The K-Cup Cloner's Dilemma

| About: Keurig Green (GMCR)

Much has been made recently about Green Mountain Coffee Roasters (GMCR) patent protection ending in September 2012. I wrote an article recently with a deep dive into the GMCR patents and the ongoing lawsuits against current knock-off manufacturers. The main focus of recent attention is that US Patents 5,325,765 and (at least part of) 5,840,189 expire this year, and short-side analyst claims that the market will be flooded with low-cost K-Cup clones. In fact, every box of K-Cups on your shelf mentions these two patents, along with "other patents pending."

What I haven't seen discussed anywhere is that the cartridges in those two expiring patents, while groundbreaking, didn't work very well. In fact, in a later patent application, GMCR discussed those two original patents:

"...the configuration of the filter element encourages rapid liquid penetration to and through the lower end, resulting in less than optimum saturation of the beverage medium at upper regions of the filter element adjacent to the container wall. The combined effect of limited storage capacity and less than optimum saturation is a lowering of the total dissolved solids ("TDS") in the brewed beverage, which translated into reduced flavor."

Keurig (prior to acquisition by GMCR) abandoned the filter approach in those patents and invented a better cartridge (patent 6,645,537, expiring in 2020) with a different filter. The goal of this design was to create a K-Cup configuration that allowed more of the beverage medium to be packaged into a single K-Cup. While this approach was better than the original patents, it still didn't produce the quality that Keurig desired. This was discussed in the same patent application cited above:

"Although this did increase the amount of beverage medium available for brewing, it did so at a cost of also increasing the amount of beverage medium receiving less than optimum saturation, with the net affect being an insignificant increase in TDS of the brewed beverage."

So both of the above approaches were abandoned, which brings us to "other patents pending." With US patent application 20050051478 (cited above), Keurig sought protection for the much superior system that is currently in use in all filtered K-Cups today. The approach in this application allows a larger volume of beverage medium, and provides a more uniform saturation of the medium within the filter. This allows for stronger brews and larger cups of coffee from a single K-Cup. GMCR and the US Patent Office have been haggling about this patent for years now, and GMCR has sued to get this patent approved. As of today, this suit has not been resolved. GMCR refers to this pending patent in last year's annual report:

"We also have pending patent applications associated with current K-Cup portion pack technology which, if ultimately issued as patents, would extend approximately 2023."

Interestingly, GMCR filed for this patent under the Patent Cooperation Treaty, which " an international treaty, administered by the World Intellectual Property Organization (WIPO), between more than 140 Paris Convention countries. The PCT makes it possible to seek patent protection for an invention simultaneously in each of a large number of countries by filing a single "international" patent application instead of filing several separate national or regional patent applications." Both the US and Canada signed this treaty. And some months back, Canada granted the equivalent of the 20050051478 patent to GMCR.

This treaty does not guarantee the patent will be granted in all member countries, but it includes a recommendation on the patentability from the WIPO which carries weight with the member countries: "...the search and examination work of patent Offices in the national phase can be considerably reduced or eliminated thanks to the international search report, the written opinion and, where applicable, the international preliminary report on patentability that accompany the international application..."

GMCR's pursuit of this patent in the US received a huge boost from WIPO and the Canadian Intellectual Property Office. Precedent carries significant weight in all legal proceedings, and this is especially true in patent proceedings. The courts recognize that this is the only way to prevent an absolutely unnavigable mess in the international patent domain. It is unlikely that anyone would be brave enough to build a knock-off K-Cup infringing on this pending patent, since patent protection starts on the day of the application, not on the day of the patent award. Any company betting that the pending patent won't be awarded would be taking an enormous risk, as the retroactive damages could be devastating.

GMCR has already shown us that anyone building a cartridge compatible with Keurig brewers will get sued, just ask Sturm and JBR. Neither of these lawsuits mentions the expiring patents, focusing rather on the brew chamber interface between the cartridges and the brewer (as discussed in my previous article). If GMCR is successful with these lawsuits, it is "game over" for anyone building a cartridge that fits in a Keurig brewer, whether open or enclosed, whether it includes a filter or not, or any other subtle distinction. And if these lawsuits are not successful, the pending patent mentioned on every K-Cup box and discussed in the GMCR annual report provides yet another line of defense. Even if GMCR's lawsuits against Sturm and Rogers fail, the options left to potential K-Cup cloners include a discouraging set of choices:

  • Use instant coffee in your cartridge, like Sturm.
  • Don't seal your cartridge for freshness, like JBR.
  • Utilize the original filter design from the expiring patents, and brew a weak cup of coffee.
  • Infringe on the pending patent and risk huge damages when it is granted.
  • Cut a deal with GMCR and become a licensee.

Thus we see the K-Cup cloner's dilemma. A lot of people are getting very excited about the expiring patents, but in reality, the filter design included in the two expiring GMCR patents hasn't been used in years. If the cloners use the original design, they get a low-quality cup of coffee to go with their (theoretically) low-cost offerings. Given the buy-in cost of the brewers, it doesn't seem likely that consumers will sacrifice quality to save a few cents per cartridge - the demographic profile of the Keurig buyer just doesn't support it. Finally, the compromises accepted by Sturm and Rogers will always limit their popularity, so don't expect cloners using those approaches to achieve significant market share.

So what does this mean to the potential GMCR investor? First, there is a reason why the short-side analysts only provide superficial treatments of GMCR patents and their implications. The deeper you dig, the weaker their argument gets. Second, while two GMCR patents may expire this year, the other 36 are still very much in force. And most importantly, the remaining granted and pending patents will force potential K-Cup cloners to compromise with their designs. While the imitators fight for the low-quality fringe of the K-Cup market that Keurig abandoned years ago, GMCR will remain firmly in control of their current system.

Disclosure: I am long GMCR.

Disclaimer: I am not a patent attorney. If you make investing decisions based solely on the advice of strangers, you will probably go broke. Verify the information presented above, and draw your own conclusions.