Why an M&A storm is brewing in the coffee market
A cup of coffee has long been an integral step in the American consumer’s daily routine, with java providing the jolt of energy needed to tackle increasingly hectic schedules. But in the past two decades, consumers have moved from viewing coffee as merely a pick-me-up to an indulgent, experience-driven occasion — a shift that has given Big Food new paths to growth.
Gourmet coffee now represents half of all consumption for the first time in history, according to research from the National Coffee Association, with trendy chains such as Peet's Coffee and Stumptown sparking product trends ranging from nitro cold brew to internationally sourced beans.
“There’s a lot of money being spent [and the coffee segment] is continuing to grow, but a lot of this growth is not coming from the brands that defined the category in the 20th century,” Michael Schaefer, global lead of food and beverage at Euromonitor International, told Food Dive.
This shift has triggered a wave of acquisitions by legacy food and beverage manufacturers looking to diversify their portfolios.
Just last week, Coca-Cola announced it will purchase Costa Coffee from U.K. drinks and hotels group Whitbread for for £3.9 billion ($5.1 billion). With nearly 4,000 stores in 32 countries, Costa is the second largest coffee chain in the world, and the purchase will give the soda giant the opportunity to expand its facilities and diversify its offerings.
"Coffee is one of the strongest growing categories in the world and Coca-Cola needs to expand into coffee and hot drinks," Coca-Cola CE James Quincey said in a video posted Friday. "We’re buying Costa to grow the business and our participation in the category."
Perhaps the most notable deal of late, however, was Nestlé’s May purchase of Starbucks’ retail products for $7.15 billion, a move that brought Starbucks, Seattle’s Best Coffee, Starbucks Reserve, Teavana and Starbucks VIA to the CPG giant's beverage segment. The business boasts $2 billion in annual sales — revenue that has been a bright spot for Nestlé.
"A lot of this growth is not coming from the brands that defined the category in the 20th century."
Global lead of food and beverage, Euromonitor International
Rui Barbas, chief strategy officer at Nestlé, told Food Dive this deal will make the company the top manufacturer in this this increasingly competitive market.
"We are very bullish about the alliance with Starbucks," Barbas said. "If you think about product format, from single-serve to ready-to-drink, we are present in the whole spectrum of coffee, and that's part of our development — evolving our portfolio toward where the consumer is going."
Nestlé has been especially active in the coffee space following criticism from activist investor Daniel Loeb, who has pressured the company to bolster margins and innovate its core business. In addition to Starbucks, the manufacturer has also taken a stake in popular coffee shop chain Blue Bottle and snapped up Chameleon Cold-Brew last year. These are all-star additions to its already sizable coffee portfolio, which includes Nespresso, Nescafé and Taster’s Choice — brands it developed long before the coffee M&A mania of recent years. The company also made a play for Italian coffee producer and distributor Lavazza earlier this year, but struck out.
"We are present in the whole spectrum of coffee, and that's part of our development — evolving our portfolio toward where the consumer is going."
Chief strategy officer, Nestlé
"You have these huge players, the constituent companies like… Nestlé who have these enormous global distribution systems but they realize they need more and better brands. That’s what Nestle is doing with Starbucks... getting access to brands with ready-to-drink coffee," Schaefer said.
According to MainFirst analysis, beverages are Nestlé's most profitable segment. Bernstein analyst Andrew Woodward told Food Navigator the Starbucks deal will boost Nestlé's higher margin coffee sales and strengthen its leadership in the global coffee market.
But Nestlé is far from being the only major competitor in this scramble for coffee growth. Schaefer said that JAB Holdings has actually been responsible for much of the M&A activity that’s transforming the market.
The company's massive portfolio includes Keurig Green Mountain — which recently bought Dr Pepper Snapple for $19 billion to form Keurig Dr Pepper — and Peet's Coffee, Stumptown Coffee Roasters and Intellegentsia. JAB also has stakes in coffee-adjacent restaurant chains including Panera Bread and Krispy Kreme donuts.
“[JAB Holdings has] been engineering the global consolidation of the coffee industry in a lot of ways,” Schaefer said.
Retail coffee chains are driving innovation
Though much of this market development is dominated by deals between industry powerhouses, coffee’s changing landscape is leveling the playing field so smaller brands can shine, too.
Data from CB Insights shows that coffee startups are on pace to raise more than $1 billion by the end of 2018, and investors have already poured $600 million into these newcomers this year alone — four times the funding in 2017. Average deal size has also shot up to a whopping $14 million in 2018 from $2.7 million last year.
Schaefer said that a combination of growing consumer demand for innovative, less sugary beverage experiences and a reduced barrier to entry has driven a slew of coffee innovation among these small brands
“There [are] a lot of occasions where consumers are open to trying something new. They’re no longer wedded to a can of Coke,” he said. “So you have a lot of smaller brands finding it much easier to reach consumers, at least initially. Whether it’s via social media or whether it’s being on Amazon, it’s just easier than it was 10 years ago for a small brand to break through.”
