CAN ANYONE WIN THE COFFEE WAR? The lesson from the endless, almost comic, battle between Philip Morris's Maxwell House and P&G's Folgers: Market share isn't always what it's cracked up to be.
By Bill Saporito REPORTER ASSOCIATE Mark D. Fefer

(FORTUNE Magazine) – WHAT HAPPENS when two extremely large, highly capable, well-financed corporations fight it out for preeminence in a commodity business like coffee? Think of two large men competing to see who can keep his hand in a pot of scalding brew the longest. For more than ten years Maxwell House and Folgers, America's biggest coffee brands, have been locked in an often profitless struggle to dominate the market, warring with blasts of advertising, perpetual rounds of price cutting, and millions upon millions of cents-off coupons. Not a happy tale, but chock-full of management lessons. The aggressor in recent months has been Maxwell House, a unit of the Kraft General Foods division of Philip Morris. Already it has regained a few drops of market share that it had lost to Folgers, a unit of Procter & Gamble, earlier in the war. To grind up its rival, Maxwell House has introduced a shelf of new products based on the novel idea of luring consumers with taste rather than price. How about ready-made coffee in refrigerator cartons and a coffee syrup, both designed for consumers to pour and microwave as needed? Maxwell House is advertising its offerings in such a creative manner that Procter & Gamble has cried foul. Recently P&G persuaded television networks not to run two commercials that claimed consumers preferred Maxwell House to Folgers. The P&G brand is still the nation's single best-seller, although the General Foods brands, which include Yuban and Sanka, give it more market share (see chart). Philip Morris is intensifying its attack with a 1990 coffee advertising budget of close to $100 million -- roughly four times what Maxwell House spent on commercials three years ago. P&G will spend a like amount. The new aggressiveness from Maxwell House has everything to do with Philip Morris's 1988 acquisition of Kraft, and the subsequent infusing of General Foods with a little of Kraft's sharper-edged corporate culture. In the old days at General Foods, when coffee accounted for nearly one-third of the . company's operating profits, managers perceived great risk in doing anything. They fretted endlessly about GF's reliance on coffee and in the ten years prior to the Kraft acquisition hadn't introduced a single significant new coffee product. With the new regime, the risk-reward profile of the business changed dramatically. Coffee now represents less than 5% of Philip Morris's sales, with gross profit margins low enough to make a cigarette company manager laugh out loud. The Philip Morris leadership figures that taking a risk on improving the margins is well worth it. Says Maxwell House President Raymond Viault, whom Philip Morris brought in from General Foods' Jell-O brand to put some jiggle in the coffee business: ''The business was under-idea-ed, undermarketed, and under-resourced. Philip Morris views the business as one of significant potential.'' Longtime students of coffee aren't so sure. The coffee wars have dragged on so long and cost so much that some consumer goods experts question whether the most basic doctrines of market share apply here. Like the notion that it's worth spending heavily to get same. What attracts consumer-marketers to coffee is obvious: The beverage is served in 55% of all U.S. households each day -- a consumption pattern that seems to promise great pots of profits for anyone who can dominate the market. But the coffee business also suffers from one slight economic flaw: The stuff is sold too cheap. Soft drinks like Coke or Pepsi command about 25 cents per serving, but the cup of coffee brewed by the average Joe costs him only about 3.5 cents. Worse, the gross margins on coffee are of the commodity variety, leaving less than a penny of profit per cup. Not many of those pennies trickle to the bottom line; typically they are sopped up by marketing expense. Coffee is among the most heavily promoted products in the American supermarket. Roasters have spent so many years in cutthroat competition that no grocer in full command of his senses buys coffee at list price. A buyer for a big supermarket chain describes the standard wisdom: ''Procter will write you a check for a couple hundred thousand dollars to drive the business.'' The coffee war is undermining the belief, long held dear by consumer- marketers, that bigger market share is always better. Nearly every major food company has made it an article of faith to be first or second in each of its