At the same time the company, as an importer of coffee, came under pressure collectively with the rest of the industry to take measures that would ensure the sustainability of the coffee industry, most notably the cause of the poorly paid farmers, by industry and regulatory circles. The response by most importers of coffee was to initiate Corporate Social Responsibility (CSR) measures aimed at the economic and social betterment of
the cocoa farmers for the sake of sustainability of the industry as a whole.
While many variants of helping the sustainability of the coffee industrys supply chain originated, however, Illycaffes strategy was based on the concept of Fair Trade (discussed later) which while promoting sustainability in return for a guaranteed minimum price, failed to accommodate the fact that fair trade, as a conceptual mechanism, did not guarantee quality implying that
Higher prices do not necessarily correlate with high quality.
Adhoc certification requirements of producers mean higher costs of compliance which spread through out the supply chain.
Fair trade is all about compliance and if compliance with standards is not met, then sustainability might not exist in the long term.
In light of the above, the company initiated a a direct purchasing model, whereby intermediaries along the supply chain were cut, high quality growers in the key source market of Brazil identified and sought out and premium prices paid for their produce. This was achieved through many mechanisms, the two major ones being
The IllyCaffe Brazil Espresso Coffee Award.
The IllyCaffe University of Coffee an academic institution aimed at knowledge transfer and information exchange.
The result of this was that the company was able to bring about knowledge transfer to Brazilian farmers that correlated into higher quality produce and justified high prices being paid to them. Removal of the middleman helped margins further with encouragement by the company and local governments for farmers to spend a portion of their new wealth into projects aimed at environmental and social betterment of their localities.
I. a Key Deliverables
However, lately, the companys strategy has come under scrutiny with respect to its long term viability, the competitive CSR strategies of its competitors and the business sense of the strategy as a whole. Furthermore, the key question is whether the strategy in question is in essence a key competitive differentiating factor
I. b Methodology
In order to properly understand the business sense of the strategy, the author has used the concept of stakeholder analysis and corporate social responsibility to answer this dilemma. At the same time, the financial impact of this strategy has been considered to look at the long term viability of the strategy and its distinctive properties as a key competitive differentiator. Similarly, financial analysis of the companys past reported financial statements will be undertaken to fully understand the viability of the business model as a whole.
II. THE CASE
II. a. The Coffee Industry
II. a. i. Demand, Supply Pricing
Historically, the coffee industry has been largely characterized by periods of over supply and low prices as a result of high intermediation costs which forced coffee growers to look for quantum sales. This had adverse effects on quality of the final produce. Oversupply of coffee reached dangerous levels by 1990 when the fall out from the dissolution of the International Coffee Organization Agreement, entrance of high efficiency producers such as Vietnam, productivity innovations in Brazil, technical and financial infrastructure problems of farmers across the globe and the protectionist policies of the European Union forced prices down.
Between 1980 to 1990, average production of coffee exporting countries was 90 million bags while prices averaged around USD 1.20pound, continuously falling over the period.
On the other hand, growth in demand for the product was, as mentioned above, restricted through protectionist measures by the European Union while the recessionary outlook of major world economies throughout the 1980s kept per capita income growth at low levels, further impacting the demand for coffee.
Even in recent times, between 1997-2003, coffee production continued to outstrip demand by a wide margin. In 2005 alone, the global coffee supply stood at 124 Million bags, global coffee demand stood at 116 million bags while prices stood at USD 0.60 per pound, falling at a CAGR of -22 between the period 2000-2005.
II. a. ii. Market Segmentation
By virtue of the depressed prices, the focus of farmers stayed on increasing quantum which impacted the quality of the final produce. This, in turn, created a market segmentation between consumers who preferred regular coffee and those who were willing to pay a premium for a higher quality product.
However, this presented another problem for marketeers of coffee brands as thriving on homogeneity meant that significant economies of scale had to exist for the firm to survive. On the other hand, for firms that adopted a differentiation and focused approach, sourcing high quality coffee started becoming a problem.
II. b . Sustainability Fair Trade
The fall out of the International Coffee Organization Agreement in 1989 coupled with falling prices for coffee growers presented a graver threat. Falling prices for farmers in an over supply context meant that the industry as a whole was threatened with extinction if , as it seemed, farmers growing coffee and facing low prices, switched to other crops in hope of higher prices for their efforts.
