Kraft-Starbucks Split Could Spawn Bitter Grocery Rivalry

Retail Java Giant Is Eyeing Expanding Single-Cup Market

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CHICAGO (AdAge.com) -- Their bitter divorce is not yet final, but when the relationship between Kraft and Starbucks ends, it could lead to a major shakeup in the grocery coffee market.

Starbucks, which claims Kraft failed to effectively market its brands, has already signaled its intent to aggressively expand its grocery offerings, possibly including in the fast-growing single-cup market, where it could compete directly with Kraft's Tassimo line.

Kraft has distributed Starbucks bagged coffee in stores for 12 years, a business that now generates about $500 million in annual revenue.
Kraft has distributed Starbucks bagged coffee in stores for 12 years, a business that now generates about $500 million in annual revenue.
Kraft, meantime, must decide if it wants to stay in the premium-ground-coffee space, either by partnering with a new upscale coffee brand or by expanding its Maxwell House brand to include more premium lines. Both moves would put the food giant in direct competition with Starbucks.

Analysts say Kraft has the most to lose.

"Kraft's strategy is really to have global brands that are in image-based categories where private label is less of a threat," said Rick Shea, a former Kraft marketing executive who now runs Shea Marketing Consulting. "Coffee -- like chocolate, like biscuits -- certainly could be one of their platforms, but, obviously, if they don't have Starbucks, they don't have the brand power to make coffee like chocolate and like biscuits."

For the past 12 years, the two corporate giants were partners, with Kraft distributing Starbucks bagged coffee in stores, a business that now generates about $500 million in annual revenue. The deal is now all but over, with the exit terms likely to be decided by an arbitrator. Starbucks wants out now, claiming Kraft failed to effectively market the coffee and support the Starbucks brand. Kraft strongly disagrees and wants Starbucks to pay it "fair market value of the business" plus a 35% premium.

In the short term, Kraft could benefit by potentially getting a hefty severance fee and from the "potential disruption from the distribution transition Starbucks could experience," said R.J. Hottovy, a Morningstar analyst. "But in the long run, Starbucks stands to benefit the most through growth."

Premium brands are alluring because they are growing faster than mainstream offerings. Unit sales of Starbucks ground coffee grew 11.3% in the year ending Oct. 31, according to SymphonyIRI, making it the fourth-best-selling grocery brand with a nearly 10% dollar market share. Maxwell House, the No. 2 ground coffee brand with 16.7% share, grew by only 2.8%.

Folgers remains the top seller, with a 28% share, but unit sales of the mainstream brand fell by 2.1%. Still, the brand's owner, J.M. Smucker Co., enjoyed big success with its more premium Dunkin' Donuts brand. The coffee, distributed in a partnership with the fast-food chain, grew by 14.8%.

Starbucks claims Kraft did not do all it could to grow the brand even more. "We consistently found our products out-of-stock and positioned at the bottom of store shelves away from the view of the consumer," Starbucks spokesman Alan Hilowitz told Ad Age in an email.

Kraft refutes those charges and claims it was Starbucks that held the partnership back. "Although Starbucks was introducing new products in its retail cafes, it was unreasonably denying Kraft the opportunity to sell those same products to its [grocery] customers," Kraft says in a legal filing.

Starbucks bypassed Kraft for one of its most significant recent grocery entries -- Via, a premium instant coffee launched in 2009. Starbucks distributes the instant coffee itself but partners with Florida-based Acosta Sales & Marketing, which works with Starbucks on sales calls and provides in-store support such as on-shelf merchandising, and in-store visits. Starbucks handles advertising, promotion, public relations and distribution.

Starbucks plans to replicate that model with its bagged-coffee portfolio. The company told investors at a Dec. 1 meeting that it struck a deal with Acosta that will begin March 1. Omnicom's BBDO Worldwide is the agency of record for Starbucks, including the partnership with Kraft.

The announcement angered Kraft, which is seeking a court injunction that will keep Starbucks from "proceeding as if the agreement has been terminated."

Additionally, Kraft claims that Starbucks demanded language in the latest contract that "precluded Kraft from selling its own and other super premium coffee brands in competition with Starbucks products ... imposing on Kraft considerable additional costs in the form of lost commercial opportunities." Kraft is citing the restriction as one reason it says Starbucks owes it a hefty payment before it exits.

Starbucks, meanwhile, is moving forward with a new grocery coffee that could pose a threat to Maxwell House. The offering, which for now is being distributed by Kraft, is branded under the Seattle's Best name and is called the "Level System," with varieties simply named one through five that vary in flavor from mild to bold. It targets consumers who are looking to take a leap from mainstream brands such as Maxwell House or Folgers but aren't quite ready for sophisticated blends.

"We think we'll get people who are trading up and maybe people who haven't found a home in premium coffee yet," said Seattle's Best spokeswoman Jenny McCabe.

And Starbucks is poised for even further grocery expansion, with speculation swirling on its next moves. Some analysts suspect that Starbucks could buy Peet's Coffee & Tea. And if Starbucks wants to look outside its traditional coffee channels, it has plenty of food options it could take to the grocery aisle. Starbucks already has its name on an ice-cream line, which is distributed through a licensing agreement with Unilever.

"I wouldn't be surprised if Starbucks introduced its oatmeal to grocery stores," said Darren Tristano, exec VP at Technomic. "It seems like a natural move, as cereal and coffee are generally in the same aisle."

At the same time, Kraft and Starbucks could soon be battling in the small but growing single-cup market, in which companies sell coffee for machines that brew one serving at a time. Kraft is the exclusive distributor of coffee for Tassimo brewers and in 2007 struck a deal to sell Starbucks branded coffee for the machines, which now account for a quarter of all Tassimo coffee revenue.

Kraft says Starbucks now wants out of the deal, which is separate from the bagged-coffee partnership. The exit could potentially free Starbucks to partner with other machine makers, or even market its own machine.

"It would be, I think, in Starbuck's interest to see if they get a better handle on the market," said Bill Paterson, who covers coffee for market researcher Mintel. "If they're linked into Kraft, it means they can't go and sell Starbucks coffees ... to other manufacturers."

While single-cup coffee sales equal just 8% of total ground-coffee sales, the market is hot, with dollar sales up 111% in the year ending Oct. 31, according to SymphonyIRI.

Starbucks has not directly addressed its next move in the single-cup market, but Starbucks CMO Annie Young-Scrivner recently told analysts that "we do feel that there is an opportunity to play in all areas."

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