These evolving consumer tastes have spurred the creation of powerful mega trends such as, butter coffee, probiotic and protein-infused CPG coffee products, as well as mission-based claims including authentic international flavors and ethical, sustainable sourcing.
"It's not just about having a superior product or packaging or communication, it's also about how you — in a sustainable and resourceful way — source your products," Barbas said. "That's one of the big advantages of this alliance between Nestlé and Starbucks, is that these are two companies focused on sustainable and responsible sourcing and manufacturing."
Changing consumer preferences also have given rise to industry fragmentation, Keurig Green Mountain CEO Bob Gamgort said at an investor day presentation in March before his company's merger with Dr Pepper Snapple.
"There [are] a lot of occasions where consumers are open to trying something new. They're no longer wedded to a can of Coke... so you have a lot of smaller brands finding it much easier to reach consumers."
Global lead of food and beverage, Euromonitor International
“It's flavored; it's multiple formats; it's single-serve; it's ready-to-drink; it's super premium. There's so much going on in coffee that it's driving the category growth," Gamgort said at the presentation. "And, interestingly, the category growth is attracting more people and entrepreneurs into the business because it's such a good business that it's continued to fuel more and more excitement. This is not a fad.”
But it's difficult for slow-moving CPG giants to stay on the cusp of ever-changing consumer coffee trends and achieve this level of product innovation in-house. That has Big Food racing to snap up the players at the epicenter of this creativity: retail coffee chains.
"[Coffee shops] realize that there's an appetite... to try something different, and consumers trust coffee shops to get it right," Schaefer said. "Coffee shops are where the new brands are being born."
By pairing their large distribution networks and R&D pipelines with cult coffee favorites, CPG food and beverage companies can gain a first-mover advantage in the coffee aisle, as well as valuable insight into consumer spending habits — with deep customer loyalty and brand recognition to boot.
Coffee chains have a daily connection with many customers, a touchpoint that is largely unparalleled in the packaged food space. Trendy brick-and-mortar coffee locations also give Big Food acquirers built-in product branding with store design, ambiance and signage creating a strong foundation for product identity and differentiation.
This strategy has proven to be one of the most successful ways for large manufacturers to up their coffee game, Scahefer said. These relationships are helpful for small chains as well, who can use the resources of billion-dollar parent companies to expand their retail footprint and get in front of more customers in grocery chains and c-stores.
“I think it's time for us to think about coffee differently. Coffee is a vibrant, growing and important mainstream beverage segment," Gamgort said. "You could no longer be a player in beverage without having a substantial position in coffee.”
Convenience and cold brew are hot commodities
Though coffee chains have the corner on indulgent experience — something for which today's coffee drinker is increasingly thirsty — CPG brands can deliver on an equally strong demand: convenience.
On-the-go product solutions are crucial for busy consumers, many of whom can no longer fit in a morning cup of joe at home before the start of their busy work days. Whether large food companies are looking to ramp up their own in-house solutions or get newly acquired coffee brands to scale in the grocery space, developing on-trend and ready-to-drink packaged coffee is critical to survival.
"In the U.S. we've seen a great deal of growth in all things ready-to-drink coffee. ... In terms of prices, there's a willingness to spend [more for it] at retail," Schaefer said. "There’s definitely still growth in roasted ground coffee, and we’re seeing that a lot of that is taking place outside of the home."
"Coffee is a vibrant, growing and important mainstream beverage segment. You could no longer be a player in beverage without having a substantial position in coffee."
CEO, Keurig Green Mountain
One form of convenient coffee packaging that has fallen from consumer graces, however, is coffee pods. The plastic capsules rose to ubiquity in the U.S. because they replaced lower quality occasions at home, giving consumers with Keurig-style machines easy access to a range of coffee flavors.
But this format is seen as too mainstream or low-brow by many consumers today, a sentiment that is reflective of more complex palates and changing expectations for the category, as well as concerns about environmental sustainability. The coffee pod segment may not be in decline — sales at Keurig Green Mountain rose $1 million to $949 million last quarter, reflecting high single-digit pod volume growth — but Schaefer said that the category has slowed over the years.
Cold brew and other chilled coffee solutions are where the future of CPG coffee lies, according to industry analysts. The segment skyrocketed 580% between 2011 and 2016, Mintel research notes, with more than one in five Gen Z and millennial coffee drinkers interested in roasts specially made for cold brew.
Schaefer expects this trend to have staying power, as it parallels broader consumer interest in cold beverages such as premium waters, seltzers and cold-pressed juices — and for more M&A to thrive here as a result.
“A lot of people are going to be throwing a lot of money at the coffee category for, I would say, the foreseeable future," he said.
Barbas said that Nestlé is constantly screening the industry landscape for new brands that may be a good fit for its coffee portfolio, but that the company's current stable of coffee brands has positioned it well for success in the space going forward.
"You see a lot of investment here... and when you see this level of innovation and competition, it is actually very good news for the health of the category and the alignment of consumer needs and consumer trends," he said. "This category is very well poised for more innovation."
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