Our Value Chain Design tools need to give us more

Posted on by Bart Doorneweert

Value chain analysis is one of the most used approaches to designing private sector development projects. It helps to obtain an overview of all the relevant details relating to how a value chain functions. Value chain analysis looks at relations, supporting policy and business environment. It utilizes that analysis as a step-up to designing development opportunities.

 Generic value chain

Value chain analysis has its roots in Porter’s sector analysis approach. It takes the perspective of competitive advantage in looking for business solutions (ie. position in relation to suppliers, bargaining power of customers, influence of new entrants, and threat of substitute products). However, current global market dynamics are very much in disfavor of sector approaches. Industry boundaries are obscuring as seemingly divergent market platforms are able to integrate and make innovative and powerful market combinations (mobile, payments, electricity, entertainment, etc).

Under these current conditions, the Porter approach has lost its ability to project towards the future. Providing the highest customer value is what will lead to a company’s advantage in the coming times, rather than the ability to contain market value within industry boundaries. (Read an excellent account on the demise of Porter’s 5-forces model, through the lens of the recent bankruptcy of the Monitor consulting group by Steve Denning). The longevity of insights captured with value chain analysis is thus eroding. Insights won’t last for as long as they should last to run value chain development projects for the 4-5 year duration that they usually do.

Development in our development tools
Despite this disability, value chain analysis as it is, is the dominant method that the development sector has to formulate development program goals and objectives. The leading, and most rigorous documentation of value chain development approaches is provided by the ILO with their Value Chain Development Guide (I performed as a tutor for a semester some years back for their online course for development practitioners). This method, in essence, attempts to create market innovation opportunities and guide their development in such way that they will achieve a more sustainable outcome (relating predominantly to labor in the case of the ILO).

Programs are designed, based on sector and market information, focus group discussions with potential beneficiaries, and surveys. This information functions as the working assumption about targeted users’ needs for the duration of the project. But the method doesn’t advise on tight feedback loops that facilitate adaptive learning to incorporate new insights about the program’s targeted users, should the initial assumptions not check out. The method thus boils down to a prescriptive, non-iterative process of project execution, which abstracts from the end-user who is foreseen to adopt an innovation.

In recognition of the low rate of adoption of the ideas, which are brought to the world through conventional value chain approaches, the Gates Foundation sponsored the development of the Human Centered Design toolkit, executed by the prime of design firms, IDEO. The HCD approach looks at innovative and nimble user-centered design approaches for value chain development. The principles for the HCD toolkit were deduced from observing the working method applied by the development organization IDE in their field of advancing appropriate technology for water management in agriculture and rural sanitation.

The strength of the HCD toolkit is that it supports immersion activities, and helps development practitioners (being non-designers) to come to insights for defining the opportunity space with their targeted users for their business development projects. It fills in the gap that is left by the ILO’s value chain development approach. However, what the toolkit doesn’t provide is support to the process of prototyping, and validating the business models that would bring commercial viability to innovations. The HCD toolkit focuses on tailoring technology, and making it utile or desirable to target groups. What it lacks is a rigorous deconstruction of an innovation process (if any), which works towards a business model outcome that is feasible and desirable for the customer, and commercially viable.  The HCD, as such, is somewhat of an island in value chain development approaches.

The last, and most recent example in the evolution of value chain development tools is the LINK methodology, developed by CIAT, again with support from the Gates Foundation. It is a first attempt at business model innovation in value chain development context. It fills in the gap of the business model perspective that is left by the HCD toolkit.  LINK puts Alex Osterwalder’s business model canvas at the centerpiece of its process. The method extrapolates one of the functions of the business model canvas, namely sketching out how a business works. It then hard-links that function to describing how a value chain operates, by mapping out various business models in the sequential order of the value chain (see figure below).  This description brings mutual understanding to all value chain community members, and is consequently used to design a new blueprint for a better, more inclusive, value chain.

 Hard-linked business model canvases, describing a value chain

Though the business model canvas is prominently featured, the conceptual focus of the innovation that LINK proposes to work with is not the business model of a particular actor in the value chain. Rather LINK attempts to prescribe a collective value chain-level business model innovation to be executed by every (or a selection of) member(s) of the value chain. It is thus unclear what the method actually encourages to prototype. The process thereby abstracts from focus on the innovation opportunity space, and the required search for the business model that can best leverage that opportunity. LINK thus loses user focus and tends towards the same prescriptive limitations of the ILO value chain development approach.

So what now?
Although I have accentuated my reservations in review of these three value chain innovation methods, I must underline an interesting progress towards more design-minded approaches to value chain development. It’s encouraging to see that the academics, who have shaped the methods that development practitioners work with, are gradually moving towards approaches that are informed by design. As Don Norman wrote in a blog post some years ago, there is great value in combining the benefits of design and science thinking. Value chain design could well be such a field to make that combination.

But, the methods above also show that we are yet to come to a complete design process for value chain innovation. In parts, most tools are available. We now need to piece them together, in recognition that the underlying process provides for exploration, before arriving at a point where we can focus on refinement. Business model innovation is a method that can help achieve that. It is a method intended for discovery of what works and what doesn’t. It allows for flexible program adaptation to progressive learning, rather than prescription. By orienting on the customer, and designing a business model that is able to provide value for the customer, projects would retain focus on their innovation opportunity space.

Lastly, we need to accept in our value chain development ambitions, that the most influential business model in a value chain is the model that leverages an innovation opportunity space, and consequently molds a value chain: it doesn’t work the other way around. Desired changes in the value chain will follow from that dominant business model. The only influence development practitioners have is to provide principle design constraints regarding ethics, or sustainability that the innovation attempts to realize.

Takeaways

  1. A lot of the design tools for value chain development only partially appraise the design process. Taken as a whole they piece together as innovation process guidelines, which contains significant gaps.
  2. We should recognize that a development project is a faith-based initiative; outcomes and the necessary steps to arrive there are not known when you begin, they need to be discovered through exploration
  3. Discovery-based learning can be done by integrating more design methodology, taking a relentless user focus to discover actionable insights, defining minimum viable prototyping cycles, testing, learning, and adapting on the go
  4. We don’t need more manuals. We need to develop an innovation process with easy-to-use, easy to tailor tools, supported by a robust innovation process logic that helps projects progressively develop their decision making, rather than prescribes solutions.

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This is the third piece in a continuing series of posts (starting here) on what the role of human-centered design could be in development work. I’m working on this together with Niti Bhan, who will also be posting her observations at her Perspective blog. Posts are categorized as VCD

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

Posted on by Bart Doorneweert

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 how to design partnerships like Nespresso, check out our trainings options!

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