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TABLE OF CONTENTS
INTRODUCTION 1 01
ABOUT NESPRESSO 03 2 2.1 A unique business model 04 2.2 Creating and sourcing the highest quality coffee 04 2.3 A dynamic and fast growing market 05 3 3.1 3.2 3.3 4 4.1 4.2 4.3 5 5.1 5.2 5.3 5.4 6 7 ISSUES IN THE GLOBAL COFFEE SUPPLY CHAIN Key facts on coffee Recent market conditions Coffee sourcing programmes 06 07 08 09
SUSTAINABILITY: A KEY BUSINESS DRIVER FOR NESPRESSO 10 Creating Shared Value and EcolaborationTM 11 The Nespresso AAA Sustainable QualityTM Program The Real Farmer IncomeTM Approach (RFI) 11 13
COLOMBIA AS A HIGH QUALITY COFFEE SUPPLIER 15 Challenges for the coffee sector in Colombia 17 Nespresso engagement in Colombia 17 Strategy in Colombia 18 Whats next? 20 REFERENCES APPENDICES 21 23
Background on Nestl Nespresso S.A. | AAA Sustainable QualityTM MBA Challenge 2013
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INTRODUCTION
INTRODUCTION
BACKGROUND ON NESTL NESPRESSO S.A. AAA SUSTAINABLE QUALITYTM MBA CHALLENGE 2013
This background document has been co-authored by the Nespresso team and their partners at The Sustainable Markets Intelligence Center (CIMS) and INCAE Business School in Costa Rica. The document is designed to give a broad introduction to the Nespresso business and to explain its commitment to sustainability along its value chain. It also contains more specific information about its coffee-sourcing programme designed to secure a long-term supply of the highest quality coffees (the Nespresso AAA Sustainable QualityTM Program). It explains the work Nespresso has been carrying out in key coffee producing countries as well as some of the challenges it has faced and will continue to face in the future. A specific focus is placed on challenges and programmes in Colombia, a key country of origin for AAA coffee. This intends to provide useful context for the forthcoming MBA Challenge case study that will be published in early 2013.
Background on Nestl Nespresso S.A. | AAA Sustainable QualityTM MBA Challenge 2013
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ABOUT NESPRESSO
A unique business model 2.1 Creating and sourcing the highest quality coffee 2.2 A dynamic and fast growing market 2.3
ABOUT NESPRESSO
The Nespresso concept was the brainchild of a Swiss coffee pioneer and inventor who was determined to create an espresso preparation system that would enable discerning espresso coffee consumers to prepare excellent quality espresso coffee at home.
2.1 A UNIQUE BUSINESS MODEL The patented Nespresso system uses a unique extraction method encased in stylish machines to extract consistently high quality espressos from exceptional coffee blends in portioned aluminium capsules. Launched in 1985 Nespresso revolutionised in-home coffee cup quality and gave rise to the entirely new home use portioned coffee category. The company has continued to innovate in various areas, and even developed specific formats tailormade for businesses like high-end hotels, restaurants and offices. The Nespresso business model is based on three pillars: the unique extraction system, an innovative and efficient direct-to-consumer club membership model (whereby those who buy a Nespresso machine automatically become members of the Nespresso club) and 24/7 service that allows club members to order capsules, send machines for repair and ask any questions related to their use of Nespresso products. Nespresso has created a brand that stands for luxury, exceptional quality and a lifestyle experience. The individual coffees in the range are described not as varieties or flavours, but as Grands Crus (a term used most often in the wine industry to denote an excellent quality, and adapted by Nespresso to denote the quality of their coffees). In addition to being able to order capsules online, club members can also shop in Nespresso boutiques, about 300 worldwide at the end of 2012, which are always located in the high-end luxury retail areas of major global cities. The brands story positions it as ultra premium, justifying (in addition to product delivery) consumer price premiums. In addition to machines and coffee capsules, Nespresso sells espresso-related accessories created by top designers and has sponsored high-end events such as the Cannes Film Festival and the Swiss challenge for the Americas Cup sailing competition.
