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Over the past couple months, I have written a couple of articles detailing Green Mountain Coffee Roasters (NASDAQ:GMCR) patents. The first one presents an in-depth discussion of GMCR's first line of defense - the patents protecting the company from K-Cup competition. This included an in-depth discussion of some key patents and ongoing lawsuits that GMCR has filed against knock-off coffee cartridge manufacturers. The next article provided information on GMCR's second line of defense - the K-Cup filter designs. There I discussed the evolution of the internal configuration of K-Cups, patents pending, and the challenges and compromises that K-Cup cloners will face. This article focuses on GMCR's third line of defense against competition - the leverage that comes with control of the Keurig brewing platform. While some of GMCR's K-Cup patents will expire later this year, several key brewer patents protect against competing brewers capable of consuming K-Cups until well after 2020.

One of the foundational claims of the short case against GMCR (pdf) that has gained a lot of attention recently is that when two of GMCR's 38 patents expire in September, low-cost competition will erode both market share and margins, and there isn't a thing that GMCR can do about it. GMCR, on the other hand, recently filed papers with the SEC indicating that it believes its position will not be materially diminished by the upcoming patent expiration. In typical GMCR fashion, management has been pretty tight-lipped about how it will prevent potential competitors from driving down its market share and margins, but it has let a couple items slip that show it intends to use its control of the brewer to protect against competition if the ongoing lawsuits against existing competitors should fail.

Brewer Pricing Strategies

GMCR currently sells the Keurig brewers with little profit, to establish a "razor and blade" model where it books a much larger profit on K-Cup sales. However, in June 2012 GMCR CEO Larry Blanford fielded a question from the audience 39 minutes into his presentation at the Piper Jaffray 32nd Annual Consumer Conference about increasing the price of the Keurig Brewers in response to K-Cup competition.

Blanford was a bit coy in his response, stating that the company tries to anticipate everything that could happen in a competitive scenario, and build in capabilities to respond to situations that may occur. He said that it has a number of "tactical responses" available if unwanted competition emerges. He indicated that the current plan is to simultaneously continue to drive adoption of both the K-Cup and Vue platforms, as well as the new espresso system (developed with Lavazza) that it will be selling for the holidays this year. The Vue cups are also patent protected, and not affected by the patents expiring later this year.

Blanford said that both the K-Cup and Vue platforms are currently priced to drive adoption, but if circumstances emerged where it wanted to promote the Vue platform more aggressively, one option would be to raise the price of the K-Cup brewing system. He said it would continue to sell the K-Cup brewers, but they would be priced for "replacement" rather than for "adoption." He stated that the increased profit from the higher-priced K-Cup brewers could be taken directly to the bottom line, or poured into the driving adoption of the Vue system. GMCR can do the same with the Vue cups - use profits from the K-Cup system to drive the price down on the Vue cups.

It is interesting that CEO Blanford provided this information only in response to an audience question. If the question had not been asked, we wouldn't have any indication of this potential response from GMCR. It makes you wonder what other options it is preparing, that we haven't heard about yet.

Radio Frequency Identification (RFID) Keurig Brewers

In a little-noticed filing earlier this year GMCR submitted paperwork to the FCC for a RFID-enabled brewer, requesting that the technical details be kept confidential. In its second fiscal quarterly report, GMCR stated:

We plan to make available a commercial Vue™ brewer for the away-from-home workplace through distributors of Keurig products in the fall of 2012. This platform will incorporate Vue™ packs embedded with Radio Frequency Identification technology, which is designed to simplify the brewing experience and ensure beverages are of the highest quality and consistency for those users who may not be familiar with the brewer.

Since GMCR has developed this technology and figured out how to integrate it into both the brewers and cartridges, other potential uses come to mind. For example, it could replace the current K-Cup brewers with new systems integrating RFID readers in the brewers, and attach RFID tags to every K-Cup. And program it so the brewer won't operate on any cartridge without a proper RFID tag. What would the contents of a proper RFID tag be? Perhaps info on the K-Cup contents, along with some simple trademarked phrase, like "Keurig Brewed®" (for which it coincidentally issued a press release on July 12, 2012). Slide 9 of this presentation (pdf) discusses the concept.

There are a lot of compelling aspects to this scenario:

  • No competitor could use the required trademark in cartridges without GMCR permission.
  • RFID K-Cups could be rolled out a few months before the new brewers, enabling legacy non-RFID K-Cups to work their way through the production-to-consumption channel.
  • Existing brewers would work just fine with the new RFID K-Cups, so consumers wouldn't complain their brewers stopped working.
  • Once GMCR announced it was going to do this, it would likely stop future competitors in its tracks, as nobody would want to make a capital investment in manufacturing the non-RFID cartridges that could only be used in systems that are no longer manufactured. While the number of Keurig K-Cup brewers would continue to increase, every day there would be fewer brewers that could consume non-RFID cartridges.
  • As soon as the RFID-enabled brewers hit the shelves, most brick-and-mortar retailers would stop carrying cartridges from the existing knock-off manufacturers. After all, who wants to sell a cartridge that won't work in the brewer that is just one shelf down? The return rate on the non-RFID cartridges would quickly become an unacceptable nuisance.
  • Printable RFID stickers "with a cost of pennies each" could be easily applied to the exterior of K-Cups, with minimal modifications to GMCR's existing manufacturing lines.
  • Short-range RFID readers have become very inexpensive. USB readers are available at under $40 to retail consumers right now. The integrated RFID readers would be much simpler than these, and would likely increase brewer cost by only about $10 per unit.

So if GMCR is heading down the RFID K-Cup path, why hasn't it made any announcement to ward off potential competitors? Well at this point, GMCR has already sued the current knock-off manufacturers for violating patents that don't expire for many years. And as I explained in my first article, if GMCR is successful in its claims that the knock-offs violate patents 7,165,488, 6,606,938, and/or 7,347,138, nobody will be able to build cartridges that will brew in a Keurig brewer until at least 2022. Life is easy for GMCR if it is successful with its ongoing lawsuits against Sturm and JBR (pdf), so adding complexity and cost with the RFID-enabled system is only desirable if the lawsuits fail. I would expect an announcement about RFID K-Cups only on the heels of an unsuccessful verdict in one of the lawsuits.

Conclusion

GMCR short-side analysts would have you believe that GMCR will just roll over when a couple patents expire this fall, and will meekly surrender market share and profitability. In my articles, I showed that GMCR has three lines of defense from potential competitors:

  1. A variety of longer-term brewer interface patents that, if successfully prosecuted in ongoing lawsuits, will protect the K-Cup system until at least 2022.
  2. A set of granted and pending patents that will protect currently used K-Cup designs until 2020-2023, and force K-Cup cloners to compromise on coffee quality.
  3. A variety of options that follow from GMCR's long-term patent protection of the brewers required to consume the cartridges.

So what does this mean to the GMCR investor? The primary conclusion is that GMCR has already taken steps to ensure that it won't face unwanted competition, and it has a variety of options to protect its control of the K-Cup market. While I presented a couple of very viable possibilities in this article, I would be willing to bet that GMCR has other well-developed options not presented here. GMCR is highly incentivized to maintain control of this lucrative market, and has the tools needed to forestall unwanted competition.

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.