Elli

CASE: SM-188A DATE: 07/26/10

ILLYCAFFÈ AND GRUPPO ILLY (A): EXPANDING BEYOND GOURMET COFFEE Our mission, passion and obsession is to delight people who value the quality of life, by offering the best possible coffee nature can provide, enhanced through the finest technologies. —Andrea Illy, Chairman and CEO, illycaffè SpA The Gruppo illy mission is to become a worldwide recognized reference in the gourmet sector. —Riccardo Illy, President, Gruppo illy SpA

In 2010, Riccardo and Andrea Illy, two brothers running the family coffee and gourmet food business, looked forward to an exciting future. The family business had been founded in 1933 by their grandfather, Francesco Illy, who had invented the espresso machine. The company had become a global company in the premium coffee market based on its uncompromising quest to provide the perfect cup of coffee. Their father, Ernesto Illy, had run the company until the 1990s, when the brothers took over the primary management. Beginning in 2004, the company had branched out beyond coffee, buying (or taking major stakes in) four small companies that shared the passion for excellence embraced by the Illys’ coffee company, illycaffè SpA. These companies, which produced chocolate, tea, candied fruits, and wine, together with illycaffè, formed a new entity, Gruppo illy SpA. Riccardo served as president of Gruppo illy, while Andrea was chairman and CEO of illycaffè. In 2009, the company had more than 700 employees, total sales of 280 million euros (US $410 million), and net profits of US $11.7 million, with exports representing 54 percent of total sales. 1 The vast majority of the business, about 90 percent, came from coffee. While the company saw attractive opportunities for their coffee business, the premium niche was limited in the long term. The new businesses provided new horizons for substantial long-term growth. The brothers 1

Illy website, “The Company,” http://www.illy.com/wps/wcm/connect/us/illy/about-illy/company/ (accessed June 8, 2010). Victoria Chang, David Hoyt, Professor Glenn Carroll, and Professor Hayagreeva Rao prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 2010 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order copies or request permission to reproduce materials, e-mail the Case Writing Office at: [email protected] or write: Case Writing Office, Stanford Graduate School of Business, 518 Memorial Way, Stanford University, Stanford, CA 94305-5015. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means –– electronic, mechanical, photocopying, recording, or otherwise –– without the permission of the Stanford Graduate School of Business. Every effort has been made to respect copyright and to contact copyright holders as appropriate. If you are a copyright holder and have concerns about any material appearing in this case study, please contact the Case Writing Office at [email protected]. This document is authorized for use only in An?lisis Mercado Entorno Competitivo 2014-I Esp. Int. Mer. JJL by Juan Jos? Lombana at Universidad de Los Andes - Colombia (UniAndes) from February 2014 to May 2014.

illycaffè and Gruppo illy SpA (A): Expanding Beyond Gourmet Coffee: SM-188A

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considered the future—how could they replicate their tremendous success in coffee with other products? Could they effectively extract significant and substantive synergies across the new product areas to add to the company’s bottom line? ILLYCAFFÈ BACKGROUND During a visit to Trieste, a city and seaport in Northeastern Italy, illy founder Francesco Illy first started thinking about starting a coffee business. He had traveled there as a Hungarian serviceman and became interested in the energetic city. What Francesco saw in Trieste was a multilingual border city with a port, warehouses, insurance companies, skilled machinery workers, and a vibrant city life with cafés. 2 In 1933, Francesco launched his coffee production and sales company in Trieste, making it the only city in the world at that time that incorporated the complete coffee production process. Francesco also sold chocolate in the early days of the company, though these were phased out in order to focus solely on coffee. Francesco ran the company until 1956, when his son Ernesto became a co-owner and director of the company. Ernesto was the company’s chairman from 1963 to 2005, then honorary chairman. Ernesto liked to call himself a “cocktail of science and business,” especially since he had a chemistry degree. 3 He focused on the company’s investment in research, and on its branding. He believed that a brand had to be “designed and created on the basis of a promise given to the consumer, and that the ethical dimension should distinguish a company’s inner life as well as its business.” 4 Ernesto’s son, Riccardo, joined the family business in 1977 as the sales director for Italy. He later became international sales director, moving to managing director in 1992. In 1993, Riccardo was elected as the city mayor, limiting the time he could devote to the company. Ernesto’s younger son, Andrea, joined the company in 1990 as quality control supervisor. 5 In 1994, as Riccardo began his term as mayor, Andrea became CEO of illycaffè. Like his father, he was a chemist by training. Andrea led the coffee subsidiary towards internationalization, while introducing process innovations, focusing on the endless pursuit of quality, and spreading the coffee culture. 6 In 2003, the company underwent a review of its long-term plans. Although they expected continued growth in the premium coffee market, eventually this market would be limited both by demand for “perfect coffee,” and by the availability of the beans needed to produce coffee meeting illycaffè’s demanding standards. They also realized that it would be prudent not to have their entire future dependent on one niche product line. As a result of this review, the company began diversifying in 2005, purchasing (or taking substantial stakes in) four companies making 2