According to studies conducted on specialty coffee and product sensory profiling by the internal green coffee experts within Nespresso, only around 1% to 2% of the worldwide coffee harvest is of the correct quality level, flavor and aroma profile for the Nespresso range of products. Given this constraint in coffee sourcing options and the significant growth rates of the business, securing a stable, long-term supply of highest quality green coffee became a key priority. Furthermore, there was a growing internal consensus that even if it could secure the coffee it needed, the Nespresso brand would suffer if it did not find a way for producers to benefit more from their relationship with the company.
Background on Nestl Nespresso S.A. | AAA Sustainable QualityTM MBA Challenge 2013
ABOUT NESPRESSO
The overall profile of Nespresso consumers is upmarket, slightly older coffee consumers. The home market of Switzerland and other European markets with a tradition of espresso consumption still constitute a significant proportion of total sales, though the brand is also growing in so called "white cup" (coffee plus milk) markets such as the US, Asia and Latin America. The unique features of the Nespresso system and business model have led to high growth rates, making Nespresso one of Nestl fastest-growing businesses and a so-called billionaire brand. The company has over 7,000 employees and the brand is now available in more than 50 countries. One of the brand's main strategic challenges in recent years and in the future will be to manage this growth, in all areas of the business, including human resources, customer service and supply chain management. Portioned or single-serve coffee is now a fast-growing segment and Nespresso's success has drawn the attention of a range of competitors with currently more than 50 competitive systems and 44 brands with compatible capsules. It is interesting to note that the two first compatible capsule competitors who entered the portioned coffee sector in 2010, have chosen a specific sustainability attribute to challenge the Nespresso position with regard to sustainability. One has focused on biodegradable capsules (as compared to the Nespresso recyclable aluminium ones) and the other is ensuring that 100% of the coffee in their capsules is certified to the European-based certification standard Utz Certified.
Figure 1: Growth of Nespresso employees as a reflection of the growth of the business from sourcing to sales
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ISSUES IN THE GLOBAL COFFEE SUPPLY CHAIN
Key facts on coffee 3.1 Recent market conditions 3.2 Coffee sourcing programmes 3.3
Background on Nestl Nespresso S.A. | AAA Sustainable QualityTM MBA Challenge 2013
Chart 2: Coffee production (Arabica and Robusta), of six representatives countries, in millions of 60 kg bags Source: ICO, 2012
1982 1986 1990 1994 1998 2002 2008 2009 2010 2011 2012
The net result of market conditions for the past 20 years has been both volatility and decreasing real prices (inflation adjusted) for Arabica coffee, as the charts below indicate.
Real prices for Arabica coffee from sources reputed for quality
250 260 240 220 200 200 180 US$ cents / lb 150 US$ cents / lb Brazil Costa Rica Colombia Guatemala Mexico 1980 1982 1984 1986 1988 1990 1992 1994 1998 2000 2002 2004 2006 2008 1996 2010 160 140 120 100 80 50 60 40 20 0 1980 1982 1984 1986 1988 1990 1992 1994 1998 2000 2002 2004 2006 2008 1996 2010 Brazil Costa Rica Colombia Guatemala Mexico
Real prices for Arabica coffee from sources reputed for quality
100
Chart 3: Nominal prices paid to growers for Arabica coffee from sources reputed for quality Source: ICO (d), 2010
Chart 4: Real prices paid to growers for Arabica coffee from sources reputed for quality. Price index 2005 =100 Source: ICO (d) and OECD, 2010
Unfortunately for the worlds Arabica producers, production costs have also increased. Compared with 1995 levels, fertilisers have increased in cost by a factor of 4 or more (largely correlated with oil and natural gas prices). Labor costs have also increased. Since chemical inputs typically represent around 1/3 of production costs, and labor costs over half profits have been squeezed, and in many cases eliminated.
Background on Nestl Nespresso S.A. | AAA Sustainable QualityTM MBA Challenge 2013
Quintals / ha
Chart 5: Green coffee productivity of selected countries in quintals (46 kilo sacks) / hectare)1 Source: Faostat, 2012
Against this backdrop, sourcing high quality coffee has become progressively a more difficult task. About 5% of the worlds coffee production is given over to Arabica high quality coffee (Giovannucci et al, 2008), and demand for those beans continues to increase. Companies like Illy Caf, Starbucks and Nespresso are all seeking to obtain these beans through their respective sourcing programmes. Issues addressed include those of quality, traceability, as well as environmental and social sustainability concerns that growing numbers of consumers care about, and that are increasingly viewed as important in the securing of long-term sustainable supplies of coffee. Third party certification standards such as Fairtrade, Organic and Rainforest Alliance have emerged as the main response by other companies to some of the most relevant sustainability issues in the coffee supply chain. The response of Nespresso to these issues and other challenges is the AAA Sustainable QualityTM Program, a holistic approach embedded in its own sourcing system. The following section describes the programme in more detail.
