Coffee and Other Things – March 2023
In this issue, we discuss pricing strategies of some of the innovative new coffee companies on the market. Looking forward, we see evidence that demand for superpremium brands – which had been on fire – may be slowing, and funding for growth is becoming more challenging. Will premium coffee startups need to adjust their pricing strategies in order to continue to drive growth?
After discussing rising coffee pricing in the last issue – we now look at the pricing strategies for startups in the coffee market. Does the benefit of adopting a premium price point outweigh the risks of limiting the potential market of your company? Will we see more innovation aiming for the mainstream consumer?
This question is especially relevant today as higher interest rates are changing the funding environment – meaning that startups may have to dial-in their strategy now rather than depending on another fundraising round to help support growth. At the same time, the consumer is coming under pressure and a recession looms on the horizon, impacting the growth of superpremium brands.
Days of Easy Money Are Over, or Are They?
As quoted in a recent CNBC publication, Rabobank’s Senior Markets Strategist sees interest rates increasing, with “the Fed going to 5.5%, with a growing risk of 6%”. Higher rates mean a sea change in how easy it is for ambitious startups to raise capital. It also means that companies that are not yet profitable may have to switch their focus from spending to grow (with the expectation of raising another round when needed) to focusing on the bottom line.
It’s not that the money has totally dried up though – canned water brand Liquid Death raised USD 70m at a 5x sales valuation in October. We have talked with many clients on the consumer side of Private Equity that still have significant amounts of money left to deploy from funds that were already raised. The difference is that our conversations around future investments focus more on current unit economics and are moving away from opportunities that have a longer path towards scale and profitability.
In the US, there are two recent coffee startups that raised significant capital – Cometeer has raised USD 100m and Blank Street coffee has raised USD 67m – that can help us understand the issues at play.
Cometeer has found a really unique niche: high-quality specialty coffee from big name roasters in a convenient, and frozen, k-cup(ish) package. The brand sells at a high price point and a recent Forbes article details some of the challenges the company has had scaling up and trying to reach a wide audience.
Price Point of Capsules
Cometeer is right at USD 2 per capsule before shipping. Looking at the broader k-cup market – the vast majority of brands are selling between USD 0.35 and USD 0.60 per cup.
To be fair, there is a move towards expanding the higher end of the market. Black Rifle coffee is selling their k-cup closer to USD 1 per cup, and Keurig/JAB just introduced Intelligentsia k-cups at a bit over USD 1 per the Keurig website.
It’s tough to compete at 2x-6x the price of the competition, even if you are bringing something special to the table. And while we do believe the premiumization trend has legs in the long term, there is some evidence to suggest that it may be slowing down – at least temporarily.
Few categories have seen more pronounced premiumization trends recently than the US spirits industry. The superpremium price segment of whiskey grew 14% in 2021, compared to 1% for the premium segment – high-priced liquors were on a tear! But in 2022, the growth of the superpremium segment of whiskies slowed to just over 3% (see Figure 1). Similar trends were seen across gin, vodka, tequila, etc. So there are some signs that the consumer dynamics that were supporting the growth of very high-priced brands may be easing (though, notably, not reversing!).
A key point about some of the ultrapremium spirits is that they do not have to achieve large volumes to be very profitable to the brand owner. I’m not sure that model works for specialty coffee pods at-home, given the challenges of building out manufacturing/shipping infrastructure and needing the (assumed) benefits they would get from greater efficiencies of scale.
But if we are talking about scale, I should offer up the story of Woodford Reserve. It was launched back in the 1990s, but has only begun to really gain traction in the last ten years or so. It’s now one of the fastest growing and most premium brands in Brown-Forman’s portfolio (Woodford sells for ~USD 35/bottle, vs USD 26 for Jack Daniel’s, and USD 20 for Jim Beam). The path to “overnight success” for many premium brand introductions (as with Blue Moon in beer) often involves a long period of brand incubation/cultivation. If you believe in the long-term premiumization trend of coffee, then perhaps you could argue that the pricing strategy of brands like Cometeer will pay off over time, but investors may require patience and deep pockets.
Maybe It’s About Aiming Big Enough (And That’s Where the Price Point Comes In)
Both specialty coffee and the overall direct-to-consumer segment of beverages are smaller slices of the overall pie. Taken together, is the target demographic too narrow in what is now a tougher fundraising environment?
Whether or not you are aiming big enough depends on framing. The overall home coffee market remains a relatively healthy segment. Keurig describes the market as tightly correlated with time spent at home. In a world where consumers have only partially returned to the office, this should be a good thing. Keurig themselves have expanded the Keurig brewing system to 38m US households, a 10m household increase since 2018. But access to a market this size depends on being at a price point that is accessible to the majority of consumers.
Blank Street Coffee provides an interesting counterpoint to Cometeer. They run minimalist stores with automated espresso machines and compete, at least partially, on price. They are trying to create:
“a micro-cafe that would be cheaper and more welcoming than Starbucks, with better coffee than Dunkin’ and more ubiquitous than any independent coffee shop or chain.”
It’s easier to imagine the runway for a coffee shop chain that is well capitalized and has an attractive price point. This is an example of being able to access, theoretically, most of the total coffee shop market. And in a market where superpremium is struggling to achieve the same levels of growth it makes more sense than ever.
How Aggressive Should Brands Be In Positioning at Higher Price Points?
A question with no single answer, of course.
When Blue Bottle sells three servings of a very rare instant coffee for USD 65, it serves a purpose of setting a higher price anchor for consumers that will hopefully benefit other purchases as well. But, as a stand-alone, that would be a brutally hard business model (and we have covered the difficulty of expensive instant coffee).
Starting out with a high price can certainly be a way to cover early costs as you scale up. But when we look at the innovation we consider worthy of a big investment, the Vertuo Pop might be another good example. Nestlé has called out its new Nespresso machine, which it launched in 10 markets, as a key driver of coffee growth. And priced at EUR 100, with the rest of the Vertuo line at EUR 150- EUR 200, it is quite accessible. In an environment where the consumer is coming under pressure, we expect to see more investment targeting the middle and lower end of the market. An affordable machine for consumers spending more time at home is an equation that checks out.
Where to go from here
Jim WatsonSenior Analyst - Beverages Read more