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Illy Caffe - Case Study
The evolution of the coffee industry
During the last 30 years, the coffee market has become extremely competitive. At the beginning of the twentieth century the majority of production (between 75 and 90 per cent) was controlled by Brazil (Lucier, 1988). From 1962 to 1989, the International Coffee Agreement (ICA), signed by the main producer and consumer countries (Ponte, 2002), regulated coffee prices and export quotas. Beginning in the 1990s, the market underwent a profound change due mainly to technological development, the entrance of new producer countries (for example, Vietnam) and the exit of the USA (the leading world consumer), which broke the equilibrium previously established by the International Coffee Organization (ICO). The glut of green coffee in the market (above all, Arabica coffee) had two effects; (1) price collapse and (2) a reduction in average quality due to the poor quality of the products from some new actors such as Vietnam (which was growing Robusta rather than ‘Arabica’ coffee) and to the reduced investment capacity of the growers, which caused them to lose influence over the market (Muradian and Pelupessy, 2005). There are approximately 15 coffee species and about 100 typologies, but the Robusta and Arabica strains are the most important species for production and consumption.
The denomination 'Robusta' comes from the resistance of the plant to parasites and illnesses. However, this species produces coffee beans that are smaller, have more caffeine and a less intense flavour, and these characteristics together create poor green coffee quality. In contrast, the Arabica species comes from a plant that is more delicate and sensible to the weather changes, and it produces coffee with a more intense and pleasant flavour. During the first half of the 1990s, the power in the coffee supply chain – which we can subdivide into five groups of actors (growers, local traders, international traders, roasters and retailers) - shifted downstream. The producers lost their bargaining power (Talbot, 1997), while the international traders engaged in vertical integration upstream with local traders and the growers (Losch, 1999) (made easier by market liberalisation) and sometimes also downstream via the acquisition of roasters. Traders took advantage of the oversupply of green coffee, obtaining a lower purchase price for an inferior end product whose lower quality would not be perceived by the consumer (Kaplinsky and Fitter, 2004).
Towards the end of the 1990s, the winning strategy in the market became coffee decommoditisation in hotels, restaurants and cafes and in big retail. The most important roasters turned their efforts to the quality of the product as perceived by the consumer, suggesting socalled 'specialities', the coffee types that are not traditional industrial blends because of their high quality (like espresso coffee) or because of their special flavouring and packaging (Ponte, 2002). In this way, they aimed for the creation of a 'consumer experience'. To support this strategy, these companies implemented 'branding' policies (for example, Nestle and Kraft) that fostered the diffusion of the coffee culture. With regard to coffee house ownership, one successful strategy has been the creation of a 'café atmosphere', as in the famous case of Starbucks.
The small- to medium-sized Italian roasters, which have historically offered espresso as speciality in their local market (and sometimes in internationally), operated in a market that was intensely transformed by the events described above without the financial resources to realise full control over and the appropriate coordination of their own coffee supply chain. This lack of control did not allow many of them to obtain the high profit margins necessary for growth of the size required to penetrate the global market as their main international competitors did. However; there are some successful examples of Italian enterprises in the global espresso coffee market, one of which is the Illy Caffe Group (Illy), universally recognised as an excellent and successful company. This case study illustrates how Illy competes and wins in the market thanks to the exemplary implementation of its business strategy, which is focused on the competitive prioritisation of quality through consistent and integrated supply chain management practices. Illy's operational integration via a medium- to long-term contract with customers and suppliers is sustained via an innovative approach: the diffusion of Illy’s knowledge, expertise and coffee quality culture along the entire value chain from the green coffee growers to the final consumers.
Illy Caffe Group
The Illy Caffe Group (Illy), established in 1933, operates in the espresso market and has more than 700 employees, with 480 working in the headquarters in Trieste (Italy) and the remainder in its subsidiaries abroad. The manufacturing plant is located in Trieste, where the coffee is processed and packaged after being shipped across the sea from more than 15 countries located mainly in South and Central America, Africa and India. Few enterprises have the ability to increase profits and market share while maintaining their own strategic direction as Illy has done; in fact, the company has always focused its strategy on high product quality and customer service with the aim of giving coffee a much greater importance than is normally associated with that commodity- dressing up a product that is normally anonymous and de-commoditising it (De Toni and Tracogna, 2005).
