Kraft's Tassimo coffee system aims to sell its beans, not the machines

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The launch of the Tassimo Hot Beverage System in the U.S. this fall is a crucial one for package-goods behemoth Kraft Foods to prove it has what it takes to become more than just a commodity broker.

Kraft CEO Roger Deromedi is investing hundreds of millions of dollars behind the development and marketing of the high-end Tassimo coffee machine made by Gillette Co.'s Braun and its proprietary single-serve "T-disks" in hopes it might provide a path toward much-needed profitability. Not only has the one-time U.S. coffee leader's sales for Maxwell House been eclipsed recently by Procter & Gamble's Folgers, but increasingly eroding margins have affected Kraft's bottom line in coffee, which brings in $4.2 billion for the company globally. Can Tassimo change all that?

Kraft wants to "prove it can leverage its technologies in ways that are proprietary, that set it apart from private label and that improve the pricing mix and, therefore, profitability," said Lehman Bros. analyst Andrew Lazar, and the move goes far beyond coffee. "Kraft is in a variety of large, commoditized categories like cheese, coffee and packaged meat, so this type of innovation is very important for them."

The strategy is certainly not without risk. This nascent coffee category has proven successful for Kraft in France over the last year and in the Netherlands especially for Sara Lee's Senseo. But it is already getting crowded with competitors in the U.S., where consumers have been slow to adapt to the new technology (AA, Oct. 11, 2004). Senseo, which pairs machines made by Philips with pods of Sara Lee's Douwe Egberts coffee and P&G's Home Cafe, which couples machines including Applica's Black & Decker with P&G's Folgers and Millstone brand pods (see chart above). launched in May of last year. Each have garnered less than $5 million in sales for the pods in food, drug and mass outlets for the 52 weeks ended Feb. 20, according to Information Resources Inc. Kraft's own Maxwell House Cafe Collection pods, designed for use in others' machines, have likewise seen sales of only $2 million in those outlets.

high priced

Bob Levi, VP-coffee at Kraft, offers that the "slow but consistent build" is to be expected based on what has happened overseas. In the Netherlands, for example, this segment now makes up 50% of brewing machines sold. In the U.S., retailers who in October began to think the category "might be a dud," saw otherwise after Thanksgiving when sales began to pick up, accounting for 12% of retailers' December coffee machine sales, he said, quite a coup given that the average coffeemaker retails at roughly $29 while the new machines start at $50. (Tassimo will retail for $189.)

And, more importantly for Kraft, whose profits will come from the coffee sold for such machines, the higher-margin coffee sales are following. One major mass retailer who has pushed hard on the category claims coffee pods now make up 12% of its total coffee sales, Mr. Levi said.

While Kraft is initially seeding Tassimo in high-end retail outlets like Bloomingdales and on the Internet featuring proprietary T-disks under its upscale direct brand Gevalia, the plan, ideally, is to expand distribution quickly to more mass and grocery outlets with T-disks under the Maxwell House name. The goal is that as the machines become more commonplace, it will raise the commodity image of the brand along with it.

Kraft has had a harder time than its competition tapping into the growing premium segment, with efforts such as Maxwell House Premium Cup Collection not faring nearly as well as P&G's Folgers Coffee House. Even Starbucks, which Kraft licenses for distribution in grocery outlets, has seen sales growth slow in recent months.

But based on Tassimo sales in France, Kraft predicts it can sell a 20 T-disk bag per week of the premium coffee to disk users at $4.99, translating to more than 28¢ a cup versus 5¢ a cup for typical Maxwell House coffee. Over the next four to five years, Mr. Levi said, Kraft predicts coffee mechanisms like pods and its T-disks will make up 20% to 25% of the $4.5 billion U.S. coffee market, which is expected to help tremendously toward turning the category into a more profitable one for the company.

analyst dubious

Unlike more typical launches for Kraft, the initial marketing spending will be focused not on mass-media vehicles but rather on the demographics and other non-traditional buzz marketing tactics to reach "key influencers," among them public relations and online efforts. European market launches have shown word-of-mouth is crucial to driving purchase. More mainstream media, like TV, will likely be added as the category grows, Mr. Levi said.

The danger, of course, as with all new categories, is that such growth will be elusive, and of course there are plenty of skeptics. One Wall Street analyst said he was "dubious about the whole on-demand push to begin with since it requires a change in behavior," something consumers have often shied away from, especially in terms of their food and beverage purchases. While the failure of Tassimo would "not derail [Kraft CEO] Roger [Deromedi's] turnaround," he said, "it would be a major setback momentum-wise and motivation-wise at the company because there is so much excitement about it."

Strategy: With the high-end coffeemaker, Maxwell House marketer Kraft is angling to shore up its margins in coffee, which even though they are eroding, brings in $4.2 billion for the company globally.

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