Nespresso: victim of a low-end disruption?
Interestingly, the posts on Nespresso are among the most popular on this blog. Every time I write about this product, audience shoots up, so why not continue… especially given that there is an interesting news with the launch of Nespresso compatible capsules by a new company called Ethical Coffee Company (ECC).
It is well known that Nespresso’s business model is mostly based on selling capsules on which Nestlé is able to make a very high margin. This margin is significantly higher than for the traditional filter coffee, Nestlé’s main business. This is in fact the same model as that of ink jet printer manufacturers: you buy a printer at a very low price; it usually barely covers the cost of the printer. The manufacturer makes its margin not on the printer, but on the cartridges, which are (relatively) very expensive. This model comes from the razor and the blades model invented by Gillette. This model is not without benefits for some users, in particular for those who have limited needs in terms of quantities. In that case, the high relative cost for one page matters less than the low absolute one. What is interesting in the case of Nespresso is that Nestlé has been able to position the product in the premium segment, so they are able to sell the machines at a high price as well, thus having it both ways…
This positioning helped fuel the success of the product and drove its exceptional profitability. It was reinforced by the creation of the Nespresso Club, adding a sense of exclusivity, and the use of actor George Clooney in the ads. In addition, the Club provides valuable customer information for Nestlé, another innovation for a company that had until then always sold only through distribution channels.
Of course, the idea of a high-quality coffee at home quickly attracted competitors such as Senseo, a partnership between coffee house Douwe-Egberts and home appliance manufacturer Philips, or Tassimo. However, despite their success, and quite unlike what Pr Clayton Christensen would predict, these lower end competitors have not been able to really to “go up” and threaten Nespresso’s position in the higher end of the segment.
This could change thanks to the entry of a new type of competitor having a different strategy: Ethical Coffee Company (ECC). ECC’s idea is quite simply to create capsules that are compatible with Nespresso machines, yet cheaper. This is a strategy that has already been successful for printers and that manufacturers were not able to successfully counter. ECC, which like Nestlé is based out of Switzerland, assures that they have found a way not to violate Nespresso’s patents and produce perfectly legal compatible capsules. ECC’s threat should be taken seriously by Nestlé because its founder is no other than Jean-Paul Gaillard, the man who successfully launched… Nespresso back in the early 1990s. Gaillard is the manager called “Yannick Lang” in the infamous and controversial Nespresso case study from IMD written by Joyce Miller and Kamran Kashani. In addition, ECC has raised €20 million in private capital and is already in production.
ECC’s capsules are legally compatible with Nespresso machines, but 20% cheaper. In addition, they can be completely recycled, a very important point as the use of aluminum capsules by Nestlé has long been criticized by environmentalists. Each Nespresso user has probably experienced a growing sense of unease when throwing away the capsules. Lately, Nestlé has undertaken a recycling program but the way it is organized does not seem to be environmentally friendly.
What can Nestlé do? Moving “downwards” is difficult for two reasons. First, because the success of Senseo and Tassimo in the mid-range market means competition is solidly present, with big brands that have strong experience of the business and the distribution network, and for which the segment is core. So expect strong resistance here. Second, because ECC’s entry will quite likely successfully occupy the “value” segment of the capsule market. Third, because it is always difficult for a firm to move downwards, regardless of the competition: margins are lower but the cost base is the same, a sure crash. This would mean hurting the brand, a key issue as the brand, more than the quality of the coffee, is what drives Nespresso’s success since the beginning. It is difficult to imagine Nestlé introducing “value” (ie low end) coffee machines or selling the capsules in supermarkets (which would instantly mean losing 25% of the margin), sitting next to Tassimo’s.
The question is whether Nespresso’s positioning can be sustained. One can certainly expect a “Clooney fatigue”, not to mention the risk, shown recently by Tiger Woods, of associating a brand with a star who is also a human being, and as such subject to image problems. Despite all the talk about experience, Club exclusivity, and choice of over dozens of coffee types, what customers want is a nice cup of coffee, and too much complexity risk turning them off. Even a visit to a Nespresso shop can be an unpleasant experience when facing the snobbery of the clerks. Last time I went there, I felt like a peasant visiting the castle.
Can Nestlé move upwards? One could imagine Nestlé introducing diamond plated Nespresso machines at €1,000 and partnering with some luxury house. Despite the fact that times of economic recession are usually not appropriate for such positioning, this would smell classic “retreat in the high-value segments”, giving away lower segments to the competition, and putting itself into a corner eventually, something that GM has experienced with SUVs.
Clearly, Nestlé seems concerned. The Swiss firm recently sued a French Web site comparing prices for “disparagement” because the site had contended that Nespresso’s capsules where expensive and environmentally unfriendly. This is surprising because these are two well recognized facts. Nespresso is clearly positioned in the high-end of the market and Nestlé gets good margins on it. This is not a crime and nothing to be ashamed about, simply a positioning that has help fuel Nespresso’s success. Similarly, the environmental unfriendliness is still very common in manufacturing, and Nestlé has made efforts recently to address this question, albeit insufficiently. The trial seems to reflect more on Nestlé’s disarray and lack of strategic clue than anything else. Let’s hope the company will find better ways to deal with its strategic problem. ECC is now sold in France through the Casino supermarket chain. Let the consumers decide…
My previous post on the Nespresso innovation story here.
Note: I no longer update this blog. Instead, I am now writing a blog with a slightly different focus with my colleague Milo Jones on geopolitics, strategy, disruptions, and intelligence. Find it here: http://silberzahnjones.com.