Background on Nestl Nespresso S.A. | Nespresso Sustainability MBA Challenge 2014.

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The Nespresso concept was the brainchild of a Swiss coffee
pioneer and inventor who was determined to create a
preparation system that would enable discerning coffee
consumers to prepare excellent quality coffee at home.
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 1986 Nespresso revolutionised in-home coffee cup quality and pioneered the
entirely new home use of portioned coffee. 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: highest quality coffees, innovative stylish
machines and personalised services. The brand welcomes coffee lovers and invites them into an
exclusive relationship (those who buy a Nespresso machine automatically become members of the
Nespresso Club). A 24/7 service 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 exceptional quality, luxury 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, more than 327 worldwide at the end of 2013, which
are always located in the high-end retail areas of major global cities. The brands story positions
it as ultra premium. In addition to machines and coffee capsules, Nespresso sells coffee-related
accessories created by top designers and has sponsored high-end events such as the Cannes Film
Festival and the Americas Cup.
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 high 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.
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.
2.1
A UNIQUE BUSINESS MODEL
2.2
CREATING AND SOURCING
THE HIGHEST
QUALITY COFFEE
ABOUT NESPRESSO
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Background on Nestl Nespresso S.A. | Nespresso Sustainability MBA Challenge 2014.
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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 9,500 employees and the brand is now available in almost 60 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 45 competitive systems and 90 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.
2.3
A DYNAMIC AND
FAST GROWING MARKET
2000
over 330 employees
2013
over 9,500 employees

Figure 1:
Growth of Nespresso employees
as a reection of the growth of the business
from sourcing to sales
ABOUT NESPRESSO
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Background on Nestl Nespresso S.A. | Nespresso Sustainability MBA Challenge 2014.
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3.1
KEY FACTS ON COFFEE
Coffee is grown in many countries. However, only a few countries are signicant exporters of coffee.
It comes in many varieties, but generally falls into two categories Arabica and Robusta. Robusta
is produced in very large volumes and is generally considered of lower quality than Arabica. Arabica
coffee is produced in smaller volumes (frequently on farms of less than 1 hectare, but sometimes
on farms of over 1,000 hectares), and is generally of high to extremely high quality. Nespresso and
its principal competitors are interested in Arabica coffee and generally compete with each other for
supply and suppliers.
Arabica coffee is traded on the New York stock exchange and its price historically varies between 150
to 200 cts/lb. Robusta is traded on the London International Financial Future and Options Exchange
in /MT. Compared to Arabica coffee its price has been uctuating between 80 to 100 cts/lb. As a
result, coffee prices are highly volatile and do not respond exclusively to coffee supply and demand.
An interesting aspect of the international coffee market is that although Arabica and Robusta
compete in very different segments, they are frequently substituted for each other in blends
produced for mass markets. As a consequence, the international market price for Arabica is highly
dependent on the supply and demand in the much larger Robusta market (see chart 1 below). The
overall result of market conditions for the past 20 years has been decreasing real prices (ination
adjusted) for Arabica coffee.
In 1989, coffee markets were made more open when a long-standing producer-country cartel was
abandoned. In the following years, producers and producer countries (particularly of Arabica coffees)
shifted their emphasis toward more differentiated markets, as aspects of quality and avour prole
became more important for a variety of international markets and trading companies.
This market liberalisation opened up new possibilities for traders and roasters. Many companies
entered this new market space. In the U.S. companies like Starbucks, Peets, Green Mountain
Roasters, and many other smaller roasters redened the retail coffee industry.
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
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ICO indicator prices, nominal (US$ cents / lb)
NATURALS
ROBUSTAS
ICO COMPOSITE
BRAZILIAN
OTHER MILDS
COLOMBIAN MILD

Chart 1:
ICO indicator prices,
nominal (US$ cents/lb)
Source: ICO, 2013
THE GLOBAL COFFEE SUPPLY
CHAIN AND ISSUES
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With the increased demand for high quality coffee, many analysts predicted skyrocketing prices for Arabica
coffees. However, new entrants in the Robusta market, most notably Vietnam supported by a massive
World Bank program, began in the late 1990s, ooded international markets with Robusta coffee (see Chart
2) driving down Robusta prices, and taking with them the Arabica prices. Vietnam thus became the second
largest worldwide producer after Brazil.
The net result of market conditions for the past 20 years has been volatility as well as a decrease in prices
for Arabica coffee for the past 3 years , as indicated by the charts below.
As seen in Chart 3, the market for Arabica coffee futures continues its downward trend against sustained
market pressure.
Comment from economic analysts indicate that the expected 20132014 surplus that would push
stocks to their highest levels in ve years is forcing us to, once again, lower our 312 month [price]
forecasts (Goldman Sachs).
Additional pressure on farmers comes from increased production costs. Compared with 1995 levels,
fertilizers 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 prots have been squeezed, and in many cases eliminated.
Depressed Robusta and Arabica prices have not helped either; with the coffee harvest currently
3.2
RECENT MARKET CONDITIONS

