BACKGROUND ON NESTLÉ NESPRESSO S.A. NESPRESSO SUSTAINABILITY MBA CHALLENGE 2014 PUSHING THE BOUNDARIES OF SUSTAINABLE QUALITY COFFEE SOURCING

Transcription

1 BACKGROUND ON NESTLÉ NESPRESSO S.A. NESPRESSO SUSTAINABILITY MBA CHALLENGE 2014 PUSHING THE BOUNDARIES OF SUSTAINABLE QUALITY COFFEE SOURCING This information may be shared freely but the document as such is for use in the context of the MBA Challenge only

2 TABLE OF CONTENTS 1 INTRODUCTION 01 2 ABOUT NESPRESSO A unique business model Creating and sourcing the highest quality coffee A dynamic and fast growing market 05 3 THE GLOBAL COFFEE SUPPLY CHAIN AND ISSUES Key facts on coffee Recent market conditions Coffee sourcing programmes 10 4 SUSTAINABILITY: A KEY BUSINESS DRIVER FOR NESPRESSO Creating Shared Value and Ecolaboration TM The Nespresso AAA Sustainable Quality TM Program The Real Farmer Income TM Approach (RFI) First Impact Results What s next? 16 5 REFERENCES 17 6 APPENDICES 19 Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge 2014.

3 1 INTRODUCTION

4 INTRODUCTION 1 BACKGROUND ON NESTLÉ NESPRESSO S.A. NESPRESSO SUSTAINABILITY MBA CHALLENGE 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 Quality TM 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. This document intends to provide useful context for the forthcoming MBA Challenge Case Study that will be published in February Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

5 2 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

6 ABOUT NESPRESSO 2 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. 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 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 brand s 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. 2.2 CREATING AND SOURCING THE HIGHEST QUALITY COFFEE 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. Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

7 ABOUT NESPRESSO A DYNAMIC AND FAST GROWING MARKET The unique features of the Nespresso system and business model have led to high growth rates, making Nespresso one of Nestlé 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. Figure 1: Growth of Nespresso employees as a reflection of the growth of the business from sourcing to sales 2000 over 330 employees 2013 over 9,500 employees Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

8 3 THE GLOBAL COFFEE SUPPLY CHAIN AND ISSUES Key facts on coffee 3.1 Recent market conditions 3.2 Coffee sourcing programmes 3.3

9 THE GLOBAL COFFEE SUPPLY CHAIN AND ISSUES KEY FACTS ON COFFEE Coffee is grown in many countries. However, only a few countries are significant 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 fluctuating 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 (inflation 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 flavour profile 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, Peet s, Green Mountain Roasters, and many other smaller roasters redefined the retail coffee industry. ICO indicator prices, nominal (US$ cents / lb) ICO COMPOSITE COLOMBIAN MILD OTHER MILDS BRAZILIAN NATURALS ROBUSTAS Chart 1: ICO indicator prices, nominal (US$ cents/lb) Source: ICO, 2013 Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

10 THE GLOBAL COFFEE SUPPLY CHAIN AND ISSUES 3.2 RECENT MARKET CONDITIONS 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, flooded 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. 60 Mb Coffee production (Arabica and Robusta) in bags (million bags) 50 Mb 40 Mb 30 Mb 20 Mb 10 Mb Brazil Colombia Vietnam India Indonesia Mexico Chart 2: Coffee production (Arabica and Robusta), of six representatives countries, in millions of 60 kg bags Source: ICO, 2013 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. Prices paid to growers (Arabicas) nominal 300 Prices paid to growers (Arabicas) real terms Producer price index 2005=100 US$ cents / lb Brazil Costa Rica Colombia Guatemala US$ cents / lb Brazil Costa Rica Colombia Guatemala Chart 3: Nominal prices paid to growers for Arabica coffee from sources reputed for quality Source: ICO (d), 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 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 surplus that would push stocks to their highest levels in five years is forcing us to, once again, lower our 3 12 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 profits have been squeezed, and in many cases eliminated. Depressed Robusta and Arabica prices have not helped either; with the coffee harvest currently Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

