Just what is Shared Value?

In December of 2010, just before the start of the World Economic Forum convention in Davos, professor Michael Porter released a much revered article in the Harvard Business Review, called Creating Shared Value, together with his partner in thought Mark Kramer. The article describes how a new form of capitalism is emerging where business looks at the possibilities it has in the core to leverage externalities for meeting social needs. The notion of Shared Value is contrary to CSR, which Porter considers as a peripheral activity to what firms actually do.

The release of the Shared Value article was well timed for the Davos convention, and turned it into the talk of the town. But, with all the ruckus of promoting the Shared Value concept, the oblique nature of the article’s main contention -that Shared Value is a markedly distinguished concept and deserves meme-status as a new form of capitalism- remained unchallenged.

The concept of Shared Value as described in the article needs more clarification. Because of the lack of clarity, the article actually unintentionally distorts the quest for achieving fundamental forms of  shared value creation. Before I get to what I think would more clearly describe Shared Value creation and highlight the challenges to create it, let’s first have a look at Porter’s take.

Porter’s take on Shared Value creation
The problem with capitalism at the moment is that firms are to narrowly focused on creating monetary profit. Under this condition, firms focus primarily on their segment in the value chain, and don’t consider the implications of their operations in relation to wider social needs. Each enterprise active in the value chain is very much its’ own island, focussed on itself, and negative social and environmental externalities remain unaddressed.

The way current capitalism works. Every company in the value chain (producer/intermediary/brand in simple form) on its’ own island, and negative social and environmental externalities remain unaddressed. Value flows upward only

Professor Porter suggests that firms have three ways of  Shared Value creation opportunities to overcome this situation:

[…] by reconceiving products and markets, redefining productivity in the value chain, and building supportive industry clusters at the company’s locations.

Regarding the first point, Porter ascribes the Shared Value label to a number of phenomena which would actually better be described as good old fashioned cost reduction, like reducing carbon emissions by increasing fuel efficiency, or slowing the rate of growth of landfills by reducing the amount of packaging. These are quite clearly not examples of Shared Value creation, but rather an internal process to the firm for increasing resource-use efficiency.

The conceptual treatment of Shared Value becomes more interesting when Porter arrives at his area of core research expertise, namely that of the cluster and the operations of firm value chains, which create competitive advantage. Porter explains the need for investing in suppliers to increase their performance and value delivery capacity to buyers and brands:

“Why are farmers poor? Because they have lousy yields. Because the quality isn’t good enough, and therefore the prices are very low.” – Michael Porter said in a debate at the World Economic Forum in Davos

And it is precisely at this point that the obliqueness of Porter’s take on Shared Value is revealed. To what extent is creating Shared Value, like investing in suppliers, about creating positive externalities in firm value chains which upgrade production, and to which extent is it about novel ways of sharing (distributing) the total value created over the value chain community? Porter appears to be clear on this:

“Shared value is not about “sharing” the value already created by firms—a redistribution approach. A shared value perspective, instead, focuses on improving growing techniques and strengthening the local cluster of supporting suppliers and other institutions in order to increase farmers’ efficiency, yields, product quality, and sustainability. This leads to a bigger pie of revenue and profits that benefits both farmers and the companies that buy from them”

Drawn out in a graph, I would suggest creating Shared Value looks somewhat like the graph below

Porter’s take on Shared Value creation. Each firm takes on to solve the negative externalities it produces. Some investment might be needed at the level of producers. This investment generally comes from public funding, but on rare occasions from other companies in the value chain. Value still flow upwards.

So the central thesis of Shared Value is that we do not look at systems for redividing the pie, but rather for ways of making the pie larger so that even the most under dealt pie eaters, can capture a bigger piece. I think, however, that this thesis won’t cut that pie, and here’s why.