Production of coffee in Vietnam corresponds mainly to Robusta coffee. Most Arabica coffee producing countries, like Mexico and Colombia have a trend of a declining total production of coffee 9
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SUSTAINABILITY: A KEY BUSINESS DRIVER FOR NESPRESSO
Creating Shared Value and EcolaborationTM 4.1 The Nespresso AAA Sustainable QualityTM Program 4.2 The Real Farmer IncomeTM Approach (RFI) 4.3
We are a part of Nestl Nestl has committed to Shared Value as an operating principle.
Richard Girardot CEO, Nestl Nespresso S.A. committed the company to the concept of Creating Shared Value (CSV)
This principle, developed by Harvard Professors Michael Porter and Mark Kramer in 2006, maintained that companies had a responsibility to create and share value not just for shareholders but also for the communities in which they operated from farmers through to customers and ultimately consumers. In the CSV approach they advocate companies identifying a "sweet spot" or point of connection between the activities and needs of a company and the activities and needs of society, and call this a process of mapping social opportunities. In this way, business organisations can be much more targeted and efficient in assessing the way their business activities create value that is shared with other stakeholder groups. Informed and inspired by the CSV approach, Nespresso identified its own social opportunities and areas of interdependence with wider society within its value chain. On this basis, the company has launched an integrated CSV framework, "EcolaborationTM2 to group together its value chain sustainability efforts in the area of carbon footprint reduction, sustainable coffee farming and spent capsule recycling3. A customer segmentation study conducted in 2008 identified that 16% of Nespresso consumers are defined as "eco-committed" (described as liking the good things in life but in a responsible way). This group is significantly more interested in the Nespresso AAA Sustainable QualityTM Program than other customer segments. This fact provided further motivation for the company to develop its strategy.
By applying the CSV thinking espeFigure 2: Quality Sustainability Productivity AAA pillars cially in the area of sustainable cofMaintaining Respecting Farm fee farming, Nespresso soon realised highest quality people and management environment that its requirement for long-term Sustainable Value sustainable sources of green cofA A A Creation fee overlapped completely with the First Second Third farmers own need to improve their long-term economic prospects and a wider societal need to improve the effectiveness of coffee farming in conserving natural resources. This led to the Nespresso AAA Sustainable QualityTM coffee sourcing program co-developed by Nespresso and Rainforest Alliance, originally rolled out in 2003, which focuses on helping coffee farmers continuously improve their ability to produce the highest quality coffee whilst addressing on-farm sustainability and farm productivity at the same time (see Figure 2 above). A central ambition of the program is that AAA farmers improve their net incomes. This has led to the conceptualisation of a farm income focus called Real Farmer IncomeTM (RFI) by Nespresso (see later section for more details on this).
2 Find more details at: http://www.nestle-nespresso.com/ecolaboration/sustainability http://www.nestle-nespresso.com/ecolaboration/creating-shared-value 3 Find details on the recycling initiatives at: http://www.nestle-nespresso.com/ecolaboration/sustainability/capsules Background on Nestl Nespresso S.A. | AAA Sustainable QualityTM MBA Challenge 2013 11
The key characteristics of the AAA program are to pay premiums to its farmers for quality, incentivise them to comply with the Rainforest Alliance standard (environmental, social and various management variables) and initiate projects to boost yields and income. Nespresso chooses very select coffee-producing regions around the world that provide the unique flavour and aroma characteristics that define its blends. The company then identifies and enters into long-term relationships with experienced coffee buying companies working in those regions that are contracted to provide coffee according to the Nespresso quality requirements. In addition, the buyers assist Nespresso and supplier farmers in advancing toward compliance with the AAA program, mostly through the provision of technical farm extensionist services. From its original inception in 2003 and through its subsequent redefinition and expansion to include Real Farmer IncomeTM as a metric, the AAA Program has now grown to be a sourcing program that reaches 50,000 farmers in seven countries, including Colombia, and twenty growing regions (referred to internally by Nespresso as clusters), and is set to grow further in the next three years. The backbone of the AAA program is the large network of agronomists in the field who offer training and technical assistance through farm visits and workshops to help farmers improve performance. As a consequence Nespresso is gradually building ever-closer relationships with its global community of AAA farmers4.