11 THE GLOBAL COFFEE SUPPLY CHAIN AND ISSUES 3.2 RECENT MARKET CONDITIONS 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 financially, 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 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 flat demand), but producers have managed to maintain profit levels through increased productivity (defined 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 profit margins have slowed reinvestment in new coffee plants, genetic upgrades, machinery and even chemical inputs. 60 Green coffee productivity of selected countries (46 kilo sacks ( qq ) / hectare) Quintals / ha Colombia Ethiopia Guatemala India Indonesia Mexico Vietnam Chart 5: Green coffee productivity of selected countries in quintals (46 kilo sacks) / hectare) 1 Source: Faostat, 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, finally 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 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 $ million (ICAFE, 2013). 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 Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

12 THE GLOBAL COFFEE SUPPLY CHAIN AND ISSUES 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 ha. In Honduras, the fungus has damaged 30 % of the cultivated area ( ha) and in Guatemala 59 % of the farms ( ha). In El Salvador, the disease has been recorded in 71 % of the coffee harvest and in Panama s 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 specifically, 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, scientific 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). 3.3 COFFEE SOURCING PROGRAMMES Against this backdrop, sourcing high quality coffee has become progressively a more difficult task. About 5% of the world s 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 Café, 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 Quality TM Program, a holistic approach embedded in its own sourcing system. The following section describes the programme in more detail. Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

13 4 SUSTAINABILITY: A KEY BUSINESS DRIVER FOR NESPRESSO Creating Shared Value and Ecolaboration 4.1 The Nespresso AAA Sustainable Quality Program 4.2 The Real Farmer Income Approach (RFI) 4.3 First Impact Results 4.4 What's next? 4.5

14 SUSTAINABILITY: A KEY BUSINESS DRIVER FOR NESPRESSO CREATING SHARED VALUE AND NESPRESSO'S SUSTAINABILITY COMMITMENT Nespresso's sustainability commitment' is built on the Nestlé approach 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 2, to group together its value chain sustainability efforts in the area of carbon footprint reduction, sustainable coffee farming and spent capsule recycling. A customer segmentation study conducted in 2012 identified that 14% 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 Quality TM Program than other customer segments. This fact provided further motivation for the company to develop its strategy. Hence in 2009, the company made the following commitments to be achieved at the end of : - Coffee sourcing: Source 80% of coffee from the Nespresso AAA Sustainable Quality Program. - Capsule recycling: Increase collection capacity to recycle Nespresso used capsules to 75%. - Carbon reduction: Reduce the carbon footprint of each cup of Nespresso coffee by 20%. At this point, 2013 became a pivotal year for the company in its sustainability journey. It marks the achievement of each of the defined targets, as well as the 10th anniversary of the Nespresso AAA Program (further explained below). In addition, it is a year were the company is defining its new strategy and commitments to continue its sustainability efforts for the next coming years. As part of this, the Nespresso Sustainability Advisory Board 4 was created, which is comprised of experts and thought leaders in the area of sustainability. It has been established to solicit views and provide insight and recommendations to enhance the Nespresso long-term sustainability strategy and to serve as a base for partnerships on sustainability initiatives. It also establishes a platform for partners to share experiences and provide insights on sustainability trends and issues. The first Advisory Board meeting took place on July 15th 2013, where global leaders in sustainability and long-time brand ambassador George Clooney announced new initiatives in areas such as environmental stewardship and farmer welfare (see Appendix 1: Nespresso Sustainability Advisory Board Key initiatives). Video: AAA Program - 10 years of shared commitment to sustainability 2 Find more details at: ecolaboration/sustainability ecolaboration/creating-shared-value 3 Find details on these initiatives at: ecolaboration 4. For more information, please go to: ecolaboration/sustainability-advisoryboard/sustainability-advisory-board Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