Chart 2:
Coffee production (Arabica and Robusta),
of six representatives countries,
in millions of 60 kg bags
Source: ICO, 2013

Chart 4:
Real prices paid to growers for Arabica coffee
from sources reputed for quality.
Price index 2005 =100
Source: ICO (d) and OECD, 2013

Chart 3:
Nominal prices paid to growers for Arabica coffee
from sources reputed for quality
Source: ICO (d), 2013
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Producer price index 2005=100
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THE GLOBAL COFFEE SUPPLY
CHAIN AND ISSUES
Background on Nestl Nespresso S.A. | Nespresso Sustainability MBA Challenge 2014.
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3.2
RECENT MARKET CONDITIONS
1 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
underway in Vietnam, the robusta price has fallen to three-year low and is likewise weighing on the
arabica price." (Commerzbank)
I&M Smith company (2013) presents a scenario in which if 35% of Arabica coffee farmers worldwide do
not have multi cropping farm alternatives to support themselves nancially, the market could see a drop
in yields of up to 50%. In this scenario they estimate a decrease of approximately 8 million bags which
could then relieve the arabica stocks in Brazil, reducing the surplus stocks by 2016.
This combination of factors is only likely to discourage farmers from investing in the necessary fertilizers
and pesticides, which could both affect the 2014 harvests and exacerbate growing problems of Coffee
Rust (see overleaf).
In other agricultural sectors, prices have also decreased (mostly due to increased supply and at demand),
but producers have managed to maintain prot levels through increased productivity (dened as total
output per hectare). However, in the case of Arabica coffee, there have been no major technological
changes to increase productivity in the past 20 years or more. In fact, productivity has actually been
decreasing in most Arabica-producing regions (see chart 5) as declining prot margins have slowed re-
investment in new coffee plants, genetic upgrades, machinery and even chemical inputs.
Another major reason for higher inputs costs and recent decrease in productivity has been coffee rust,
which is a devastating disease caused by the fungus Hemileia vastatrix (it produces yellowish, oily
spots on the upper leaf surface that expand into larger round spots causing the leaves to drop, nally
leaving the tree denuded). According to new data published by scientists in Central America, rust has
affected 49 % of the coffee throughout the region and forced the pruning of 28 % of coffee plantations,
despite measures taken in each country (Guatemala, Honduras, El Salvador, Costa Rica and Nicaragua)
to combat the disease. It is estimated that about 505 000 people (farmers and their dependents) have
been affected due to the impact of rust in the region. In October 2013 the Regional Forum on Coffee Rust
Mesoamerica met in the Tropical Agricultural Research and Higher Education Center (CATIE) concluded
that since 2012, the fungus has to date caused economic losses of $ 681.3 million (ICAFE, 2013).
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Green coffee productivity of selected countries
(46 kilo sacks (qq) / hectare)
Colombia
Ethiopia
Guatemala
India
Indonesia
Mexico
Vietnam

Chart 5:
Green coffee productivity of selected countries
in quintals (46 kilo sacks) / hectare)
1
Source: Faostat, 2013
THE GLOBAL COFFEE SUPPLY
CHAIN AND ISSUES
Background on Nestl Nespresso S.A. | Nespresso Sustainability MBA Challenge 2014.
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3.3
COFFEE SOURCING
PROGRAMMES
Against this backdrop, sourcing high quality coffee has become progressively a more difcult 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 certication
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 Quality
TM

Program, a holistic approach embedded in its own sourcing system. The following section describes
the programme in more detail.
More alarmingly, farms that have had to be pruned due to the disease will not be able to produce
coffee for the next two years. In the case of Costa Rica, rust was detected in 64 % of the coffee
plantations, approximately 60 449 ha. In Honduras, the fungus has damaged 30 % of the cultivated
area (84 754 ha) and in Guatemala 59 % of the farms (163 041 ha). In El Salvador, the disease has
been recorded in 71 % of the coffee harvest and in Panamas case 32% of its farms have been
affected (ICAFE, 2013).
The severity of the problem has led to a range of baseline economic and technical assistance
proposals and specically, an action plan in September 2013 in which various institutions such as
CATIE and CIRAD (French Agricultural Research Centre for International Development) propose a 4
point strategic management plan that addresses development of institutional capacities; genetic
improvement; integrated approach to combat rust and attention to vulnerable communities.
In the longer term, and against a backdrop of a complex array of challenges, the situation does not
look much better for producers of Arabica coffee. This is particularly so for those in Central America,
who, unlike Colombia do not currently receive any price support from government, and whose farmers
face greater challenges and costs associated with Leaf Rust.
In addition, Climate change is another factor that has to be added into the equation. Coffee plantations
are starting to be affected by extreme weather events, such as temperatures. Furthermore, scientic
research shows, that many of the current coffee growing regions are very likely to be affected in the
near and long-term future. This might have severe consequences for all actors of the coffee value
chain as for the production costs, the coffee price and world market conditions (Haggar and Schepp,
2012).
THE GLOBAL COFFEE SUPPLY
CHAIN AND ISSUES