The Nespresso AAA Sustainable QualityTM Program pays premiums for both quality and sustainability. The premium is around 30% to 40% above the standard market price for coffee and 10% to 15% above the general local market price for coffees of similar quality, a key benefit from the farmers perspective, for participating in the Program. (see Chart 6)
4 For more information, please go to: http://www.nestle-nespresso.com/ecolaboration/sustainability/coffee Background on Nestl Nespresso S.A. | AAA Sustainable QualityTM MBA Challenge 2013 12
Chart 6. Drivers of satisfaction among AAA Sustainable QualityTM participants (Colombia) Source: Crece, 2012
The price premium that Nespresso pays to its buyers has two components: one corresponding to technical assistance and one that is actual cash to be paid to the farmers for their coffee. One other important aspect of the Nespresso sourcing programme is that usually only a relatively small percentage of each producers coffee is eligible to receive the Nespresso AAA premium (only this percentage passes the quality test due to size of beans, harvesting approach, and post-harvest handling). Coffee that does not comply with Nespresso's high quality standards will be sold to other buyers.
In 2008, Nespresso committed to RFI as one of its strategic pillars. We are committed to increasing Real Farmer Income as the expression of our commitment to create shared value with our key farmer partners. RFI is critical to us, because of our corporate culture, because it maintains the health and vitality of our supply chain, and because it is the right thing to do for the farmers who are such an important part of the Nespresso success. CEO, Nestl Nespresso S.A. Richard Girardot The Real Farmer Income concept involves taking a close look at the farmers business model and with this information, identify ways of transforming coffee farming into a more profitable economic activity. While most Nespresso executives saw RFI as a key strategic approach, farmer well-being has not been an explicit part of the traditional coffee buying and trading culture. Historically, the relationships between roasters/brands, their trader suppliers and farms has been of a transactional nature, and nearly always based on negotiations for the current years harvest, although it is not unusual for
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COLOMBIA AS A HIGH QUALITY COFFEE SUPPLIER
Challenges for the coffee sector in Colombia Nespresso engagement in Colombia Strategy in Colombia Whats next? 5.1 5.2 5.3 5.4
Colombia is the third largest coffee producer in the world, and a significant producer of much of the worlds premium quality coffee.
Demand has been constant and growing (Perdomo and Hueth, 2011); in particular, high quality coffee has seen a rise in demand, increasingly from growing middle classes in countries such as China, Coffee growers participating in specialty coffee programs India and Brazil. This has caused 2005 - 2009growing pressure on the supply of beans (SCAA, 2012). Total coffee production and exports grew 50% between 1977 and 2007. (FNC, 2007)
80,000 70,000 60,000 50,000 40,000 3.0,000 20,000 11,567 10,000 4,051 2005 2005 2005 2005 69,568
74,927
24,372
Chart 7. Participation of coffee growers in specialty coffee programs, Colombia Source: FNC, 2010
2005
Coffee is an important contributor to the Colombian economy, particularly in rural areas where this labour-intensive crop is produced. Although the significance of coffee to the Colombian economy has declined in recent years the crop still represents 10% of agricultural GDP. Coffee has an even higher share of the cultural and social significance in the country with 500 000 farmers, and the crop employs close to 35% of the agricultural workforce. The country has a long and deep rooted tradition as a quality coffee producing and exporting country. Since 1927 the Federacion Nacional de Cafeteros de Colombia (FNC), a business cooperative, has provided an institutional framework for the coffee sector in Colombia and this focus has enabled Colombia not only to be the second biggest supplier country of Arabicas but also to gain higher prices for quality on the international market. Given the high quality of its coffee, Colombia remains one of the key sourcing markets for Nespresso, and for this reason it has focused considerable attention on its coffee-growing communities.
