Nespresso: Porter's Five Forces of the Portion-Coffee Market

Nespresso: Porter's five forces of the portion-coffee market

Introduction

Portion-coffee is defined as single cup coffee systems, offering individual portions of freshly ground coffee. Portion-coffee systems come in several coffee machines systems like, filter, automatic, pads or capsules . In this segment, Nespresso offers hermetically sealed and colored capsules containing a wide range of tastes. The portion-coffee market could be of great interest for investors, as this market grew by 44% between 2006 and 2007 (see Appendix XX) and has been growing constantly since then. In 2009, Nespresso held 20% of the espresso & filter portioned coffee machines market, and its sales grew 30% annually over the past 8 years . The portion coffee market is one of the fastest-growing segments of the coffee market. Pods represented, 20 to 40% of the value of ground coffee sales in the $17 billion European coffee market in 2010. Moreover, the portion-coffee market is expected to triple to $15 billion by 2012 .

The following sections will analyze the competitive environment of portion-coffee through the five-force analysis. Conclusions are made on the global investment interest of the portion coffee market.

Threat of substitutes

Substitutes of portion-coffee are the following: filter coffee, instant coffee and traditional espresso. Additionally, substitutes of coffee, in general, are also other hot drinks such as tea or non-caffeine products that imitate coffee such as roasted grain beverages.

Portion-coffee is the most expensive system. Costs are high due to the sophisticated machine and capsules. As an example, Nespresso costs about 90 CHF/Kilo (0.50 CHF per capsule), Nescafe instant coffee between 45 and 75 CHF/kilo and a standard molded coffee between 10 and 20 CHF/kilo .

Switching costs to a substitute product are low (<100 CHF). In terms of price, consumers have a propensity to switch to substitute. Nevertheless, portion coffee has a high-perceived product differentiation, which prevents substitution. Portion-coffee systems focus on coffee lovers who are willing to pay the difference in price, in order to enjoy high quality coffee. As portion-coffee sales keep growing at impressive rates, it seems that portion coffee buyers are not price sensitive and do not show propensity to substitutes over other products and hence substitute products do not impose a high threat to the industry.

Bargaining power of buyers:

The bargaining power of consumers is determined, by their concentration, their captivity and by the alternatives available in the market. There are actually few producers of portioned coffee such as Nespresso, Dolce Gusto, Senseo, and Tassimo. Producers are, though, concentrated, which relatively increases their bargaining power in comparison to customers.

Individuals cannot be considered as concentrated, and are, for the time being, forced to buy capsules from the brand whose machine they have acquired (captive consumers). Even in the case of the expiration of patents of several portion-coffee systems, the bargaining power of individuals will remain significantly low.

Retail chains, have a low bargaining power because of the independent and online sale system of the main producer Nespresso. Retail chains are constrained to furnish themselves with the few competitors. However, the upcoming appearance of Nespresso compatible products will enhance the competition in the segment and, will thus also increase the bargaining power of retail chains.

Bargaining power of coffee suppliers

Coffee suppliers are often cooperative importers, who sell their products on the coffee market at the current global price. This kind of suppliers have an extremely low bargaining power, considering the numerous coffee producers. However, in the case of high-end portion-coffee (Nespresso for instance), portion coffee makers have to secure themselves a small portion of the global coffee production. The need of exclusive and high quality coffee induces higher prices and more bargaining power of the coffee producer. This fact is magnified in the case of environmental friendly products for example the AAA coffee purchased by Nespresso though, the bargaining power of high quality coffee producers remains low. Additionally there is no threat of forward integration into the industry's business.

Threat of entry of new competitors

Entry into the portion coffee market is prevented by relatively high capital requirements to develop and patent a portion/capsule coffee system. First of all, high investments have to be made in the R&D and production of new capsules. For example, the Ethical Coffee Company estimated that its starting capital would rise to 75 million CHF . Technical issues can also be problematic for the development of a new system, and remain costly. Nestlé's R&D had to solve unexpectedly high production costs, cup-to-cup quality inconsistencies and quality losses of the encapsulated coffee . Moreover, specific assets are required for the production of portion coffee. Roasting and grinding expertise, technology and plants are prerequisites and are not easily tradable from another industry.

Additionally, following the strategy of the actual players of the market, a partnership must be found with the producers and sellers of machines, like Nespresso's partnership with Eugster and Frismag (production) , or that of Sara Lee Corp with Philips . The companies present on the market already have exclusive partnerships with key machine manufacturers. This could prevent new entrants from having access to an efficient distribution system and penetrate the market. Economies of scale are another barrier, as actual key players now have important production capacities, which provide them the ability to lower the average costs per production unit. For instance, Nespresso can invest aggressively in marketing and R&D as it spreads the costs through its high production and sales all over the world.

The purchase and treatment of raw materials, i.e. coffee or capsule material, is not an entry barrier, as they can be purchased on the global market and suppliers are not concentrated.

Patents play a key role in the portion coffee industry as they determine the ability of a capsule retailer to assess 100% of the capsules sales for its specific machine system (captive customer). As patents prevented competition on Nespresso's system for now 20 years, the threat to Nespresso patents is today rising due to new comers developing systems compatible with the Nespresso