Illy website, “Traditions,” http://www.illy.com/wps/wcm/connect/us/illy/about-illy/traditions/ (accessed June 8, 2010). 3 illy website, “Ernesto Illy,” http://www.illy.com/wps/wcm/connect/us/illy/about-illy/traditions/ernesto-illy/ (accessed June 8, 2010). 4 Ibid. 5 Ernesto had one other son, Francesco. He also had a daughter, Anna, who was in charge of marketing for the green coffee department. 6 Illy website, “Traditions,” loc. cit.

This document is authorized for use only in An?lisis Mercado Entorno Competitivo 2014-I Esp. Int. Mer. JJL by Juan Jos? Lombana at Universidad de Los Andes - Colombia (UniAndes) from February 2014 to May 2014.


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premium food products: tea, chocolate, candied fruits, and wine. These companies, together with illycaffè, formed a new entity, Gruppo illy SpA. By 2010, Gruppo illy had total sales of 315 million euros (US $460 million). This was dominated by illycaffè, with sales of 280 million euros (US $410 million) and net profits of US $11.7 million. Illycaffè had 11 direct and indirect subsidiaries and more than 700 employees. It sold its products in 140 countries spanning all five continents, with exports representing 54 percent of sales. Illycaffè reached more than 50,000 of the finest restaurants and coffee bars/cafés in the world. 7 By comparison, the sister companies were far smaller, and were still building their international sales networks in 2010. ILLY COFFEE: A SINGLE BLEND Coffee could be composed of a single type of coffee bean or a blend of several types. Blended coffee produced a richer, more complex flavor than single-bean coffees. 8 Illy believed in producing a single, unique, perfect blend of coffee for both brewed and espresso preparations. “A single blend means that illy can always be counted upon to have the same consistent taste, cup after cup, year after year.” 9 Illycaffè was the only company in the world that produced only one blend of coffee. Illy’s single blend of 100 percent Arabica beans came from nine growing regions around the world: a Brazilian base made up over 50 percent to give the blend body and aroma, enriched with the sweetness and aromatic notes of wet-processed African and Central American coffees. 10 Thus, in order for illy to achieve the same consistent taste in its product, it needed to blend different types of coffee together “based on their individual characteristics, all the while adjusting the amounts of each type to achieve the desired balance and signature taste of the illy blend.” 11 The company blended its coffee prior to roasting in order to achieve the greatest homogeneity in taste and aroma. To ensure that the illy blend achieved its perfect balance and consistency regardless of the variations from one harvest to another, the company employed a liquorer, or a master blender. Riccardo Illy made the decision to focus on one blend when he first joined the company in 1977. At that time, the company had 20 different blends of coffee and was producing, according to Riccardo, “high quality within a high quantity of blends, not solely high quality.” Over a few years, he eliminated all but one blend, totaling 50 percent of the company’s sales in order to concentrate only on the best. After that, the company grew much faster and went from selling 1,000 tons of roasted coffee a year to 15,000 tons by 2009.

7

Illy website, “The Company,” loc. cit. Answers.com, “Coffee,” http://www.answers.com/topic/coffee (accessed June 8, 2010). 9 Illy website, “Blending,” http://www.illy.com/wps/wcm/connect/us/illy/the-world-of-coffee/origin-andblend/blending/ (accessed June 8, 2010). 10 Illy website, “Blending,” loc. cit. In wet-processing, the skin and pulp from the coffee bean is removed when the coffee is still wet. This is the method used in most of the world’s best coffees (Coffee Review website, “Coffee Glossary,” http://www.coffeereview.com/glossary.cfm?alpha=W, accessed July 12, 2010). 11 Illy website, “Blending, loc. cit. 8