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In the last few years, total volumes of coffee sourced in Colombia by Nespresso have tripled. The company is now engaged in four regions sourcing from more than 37,000 farmers. It has increased its involvement in the country since its entry in 2004 and currently sources AAA coffee from five clusters highlighted in ANTIOQUIA this map below.
CALDAS
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For the effective deployment of the AAA program in the country, Nespresso has developed a 5 point strategy. This entails a closer collaboration with institutional partners such as FNC, focused targeting of potential public private partnerships (PPPs), a focus on yield and quality (QualitivityTM), innovation in addressing water management and a process for measuring and tracking CSV performance. A range of projects in partnership with suppliers show positive early indications of yield improvements (find a complete list of projects in Colombia in Appendix 2). The program is also having a positive impact on environmental outcomes, in particular in the area of water consumption and wastewater treatment, as farms move towards compliance with Rainforest Alliances Sustainable Agriculture Network (SAN) standards.
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Subsequent research done in Colombia over the past year by a local organisation affiliated with FNC (Crece) has shown indications of improvements in farm sustainability performance suggesting that some investments are beginning to show positive pay offs. CRECE has been measuring AAA farm performance in Colombia against a control a control group of farms using sustainability indicators across the social, environmental and economic spectrum. Their study demonstrates a higher performance for AAA farms with evidence of progress on a range of social, environmental and economic criteria (see below charts).
AAA farmers + AAA farmers with Rainforest Alliance (RA) certification had better social conditions
100 80 60 40 20 0 2009 2011 46 54 53 65 67 CONTROL AAA RA AAA
AAA farmers + AAA farmers with Rainforest Alliance (RA) certification had better economic conditions
100 80 60 40 20 0 2009 2011 40 49 55 39 CONTROL AAA RA AAA 59 100 80 60 40 20 0
AAA farmers + AAA farmers with Rainforest Alliance (RA) certification had better environmental conditions
79
68 49 48
73
2009
2011
Chart 8: AAA farmers + AAA farmers with Rainforest Alliance (RA) certification had better social conditions Source: CRECE
Chart 9: AAA farmers + AAA farmers with Rainforest Alliance (RA) certification had better economic conditions Source: CRECE
Chart 10: AAA farmers + AAA farmers with Rainforest Alliance (RA) certification had better environmental conditions Source: CRECE
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Through its MBA challenge programme, INCAE Business School, CIMS and Nespresso are seeking support from the global academic community to help it develop innovative solutions to the challenges in its coffee supply chain. This document is a background document that aims to help set the scene for the Challenge. The Case Study will be released early February 2013.
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REFERENCES
REFERENCES
ALDRIDGE, M. 2003
Civil War and United States Involvement in Colombia. Available at: http://www.stanford.edu/class/e297a/United%20States%20Involvement%20in%20 Colombia.pdf Consulted on: December, 2012.
BOTELLO, S. 2010
Jornales cafetaleros e integracin del mercado laboral cafetero: 1940 to 2005. Available at: http://www.federaciondecafeteros.org/static/files/Jornales_e_integracion_al_mdo_laboral_cafetero.pdf Consulted on: November, 2012
FAOSTAT 2012
Agricultural Production and Yield Statistics. Food and Agriculture Organisation of the United Nations (FAO). Available at: http://faostat.fao.org/site/567/default.aspx#ancor. Consulted on: December, 2012
Colombian coffee sector outlook. World Coffee Conference, 2010. Available at: http://dev.ico.org/event_pdfs/wcc2010/presentations/wcc2010-munoz-e.pdf Consulted on: December, 2012 Principales cifras de la caficultura colombiana. Available at: http://mailin.cafedecolombia.com/productivo/Inscripc.nsf/792337e17cf5a4f6052 56d51008185f3/2c078acdd6d20f830525730200816139/$FILE/B-3-Principales%20 cifras%20de%20la%20caficultura%20colombiana.pdf Consulted on: November, 2012
Adding Value: Certified Coffee Trade in North America Pascal Liu (Ed.) Value-adding Standards in the North American Food Market - Trade Opportunities in Certified Products for Developing Countries. FAO. Rome.