markets. Supposedly, size affords the ability to spread overhead, get better deals from suppliers, leverage the advertising, and carry a big stick with retailers. Once the market has shaken out to two or three players, the theory goes, competitors ought to be able to raise prices, finally securing by virtue of their oligopoly the kind of ''economic rent'' from consumers that some airlines have been collecting lately. IN PRACTICE, however, such market concentration is often no advantage at all, says professor Richard Staelin of the Fuqua School of Business at Duke University, who has evaluated dozens of such situations. Staelin's research indicates that a couple of heavyweights fighting for a single market tend to do the work of many competitors, increasing the degree of competition rather than diminishing it. ''People piddle away their advantages,'' he says, pointing out that instead of coaxing consumers to buy higher-quality, higher- priced coffee, producers have spent millions over the years cheapening their products' images by offering coupons and price cuts. ''CEOs have long associated high market share with high profit. Share has nothing to do with it,'' Staelin concludes. If you want profitable market share, his study suggests, get better management and better products. The behavior of the big coffee brands during the 1980s is all too squarely a case in point. Slugging it out on price, they passed up a major opportunity to capitalize on the popularity of specialty coffees. Most of these are sold in small shops or delis for $6 a pound and up, or more than 10 cents a cup, and the $700 million segment is growing at about 20% a year. Maxwell House made a belated effort to sell gourmet coffee, but got a tepid response. P&G, ever the everyman marketer, didn't even try. Instead, to push up the profitability of their products, the roasters hit on the somewhat inelegant idea of putting less coffee in each can. Last year the major roasters converted their can size to 13 ounces from 16 ounces. Consumers presumably didn't view this as value added, though the producers claim the smaller cans yield the same number of cups. From the Staelin perspective, the most sensible participant in the coffee market is Nestle, which markets under such brands as Hills Brothers, Nescafe, and Taster's Choice. While the two big guns have blasted away at each other, Nestle has taken the crafty Swiss tack of avoiding conflict and making money, even at the cost of market share. Says Jeff Caso, director of Nestle's coffee business: ''If maintaining market share involves jumping off a bridge, I am not jumping off a bridge. But I am not sure the other two guys see it that way. We see them in the water a lot.'' EVEN THOUGH he tries to abstain from bare-knuckle price competition, Caso isn't necessarily thrilled to see the two palookas thrashing about. The total market for coffee has been flat or declining, and price competition has done nothing to broaden the product's appeal. Says he: ''You have to give consumers a reason to choose a brand other than price.'' Nestle did just that in 1984, when it began segmenting the market with a dark roast of its Taster's Choice instant brand and later a 50% decaffeinated product. Today it sells 11 flavors of instant coffee and recently introduced eight varieties of ground roasted coffee into market niches. Both Folgers and Maxwell House now say they are committed to higher quality, and that premium coffees aimed at particular market segments are important to their plans. Viault at Maxwell House has his product developers in high gear; besides their new refrigerated coffees, they have unleashed 18 other products in the past year. Each is designed to command an extra 40 or 50 cents a pound, an extraordinary difference to a company that roasts millions of pounds of coffee annually. Meanwhile P&G has introduced a coffee called Folgers Gourmet Supreme and reformulated ordinary Folgers to include a higher proportion of better beans. A Folgers spokesman says there is no turning back. If the price of coffee beans goes up, the company will not cheapen the product but will raise prices. That is startling talk from a coffeemaker that routinely ships grocers hundreds of thousands of dollars in discount money each month along with the coffee. Discounting, just like coffee, may be addictive. But if P&G and Philip Morris ever want to make real profits in the coffee game, they had better break the habit of giving money away. Unlike coffee, it does not grow on trees.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: 1989 U.S. COFFEE MARKET SHARE The $3.5-billion-a-year ground-coffee segment represents 75% of the U.S. coffee market.