Nespresso: Stirring Up the Pod
Once the undisputed leader and pioneer of the single-serve coffee industry, Nespresso now faces serious competition as it struggles to figure out the North American market.
A Latte Problems
Despite its global leadership in the single-serve market, Nespresso failed to gain significant market share in the North American market since its entrance in 1991. It currently has only 4% market share in the region while its competitors, Tassimo and Keurig, lead with 25% and 53%, respectively. Released in 2014, Nespresso’s VertuoLine machine was designed to specifically appeal to North American consumers by allowing users to brew large cups of coffee unlike Nespresso’s flagship product which brews small espressos. Over the last two years, however, Nespresso has failed to increase its North American market share.
Moreover, Keurig was recently acquired by JAB Holding Company (JAB), a German consumer goods conglomerate. JAB owns several coffee brands including a majority stake in Jacobs Douwe Egberts, whose product portfolio also includes Tassimo. With the acquisition, JAB is expected to consolidate Keurig’s hold over the North American market and increase Keurig’s European presence. JAB’s corporate capabilities and strong industry portfolio pose a serious threat to Nespresso. Nespresso’s parent company Nestlé is also facing problems. Since 2011, sales growth in Nestlé’s powdered and liquid beverage segment has slowed and has experienced its weakest volume growth in a decade over the first nine months of 2015. Powdered and liquid beverages represent the largest segment within Nestlé, constituting approximately 22% of the company’s sales. Nespresso is Nestlé’s fastest growing segment and accounts for 25% of Nestlé’s coffee sales Additionally, Nespresso products currently have a 25% margin compared to Nestlé’s overall margin of 15%, making this segment highly lucrative to the parent company. Given Nespresso’s value within the Nestlé portfolio, a successful North American turnaround strategy will be paramount.
Single-Serving up Opportunity
The coffee industry’s single-serve segment, which consists of machines that brew single cups of coffee using pre-packaged pods, is currently the fastest growing segment and is expected to grow at five times the rate of the overall industry. Today, approximately 27% of American households own a single-cup brewer, compared to 7% of households in 2011. The growth of the market has led to intense international competition as market players compete to wear the “single-serve coffee crown”.
In 2013, North America made up 45.4% of the $10.8B global single-serve market and was the fastest growing region in this market. North American consumers are increasingly switching from high-volume, low-quality coffee to specialized gourmet varieties such as espressos, lattes and cappuccinos. Per capita income growth in the US, anticipated to be 2.4% annually over the next five years, will likely further increase demand for premium single-serve coffee products. Given that gross margins in this segment are approximately 20% higher than traditional drip coffee, the premium single-serve market will be a major value driver for the overall industry.
27 years ago, Nespresso pioneered and dominated the single-serve market in Europe. The five key success factors included the following:
1) A first-mover competitive advantage secured as the industry’s pioneer
2) Machine and pod patents served as a barrier to potential entrants
3) Machines were less expensive than existing espresso machines that cost thousands of dollars
4) Strong product awareness in market achieved through business-to-business (B2B) sales
5) Unique marketing techniques that emotionalized its brand; the Nespresso Club provides delivery and personalization perks as well as a sense of exclusivity to all machine owners
When entering the North American market, Nespresso CEO Jean-Marc Duvoisin argued that Nespresso would face no competition as it would be creating a new single-serve market in North America as it did in Europe 27 years ago. Nespresso believed it could repeat its success by using the same advantages it had when pioneering the market in Europe. However, aside from extending Nespresso Club membership to North American customers, Nespresso did not actually possess these advantages when entering North America for the following reasons:
1) The single-serve market was already well-established with industry leaders (i.e. Keurig, Tassimo)
2) Patents on Nespresso product were meaningless as competitors already had proprietary designs
3) Nespresso products were more expensive than competitors’ products
4) Nespresso established very few B2B partnerships within North America
Single-serve coffee cups cost about five times more than traditional coffee. Despite this fact, North Americans have bought into the efficiency, quality, accessibility and variety provided by single-serve systems. Out of these four buying criteria, Nespresso only delivers on efficiency and quality while its competitors, Keurig and Tassimo, provide brewing machines with dozens of pod options consisting of popular brands including Tim Horton’s, Starbucks and McCafé. Conversely, Nespresso has pods that are only compatible with its own machines. Additionally, Keurig and Tassimo pods are widely available at all major grocery chains, whereas Nespresso’s pods are exclusively available in its boutique shops, or through phone and online order. To top it off, Nespresso’s machines start at $149, while Keurig’s can be bought for as little as $79.
A Premium Blend
Despite its North American challenges, Nespresso still has a strong global presence and the resources of a market-leading parent company. Nespresso must realize it is no longer creating the single-serve market. Instead, it is competing within an existing market and must meet consumers’ demands. As an authentically premium brand, Nespresso is positioned to capitalize on the North American single-serve market’s growing demand for premiumisation. To minimize switching costs and to increase the accessibility of its products, Nespresso should create a sub-brand to release a line of pods compatible with Keurig machines (K-Cups) in North America. This tiered product-line strategy, popularized by retail fashion companies such as Armani, enables premium brands to expand its reach while preventing brand dilution. To drive demand for Nespresso K-Cups, the company should also boost brand awareness by creating more B2B partnerships in North America which were a key success factor in Europe.
