The R&D Tax Credit Aspects of Coffee



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        Regular, espresso, cappuccino, mocha, latte, macchiato, cafe au lait, decaf, iced. So many different terms around one national passion: coffee. The "cup of Joe" is an essential part of most Americans' daily routine. According to the National Coffee Association, more than 80 percent of U.S. adults drink coffee, accounting for the world's largest market and a $30 billion coffee industry.

        Among the word's most caffeinated countries, the U.S. is also home to important coffee-related innovations. This article will discuss recent trends in coffee and beverage dispensing equipment along with other advances in the coffee industry. It will further present the tax credit opportunity available for companies engaged in coffee-related R&D.



The Research & Development Tax Credit

        Enacted in 1981, the Federal Research and Development (R&D) Tax Credit allows a credit of up to 13 percent of eligible spending for new and improved products and processes. Qualified research must meet the following four criteria:

  • New or improved products, processes, or software
  • Technological in nature
  • Elimination of uncertainty
  • Process of experimentation

        Eligible costs include employee wages, cost of supplies, cost of testing, contract research expenses, and costs associated with developing a patent. On January 2, 2013, President Obama signed the bill extending the R&D Tax Credit for 2012 and 2013 tax years.



Innovation Capsules

        Offering convenience, quality, and user-friendliness, single-serve coffee makers are gaining space in American households. In the U.S., single-cup coffee sales have tripled since 2011. Currently, a quarter of every dollar spent on coffee to drink at home is destined to single-serve systems. Market-research firm Mintel expects roasted coffee to keep losing ground in the near future, with consumers spending nearly as much on coffee pods as they do on bulk coffee by 2018.

        One of the fastest growing areas in the packaged-food industry, the $8 billion global single-serve coffee market is largely dominated by Nestle, which controls 70 percent of the European market. However, Nespresso's prevalence isn't verified in the U.S., where Green Mountain's Keurig system controls over three quarters of the market.

        Vermont-based Green Mountain Coffee Roasters has experienced a nearly twentyfold growth in sales since the acquisition of Keurig in 2006. First introduced in 1998, Keurig's single-cup brewing system has evolved over the years, setting an example of continued innovation. Available since 2012, the KeurigVue system offers customizable brewing processes in which water pressure, timing, and airflow can be adjusted to consumers' taste. Also recently launched, KeurigRivo, is the first single-cup system capable of frothing milk for lattes and cappuccinos.

        Keurig's latest innovation is the K-Carafe, expected to reach the market in fall 2014. The novel capability is designed to the new Keurig 2.0 System and will enable the brewing of both one cup and one carafe (28 ounces) of coffee, using the single-serve pack and the new Keurig K-Carafe pack, respectively. This innovation, which required advancements in roasting and flavor extraction, thermodynamics, and mechanical and software design, is a response to consumers' expressed desire of being able to brew different quantities of coffee in one single system.

        Nestle is also turning toward innovation as a means to expand its presence in the Americas, where it currently holds a mere 3 percent share of the market. Recognizing Americans' taste for large cups of coffee, Nestle launched the Nespresso VertuoLine, which is capable of brewing eight types of 8-ounce servings as well as four espresso blends (including four first-ever flavors).

        Vertuo's pods come equipped with barcodes that are automatically recognized by the system, which adjusts to different kinds of brew. In addition, VertuoLine's coffees are characterized by a rich and generous foam (called "crema"), created through the innovative Centrifusion technology.

        Considered by experts as one of the most important innovations for Nestle in the last 25 years, VertuoLine is certainly not the only one. Since 2009, Nespresso's Ecolaboration has supported numerous sustainable innovation efforts, particularly in the areas of coffee sourcing, capsule recycling, and energy-efficient machines.

        The single-serve industry is also enabling innovation for new entrants trying to break into the market. New York startup HiLine Coffee has developed a line of coffee pods that work on Nespresso systems. The company already sells hundreds of thousands of capsules per month, capitalizing on Nespresso's higher prices and limited distribution in the U.S.



What About Single-Serve Soda?

        Coca Cola recently announced a partnership with Green Mountain Coffee Roasters that will involve a $1.25 billion investment over 10 years and a 10 percent stake in the coffee company. The objective is to develop a single-serve system for carbonated drinks, the Keurig Cold.

