Keurig Green Mountain and the limits of tax incentives

Photo from killthekcup.org.

Photo from killthekcup.org.

Last week, Keurig Green Mountain announced 330 layoffs, including 200 in Vermont. The move came after sales and profit shortfalls hammered the company’s stock price. (Last November, KGM traded at more than $150/share. Now it’s barely over $50.) One analyst told MarketWatch.com that KGM shows “‘telling’ signs of a company struggling to turn around its business.”

The layoffs were widely reported in the Vermont media. What wasn’t mentioned is that since 2007, KGM has received approval for a whopping $7 million in job creation tax incentives through the state’s Vermont Economic Growth Initiative (VEGI). What does KGM’s contraction (and uncertain prospects) mean for its generous tax incentives?

I sought answers from Fred Kenney, Executive Director of the Vermont Economic Progress Council and head honcho of VEGI. He offered a fair bit of reassurance on the VEGI mechanism and state oversight of KGM grants, but I remain dubious on the fundamental concept of tax incentives as a means to economic growth.

In short, while VEGI is a well-designed program of its kind, the KGM experience rings some very real alarm bells about it.

The good news first. My fear was that KGM would continue to rake in the taxpayer cash, even if its workforce continued to shrink. According to Kenney, that’s not so. KGM has received several different VEGI incentives. Each is doled out over a five-year period, and the company must show every year that it has created at least as many jobs as promised, and maintained that larger payroll.

Some of KGM’s early incentives have been fully paid out. But incentives authorized in 2010 or later are still in the five-year window. If KGM falls short of promised employment growth or retention, the funding stops. Automatically. And the process is overseen, not by Kenney or VEPC, but by the state’s Tax Department.

Kenney points out that “in past years, they’ve far exceeded the requirements” for job growth. Which means that KGM may continue to draw VEGI payments from earlier years because its workforce will still be larger than it was in, say, 2010. But KGM’s eligibility would be limited, and would dwindle to nothing in a couple of years if KGM continues to shrink. The best news, to me, is that the process is automatic. And because it’s done in the Tax Department, it should be insulated from political pressure.

KGM and VEGI in review

At this point, a brief history of KGM is helpful. The single-cup brewing system was developed by Massachusetts-based Keurig back in the 90s. In 2006, Keurig was acquired by Green Mountain Coffee Roasters, and the synergy sparked rapid growth for the combined firm. But in 2012 key patents expired, leaving KGM vulnerable to price-cutting competition on the single-brew K-Cups, the source of KGM’s substantial profits. (It’s the same business model as, say, home office printers: the machine was effectively a loss leader, while the real money is made on the refills.)

The loss of patent protection was an existential challenge to KGM’s growth, if not its very future. KGM has responded with some really bad decisions. Its move to effectively DRM its Keurig 2.0 alienated customers in droves. Sales of the 2.0 machines have been well below expectations. Even more troubling is its next big innovation, the Keurig Kold device. It seems to answer a question that nobody is asking: How can I home-brew a one-cup serving of a cold beverage at a vastly inflated price?

Market analysts warn that Keurig Kold may never catch on. And now, the company itself is downplaying expectations for KK’s launch: CEO Brian Kelley told MarketWatch.com he’s expecting a mere “minimal sales contribution” from KK in its first months on the market. All this led to KGM’s decision to lay off five percent of its workforce.

There’s KGM in a nutshell. Now, let’s overlay that with the VEGI program.

A crucial aspect of VEGI is the “but for” provision. Here’s the relevant bit of the law:

“The council shall first review each application [for VEGI incentives] and ascertain, to the best of its judgment, that but for the economic incentive to be offered, the proposed economic development would not occur or would occur in a significantly different and significantly less desirable manner. Applications that do not meet the “but for” test are not eligible for economic incentives, and shall not be considered further by the council.”

The aim of “but for” is to ensure that VEGI performs as intended: it fosters job creation that would not happen “but for” the VEGI incentives. Because, after all, if job growth would have happened without VEGI, then we’re just giving away taxpayer dollars to a growing business. And failing to support other worthy enterprises for which VEGI might be crucial.

Okay, now look at the arc of KGM history and tell me what wouldn’t have happened “but for” the VEGI incentives. The acquisition of Keurig by GMCR happened before the first VEGI grant. It seems rather obvious that the acquisition was the moving force in GMCR’s growth, and it’s awfully difficult to argue that GMCR would not have bought Keurig “but for” VEGI grants it had yet to receive.

This is a broad overview, and I may well be missing some important details. Maybe the growth would have happened outside Vermont. Maybe VEGI helped the company mature quickly into a market leader. (The hardest thing for a mid-sized enterprise to do is make the leap to national and global markets. That’s a very expensive and risky proposition. It’s why growing companies like Ben & Jerry’s and Stonyfield have merged with larger firms.) But looking at the broad outline, I don’t see how anyone can say the VEGI funds were an indispensable element in the growth of KGM.

And now KGM is at a crossroads. Wall Street has soured on the company, and its short- and medium-term prospects are iffy at best. KGM will have to overcome serious corporate mistakes and self-inflicted reputational damage to re-establish itself in a now-mature market. But even so, because of its K-cup-fueled growth from 2006 to 2014, KGM could be in a position to continue receiving VEGI funds for at least another four years.

Which raises the same question in a different way: even if a VEGI incentive passes the “but for” test, does it really accomplish its purpose? If a growing company like KGM can go from rockstar to “Where Are They Now?” in a matter of months due to the vagaries of the marketplace and the quality of its management, how can you argue that VEGI really helps retain jobs? Compared to the billions at play in a given market, how can you assert that a million or two VEGI dollars can make a tangible difference?