15 SUSTAINABILITY: A KEY BUSINESS DRIVER FOR NESPRESSO THE NESPRESSO AAA SUSTAINABLE QUALITY TM PROGRAM "The Nespresso innovative program, which helps farmers achieve higher prices, better yields and greater environmental performance and sustainability, is not driven by charity but by creating value. Nespresso will benefit strategically from the quality improvements that farmers achieve and coffee supplies that will be far more sustainable over time. It is this alignment between corporations and social challenges, not a mindset of separation and tradeoffs, which is the key to both economic and social progress." Michael Porter Professor in Business Strategy, Harvard Business School By applying the CSV thinking especially in the area of sustainable coffee farming, Nespresso soon realised that its requirement for longterm sustainable sources of green coffee overlapped completely with the 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 Quality TM 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 Income TM (RFI) by Nespresso (see later section for more details on this). 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 agronomist services. From its original inception in 2003 and through its subsequent redefinition and expansion to include Real Farmer Income TM as a metric, the AAA Program has now grown to be a sourcing program that reaches over 60,000 farmers in eight countries (Brazil, Colombia, Mexico, Costa Rica, Guatemala, Nicaragua, Ethiopia and India), and 29 growing regions (referred to internally by Nespresso as clusters ), and is set to grow further in the next 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 farmers 5. Quality Maintaining highest quality First Sustainability Respecting people and environment Second Productivity Farm management A A A Third Sustainable Value Creation Figure 2: AAA pillars 5 For more information, please go to: Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

16 SUSTAINABILITY: A KEY BUSINESS DRIVER FOR NESPRESSO THE NESPRESSO AAA SUSTAINABLE QUALITY TM PROGRAM Video: Coffee sourcing in Colombia The Nespresso AAA Sustainable Quality TM 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) One key aspect of the programme that ensures loyalty from farmers is the commitment to price premiums (see below chart). However one of the real drivers behind improvement at farm levels is the commitment to farmer extension work, technical assistance as well as building a long-term Drivers of satisfaction among relationship with coffee producers. AAA Sustainable Quality TM participants PREMIUM 29% BENEFITS RECEIVED BETTER FARM MANAGEMENT 16% 17% COFFEE QUALITY 9% OTHER 7% BETTER QUALITY OF LIFE TECHNICAL ASSISTANCE ENVIRONMMENTAL PROTECTION CONTINUOUS IMPROVEMENT 6% 5% 5% 5% Chart 6. Drivers of satisfaction among AAA Sustainable Quality TM participants (Colombia) Source: Crece, % 5% 10% 15% 20% 25% 30% 35% The price premium that Nespresso pays to its buyers has two components: one corresponding to technical assistance and one that is actual cash 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 producer s 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. Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

17 SUSTAINABILITY: A KEY BUSINESS DRIVER FOR NESPRESSO THE REAL FARMER INCOME TM APPROACH (RFI) In 2008, Nespresso committed to Real Farmer Income as one of its strategic pillars. The RFI concept involves taking a close look at the farmer s 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 farmers to sell to the same buyer for many years. An extensive field study conducted by its research partner, the Sustainable Markets Intelligence Center (CIMS, based in INCAE Business School in Costa Rica) concluded that productivity was the key driver of farmer income, while prices and premiums remained as secondary drivers. Productivity is dependent on a number of variables, including farm management (activities like record keeping, pruning and fertilisation), age of coffee trees, weather and pests. Separately, quality has its own set of variables, some of them also linked to productivity, but also related to the quality of the processing (milling and fermentation stage) and optimal ripeness for picking the coffee. The study, conducted between 2008 to 2010 across 5 countries (Costa Rica, Guatemala, Colombia, Mexico, Brazil) also concluded that while some improvements were seen in social and environmental management of farms, positive net incomes in some regions (clusters) were by no means guaranteed for all farmers in the programme, and that uncertainty for the farmer remained. (please find results on farmer income from the RFI study in Appendix 1) Notwithstanding the company s commitment to having a positive impact on Real Farmer Income TM, it was clear that there are many challenges to the realisation and execution of the RFI approach. Each coffee growing region (cluster) has its own difficulties and each requires a specific diagnosis of its own challenges related to farming culture, scale, social and environmental constraints, effects of climate change and incidence of disease and many other variables. The scale of the challenge is also significant. Many of the farms in the programme are smallholdings of a few hectares. Head of Sustainability at Nestlé Nespresso S.A., Jérôme Perez, noted some of the important challenges. In practical terms, Nespresso has over 62,000 farmer suppliers, and no two are exactly alike in their strengths or weaknesses. Virtually all will need some assistance to increase their income, most will need a great deal of help and not just in production, but in quality management, and reducing their environmental impact. Video: Coffee sourcing in Costa Rica Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