        The idea of a do-it-yourself countertop Coke machine comes at a time where SodaStream, an Israel-based company with U.S. headquarters in Mt. Laurel, NJ, has gained increased attention for its innovative at-home bottle-filling system. Named one of the world's 50 most innovative companies by Fast Company Magazine, SodaStream offers a more convenient, healthier, and eco-friendlier alternative to traditional soda and the disposable plastic they produce.

        SodaStream sells more than 100 different types of concentrated syrups and flavorings to make carbonated drinks. Using CO2 refills, the system turns tap water into sparkling water in only three seconds. The company leads its niche in various countries; however, most of its projected growth for the upcoming years depends on U.S. sales. Revenues are expected to more than double to around $1 billion by 2016.

        Different from SodaStream, the future Keurig Cold will not depend on canisters of CO2. To further enhance convenience, the system will also offer instant chilling.

        There is no guarantee of success for Coke's bold step. Unlike coffee, soda doesn't need to be brewed fresh to taste good. On the contrary, it can be on shelves and in fridges for weeks without loosing taste. In addition, soda is widely available and considerably cheap.

        However, the opportunity is too big to be missed - the U.S. household penetration of soda is around 90 percent. Consequently, the new at-home model could change the face of the beverage industry. It could be the answer to the high-cost, low-margin business of bottling and distributing soda. The lightweight of pods would decrease transportation costs, enhance e-commerce, and raise profits.



Starbucks' Clover Machine

        Single-cup brewing systems have also caught the eyes of major coffeehouse chains. In 2008, Starbucks purchased Seattle-based Coffee Equipment Company, creator of the five-figure priced Clover machine.

        Considered one of the most revolutionary innovations in the coffee industry since the espresso machine, the Clover combines the vacuum pot and the French press methods. The exclusive Vacuum-Press technology allows for a greater experimentation with beans, roasts, and strengths of specialty coffees, developing and unlocking unique flavor nuances.

        Contrary to other bean-to-cup systems, which are largely automatic and very easy to use, the Clover required training and adaptation of Starbucks' staff. Maybe for this reason, the initial implementation of Clover machine has been rather slow-paced.

        However, on the fifth anniversary of the Clover brewing system at Starbucks, the company expressed its intention to double the number of Clover locations around the globe by the end of 2014. This will be made easier through the CloverNet, a built-in system that allows the programming of Clover machines over the Internet. The innovative software enables each Clover location to stay connected to a central source of information and receive brewing parameters for each type of beans. In other words, Starbucks headquarters can decide on the best recipes and maintain a consistent experience throughout its stores.

        CloverNet is also a powerful tool for collecting information on brewers' performance and customer preferences - which sizes of which drinks have been ordered. Further innovation is on the horizon, as Starbucks plans to link other in-store equipment, such as refrigerators, to CloverNet.



Built-In Coffee Makers

        Integrated brewing systems are gaining space in luxury homes. Appliances and presses are disappearing from countertops as built-in coffee machines begin to offer increasingly automated solutions.

        German domestic appliances manufacturer Miele offers different systems which include bean grinders with a half-dozen settings, adjustable dispensers for various cup sizes, and multiple spouts that enable the preparation of more than one drink at a time. The company has developed innovative systems that can be installed virtually anywhere, from wet bars to master bedrooms, provided that they are attached to the plumbing system or to a water reserve.

        Ongoing innovative efforts have led to enhanced functionalities. While some systems allow owners to program brewing schedules (meaning that coffee can start being prepared even before they get out of bed), others integrate high-tech remote features. Danish company Scanomat has developed a system that can be controlled by mobile devices using downloadable applications.

        For now, built-in systems are more common in Europe than in the U.S. The expansion of American markets is dependent on innovative efforts in developing devices that meet stricter regulations. Manufacturers of integrated brewing systems should take advantage of federal R&D tax credits to conquer the American kitchen.



Challenges to Coffee Farming

        In addition to the development of new and improved brewing systems, other coffee-related innovation efforts are underway, particularly for the preservation of crops. Challenges include the recurrent problem of coffee rust, a leaf-blighting fungus that has already infected nearly all the coffee growing areas across the globe.

        Climate change and new growing practices, which include direct sunlight exposure, have contributed to the spread of the fungus, which thrives in high temperatures and humid air.