In the single-serve market, Nespresso can compete through machines or through pods. To compete through machines, Nespresso must expand its product line to provide consumers with more variety in coffee types. Variety is a key buying criterion for North American consumers in single-serve machines, and a key success factor for Keurig and Tassimo. With dozens of product partnerships and hundreds of pod options, Keurig and Tassimo provide consumers with extensive variety. Conversely, Nespresso machines are only compatible with its own pods and flavours are limited. To better compete on variety, Nespresso could add more beverage options. However, this would require Nespresso to move away from its core competency in premium coffee and espressos. Another alternative is to pursue product partnerships and create compatible pods for its machines. However, this could dilute its brand equity since Nespresso would be unable to control the quality of the coffee coming out of its machines. Therefore, it is not advisable for Nespresso to compete through machines.
The second option is to compete through pods. Similar to the razor/razor blade business model, which involves two dependent products – one single purchase and the other a high-margin repeat purchase – the single-serve market generates most of its value through high margin repeat pod sales. Pod sales comprise of approximately 70% of revenues with machines sales making up the remainder. Increasing premiumisation of the market should translate to growing demand for Nespresso’s products. The issue however, is that approximately 80% of consumers in the North American single-serve market already use a Keurig or Tassimo machine. Therefore, Nespresso should leverage the existing machine ecosystem in consumers’ homes to increase pod penetration. Keurig’s patents on its first-generation brewers and pods expired in 2012 and any competitor can now manufacture its own K-Cups for these machines. For Keurig’s second generation brewers which require pods with a proprietary digital rights management code, Nespresso should secure licensing partnerships with Keurig by offering a competitive royalty rate and the opportunity to further diversify Keurig’s pod portfolio. Releasing sub-branded K-Cups will allow Nespresso to access the 53% of single-serve coffee consumers who own a Keurig machine.
To prevent brand dilution of the original Nespresso line, Nespresso should communicate that its coffee is still best served through its own machines. Moreover, Nespresso can prioritize or restrict the release of new pod variations to its own machines before releasing K-Cup equivalents to protect the value of its own product line.
A Grandé Market Opportunity
By maintaining its existing products and services (i.e. Nespresso Club), Nespresso can continue to serve the niche group of North American consumers who seek an exclusive premium espresso/coffee experience. By also improving product accessibility through Nespresso K-Cups, Nespresso can access a greater share of the market, specifically Keurig owners who are unlikely to purchase an entirely new single-serve machine despite increasingly premium coffee preferences. This strategy enables Nespresso to take advantage of Keurig’s success in North America.
Through this strategy, Nespresso will target a particular consumer segment coined by Fortune Magazine as HENRYs, also known as “High Earners Not Rich Yet”. HENRYs consist of individuals who make $150,000 -250,000 per year and comprise of 21.3 million households in the US. Of Keurig’s 26 million consumers, HENRYs comprise approximately 17.1% and are likely to exhibit increasingly premiumised purchasing preferences. As such, Nespresso should release its sub-branded K-Cups at a premium price point of $0.95/pod, below the price point of its regular $1.10/pod. Currently, the most expensive K-Cup is the Starbucks K-Cup at $0.92/pod with approximately 14% share amongst all Keurig owners. Assuming that Nespresso K-Cups can gain 4% share in the Keurig market, Nespresso can gain close to $400M in additional yearly revenue.
To drive demand, Nespresso must strengthen its brand equity and increase consumer awareness of its premium quality. To make its machines appeal to its target market, Nespresso should focus on B2B partnerships with North American luxury brands in the retail, vehicle, airline, restaurant and hospitality segments. When Nespresso launched in Europe, 57% of customers reported a time lag of one year between hearing about Nespresso and purchasing a machine. Considering this lag, partnering with luxury companies within these segments will expose Nespresso’s target market to its products. Nespresso currently serves several international airlines including Swiss International Airlines, British Airways, Lufthansa and Cathay Pacific. However, it has no presence amongst North American airlines. Nespresso is also served in hundreds of high end hotels and restaurants within Europe but only a handful within North America. Therefore, its current focus should be to capture more B2B partnerships to increase brand awareness within North America. Such brand partnerships will be the most authentic way to convince consumers that Nespresso is the best premium product in the market.
To ensure that HENRYs are aware of this branding strategy, Nespresso should highlight its luxury partnerships through marketing initiatives. Additionally, a tactic used by several beverage companies involves releasing a product line in partnership with a high-end designer. Examples of this include Karl Lagerfeld and Marc Jacobs for Diet Coke and Missoni for San Pellegrino. Releasing K-Cups and pods with such designers will help Nespresso distinguish itself against other premium brands.
To Capp it Off
To maintain its leading position in the single-serve industry, Nespresso must succeed within the North American market. The growth of the premium single-serve market within North America is an important opportunity for Nespresso. By successfully distinguishing itself as the top premium brand for single-serve coffee and leveraging the ecosystem of competing machines, Nespresso can appeal to the evolving single-serve market in North America and successfully capture the single-serve coffee crown.