To me, the whole KGM experience shines a very harsh light on VEGI and similar incentive programs. At the very least, it argues for a tight focus on startups and small businesses with growth potential, where the state’s money can have the most significant impact. GMCR may have fit that profile in 2007; it doesn’t anymore, and hasn’t for quite a while.

Advertisements

15 thoughts on “Keurig Green Mountain and the limits of tax incentives

  1. climateplan

    “I may well be missing some important details. Maybe the growth would have happened outside Vermont.”

    A good question to ask is, “Why are these incentives offered?” The answer: because they are offered in every state that competes for business growth.

    A critical analysis might focus on startup businesses. VEGI does a good job overall. But Vermont is competing with every other state in the country, including our close neighbor, New York.

    http://startup.ny.gov/

    Reply
  2. Cynthia Browning

    The second comment is quite relevant. Every time tax credits are given, other taxpayers have to pay more to make up the difference or some spending item has to be cut. I think that it would be better for Vermont to do the basics like transportation and telecommunications really well, and to do things like controlling the growth of property taxes rather that providing subsidies to particular companies. The “but for” criterion is indeed quite slippery.

    Rep. Cynthia Browning, Arlington

    Reply
  3. Doug Hoffer

    The amount of “incentives” awarded to KGM is understated. In addition to the $7 million through the VEGI program, then-GMCR was also awarded $2 million in 2004 from the EATI (the VEGI predecessor also administered by VEPC; see http://accd.vermont.gov/sites/accd/files/Documents/business/vegi/2012_EATIAnnualReport.pdf). In addition, KGM has received over $600,000 in grants from the VT Training Program. The total public subsidies to KGM from these programs exceeds $10 million.

    Note also that while it’s true that KGM might lose the ability to collect future pay outs from the VEGI program, it will not be asked to repay any of the money it has already received. The recapture (clawback) provision doesn’t kick in unless the employer eliminates 90% of all the pre-application jobs. That is, KGM could lay off all of the workers hired because of the incentives and still get to keep the money.

    Finally, you raised a very important issue regarding the “but for” and the arc of a company’s growth. I’ll skip the details but the VEGI rules utilize a so-called background growth rate to limit awards by only allowing incentives for jobs above and beyond the average industry growth rate. Needless to say, some firms grow much faster than the industry average but the program doesn’t use company-specific growth rates; just the industry average. In any case, VEPC is preparing to ask the Joint Fiscal Committee for permission to alter the background growth rate methodology. The likely fiscal impact of such a change has not yet been estimated. Stay tuned.

    Reply
  4. jlpen

    Good reporting here.
    I too am skeptical of the value of tax incentives for nonstartups. Experience shows the most reliable form of job creation is ensuring that workers in existing jobs are paid a living wage– so they can spend money, generating a need for more workers. Corporate tax breaks of all kinds siphon money out of the economy. Question: In Vermont’s tax incentive program, are there requirements for the quality of the jobs to be created, i.e. Requirements that wages be above the minimum?

    Reply
    1. Doug Hoffer

      At the request of VEPC (VT Economic Progress Council), which oversees the VEGI program, the legislature just reduced the wage requirement for applicants. It used to be 1.6 x the minimum wage (currently $9.15/hr so the threshold would have been 14.64/hr), but is now the official livable wage ($13.00/hr), which assumes a couple with no kids living in a one-bedroom apartment. The livable wage methodology also assumes generous employer assisted health care, which may not always be the case.

      Reply
  5. NanuqFC

    And one other question yet to be asked: what “incentives” are needed before the company makes those millions of k-cups recyclable? They are costing the state a lot in terms of trash collection and storage and nasty crap going into the watersheds.

    Thanks, John, for filling in the story.

    Reply
  6. Stuart Lindberg

    A liberal news source criticizing government handouts (taxdollars) to one of its special interests. Damn! Hell just froze over!

    Reply
    1. John S. Walters Post author

      You haven’t been reading me very long, apparently. I am frequently critical of liberals when I think they deserve it. Because I believe government has a crucial role to play in a healthy society, I want government to work as well as possible.

      Reply
  7. Stuart Lindberg

    We are a nation addicted to government “grants”, subsidies and tax credits. Government incentives for the benefit of special interests, union or corporation, drive up prices above what would be a natural competitive price.

    Big government interventions in our economy not only drive up prices. These interventions increase taxes, increase our national debt and create economic instability. If a producer knows the government (the taxpayer) is going to pay for a substantial amount of their costs of production, what does the producer do? Raise prices! This is most evident in the staggering price of a college education, public education and health care. Progressives and Democrats would have us “fix” inequities with more taxes, more wealth redistribution and more “free” stuff. An intelligent approach would be for our so called “leaders” to unleash the power of a true free market by eliminating taxpayer subsidies for any industry or union. Historically, free markets have proven to be the only way to lower prices, improve quality and create abundance. Big government central planners consistently fail all of us by picking winners and losers in the economy. The winners are far too often chosen by who donates the most money to the campaign coffers of professional career politicians.

    Reply
    1. John S. Walters Post author

      I’d agree with you if we could truly wipe the slate clean of all government grants, subsidies, and special deals. However, most of those programs have the backing of the business community. Big Sugar, Big Corn, and the fossil fuel industry are at the front of this Piggy Parade. And your conservative politicians are passionate backers of this kind of “interference” in the free market.

      Reply
      1. stuart Lindberg

        This is true. We have a real bipartisan screwing of the American Taxpayer and Consumer. We differ in that I feel the role of government should be minimal in the health of our society. The government has proven to be a dishonest steward of the health, welfare and liberty of just about everyone.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s