in 2012.

Keurig, the top-selling single-serve machine in the U.S. according to NPD Group, doesn't brew espresso but still delivers an array of beverages. "They were the first to offer a machine making coffee, tea, and milk drinks using the K-Cup pack system, which really revolutionized the business," says Mednick.

The Keurig machine brews coffee by piercing the foil seal on top of the plastic K-Cup pod with a spray nozzle, while simultaneously piercing the bottom of the pod with a discharge nozzle. Vermont-based Green Mountain Coffee Roasters, Inc., acquired Keurig in 2006, having initially purchased a stake in the company in 1996. At present, Green Mountain estimates that more than 378,000 U.S. offices and 10.8 million homes have one of its machines in place.

Single-Serve Coffee: The Next Big Trend "We believe there is a significant market opportunity in the U.S., given there are 118 million households and roughly 90 million of them have some sort of coffee maker," says Suzanne DuLong, vice president of investor relations at Green Mountain (2011 revenues: $2.65 billion). "We are at the early stages of what could be significant adoption."

Variety Is the Spice of Coffee

Via licensing agreements, Keurig's single-cup brewing technology is also used in machines carrying the Cuisinart, Mr. Coffee, and Breville names. Green Mountain also has inked distribution agreements for its pods to cover a wide range of brands, including its own and Eight O'Clock, Dunkin' Donuts, Starbucks, Folgers, and Millstone.

Mintel senior beverage analyst Garima Goel Lal says this variety is a differentiating market factor: "Single-cup coffee makers are realizing that the more brands a machine can brew the better the chances with consumers, unless consumers show high loyalty to certain brand."

What's Next

The patent for the Keurig machine, set to expire in September 2012, prompted Green Mountain to develop a new machine, the Vue V700, which made its debut in February. Its chief difference: Vue allows users to select the temperature, size, and strength of their cup. And the machine can make iced fruit-based drinks.

Vue also responds to the environmental drawbacks of K-cups, which are made of non-biodegradable plastic, heat-sealed paper, and polyethylene-coated aluminum. While these components can theoretically be recycled, they can't be separated and must be trashed, along with the compostable coffee grounds inside them. With total single-cup pod sales topping nine billion, according to The Wall Street Journal, the pods are a growing environmental concern.

Vue portion packs are made of polypropylene #5 plastic, the same material used in many containers for dairy products like cottage cheese, yogurt, and cream cheese. "The packs are completely recyclable in areas of the country that recycle polypropylene #5 plastic, currently about half the communities in the U.S. and growing," DuLong says.

The big question about these machines is whether or not they will take a bite out of the barista business. "We've not seen any evidence that single-serve pod machines have affected the away-from-home business," Mednick says. "People go to cafés to relax, and for social and other reasons beyond just a cup of coffee."

Goel Lal has a similar perspective. Nevertheless, she notes that Starbucks isn't taking any chances. With its Keurig partnership and its own new brewing machine, the company that transformed the premium out-of-home coffee market is definitely playing in the single-serve game. "This suggests that the company will more than make up for the loss of sales, if any, at its cafés," she says.

The bottom line for consumers is that there are more ways than ever now to get their morning fix. And for coffee roasters and retailers, that means new ways of driving revenue and growth.

Russ Banham is a veteran financial journalist and frequent contributor to "The Wall Street Journal", Chief Executive, CFO, and many other business publications. He is the author of several books, including "The Ford Century," a history of Ford Motor Co.

The following securities were not held by the T. Rowe Price New Horizons Fund, the T. Rowe Price Small-Cap Stock Fund, or the T. Rowe Price Value Fund as of June 30, 2012: Sara Lee, Philips, Kraft, Bosch, Saeco, Nestle, Krups, DeLonghi, Siemens, Green Mountain Coffee Roasters, Starbucks, Mintel International, Krueger, Cuisinart, Mr. Coffee, Breville, Millstone, Folgers, 8 O'Clock Coffee, Global Beverages Ltd, Dunkin' Donuts, Krups. The funds' portfolio holdings are historical and subject to change. This material should not be deemed a recommendation to buy or sell any of the securities mentioned.

T. Rowe Price and Russ Banham are not affiliated.

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