Funciones de la produccin, anlisis de economas a escala y eficiencia tcnica en el eje cafetero colombiano: una aproximacin con frontera estocstica. Available at: http://www.federaciondecafeteros.org/static/files/funciones_produccion_analisis_economias_escala.pdf Consulted on: November, 2012
Specialty Coffee Facts and Figures. Available at: http://www.scaa.org/PDF/resources/facts-and-figures.pdf Consulted on: November, 2012
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APPENDICES
APPENDICES
APPENDIX 1
Farmer income in Nespresso purchasing regions in five countries, in US$/ha (ordered from least to most profitable farm)
4,000 3,000 Net income (US$/ha) 2,000 1,000 0 - 1,000 - 2,000 0% 20% 40% 60% 80% 100% Brazil Costa Rica Colombia Guatemala Mexico
Source: CIMS (cl. 2010)
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APPENDICES
APPENDIX 2
OBJECTIVES
ACTIVITY A1 Promotion of a culture of quality leveraging continuous improvement of coffee cup profile. A2 Improvement of postharvest equipment and infrastructure in the farms. A3 Implementation of good agricultural practices and continuous improvement processes. A4 Implementation of environmental management plans in the farms. as AAA.
85% average acceptance rate of the coffee at the cooperative 10% of the farmers achieved and maintained at least the 9,000 equipment installed in the farms to have better
productive infrastructure for coffee processing. 4,500 new sun dryers installed in the farms. 4,500 new fermentation tanks installed in the farms. emerging level under the TASQTM assessment for Quality.
Coffee growers adopt a Quality System to improve their coffee quality and sustain it.
The smallholders adopt an Environmental Model for protection of coffee ecosystems in each production unit.
6,000 farms are certified RFA in 4 years. 96.3 millons of plantlets produced (Cenicafe certified). 22,542 hectares are renovated with optimal density for the
farm conditions.
The smallholders adopt a farm management system to increase the productivity in their farms.
4,592 hectares are optimised for coffee production. 14% incentive grant for fertilisers given to farmers. 7,000 samllholder families are trained on food production
and good nutrition.
A6 Implementation of self consume plots in the farms for food security. A7 Establishment of community participation mechanisms.
42% of the trained families implemented food security plots. 20 producer groups are created. 2 Prospresso Local Participation Committees are created. 100 agronomists trained for assisting farmers. 33,000 smallholders receive technical and social support. 5% of the youngsters of the smallholder families particpate in the "Young Coffee Growers" program. in the School and Coffee program. and interpretation.
The Coffee Grower Community engage for a People Development Plan for good governance, empowerment and cohesion.
A8 Implementation of Capacity Building Plan for the Coffee Grower Community. A9 Implementation of the next generation program. A10 Implementation of Real Farmer IncomeTM Model by the Coffee Growers.
5% of the children of the smallholder families participate 35,394 trainings to farmers on Farm Income Model application 10% of the farmers have achieved and maintained at least
the emerging level under the TASQTM assessment for Economical aspects. farmers as AAA (Loyalty rete). with an over price.
Enhanced Economic Support System to increase Coffee Farmers loyalty and Real Farmer IncomeTM.
70% of the coffee is commercialised in specialty markets 6,000 farmers secured a buying contract for certified
responsible coffee.
2 Regional Inter-sector Committees created and operating. At least 2 Private-Public Partnerships for the action are
settled.
Source: Nespresso
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APPENDICES
APPENDIX 3
Correlation between Real Farmer IncomeTM in its key drivers in five Nespresso supplier countries
COSTA RICA GUATEMALA COLOMBIA (NARIO) BRAZIL MEXICO
CORRELATION BETWEEN NET INCOME AND PRICES CORRELATION COEFFICIENT P-VALUE -0.09031 0.3691 0.05854 0.5772 0.06883 0.552 0.358 <.0001 0.403 <.0001
CORRELATION BETWEEN NET INCOME AND YIELD CORRELATION COEFFICIENT P-VALUE 0.84257 <.0001 0.64509 <.0001 0.70133 <.0001 0.6100 <.0001 0.742 <.0001
APPENDIX 4
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Background on Nestl Nespresso S.A. | AAA Sustainable QualityTM MBA Challenge 2013
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Nespresso Backgrounder | Sustainability MBA Challenge This information may be shared freely but the document as such is for use in the context of the MBA Challenge only.