Illy Caffe's strategy in the espresso market
Illy has created a balance between a clear strategic vision, defined at the corporate level, and competent business management focused on very effective supply, logistics, production and distribution policies. These two levels, entrepreneurial and managerial, are connected in their focus on ethics, excellence and the centrality of the customer. The competitive priority on which the corporate strategy is based is the high level of quality of the product and of the services offered to the consumer. Illy's vision is as follows:
We aim to be the world reference for coffee culture and excellence. An innovative company offering the finest products in the best places, growing to become the high-end segment leader and creating superior stakeholder value (Illy Caffe internal documents). Likewise, its mission is: Thanks to our enthusiasm, teamwork and values, we aim to delight people all over the world who value quality of life by offering the best possible coffee nature can provide, enhancing its perfection through the most innovative technologies, and inspiring emotional and intellectual involvement by seeking beauty in everything we do. (Illy Caffe internal documents).
It is fundamental to highlight the uniqueness of a particular strategic choice, Illy’s 'one blend, one brand' philosophy: the company seeks to provide high-quality coffee that is identical all over the world at any time (Andriani and De Toni, 2008). Consequently, Illy produces and distributes a unique, 100 per cent high-quality Arabica coffee blend.
The three pillars of Illy’s competitive strategy are:
• The creation and development of a global identity for Illy’s brand as a synonym for quality and excellence;
• A focus on the premium market segment;
• Product differentiation based above all on the qualitative excellence of the coffee in every respect, which allows the consumer a unique experience.
Illy's leadership in the espresso market
The Italian espresso coffee market is dominated by medium- to-large-sized roasters that own more than 90 per cent of the market share, one of which is Illy, and by many microenterprises. Illy is a leader in the Italian market thanks to its market share, while in the international market, characterised by the presence of large players, Illy’s brand is famous throughout the world for its high-quality espresso blend. Thus, Illy is the global leader of the premium market segment. The company's success can be evaluated based on its turnover growth, €280 million in 2008 (+400 per cent in the last 15 years). The Illy Group distributes its unique espresso blend, composed of 100 per cent of Arabica coffee, in 130 countries through three strategic channels:
1. Hotels, restaurants and cafes;
2. Retail (large-scale retail and small-scale traditional retail markets); and 3. Vending machines.
The Illy coffee supply chain
There are different interaction levels in a coffee supply chain, some characterised by strong integration performed by multinational companies and others fragmented with many specialised network actors (growers, local traders, international traders, roasters and retailers). The large multinational companies in the food industry use vertical integration to raise profit margins, increase their control of part of the competitive environment and especially (in the particular case of specialities) maintain the quality level of the product as requested by the market. Illy bases its business strategy on product and service quality, obtaining an evident competitive advantage in the espresso market thanks to the careful management of its supply chain from the supply of green coffee and its direct relationships with the growers to distribution and its indirect relationships with consumers. However, it does this without implementing traditional vertical integration, which would be rendered less effective because of the small size of the firm. Thus, from this perspective, Illy’s strategic and operational management of the coffee supply chain (as in the Figure) has distinctive characteristics that are aligned with its business model. However, this strategic choice does not guarantee the quality of the espresso in the cup because the coffee beans can undergo variations in quality from the harvesting phase through the entire supply chain. For this reason, Illy has implemented a set of technical, social and cultural practices at every level of the coffee supply chain.
First, to produce coffee of excellent quality requires high-quality raw materials (or green coffee). Coffee grows in hot and humid or hot and temperate climates in the regions between the two Tropics, where a rainy season follows mild rains. As a result, coffee growers are located in continents far from Italy: Africa, Asia and Latin America (see Figure below). Only through the careful selection of suppliers, it is possible to obtain high-quality green coffee without the growers' direct control. Therefore, in recent years, Illy has begun some initiatives in green coffee-growing countries to select and motivate the growers (of which there are almost 4000 in the Illy database) and enhance production quality.
In 1991, Illy instituted an award for the best Brazilian green coffee growers, the 'Premio Brasil de Qualidade do Cafe Para Espresso', with the aim of encouraging a culture of excellence in coffee growing; the prize was intended to combat the problem of poor quality green coffee in Brazil, the main worldwide producer and exporter but also the country with the highest percentages of batches rejected by Illy. As a result, the growers began to engage in research into improving the quality of their own product, collaborating among themselves and transferring knowledge. Illy fosters this phenomenon of cross-cultural fertilisation and imports, transfers and shares practices and expertise developed in other countries (the crossfertilisation of knowledge and expertise).
