Green Mountain's War

The brew-at-home war is heating up like a pot of decaf -- everyone seems to be watching, but no one knows if they really want a cup. The recent round of salvos has been aimed at cost-cutting, and while Green Mountain Coffee Roasters (NAS: GMCR) launched the largest artillery, it's not clear that the company is any closer to winning the war. Starbucks (NAS: SBUX) responded with its own covert operation, and even grocery chains are starting to weigh in on the issue. It looks like Green Mountain is beset on all sides, with very few options for escape.

Can't we all just get along?
The crux of this battle is the end of Green Mountain's patents for the design of its K-Cups. Those patents meant that the razor distribution model Green Mountain had going was its show to run. The company sells brew-at-home devices, makes a small profit at most, then makes a fortune from the coffee packages that fit into the brewer. Now that the patents have expired, everyone can make the K-Cups. And, due to the relatively simply design, everyone has taken up the challenge.

That's issue one. Issue two is that Starbucks decided earlier this year that Green Mountain was on to something good. So in March, the coffee chain announced its intention to sell its own machine, which brews both normal coffee and espresso drinks. The new Verismo machine hit stores in September, and the company reported in late September that sales had exceeded expectations.

So now Green Mountain is looking at a future where anyone can make the profitable part of its system and where a huge, internationally recognized coffee company is selling a competing product. Time for action!

Green Mountain answers
I'm usually pretty down on Green Mountain, due to some accounting irregularities that it had in the past and its ever-shrinking competitive moat, which now resembles a backed-up drain, but I've been impressed with how the company has responded to the pressure. Earlier this year, it decided to try to revive its original business model by designing a new espresso brewer with Italian coffee company Lavazza. While that will offer a counter to Starbucks' espresso-brewing capability, it also puts Green Mountain in competition with Nestle's (NASDAQOTH: NSRGY.PK) Nespresso machines, which have a dominant foothold in the espresso-at-home market.

In addition to a new espresso machine, Green Mountain is also pushing its new Vue range of brewers. These machines offer a lightly augmented consumer experience, but more important, are based on patented technology. This is going to be a hard sell for current brewer owners, though it may win over new customers.

Finally, Green Mountain is embracing the "get 'em hooked" mentality and has offered a discount on all its brewers through the end of the month. This might help control a bit of damage from the introduction of the Verismo, but I think the timing would have been better a little later in the year.

The last big problem
Green Mountain's biggest problem might not be Starbucks. While the two are competitors, Green Mountain has built up a pretty large fan base, and the Starbucks machine has a price point that Green Mountain can easily beat. The bigger problem is the blade side of the model. Companies like Kroger (NYS: KR) are already getting in on the K-Cup game, and those companies have the ability to produce cut-rate products.

That could seriously damage Green Mountain's bottom line, and I'm going to be watching the company's next set of results closely. I expect that the Nov. 5 year-end is going to be disappointing, but hopefully the company will have a realistic outlook and clear plan for the next fiscal year. I'm holding off until I see those plans before I decide whether or not to get into Green Mountain.

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Fool contributor Andrew Marder does not own any of the stocks mentioned in this article. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services have recommended buying shares of Green Mountain Coffee Roasters and Starbucks. Motley Fool newsletter services have recommended creating a bear put spread position in Green Mountain Coffee Roasters and writing covered calls on Starbucks. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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