18 SUSTAINABILITY: A KEY BUSINESS DRIVER FOR NESPRESSO FIRST IMPACT RESULTS The independent Colombian research institute CRECE conducted a survey to analyze the impact that the Nespresso AAA Sustainable Quality Program has had in the lives of coffee farmers in Colombia during the period 2009 to 2011, using data collected by them in Nespresso clusters (Antioquia, Caldas, Cauca, Nariño, Huila), for 1,222 AAA farmers and 563 control group farmers. CRECE applied its sustainability index monitoring to measure AAA farm performance versus the control sample. The methodology used has been based on COSA 6. The COSA approach consists of the development and application of an internationally-recognized methodology and data gathering process so that farmers and other stakeholders can more effectively measure, and predict, the outcomes, including costs and benefits, of the adoption of one or more sustainability initiatives. This study implies positive progress on social, environmental and economic criteria for AAA farms (including those that are already Rainforest Alliance certified) WHAT'S NEXT? 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 For more information please refer to 7 For more information, please go to: Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

19 5 REFERENCES

20 REFERENCES 5 AGRITRADE 2013 Falling arabica coffee prices could boost demand from coffee blenders in emerging markets Available at : Accessed on: December, ALDRIDGE, M Civil War and United States Involvement in Colombia. Available at: Colombia.pdf Consulted on: December, FAOSTAT 2012 Agricultural Production and Yield Statistics. Food and Agriculture Organisation of the United Nations (FAO). Available at: Consulted on: December, GIOVANNUCCI, D., LIU, P. AND BYERS, A 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. HAGGAR, H AND SCHEPP, K Coffee and Climate Change Desk Study: Impacts of Climate Change in the Pilot Country Brazil the Coffee & Climate Initiative. Available at: profiles/report%20coffee%20climate_pilot%20brazil_haggar%20schepp.pdf. Accessed on: December, ICAFE 2013 Estadísticas Sector Cafetalero. Available at: %20de%20Octubre% pdf. Accessed on: November, I&M SMITH 2013 Tea And Coffee. Available at : Accessed on: December, Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

21 REFERENCES 5 RUDARAKANCHANA, N Coffee Beans: A Market To Watch In International Business Times. Available at : Accessed on: November, TRIPATHI, M World Coffee Slithering Prices, Brewing Trouble. Available at: world-coffee-slithering-prices-brewing-trouble. Accessed on: December, Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

22 6 APPENDICES

23 APPENDICES 6 APPENDIX 1 Nespresso Sustainability Advisory Board Key initiatives 1. THREE NEW KEY INITIATIVES Expanding the AAA Program in Africa and reviving high quality coffee production in South Sudan Nespresso in partnership with TechnoServe and local governements aims to expand the AAA Program in Africa and to increase high quality coffee production in South Sudan. The goal in Ethiopia and Kenya is to include more cooperatives and smallholder farms and improve coffee traceability to farm level. This initiative has Development programs that aim to revive high quality coffee production in the country addressing key socio-economic challenges in the coffee growing communities and supporting farmer welfare. Furthermore, in South Sudan s case, Nespresso plans to be the first company to offer coffee following its independence; hence contributing to economic development and creating coffee supply. 2. AAA Farmer Future Program with Fairtrade International and Colombian farmer cooperatives Nespresso aims to collaborate with Fairtrade International to pilot the AAA Farmer Future Program. The program aims to introduce social welfare provisions to benefit farmers and their families, including health and accident coverage and retirement planning. As part of the initiative, Nespresso will market coffee sourced from the AAA farmers cooperatives in the region and certified by Fairtrade. 3. Reducing the carbon footprint of coffee farming Nespresso pursues to expand its Agroforestry program, in partnership with the Rainforest Alliance and Pur Projet, to optimise the carbon footprint of coffee farming. The program will help farmers step up their investment in agroforestry, seek to create carbon credits and drive new revenue streams. APPENDIX 2 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, ,000-2,000 0% 20% 40% 60% 80% 100% Brazil Costa Rica Colombia Guatemala Mexico Source: CIMS (cl. 2010) Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