The knowledge and expertise transferred among the different growers allows them to reach Illy’s quality standards and, substantially, to self-select; growers with poor-quality products decide not to submit green coffee batches for the competition, reducing Illy’s efforts in terms of supplier selection. Moreover, Illy guarantees for its best growers (even the ones not awarded prizes!) a premium price at least 30 per cent higher than that in the New York Coffee Stock Exchange when they demonstrate that they have attained the requested level of quality. The knowledge and the know-how accumulated by the enterprise, based on many years of experience and continuous research and development, has been transferred to the coffee growers (especially in Brazil and India) through academic courses (the University of Coffee). The aim is to teach the best techniques and technologies for harvesting and postharvesting as well as business management. An example of the effect of this knowledgesharing has already manifested itself in the first phase of coffee-processing: cherry harvesting from the plant. There are two main methods of harvesting: picking and stripping.
The first is the process of hand-picking only the mature cherries from the branches of the coffee tree, guaranteeing a higher-quality harvest. The second method refers to the mechanised or manual picking of every cherry on the branch, with no regard for its maturity, so that the harvesting process is more efficient in terms of time and cost but produces a lower-quality result. Thanks to cultural diffusion and to knowledge sharing practices, Illy technicians have been able to push their growers to adopt the picking technique.
After the harvest, as shown in the figure, the cherries are sent to 'parchmenting' factories where the green coffee beans, after a processing phase, are divided from the rest of the cherry, dehydrated and sent to the market. During this phase, the technicians, selected and trained by Illy, pick the first sample (called the 'offer sample') from batches that can be potentially bought by the firm and send them to the laboratories for analysis, where a preliminary screening or a final evaluation of the sample being submitted for acceptance and the corresponding batch takes place. The laboratories only fulfil a screening function, are located in the growers' countries and are not owned by the Italian company, so they have limited responsibility for the sample pre-selection process, working from Illy’s evaluation criteria and parameters. The laboratories commissioned for the final evaluation of the samples have a greater degree of responsibility and are either owned by Illy (the laboratory in Trieste) or are engaged in a permanent collaboration with the company (the laboratory in Brazil). When the offer sample is approved by one of these two laboratories, Illy signs the supply contract with the grower in question.
Green coffee transport to Illy’s plant
When the contract is signed, the green coffee is transported under the grower's supervision from the plantation to the dock, where Illy takes a second sample, called the 'shipping sample', from every batch and tests it in the same manner as the previous sample was analysed. If there is a complete match between the beans and shipping samples, the batch obtains shipping authorisation. The process of loading the batch onto the ship represents the transfer of the property from the grower to Illy. Owing to the main characteristics of green coffee beans (their flavour and the possibility of degradation), the transportation process is critical for the quality of the final coffee because it can influence its degeneration in two ways:
1- Through container pollution caused, for example, by water, light or the remnants of products with other flavours (for example, cardamom) from the previous transport process; or
2- Through the position of the container on the ship, including proximity to containers containing flavouring products or positioning over the deck; in fact, the shipping lead time of about 3-4 weeks, of which two are near the equator; exposes the green coffee to thermal shock, making it taste 'woody'. Although Illy does not have the control over the transport process, it shares its knowledge about these critical potential issues with the shipping companies (diffusion of awareness) to safeguard against from the potential negative effects of container type, container position and lead-time. From a technological point of view, Illy began the use of plastic bags containing one ton of green coffee that could be moved by machine. These are called 'big bags'. The advantages of this innovation are:
• The reduction of personnel costs;
• Materials handling is less onerous for a healthy individual (with no more than 60 kg of manual weightlifting required);
• Increased materials-handling speed; and
• Better thermal insulation from humidity and temperature changes, which permits better product preservation during the transport process.
Green coffee storage, transformation and packaging
Once the coffee has arrived at Trieste's seaport, Illy conducts the third and last quality test. After the green coffee has passed all three quality tests, it is stored in a suitable warehouse for a period of 7 to 12 months. For this purpose, Illy has acquired an area of 60,000 square metres near the Trieste port where all of its logistical activities are carried out. It was necessary to build a clean warehouse with a high rate of insulation and a steady temperature (T = 15°C) and humidity level (50 per cent); this allows both a storage period of 12 months (versus 7 months in the previous warehouse) and a reduction of 50 per cent in the amount of faulty coffee beans discovered.
