Green Mountain Brews Profits a Cup at a Time

Green Mountain staffers put a series of brews through quality control tests.

The days of drip coffee may be numbered. From the sleepy skiers' town of Waterbury, Vt., Green Mountain Coffee Roasters is brewing up a revolution in the form of airtight capsules of coffee that are prepared one cup at a time. Although machines that make single-cup brews account for just 6 percent of the 90 million brewers in U.S. homes, the trend is gaining steam as consumers rein in spending and trade old-school pots for machines that make gourmet coffee at home. Considering the sluggish sales of coffee makers overall (the entire category posted a 3 percent drop over the past year), a 50 percent jump in sales of single-serve units is a huge coup for these new brewers on the block.

While coffee chains duke it out with fast-food joints trotting out their own lattes, Green Mountain dominates a niche of the java market with few competitors. The company's roots are in specialty coffee sales, but its crown jewel—the Keurig machine—is the market leader among single-cup brewers, accounting for more than half of all machines sold. Other players in the single-serve category include Kraft's Tassimo system, made primarily for at-home use, and Mars's Flavia, which targets offices. Keurig, on the other hand, is making a play for the home, office, and upscale hotel crowds. "The idea is to surround our target consumer, so wherever they are, they see our brewers," says Chief Executive Larry Blanford, 54. (Keurig's target market is households earning more than $50,000.)

Brewing with a Keurig machine is simpler than spooning grounds into a filter and pressing a button. The capsule, which contains its own filter, fits into a slot, combines with pressurized hot water, and turns out one fresh cup of coffee in seconds.

Keurig isn't the only thing going for Green Mountain. From beer to coffee and even olive oil, Americans have been trading up across the food and beverage spectrum. Although coffee consumption has remained relatively flat over the past few years, a consumer survey by the National Coffee Association reveals that the percentage of people drinking gourmet coffee on a daily basis increased from 14 in 2007 to 17 earlier this year.

Coffee convert. The shift bodes well for Green Mountain, a company that sold almost 27 million pounds of coffee through various retailers in 2007 (up 10 percent over 2006), including more than 100 gourmet coffee varieties under its namesake brand as well as Newman's Own Organics. Gourmet coffee "tastes different—for the most part, it's better than commercial-grade coffee—and people are waking up to that," says Dan Cox, owner of Coffee Enterprises, an independent coffee-testing company in Burlington, Vt. Green Mountain's chairman and founder, Bob Stiller, admits that even he wasn't much of a coffee drinker before starting the company in 1981. "I grew up with instant and the percolator, and I just had never had good coffee before," says Stiller, 65, a free spirit who made his first fortune selling rolling papers under a brand called E-Z Wider. He attributes his coffee conversion to a life-changing cup of joe from the rural Vermont roaster that eventually became Green Mountain. (These days, Stiller kicks his days off with a Colombian fair-trade brew.)

Over the past 27 years, Green Mountain has grown from a small-time brewer focused on social responsibility and environmental stewardship to a $617 million publicly traded company that still champions social and environmental causes. Each year, the company donates 5 percent of pretax profits to charity, and its eco-savvy business practices include using renewable materials in to-go coffee cups. (The K-Cup's petroleum-based packaging remains an issue for environmentally focused Green Mountain, but the company is busy researching alternatives.)

"Early on, Stiller imposed a certain culture that said we're going to be on the leading edge and we're going to take care of farmers and not rape our producers, because this is our lifeline," says Cox, who was an early employee of the company. "He put a stake in the sand with fair trade."

Trips. In fact, Green Mountain is one of the largest dealers of organic and fair-trade coffee. Fair trade guarantees farmers a minimum price that's often higher than the market rate and also ensures that producers meet social and environmental standards. Building strong relationships with farmers' co-ops in countries like Guatemala, Mexico, and Nicaragua is a big part of the process, which involves sending groups of U.S. employees there "to take in the experience," Stiller says. "It's equally motivational for the farmers to know we care about how the product is made."

Although its headquarters today include a vast, 90,000-square-foot roasting and distribution facility, the feel is somehow homey. Employees, typically with coffee in hand, seem relaxed and engrossed in their work (perhaps the on-site meditation room has something to do with it). "It's a very strong culture, but now with the dominance of Keurig, there appears to be a constant push and pull," Cox says. "It's a little bit of an identity issue: 'Who are we? Are we a coffee company, are we a beverage company, or are we going to be a consumer product company?' "

Growth. Unquestionably, Keurig, in which Green Mountain first invested in 1996 when it was a start-up and which it acquired 10 years later, has been the engine behind the company's rapid growth over the past two years. But Green Mountain's aggressive strategy of pushing its coffee through multiple channels—grocers, convenience stores, gourmet markets, restaurants, and direct mail—got the ball rolling. Since 1993, the company's annual sales have nearly tripled, from $117 million to $342 million last year. Although Green Mountain is best known in the Northeast—and "most would argue that it's still an East Coast brand," according to Piper Jaffray analyst Nicole Miller Reagan—its pending acquisition of West Coast coffee wholesaler Tully's and a new manufacturing facility in Knoxville, Tenn., are helping it establish a nationwide presence.

The Keurig machine handily fits the razor-razor blade model, since most of its K-Cup cartridges are filled with Green Mountain coffee and sold separately. Perhaps not coincidentally, the company recently tapped Michelle Stacy, a former senior executive at Procter & Gamble and Gillette, to take over as president of the Keurig unit. "That recurring revenue stream produces exactly the kind of high-multiple revenues and long-term growth rate we look for," says Jack Robinson, comanager of the Winslow Green Growth fund, a longtime investor in the company. Green Mountain's sales have been growing at an average of 20 percent annually over the past five years, and the company is projecting another 44 to 46 percent jump in its fiscal 2008 year, along with an earnings increase of 52 to 56 percent (full-year earnings are to be posted November 12).

Challenges. Like most stocks, Green Mountain's has taken a big hit over the past year, dropping from $40 to as low as $25. But the stock is in much better shape than that of Starbucks and its rival Peet's Coffee & Tea. Then again, Green Mountain plays in a slightly different ballpark. "They're not burdened with the financial aspects of having a lot of real estate or operating in a saturated market," Robinson says. "Not to mention the fact that it costs a minimum of $1.60 for a small cup at Starbucks, while a K-Cup costs a third of that."

On the home-brewing front, Green Mountain's goal is to claim a chunk of the 20 million coffee brewers sold each year and tackle the lofty feat of converting half of the 90 million American homes with coffee brewers to the Keurig. Blanford, who became CEO in 2007, also hopes to replace traditional coffee pots in offices and tackle upscale hotels. So far, of the 12 percent of single-cup brewers in offices today, Keurig accounts for half, according to the company.

Even in this weak retail environment, the machine's cost hasn't hurt Keurig's sales so far. But whether consumers will continue to fork over between $80 for a mini version and $300 for the sleekest brewer remains to be seen. Over the past year, commercial sales have doubled and home sales are up more than 50 percent. Thanks to those brisk increases, Blanford says Green Mountain is in a much stronger position today than in the last economic downturn. "At this stage in our growth, we're not fundamentally concerned," he says. "Certainly, we're watching, but the reality is that even in tough economies, people need their coffee, and it's going to be one of the last things that they compromise on."