From Business Model to Value Chain Impact: Revisiting the Nespresso case

Nespresso is a machine-and-pod coffee concept for making espresso, developed by the food multinational Nestlé. By fitting an aluminium coffee pod into the machine, perfect espresso can be made at the push of a button. The Nespresso case is a famous example of business model innovation, propagated often by business model protagonists, and with good reason. It is one of the liveliest arguments that the future of competition will not so much be driven by innovation in products or services themselves, but by the activities surrounding the products and services that bring them to market. Specifically, what makes the Nespresso case appealing is that the model:

  • lures clients through an upper segment marketing strategy, with George Clooney at the helm creating that “club” feeling
  • ties customers directly to Nespresso through direct sales systems for the cups that go into the machine, both online (10 million online subscribers) and through boutiques (over 200 worldwide). This keeps margins close and warm for the company
  • outsources production of the coffee machines to 3rd party manufacturers under “at cost” technology licensing. At the same time these manufacturers function as part of the distribution channel, as customers buying the machines are also tied to using the cups
  • safeguards the major revenue stream through the cups with patents, and through Nespresso’s own high-tech processing facilities, which put coffee in the cups and seal them

When the Nespresso business model is drawn out on the business model canvas, the overview looks more or less like this:

Nespresso’s business model wasn’t built in a day. Since its first patent in 1976, Nespresso fiddled around with the technology for 10 years, before incorporating the company in 1986. The company decided to service the business-to-business market in the 1990’s, in joint venture with a machine manufacturer that also maintained a sales force. This model failed, and almost bankrupted the company. Around 2000 Nespresso innovated in its business model and worked it out to what it currently is: a model which shows a year-on-year growth rate of around 25% (the fastest growing division at Nestlé), and which noted revenues of over Euro 2.4 billion in 2010.

Upstream business innovation

The case is most noted for its downstream business model innovation. In last few years however, interesting things have started to happen upstream as well in the company’s sourcing practices. The company’s bullish growth rates have put pressure on sourcing specialty coffees. Nestlé claims that only 1-2% of coffee produced in the world fits to their quality requirements for Nespresso, and competition for sourcing in this segment is fierce. In order to provide the distinctive coffee quality and aromatic characteristics, farms need to fit to a rare combination of several specific production parameters of soil type, altitude, and vegetation. Scarcity is thus starting to work on the business model, and this has pushed Nespresso to refine its sourcing practice, where closer relations with farmers are key.

The sourcing model is called the Nespresso AAA Sustainable Quality™ Program. Nespresso targets the farmers, or rather clusters of farmers (farmer clubs), that fit to the quality specifications it needs in Brazil, Colombia, Nicaragua, Costa Rica, Guatemala, and India. The program focuses on quality, environmental and social sustainability, and productivity (further details of the program can be found here).

Source: Nespresso.com

The program is operationalized by a consortium of several distinct partners. The partnership constitutes a business model in itself. This business model (depicted below) involves the following key partners:

  • the commodity trader ECOM (marked purple).  Farmers are reached through three channels: extension, credit, and trade, all organized by the commodity trader ECOM. Relations with farmers are built through the farmer club, which maintains a progressive quality segmentation of Cherry, Parchment, and Gold. The quality level is determined through an assessment of production practices by ECOM’s local extension support staff. The quality of coffee from each cluster is verified by Nespresso in Avenches (Switzerland), allowing for full product traceability from origin to pod.
  • the environmental NGO Rainforest Alliance (RFA- marked in green). Sustainability performance of farmers involved is measured according to a watered down version of the RFA sustainbility standard, tailored to the Nespresso premium quality demands. In order to assess performance RFA has developed a tool called TASQ™, which can be used by producers for self-assessment and for verification by RFA as outside party at the same time.
  • the financier International Finance Corporation (IFC- marked in orange). The IFC provides the program with USD 750k of the 1.5 million required  for technical assistance (eg. developing the TASQ™ tool, and the extension system for farmers). Also IFC provides ECOM with USD 25 million of debt finance to support farmers in buying inputs for production and financing trade.
  • Nespresso (marked in yellow) provides a modest role in the model by selecting farmers and providing product quality feedback on the coffee it purchases from the farmers involved in the program.

