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Business Model Innovation – Keurig’s C/OS “Coffee Operating System”

Last weekend, my wife made a convincing case for an interesting kitchen appliance – the Keurig Platinum Single Cup Brewing System. The device is really innovative – it brews a single cup of coffee, tea, hot cocoa or even iced coffee in less than a minute, using “K-Cups” that you load into the machine and discard after each use. It is easy to use, easy to clean, and looks really cool. And you can choose from a lengthy list of branded providers of beverages.

I was skeptical, arguing that we didn’t need yet another space-age kitchen appliance and that the TCO (Total Cost of Ownership) was very high. But she won me over with her arguments that convenience trumps TCO and a hot cup of on-demand Joe was well worth the financial sacrifice and shelf space. As I sip my cup of Newman’s Own Extra Bold coffee that I made on the Keurig, I must say that she was right, as usual. This machine is the greatest thing since sliced bread! The coffee comes out piping hot, it tastes great, and the kids love the fact that they can make hot cocoa in less than a minute whenever they want.

But what impressed me more than the device is the innovative business model that Keurig and its competitors (Tassimo and Lavazza, among others) have created. I call it “Apple iPod/iTunes meets coffee”. Let’s look at the similarities:

  • Like Apple, Keurig began with the premise that, while coffee makers have been around for a long time, the customer experience of making a hot, consistent and convenient cup of coffee in the home leaves a lot to be desired. Coffee makers are difficult to clean, a hassle to operate, the coffee sits there and becomes cold and bitter, and it is difficult to figure out exactly how much coffee to put into the filter.

  • Like Apple, Keurig created a superb end-to-end customer experience consisting of an elegant hardware device, single-use “K-Cups” and a comprehensive ecosystem of “content” from 13 branded beverage manufacturers. Further, like Apple’s proprietary AAC format, the Keurig K-Cups are not compatible with other systems.

  • Like Apple, Keurig sells the hardware for a similar price point as the iPod ($199), and content at a similar price ($0.60 per K-cup).

  • Like Apple, Keurig creates an “open yet closed” customer experience by allowing independent content providers to offer their own branded beverages, while maintaining tight control over the buying and brewing experience.

  • Like Apple, Keurig has been able to convince all beverage providers to sell the beverages at the same price. Just as i-Tunes sells all songs at $0.99, all K-cups sell for $13.95 for a pack of 24.

  • Like Apple, Keurig has created a number of accessories, including reusable filters, milk frothers, travel cups, etc. that it sells at healthy margins.

  • Like Apple, Keurig has created a strong lock-in effect because of the investment that customers have made in its hardware and accessories.

All this allows Keurig to make a killing, first on the coffee maker and then on the K-cups. For my household, here is the stimated CLTV (Customer Lifetime Value), assuming a 36-month horizon:

  • Coffee Maker: $199

  • Accessories: $50 (we have already spent about $30)

  • K-Cups: $6,000 ($0.60/cup x 10 cups/day x 365 days x 3 years)

That’s a CLTV about $6,150, assuming a 10% discount rate. And you thought Starbucks was an expensive habit!!

Here are the lessons to be learned from Keurig and its competitors:

  • Even a commodity category like coffee can be reinvented by focusing on creating innovative solutions and an innovative customer experience.

  • Business model innovation has far greater payoffs than product innovation

  • There’s a lot you can learn about business model innovation if you look beyond your industry

Now, I wonder why P&G and Kitchen Aid haven’t thought about creating a “personal laundry system” or a “personal dishwashing system”. This could include appliances that would accept proprietary “pods” of Tide or Cascade that would be inserted for each load, and would take the guesswork out of doing laundry or dishes. If HP can make money from ink, Gilette from razor blades and Apple from MP3 players, what’s stopping other consumer packaged goods companies from using a similar “razor-razor blade” business model?

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