The concept of free trade became a starting point for most initiatives aimed at sustainability of the coffee industry. The concept of Fair Trade, after starting on a small scale in Mexico, today represents a an increasing share of the coffee industry with sales of coffee under the Fair Trade label standing at USD 87 Million in 1998 and 40 growth recorded between 2004 and 2005. The Fair Trade movement is described as a market based approach to alleviating global poverty and promoting sustainability whereby producers and consumers are grouped together and minimum standards created that producers must adhere to. The benefit of this compliance is that producers get a guaranteed minimum price for their produce (called the fair price) while premium (fair trade premiums) are paid to those producers who invest in projects that promote human development, environmental preservation and social advancement for the purpose of promoting sustainability.
However, Fair Trade failed to accommodate the fact that fair trade, as a conceptual mechanism, did not guarantee quality implying that
Higher prices do not necessarily correlate with high quality.
Adhoc certification requirements of producers mean higher costs of compliance which spread through out the supply chain.
Fair trade is all about compliance and if compliance with standards is not met, then sustainability might not exist in the long term.
Hence, it became necessary for marketeers of coffee brands to undertake a strategic exercise at perfecting their supply chain in a stakeholder context by taking initiatives that would correspond with greater concern for sustainability of the industry. The response by most importers of coffee was to initiate Corporate Social Responsibility (CSR) measures aimed at the economic and social betterment of the cocoa farmers for the sake of sustainability of the industry as a whole.
In this regard, various approaches came forward as to how the sustainability issue can be tackled. These are presented and discussed in the following sections.
III. THE ILLY APPROACH
IllyCaffe is am Italian processor, marketeer and distributor of high quality coffee with sales and market presence in 130 countries worldwide. The company too was faced with the problem of low quality coffee beans while essentially targeting a high end market. With the fall out of the ICO, the company initiated its own CSR strategy that would correspond with the industrys sustainability needs, be adoptive of the essence of the Fair trade movement and at the same time be compliant with the companys own long term strategy of supply chain perfection in order to keep its market share intact.
In light of the above, the company initiated a a direct purchasing model, whereby intermediaries along the supply chain were cut, high quality growers in the key source market of Brazil identified and sought out and premium prices paid for their produce. This was achieved through many mechanisms, the two major ones being
The IllyCaffe Brazil Espresso Coffee Award.
As a first step, the company initiated a competition whereby local growers of coffee were encouraged to submit samples of their produce which if found of high quality were recognized through the conferment of the The IllyCaffe Brazil Espresso Coffee Award with incentivization being made for further increase in quality of coffee by purchasing high quality produce at above market prices.
The IllyCaffe University of Coffee
An academic institution aimed at knowledge transfer and information exchange was formed in the year 2000 in conjunction with the University of Sau Paulo. The result of this was that the company was able to bring about knowledge transfer to Brazilian farmers that correlated into higher quality produce and justified high prices being paid to them.
Effectively, this innovation driven networking soon translated into knowledge transfer as the company initiated a project aimed at increasing the knowledge and skill level of these growers so that in effect they provided it with high quality raw materials for which they were paid a premium price. The companys strategy of targeting a niche of expensive blend coffee lovers enabled it to effectively pay for this initiative without effecting margins. Slowly, the company incorporated other measures into the project such as social plans and conservation of the environment hence ensuring that raw material suppliers were not just high quality producers but also socially responsible. The companys target market again made these initiatives possible.
III. a. The Business Sense Debate
A Stakeholder is any group or individual who can affect or be affected by the achievement of an organizations objectives. The role of business as a pristine capitalist enterprise focusing on shareholder wealth maximization as its only aim has enlarged over the years to include a wider spectrum of beliefs encompassing many social issues that are directly related to the well being of the firm either in a financial, ethical, business or strategic perspective. This has led to the focus on stakeholder well being, rather than shareholder wealth maximization, as firms have come to understand that stakeholders do not simply exist (as far as the organization is concerned) but make demands of it implying the notion of stakeholder claims, that is, they want something of an organization.
However, at times voicing ones claim might become a bit problematic as the stakeholders making the claim may be inarticulate or voiceless. Typical reasons for this lack of expression include the stakeholder being (apparently) powerless (eg an individual customer of a very large organization), not existing yet (eg future generations), having no voice (eg the natural environment), or being remote from the organization (eg producer groups in distant countries).
This is where corporate social responsibility comes in as a practice whereby voiceless claims are interpreted and given a voice by the management of the company. This might include training local suppliers in a far away raw material producing country (voiceless), looking out for the environment by reducing greenhouse gas emissions (voiceless) and taking care of future generations through the use of renewable energy resources (voiceless).
Hence, CSR gives the firm a self regulating environment whereby it, while adhering to pristine capitalist principles of shareholder wealth maximization, continue to seek stakeholder betterment through the upholding of laws and regulations and the best ethical practice while at the same time committing to invest in voiceless claims as these help in the overall strategic and business viability of the firm in the long run.