24 APPENDICES 6 APPENDIX 3 Correlation between Real Farmer IncomeTM in its key drivers in five Nespresso supplier countries COSTA RICA GUATEMALA COLOMBIA (NARIÑO) BRAZIL MEXICO CORRELATION BETWEEN NET INCOME AND PRICES CORRELATION COEFFICIENT P-VALUE <.0001 <.0001 CORRELATION BETWEEN NET INCOME AND YIELD CORRELATION COEFFICIENT P-VALUE <.0001 <.0001 <.0001 <.0001 <.0001 Source: CIMS, 2011 APPENDIX 4 Nespresso AAA in Action: Regional Projects Progress COLOMBIA PROJECT Beneficiaries Goal Key Achievements CREATING SHARED VALUE IN CAUCA AND NARIÑO 47 municipalities of Cauca and Nariño To boost the sustainability of coffee production, while safeguarding future supply of high quality coffee 1,998 wet milling wastewater ecological treatment systems 5,232 household residual waters treatment systems 3,561 waste management systems 5,766 hectares renovated million plantlets delivered 97 agronomists trained PROJECT Beneficiaries Goal IMPROVE PRODUCER COMPETITIVENESS IN INZA, CAUCA 170 coffee farmers in Inza, Cauca To boost the productivity of coffee farmers through support in infrastructures, investments and agronomy training PROJECT Beneficiaries Goal Key Achievements RENOVATE COFFEE FARMS IN CALDAS AND ANTIOQUIA Coffee farmers in the Antioquia and Caldas region To safeguard productivity and quality levels by replacing old Catimor coffee plants with Castillo, a rust resistant coffee variety 400,000 seedlings planted in 2013 Nursery construction to deliver seedlings to farmers Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

25 APPENDICES 6 APPENDIX 4 COLOMBIA PROJECT Beneficiaries Goal Key Achievements BUILDING A CENTRAL MILL IN JARDÍN 170 Coffee farmers in the Antioquia region To build a milling center ensuring increased volume and quality consistency of coffee Central mill has reduced water usage by 63% Integrated sun drying and water treatment Creation of a quality sensory profiling labs as well as quality traceability processes Doubled volume sold by farmers, increasing their income by 17% Creation of a waste management system to prevent pollution Water pollution has been reduced by nearly 100% CENTRAL AMERICA PROJECT Beneficiaries Goal Key Achievements COOPERATION WITH IFC AND ECOM 4 Nespresso clusters in Mexico, Guatemala, Costa Rica and Nicaragua To provide a continuous improvement to meet AAA sustainability standards Assistance to 5,000 farmers to meet TASQ TM requirements More than 1,000 training workshops and farm visits 93% of farmers reached basic or emerging standars in Guatemala 100% of farmers reached the basic, emerging or high performing standard in Nicaragua GUATEMALA PROJECT Beneficiaries Goal Key Achievements EDUCATIONAL PROJECT WITH ROOT CAPITAL 250 coffee farmers in Guatemala To improve sustainability of farms through training in management areas More than 40 workshops in basic accounting, internal credit management, organizational management and financial issues APPENDIX 5 First impact results of the Nespresso AAA Program in Colombia. SOCIAL INDEX CONTROL GROUP 2011 AAA Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

26 APPENDICES 6 APPENDIX 5 First impact results of the Nespresso AAA Program in Colombia. ENVIRONMENTAL INDEX CONTROL GROUP AAA 2011 ECONOMIC INDEX CONTROL GROUP AAA 2011 Source: CRECE, 2011 For more information, please go to: Background on Nestlé Nespresso S.A. Nespresso Sustainability MBA Challenge

27 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.