When the green coffee is dispatched for the blending, roasting, cooling and milling phases, it undergoes innovative technical processes that are meant to ensure quality (for example, the process of cooling the air and pressurising the coffee using nitrogen). The more critical phase is the blend preparation phase because if the Arabica coffee batches have heterogeneous characteristics (even if they arrive from the same grower), the coffee still has to meet the 'one blend, one brand' requirement to be considered high-quality: a clear strategic priority of Illy’s. For this reason, during this phase, there is an additional test carried out that only requires tasting the coffee. The firm has organised three years of internal tasting courses for this purpose (versus courses of a duration of only 3-6 weeks at other companies). As a result, Illy has a high number of internal experts involved in the tasting process. In the final packaging phases, the quality of the coffee is maintained via so-called 'active packaging', the introduction of nitrogen under pressure inside metal cans. This technique has three main objectives:
Preserving quality: the techniques and materials used for the packaging protect the properties of the coffee from the atmospheric agents for a longer period of time:
• Quality improvement: during the first two months after packaging using nitrogen, there is a notable improvement in the product's qualitative characteristics;
• Image: the fashionable silver design of the can is soon noticed on supermarket shelves.
The coffee cans are then stored in the warehouses both in Trieste and in the main commercial subsidiaries for about three months. In the other 100 countries, the local retailer stores them.
Coffee distribution and sales
The two channels on which Illy focuses its major efforts are the hotel, restaurant, coffee shop channel (with significant attention to the needs of cafe owners) and retail. These channels require different modalities based on the specific needs of the customer. The hotel, restaurant, café channel is characterised by its selling network and the capillarity of the service offered. Therefore the Illy strategy, besides offering high-quality blends, is to assure a high level of service through a high rate of visits and deliveries, technical and commercial customer support and particular payment terms for its coffee machines. To satisfy the need for efficient and reliable deliveries, Illy chooses an express courier even if this method is more expensive; the choice allows for knowledge-sharing regarding the measures that the courier must take to guarantee the service level requested by the customer (diffusion of awareness). Retailers' requests are very different. Illy uses retailer distributors who offer a tailored and less expensive service than express couriers. For example:
• The express courier delivers the product in 24 hours, but delivery speed is not a priority of the retailer, so for them, the arrival of the material is scheduled for 3-4 days after order confirmation;
• The multi-product trucks arrive at the multi-product retailer warehouse, so the customer enjoys logistical and operational advantages in managing a smaller number of trucks;
• Costs decrease by one-third compared to those charged by the express courier, thereby permitting economic compensation.
Coffee sales
Finally, Illy not only employs a typical branding strategy but also diffuses the culture of its coffee on a downstream network level. In the opinion of the firm, the quality of the coffee is in fact due 50 per cent to the blend quality and the transformation/packaging processes and 50 per cent to the way in which the drink is prepared and consumed. In fact, consumerperceived quality is partly a result of objective factors such as the water used, the cleanliness of the cup, the ability to properly use the espresso machine, the flavours in the consumer's mouth. However, it is also partly a result of perceptual factors like, for example, the kindness of the personnel and environment reception. If some factors can be overseen by the cafe owner; others depend on the consumer. There are three initiatives that Illy has implemented to help the customer (cafe owner) and the consumer understand product quality:
• Illy’s specialised technicians visit cafes to teach to their owners the art of making a good coffee and the importance of kindness and professionalism in satisfying the consumer.
• Illy has developed the 'coffee university', intended not only for the cafe owners but also for anyone else interested in deepening their knowledge of the coffee world.
• 'Espressamente Illy', a cafe concept created by Illy, is intended to produce a particular atmosphere in which consumers can have a pleasant experience.
Conclusions
The figure below synthesises the practices implemented by Illy in a framework that illustrates the supply chain management areas (purchasing, inbound logistics, firm, distribution and sales) and managerial levels (quality management, knowledge/know-how and cultural diffusion) where the company operates to achieve its strategic purpose: high product and the service quality.
Illy’s quality management and knowledge/know-how diffusion along the supply chain As highlighted in the first part of the case, many researchers have already proven how the overall integration of quality management practices along the supply chain has a positive effect on the quality of products and services. This topic is central in the food industry and particularly in the espresso coffee market. Consequently, it is necessary to implement quality management practices at every link in the supply chain from the producer (in our case, the green coffee grower) to the consumer. However, to manage quality efficiently and effectively, it is necessary to control and coordinate the entire supply chain.