        Long-lasting droughts are also a threat to coffee crops. One of the most important producers of coffee, Brazil is currently going through its worst drought in decades. The destruction of crops has already led to a 50 percent increase in the price of coffee and experts begin to consider a coffee deficit. This scenario is particularly worrisome for the U.S., where coffee is the largest food import and the second most valuable commodity, after oil.

        For this reason, various American universities have been engaged in coffee research. The University of California at Davis recently established a Coffee Science Study Center. Research topics will include the genetics of coffee, sustainable coffee growing, and the sensory perception of coffee drinkers. The school considers eventually offering a major in coffee science.

        Texas A&M University manages the World Coffee Research, a nonprofit funded by the coffee industry. The organization has a wide research portfolio, including efforts in the fields of genetic biodiversity (development of "seed" multiplication technology and new breeding populations), productivity enhancement, climate change, and coffee information retrieval systems. Similarly, the Vanderbilt University Institute for Coffee Studies has investigated the health effects of coffee consumption, among other subjects.



Corporate Coffee Innovation

        The coffee industry has been built on continued innovation. Numerous companies are engaged in R&D efforts to meet the challenges of a highly dynamic and competitive market.

        The world's second largest food company, Kraft Foods owns a variety of coffee brands including Maxwell House, Caffe Origins, The Nabob Coffee Comapany, Gevalia Kaffee, Yuban, Sanka, and the Tassimo single-cup brewing system.

        The company's recent focus on innovation has been an iconic example of success. In 2008, innovation was one of Kraft Foods' biggest weaknesses. It ranked next to last in its peer group for new product successes. Since then, however, a new process for meaningful innovation based on a focused and committed approach has turned the tables. The highly successful MiO, a liquid water enhancer, is a concrete example of this approach.

        Through the Kraft Foods Collaboration Kitchen, Kraft has also established a successful open innovation strategy where the public is invited to contribute to the solving of needs and questions predetermined by employees. Current innovation "briefs" include the creation of a new method or technology to improve robusta coffee flavor or mitigate its negative properties (harsh, spicy, earthy flavor notes) and the development of technologies to increase coffee yield through roasting and grinding manufacturing process.

        The J.M. Smucker Company, owner of coffee brands such as Folgers, Millstone, Douwe Egberts, Good Origins, has also engaged in important innovation efforts. It has recently partnered with Life is Good to create a new premium coffee product. Available since summer 2013, the line includes five different flavors made of sustainably farmed beans, constituting Smucker's first line of 100 percent certified coffee.

        A strong believer in robust innovation, Smucker has launched 70 new products in 2013. Among them is the new "bakery series" for the Dunkin' Donuts packaged coffee line, which includes flavors such as blueberry, jelly, and chocolate.

        And this is not the only Dunkin' Donuts innovation to hit the market. The company has recently announced a licensing agreement with WhiteWate Foods to the development, manufacture, and distribution of a new line of Dunkin; Donuts Coffee Creamers.

        According to John Costello, Dunkin' Brands' President, Global Marketing and Innovation, innovation is a primary means to reinforce the company's position as America's leading retailer of coffee-by-the-cup. Dunkin' Donuts runs a state-of-the-art new product research and development facility located in Canton, Massachusetts. It includes a sensory lab, a quality assurance lab, and a demonstration test kitchen.

Figure 1 bellow illustrates the R&D expenses of three leading companies in the coffee industry.

R&D Benchmarking Comparison/ Book per Capita R&D Expenses

r&d-expenses-coffee

*NOTE: Per capita R&D expenses concern multiple food product lines, including coffee.



Conclusion

        Constant innovation guarantees that the centuries old tradition of drinking coffee is continually reinvented to meet modern lifestyles. From new single-serve machines to gourmet brewers and built-in systems, the coffee dispensing equipment industry offers groundbreaking solutions to add convenience and uniqueness to our traditional cup of coffee. New lines and flavors along with novel crop preservation technologies are also important examples of innovation. Companies engaged in coffee-related R&D activities may be eligible for significant federal tax credits.

Article Citation List

   


Authors

Charles R Goulding Attorney/CPA, is the President of R&D Tax Savers.

Andressa Bonafé is a Tax Analyst with R&D Tax Savers.

Lynn Bertrand is a Tax Analyst with R&D Tax Savers.


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