In light of the above, we see that, in effect, coffee bean growers in Brazil do represent voiceless claims as they are small and disintegrated to such an extent that voicing their concerns for higher prices or the pursuit of knowledge do not seem possible. At the same time, Illycaffe has the wider issue of having to spend exorbitant amounts in sourcing high quality coffee beans from intermediaries who keep their own margins at every step of the supply chain.
At the same time, respect for environmental standards and for human development and safety go un noticed meaning that the finest coffee being sold at restaurants across the world involves the blood and sweat of the poorest people of the world for which they are paid little while corporate profits are made at the expense of these very people and the environment.
Hence, what we see is that by embarking on this strategy, the company has self regulated itself as an ethical enterprise with a socially responsible face. This has major advantages in terms of company outlook and reputation with many customers favoring such companies and their products. Bear in mind that reputation risk is a major threat for most companies in the modern age of consumer awareness. At the same time, the company, through its direct purchasing model, has ensured that supply chain metrics are perfected in the long term while measures to ensure safety, human development and environmental protection allow for sustainable development.
To conclude, the strategy does make business sense as the competitive characteristics of this program are immense. Nor does it portray the company as ethical and socially responsible, it yields major advantages in terms of long term growth of the company by perfecting its supply chain and by ensuring the long term survival of the company itself. We can see this accurately reflected in the financial statements of the company whereby the introduction of these CSR measures has yielded a CAGR of 7 in revenue between 1998 to 2005 and 12 CAGR in terms of profitability growth.
III. b. Short or Long Term View
The theory of business analysis implies that firms can take one of two approaches, that is, either they can be
focused on their core businesses
diversified into various product lines or value chain levels.
While focusing on a companys core business premise is generally preferable as it confirms to the concept of specialization and the advantages that it entails in terms of economies in skills and capital. However, specialization also entails dependence on the last person to do his or her job correctly and hence as a short term measure, firms may help their peers in perfecting themselves through knowledge transfer and other measures aimed at helping them reach the standard expected of them. This backward vertical integration, however, may sometimes become a long term strategy, with the aim of continuously improving core supply chain networks. The relative merit or demerit of such diversification, however, stems from the business premise and the alternates available.
At the same time, from a strategic perspective too, a policy based on close supplier relationships is extremely beneficial for firms whose business models are highly dependent on the quality of the inputs to the production process. The reason is that by having a secure supply chain with regard to certainty of adequate supply with reasonable quality ensures that the core operational performance of the company does not get effected. At the same time, by extending help to suppliers in promoting their economic and social interests (thus allowing them to climb the social ladder), we see that any company will be able to build a reputable impression amongst suppliers. This impression building is instrumental when it comes to business cycles as it cements loyalty whereby suppliers will feel obliged to accept, for example, lower prices for their produce if the marketeer producer of their product to the final consumer is faced with some financial or operational difficulty. Hence, good supplier relationships built now can prove to be a tactical advantage in the long term.
Hence, IllyCaffes strategy of long term direct purchasing and backward vertical integration through high indulgence and perfecting core supply networks is, in essence, a correct strategy given the fact that reverting to the indirect purchasing model involving intermediaries pulls down margins for the grower and hence limiting continuous improvement at their end, increases searching costs for the firm while raise the prospect of having to deal with a low quality produce. Hence, as a long term strategy, this direct purchasing model is justified as long as a more cost and business wise effective strategy comes along. In other words, as far as the cost benefit analysis of the strategy remains in the companys favor, there is little need for the company to change its strategy.
In this respect, we see that IllyCaffes financial statements, from the period 1998 to 2005, seem to confirm in terms of revenue and profitability growth (growing at a CAGR of 7 and 12 respectively) coupled with the 5 increase (on a CAGR basis) in the credit period allowed by farmers, the 4 increase (on a CAGR basis) in profitability margins, 14 increase (on a CAGR basis) in cash flows and a 5 decrease (on a CAGR basis) in interest charges all pointing to increasing liquidity and profitability at the company as a result of this strategy.
III .c. Key Competitive Differentiator
The theory of competitive advantage states that firms may at times develop such competencies that allow them
to earn above normal profits then the rest of the industry or
sustain market shocks and changes for a longer time and sometimes even survive them or
increase market share at the expense of other firms.
These competitive advantages may take the shape of economies in skill, scale and capital presenting significant barriers to entry, close relationships with suppliers and or customers, low threats from substitutes and lower degree of rivalry.
