Like many industries, coffee was in a state of flux around the turn of the millennium. The explosion of Starbucks’ coffee shop culture and the rise of gourmet roasts threatened the traditional home-brewed cuppa. The number of coffee drinkers had flatlined. But a new market entry was poised to shift the entire coffee world out of its malaise.

“When retail companies are thinking about how to grow revenue, there are normally three questions they have to ask,” says Eric Anderson, a professor of marketing at the Kellogg School. “The first is: How much incremental demand will this new product or service generate? The second question is: Where will that growth come from—will the company be able to expand, rather than cannibalizing, the current market? Finally, companies must ask whether they can create a product that commands a price premium.”

Keurig, a manufacturer of coffee brewers, managed to not just survive in this environment, but to reinvent the category. Keurig looked at the numbers and concluded that their best bet for growth was not to bring new converts to coffee, but to offer better coffee to regular drinkers. And as for expanding versus cannibalizing the market of home-brew coffee drinkers—why not do both?

Keurig’s innovation was the “K-Cup,” a single cup brewing system that makes having a cup of coffee (or tea, or hot cocoa) as simple as popping in a single-serving pack of grounds and pressing “brew” on any K-Cup brewer. K-Cups had the potential to expand the market for home drinkers by positioning its product as comparable in quality to coffee shop coffee at a better price. It also appealed to drip coffee drinkers looking for a taste upgrade.

But it was Keurig’s finessing of the third question—commanding a price premium—that presented them with an opportunity for revenue growth.

“If you are in a relatively inelastic category, there are two ways to grow revenue in this environment,” Anderson says. “The first is through unit volume—sell more coffee to those who drink coffee. The second is by growing margin. Keurig asked ‘what kinds of products can command a price premium?’ and in the process transformed a daily ritual for many people, including how much they pay for that cup of Joe.

“By growing margin, Keurig has transformed not only their own business, but the entire ecosystem,” Anderson continues. In 2002, the average price of a coffee maker was about $35. By 2013, that number had risen to around $90. The single cup system has a significantly higher margin per cup than a can of Folgers, or even a bag of beans from a local roaster. “So while the size of the coffee market remains relatively inelastic,” Anderson says, “drinkers are migrating to the higher end of the market,” out of the convenience and perceived quality of the product.

Having recalibrated coffee drinkers’—and retailers’—expectations about the price and quality of a cup of coffee, can Keurig sustain the kind of growth it has seen across the market? This remains to be seen, but Keurig is not standing pat. The company announced that it will raise prices on portion packs by an average of nine percent in November.

The company has also entered into, or expanded, a series of high-profile partnerships and licensing agreements with beverage companies including Coca-Cola and Peet’s Coffee and Tea. The Coca-Cola partnership includes Coke taking an ownership stake in the company, as well as Keurig developing new applications for the K-Cup technology.

“You can now make iced coffee, teas, hot chocolate, and even soup on this platform,” Anderson says. It appears Keurig’s growth vision may only partially depend upon how it approaches the coffee market.

Editor's Note: Eric Anderson is Hartmarx Professor of Marketing and Director of the Center for Global Marketing Practice, Kellogg School of Management, Northwestern University.
Photo credit belongs to Ian Ransley. Published under a Creative Commons license.

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