What creating Shared Value should actually be tackling
There is an inherent flaw in Porter’s thesis, and I’m lucky to demonstrate it, as Porter makes his case, by looking through the lens of the agricultural value chain. Farmers are generally at the closing end of the value distribution and capturing process in value chains. They create a lot of the value, but due to their position in the value chain system, they always get dealt the piece of the pie that’s left after everyone else has taken their share. Companies situated more downstream in the value chain have more opportunity for capturing value in the market, and this suppresses farmers’ value capturing opportunities, putting them in a structurally precarious position. In effect, if the pie is enlarged under these conditions, chances are very likely that the relative share of groups like farmers will decline as a consequence, not increase.

I would argue that unless new forms of value distribution are developed, which can patch this precarious position due to lack of value capturing opportunity, farmers will always face the issue of not being adequately able to upgrade their production standards to more sustainable use of natural resources. Grave externalities will remain. Increasing productivity and yields might work in the short run, but in the long run this will not suffice.

I can vouch for this with the case of agriculture in my home country, The Netherlands. Although we have one of the world’s most efficient and productive agricultural sectors, farmers are struggling to invest in adapting their businesses to changing consumer and societal demands, and even to make a decent living, because of a lack of value capturing opportunities. Finding solutions is thus not all about the yield and quality. It’s about what kind of business models we can design in the value chain that will adequately distribute value according to the performance that is actually delivered by the producer.

The idea of fundamentally Shared Value
What needs to change about the way capitalism functions is the opportunities parties have to capture part of the total value created in their value chains. To provide this opportunity, we need to develop new value distribution mechanisms, which are able to equitably distribute value according to performance delivered by value chain members, regardless of whether this is product quality performance or social/environmental performance. These mechanisms could be for instance tradable environmental services, or producer participation in brand value creation with lead firms. There are all kinds of innovations we can experiment with to distribute this value.

If we succeed then the pie will most likely be divided differently, between parties in the value chain who have actually contributed to shared value creation. This will be a new form of capitalism, which breaks through the old issue of islands in the value chain, and connects communities that distribute value based on respective contribution, rather than ability to capture it. New capitalism is not about the size of the pie, it’s about fundamental Shared Value.

In the case of fundamental Shared Value, value flows differently: both upwards and downwards. Value is shared by parties who have contributed to creating it. This is the only way to sustainably deal with covering the costs of dealing with negative externalities in the value chain, regardless of whether the pie is large or small.

Design the Shared Value Chain
After this conceptual clarification, I can’t leave you without showing how Shared Value creation can be made operational. Interestingly, Porter’s article reveals what would be the way forward with the value chain of Nespresso as example  (as covered before on this blog, naturally):

“Africa and Latin America, who are trapped in a cycle of low productivity, poor quality, and environmental degradation that limits production volume. To address these issues, Nestlé redesigned procurement.”

Overall, this design process requires making new choices as Porter continues explaining

“New products and services that meet social needs or serve overlooked markets will require new value chain choices in areas such as production, marketing, and distribution.”

These choices will need to be made on the basis of fundamental understanding of the value chain community, and the business ecosystem in which it is embedded. Only this understanding will provide the new fabric with which more robust and sustainable form of capitalism can be created.

An inspiring example of this integrated thinking on value chain design is provided in the following presentation of designer Yves Béhar. In this presentation, Yves talks about the journeys he undertakes in designing new radically sustainable products (like the famous Cradle-to-Cradle Herman Miller chair). The presentation clearly shows that the design challenge we are facing to reinvent the capitalism in meeting societies needs, lies in finding new ways of value creation, capturing, AND distribution. Enjoy the process!

Post take-away points:

– Porter’s Shared Value creation is a thin rework of his previous more fundamental work on the relation between sustainability and core business.

– Value distribution is key to shared value creation. It is equally important to value creation and capturing. Share Value creation should encourage continuous innovation in those aspects of the chain where sustainability impact is created (in the case of agriculture, upstream!) Shared Value should warrant a system of economic distribution that is able to reward those that deliver on performance

– In order to find distributive mechanisms, we need to delve deep into the operations of the value chain. Design thinking approaches are needed to integrate product design with impact on social (business) system design.

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All quotes are from the Porter and Kramer’s Harvard Business Review article, Creating Shared Value (which is linked above), unless referenced otherwise

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 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.