Interestingly enough, we see that that the companys strategy is quite different from most of its peers who have largely shunned the direct purchasing model and consider that the long term solution to the welfare of the farmers lies in a strategy that involves short term backward integration whereby farmers are equipped with the necessary tools, skills and equipment that allows them to grow good quality coffee and hence be paid a premium price for it. However, this contact should come through social action groups at the companys expense, instead of direct contact. At the same time, companies seem to be keen on investing in social and economic betterment programs for the benefit of the farmer community while the IllyCaffe approach aims to do that by empowering farmers to do so.
To fully understand this fact, we have to look at the market positioning of illycaffe and the financial impact of the strategy as represented by financial statements. As a first step, the market positioning that Illycaffe has, as a result of its strong margins, is one where it focuses on a strategy of differentiation based on branding and more importantly quality. In this respect, it can charge higher prices and hence pay farmers higher prices too. Due to the unavailability of detailed financial information, it is hard to answer as to how much the company can pay, but, with net profit margins of 9.31, there seems adequate room for the company to reward farmers (or reduce selling price) without making a loss.
Secondly, looking at the financial statements of the company for the past few years since the strategy was introduced shows that the company has benefited immensely in terms of sales, profitability and balance sheet growth with the case literature also pointing to increase in market share, introduction of new products and patents. Key positives are highlighted below
Growth in Sales CAGR of 7
Growth in Profitability CAGR of 12
Growth in Profitability Margins CAGR of 4
Growth in Cash Flows CAGR of 14
Growth in Financial Expenses CAGR of -5
Balance Sheet Growth CAGR of 11
All these point to a company that is highly as well as increasingly profitable and liquid and creating value for shareholders as well as stakeholders. This corresponds well with the overall strategy of the company to sell high quality blended coffee products and suggests that its customers do value its high quality and ethical and socially responsible business outlook.
IV. THE COMPETITION
IV. a. HOW MUCH ARE THEY PAYING
Detailed information for all the firms in competition with Illycaffe is not available except for Starbucks, a key US competitor who is paying up to 23 higher than the New York Commodity exchange average (or USD 1.28 per pound) to farmers in 2005. It is pertinent to mention here that not all CSR initiatives by competitors provide for a higher price for higher quality. In effect, many have linked sustainability measures as a method of conserving the farmers interests so that they can rise to negotiate a better market price with no prior guarantees.
IV. b. WHAT PERCENTAGE DO THEY SPEND ON FAIR TRADE COFFEE
Starbucks launched its own CSR initiative dubbed C.A.F.E. under which high quality farmers were sourced and rewarded with long term relationships built provided standards in relation to economic, social and environmental concerns were met. However, the company continued its acquisition of coffee through the fair trade initiative and in 2005, 3.7 of all coffee purchases came through the fair trade label. Globally too, the share of Fair trade coffee has jumped by 40 between 2004 and 2005 with sales under the label touching the USD 232 million mark.
IV. c. CAN ILLYS CONCEPT BE APPLIED ON A LARGER SCALE
Illys concept can certainly be applied on a larger scale but there is a relative catch. If Illys approach is applied by Illy itself in other raw material markets, competitive advantages will accrue to it. However, whereby the whole industry takes the same approach, the issue we will see is that the competitive advantages that Illy enjoys in terms of good supplier relationships with guaranteed supply chain quality perfection will become available to the industry as a whole and hence the competitiveness of Illy will be reduced. At the same time, we also have to look at the fact that for the whole industry to deal with individual farmers, the task of integrating Illys model on an industry wide scale seems to be impossible as it implies a very high level of market efficiency from an economic perspective and a high cost base from a financial perspective. Thus, an industry wide adoption of the concept will only help the farmers cause (in terms of sustainability of the industry) but fail to reflect materially any positive sign on the individual financial statements of the industry actors as gross gains get distributed.
V. CONCLUSION
To conclude, it seems reasonable to believe that while competitive pressures built up from CSR strategies of other competitors, it is important to understand that IllyCaffe targets a niche market where all the factors interplay extensively and hence the company may continue with the strategy as long as the cost benefit analysis allows to do so and as long as the company reports improving market share and financial performance.
In essence, we see that the case for corporate social responsibility is not just ethical, but also a strategic and financial one. The case of IllyCaffe increasingly points to the financial as well as strategic advantages that a responsibility driven firm creating and nurturing value for all shareholders (as opposed to only stakeholders), can enjoy. In effect, a strong CSR driven firm can develop relationships with key stakeholders across the value chain of activities and use it as a key competitive advantage. Illycaffe is a prime example of this.
Categories:
0 comments:
Post a Comment