Drawn out on another business model canvas, the sourcing model looks like this:

Upstream Impact

According to Nespresso’s own statements, the program is working out very well. It claims to be able to reach its target of buying 1.3 million bags of coffee (60 kg. per bag) under the AAA program in 2013, corresponding to 80% of Nespresso’s requirement. Also Nespresso states that farmers are paid a price which is 30-40% above prices which are paid for regular quality coffee at the New York Stock Exchange, and 10-15% above prices paid for top quality. Furthermore the company claims to pay over 75% of the export value directly to farmers. As a result 40.000 producers supplied 60% of Nespresso’s coffee in 2010, and in 2013 this number is expected to reach 80.000. An impact assessment report by the IFC has shown that farmers’ club incomes are 27% higher than those from clusters of farmers which are outside of the program in Mexico and Guatemala. A small work-around of the figures shows that procurement of coffee is around 10-20% of the business model’s cost structure. This is very low by food industry standards and a very small price to pay for so much alleged positive impact.

In perspective

These types of partnership models are increasingly appearing in food and agriculture value chains of late. They are generally a response to pressures on resources and global commodity prices, where downstream companies build closer relations with suppliers in order to secure their production base. Regarding the Nespresso partnership the following observations can be made in SWOT form:

Strengths: The model provides a low risk venture into the value chain for securing supply. Most of the funding and activities are conducted by Nespresso’s partners Weaknesses: The sustainability performance is not likely to be high. The model is deliberately progressive, but the standards chosen for AAA quality are a selection amongst the Rainforest Alliance certification standards
Opportunities: The partnership is very flexible. It is already being expanded with other traders which can fullfill the role of ECOM (as shown by Cranfield’s study into the partnership here and here). As long as the trading company is substantial in size, and has local presence with farmers, it can be fit in with the program. For the sourcing model this means that Nespresso can start up new specialty coffee product ranges with new partners, sourced from remote areas in the world with distinct characteristics Threats: It is as yet unclear what percentage of total production of the AAA farmers is actually bought by Nespresso, but it is likely not to be everything. Farmers are required to sell their remaining produce to other buyers, who are likely to have lower quality demands and therefore prices. If volumes bought by Nespresso are too small, then farmers could loose the incentive to produce against Nespresso’s high quality standards.

As a whole, the Nespresso case is a very compelling case of business model innovation for both downstream and upstream segments, and holds potential for improving sustainability of the whole value chain. The most important observations for value chain innovation are that:

  • the branding firm’s business model design matters for sustainable development in value chains. The Nespresso case has shown that value chain development entails designing compatible business models at the level of the lead firm, and at the level of suppliers. Nespresso’s continuing changes in its models both down and upstream have meant that is has been able to refine a fitting match. This design process is paying off well for the company and it is known to pay off for other companies using such principles as well.
  • business models are in constant development. Some leading brand firms are ready to engage in business model innovation in their upstream segments, some are not. Nespresso has taken roughly 25 years before it started engaging with its producers. Business model innovation should only be started with firms that are ready to commit themselves to experimentation, learning, and change.
  • despite taking leadership in value chain development, Nespresso is not active itself in execution of its sourcing model. There are an estimated 7 people working on the sourcing program from Nespresso’s side, in a company with currently over 5.000 employees, of which 70% belong to the sales force. This is a very small extra cost to operations of the company
  • certification is not the driver for sustainability, but the lead firm business model is. The premium price was installed as an incentive for producers to deliver AAA quality coffee, and this could only be offered by Nespresso’s business model which has created a leadership position for the company in a premium quality market. The question remains what the overall impact will be on environmental sustainability, but the company has taken its value chain a step in the right direction.

If you want to learn more about the innovation process behind the Nespresso case, and about how you can apply this process yourself,
then have a look —> here

———————–

The business models were drawn using the Business Model Toolbox iPad app, available on the AppStore.

14 thoughts on “From Business Model to Value Chain Impact: Revisiting the Nespresso case

  1. Thanks Bart!

    Love the analysis and I am inspired. Wonder who else should be reading this? Brand CEO’s? Development investors? Social enterpreneurs partnering with large corporations?

    Do you think this is good news for our business model @ http://www.tip4change.wordpress.com ? It could mean two things: 1) brands are best placed to control their own sustainability impact rather than involve their end users/consumers or 2) brands need help from credible impact agencies (like in this case Rainforest Alliance) to supplement their own message & expertise. What do you think?

  2. I think that business model based value chain development is a trend that will see its launch in this year of 2012. Business modeling is a design exercise. You create ideas, work them out in many forms, and do small and controlled experiments with prototypes to sort out what works well and what doesn’t. Small experiments enable you to learn from doing things right, because you get a point blank sense of the effects you control. Small experiments also enable you to learn from failure, because failure won’t decimate your business when they hit.

    Firms are gradually seeing the benefit of using design principles to create competitive advantage. This year I will have the opportunity to do some experimentation with three food industry firms and I hope that the process results will be satisfactory enough to warrant for more! Also I’ll be engaging with government and business on several occasions to invite discussion, also through this blog. I think that anybody interested in sustainable business development in agriculture should seriously adopting the business model design approach.