Small- to medium-sized enterprises encounter significant challenges in obtaining this type of control because of the practical unfeasibility of vertical integration. Moreover, in the coffee sector, this dynamic is heightened by geographical distances, the great number of potential suppliers and the barriers created by international traders. The Illy case study shows how a small- to medium-sized enterprise can overcome all of the issues above by becoming a supply chain coordinator (SCC) and control quality at every link through the adoption of quality management practices and the systematic application of knowledge to the whole supply chain.
Cultural diffusion towards a supply chain learning (SCL)
In section A, we pointed out the voluntary and participative nature of SCL and the need for a real effort and an extended use of resources in SCC, but we also noted how trust and the diffusion of a shared culture can sustain learning processes. In the Illy case (figure below), the relationships of quality culture diffusion (even with non-essential suppliers) are fundamental for the coordination of the supply chain and the improvement of product and service quality. The cultural initiatives implemented by the company have a positive effect on quality output along the whole supply chain, from the quality of the raw material to the product quality perceived by the final consumer. Furthermore, the effect of cultural diffusion is to mitigate the Illy effort to maintain continuous improvement because it creates emergent behaviour in the different actors that is self-aligned with the Illy vision. During the last 20 years, Illy has exposed its entire supply chain to the knowledge, know-how and coffee quality culture developed inside the company in numerous countries (via the cross-fertilisation of knowledge and know-how) to obtain the best quality coffee possible. If adaptive learning is the 'doing what we do better', the Illy cultural strategy has created real generative learning, defined by Bessant and Buckingham (1993) as the ability to step back and reframe the problem. All of these events have helped to improve and sustain the knowledge diffusion processes performed by Illy from a SCL perspective.
Discussion
The group has chosen to directly address the grower, bypassing the international traders and managing upstream activities. This choice was feasible only because the enterprise enjoys an in-depth knowledge of products and processes. As a matter of fact, the diffusion of knowledge, expertise and quality culture as performed through many initiatives (guidance regarding picking methods, the Premio Brasil de Qualidade do Cafe Para Espresso in Brazil, the foundation of the coffee university and so on) has allowed the emergence of virtuous behaviour among green coffee growers like supplier self-selection, thereby considerably improving coffee quality. In relationships with shipping firms and express couriers, the diffusion of expertise and the quality culture is translated into the sharing of awareness, which indirectly guarantees high quality.
However, it is within the walls of the firm that knowledge, expertise and a coffee quality culture originate, develop and are diffused; these can only become sources of company competitive advantage and supply chain coordination through their constant renewal. The real 'engine' of this diffusion of knowledge, expertise and culture about coffee is Illy’s effort to deepen and create better comprehension of product and production processes. In this regard, the company has promoted many research and development projects in collaboration with Italian and international universities. For example, some projects are focused on the relationships between taste, perception and genetics, seeking to ascertain how coffee features arise from its genes.
The key to Illy’s success can be found not only in its strategy of marketing an excellent coffee that is identical all over the world (summarised as the 'one blend, one brand' philosophy) but also in the careful integration and coordination of quality management practices along the whole supply chain. This coordination allows Illy to obtain very high standard product quality from the green coffee to the cup. If internal and external quality management practices and cultural diffusion in the downstream network are typical of the espresso coffee sector, its extension to the whole supply chain provides a persuasive and innovative explanation for the success of Illy.
Knowledge diffusion and cultural diffusion as drivers of SCM integration in the pursuit of product quality
The Illy Caffe case study suggests how a medium-sized enterprise can compete and win in the international market by integrating quality management practices along its supply chain and, above all, by becoming the supply chain coordinator through the systematic diffusion of knowledge, expertise and culture to the actors involved in pursuing product quality.
Original source: De Toni, A.F., Franco, R.D., Li., J., Li, Y., Nassimbeni, G., Sartor, M., Zhao, X. and Xu, X. 2011, International operations management – Lessons in global business, Burlington, VT, USA: Gower Publishing Company.
Using evidence from the Illy Caffe case and your own research, address the following questions:
1. Outline Illy Caffe’s core competencies and capabilities. (5 marks)
2. Explain the relationship between capacity planning and location and their importance to Illy Caffe. (5 marks)
3. Assess the specific measures of quality used at Illy Caffe. (10 marks) 4. Consider sustainability challenges in relation to Illy Caffe’s supply chain. Recommend three UNSDGs Illy Caffe could include in their supply chain strategy. (10 marks)
5. In graphical form, show how innovation and development ultimately proceed from the competitive strategies of Illy Caffe, and how they enhance the performance of the firm. (10 marks)
6. Discuss present and foreseeable challenges for Illy Caffe. (10 marks)