    Regarding your TiP venture, I think that it is indeed an experiment that brands should take on. The challenge will be to find out who is up for it, and how you can set up a safe experiment to demonstrate how TiP can disrupt the way sustainable development is currently approached in value chains. I’ll be in touch soon on how we could organize such a small experiment. Thanks for your compliments and questions! :-)

    Bart

  3. I love the coffee but feel trapped in the business model. I also hate to think of the foot print for all the brightly coloured aluminium cups for each 5 gr of coffee, plus the extra transport. With filter coffee or even with paper pads, the coffee grind can be separated easily; impossible now. With this example, business model innovation looks like ‘complicating things’. I hope for more inspiring examples, like the wonderful walmart vid!

    1. Hi Josien!

      It’s true, the outset of the business model is to tie the consumer to the machine with the pods. That’s what they call switching costs. There are alternatives of course for getting a great cup of coffee: for instance with those big and bulky expensive espresso press machines. But Nespresso provides more convenience, and the same kind of coffee. That’s why a lot of consumers choose to chain themselves to the coffee pods voluntarily.

      Speaking of pods, Nespresso is working on their aluminium footprint in another partnership with the IUCN. The Nespresso site has more info on this: http://www.nespresso.com/ecolaboration/nl/en/themes/9/0/capsules.html
      I also think it is a very important “wobbly” aspect to the overal sustainability of the business. However, I didn’t include it in my blog, because I wanted to focus more on the development in relations with coffee producers in the supply chain and the importance of the fit between the business model and achieving sustainable sourcing.

      I don’t quite agree though, with your statement about the complexity of the Nespresso innovation example. It would be complex if Nespresso would have tried to implement this whole business system in one go. But in fact it has been the result many experimental iterations with different kinds of models,and of incremental learning from failures in such a way that they were able to design and roll out the current model. And it is really working out well.

      The question will be though, how long this model can be sustained. The patent on the pods is running out this year, and they will probably need to innovate in their current model to remain competitive. The business model innovation process is never finished. Perhaps it will give them the incentive to launch something new with a completely green compostable pod patent to regain their competitve edge, who knows!

  4. cool example of how a business model meets value chains. It shows how a triple P (or corporate social responisbility, what ever you want to call it) approach is only addressed at some stages upstream and downstream in Nespressos value chain where it has an impact on price, quality, supply and consumer perceptions. i.e. the high environmental footprint on the consumer side, a high postive social foot print on the coffee bean producers…. but they have not promoted this to the extent that certificaiton is a key part of thier model.
    the blog also shows how lead firms really drive a sector: you didnt mention it, but Nespresso has spawned a range of rip offs such as the nep-espresso pods which appear to have less lofty ambitions).
    be good to explore who or what is really in the driving seat in this chain and the coffee sector- consumers not wanting coffee tainted by child-labour, labour unions pushing the big buyers, farmers in coffee growing countries not seeing the valaue in coffee and switching to other crops, or being busy in conflicts driving up the price …….

    1. Hi Verina,

      Thanks for your comment! Some good points there. I think that there will always be tension between the certificate, and the firm’s own ability to communicate and manage sustainability in the value chain. Firm’s not much involved in value chain relations, will more readily resort to outsourcing this responsibility to certification. Firm’s more involved will look for hyrbid forms, where certification is part of an overall strategy to influence responsible conduct in value chains.

      I agree that Nespresso the Nespresso model is under siege at the moment from competitors supplying cheaper pods (as the patent expired I think last year) or alternative like Starbucks. Read more here: http://www.ft.com/intl/cms/s/0/d90109a4-66ec-11e1-9e53-00144feabdc0.html#axzz1oMKebuNU

      But, I think that Nespresso is consciously using business model innovation to stay ahead. The new tie-ups with producers as I explain the blog, is that step ahead. Nespresso is putting more single origin specialty coffee on the market, and are aiming to keep the upmarket coffee customer satisfied in that way. Very interesting to case to follow indeed!

  5. I really liked your blog, but I couldn’t get past the fact that you put an apostrophe after the “s” in “its” on more than one occasion. FYI – The possessive pronoun is “its” with no apostrophe.

    Please understand that I’m not trying to go grammar or punctuation Nazi on you, I just want to point out this very diminutive error.

    Like I said, I really enjoyed the blog and will be subscribing to future posts.

    Cheers.

    1. There, fixed! Thanks for taking the time to provide your input, and thanks for the compliment on the blog!

  6. Excellent post. I was checking continuously this blog and I am impressed!

    Very useful information particularly the last part :) I care for such info a lot.
    I was seeking this particular information for a very long time.
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