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Greg Fea, CEO and president of illycaffè North America, said of the one-blend strategy: “I think this was one of the most important company decisions. Many other coffee companies have a vertical tier of different products of varying quality. But illy just makes one brand, which is the best in the world. It’s like making a Ferrari, but not making any cheaper versions of the same car. The difference between us and Ferrari is that a Ferrari is only for a privileged few, whereas illy is an accessible luxury for millions.” 12 ILLYCAFFÈ TARGET MARKETS AND COMPETITORS Illycaffè sold its coffee to the hotel, restaurant, and café sector (HoReCa); to general consumers; and to corporations and companies. Throughout illycaffè’s supply chain, all of its constituents down to the consumer paid a premium for its products. Andrea Illy commented that, “The strategy of making the best coffee in the world makes us a niche player. We work only in the premium market, with a significant premium price, even to other premium coffees.” The company worked with some of the best restaurants and hotels in the world, including the Four Seasons, the Mandarin Oriental, and the Meridien Hotel. In essence, illycaffè targeted the sophisticated coffee drinker. Fea said: Our target market consists of people who are really passionate about quality and about coffee, who find illy and realize it’s like the best Bordeaux in the world, and so they stay with it. Our consumers want the same experience over and over and they look for our product. Thus our cafés and restaurants draw from a much bigger radius because people will actually go out of their way if they know that they just need to walk a little bit further to get an illy instead of something else. The markets in Europe and the United States were extremely different. In Europe, particularly the southern European countries such as France, Spain, Greece, and Italy, there was a highly developed coffee bar culture, particularly as compared to the United States. In 2010, Italy had a population of 60 million people with 105,000 coffee bars, 13 while the U.S. had 300 million people, but only 34,000 coffee bars. Moreover, in the U.S., consumers tended to prefer drip coffee and other forms of coffee, while Italians preferred espresso. Because of these factors, illycaffè’s target market in the United States was the consumer at-home segment, where 80 percent of the coffee was consumed. 14 Because illycaffè was so focused on quality and was unique in its approach, competitors differed depending on the customer segment. For instance, in the global HoReCa sector, illycaffè competed with companies such as Starbucks and Lavazza, an Italian company. In the market for machines and coffee capsule systems for making espresso, it competed with companies such as Nespresso, a division of the Nestlé Group.

12

Quotations are from interviews with the authors, unless otherwise specified. Greg Fea, CEO and president of illycaffé North America. 14 Ibid. 13



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ILLYCAFFÈ’S PRODUCTS Home Products Espresso and Cappuccino Products Espresso is a strong coffee brewed by forcing steam under pressure through darkly roasted finely ground coffee beans. “Espresso” means “very quickly” in Italian, referring to the time it takes to make the drink. The company’s founder, Francesco Illy, had invented the “illetta,” the first espresso machine. Espresso is a potent and concentrated drink, characterized by its top layer of foam called crema. The drink is used as the foundation for other drinks such as lattes, cappuccinos, and mochas. Cappuccino is prepared using espresso, hot milk, and steamed-milk foam. The European cappuccino was much smaller than the U.S. cappuccino. Illycaffè offered many coffee products to make espressos and cappuccinos, each available in decaffeinated, dark roast, and medium roast varieties. These products included whole bean espresso, ground espresso, and E.S.E. (easy serving espresso) pods that made it easy for consumers to make espresso. They also offered a next generation espresso capsule technology called Metodo Iperespresso, consisting of capsules that contained seven grams of roasted, grounded, and tamped illycaffè coffee. The E.S.E. pods could be used in machines made by a variety of manufacturers under an open international standard, while Metodo Iperespresso capsules were used as part of a proprietary, closed system made by illycaffè. The “Metodo Iperespresso” process involved a two-phase extraction method that resulted in a rich, smooth espresso with a velvety, long-lasting crema. Since the capsules kept coffee from touching the espresso machine, there was no coffee oil buildup. Users could drop the capsule into the machine and turn a dial to enjoy an espresso in a few seconds. The machine allowed users to employ an auto-frothing steam wand to create cappuccino, latte, and other coffee drinks. This made it much easier for consumers to make espresso at home, ensuring a good final result— there were so many variables in the manual process that any mistake could result in a bad cup of espresso. On the growth of this market, Giacomo Biviano, a long-time employee and head of the Europe, Middle East, Africa, and Latin America division, said: “Coffee is stable, but the capsule system market is growing over 10 percent a year because it is a much easier way to prepare coffee.” The shift towards closed systems, or machines that allowed consumers and businesses to make various coffee drinks that only used illy coffee, required changes in the company. Durable goods such as machines were a relatively new area for the company, with new challenges. The shift also brought a potential risk, as there was an intense battle being fought by giant multinationals with large legal budgets over machine standards. Small companies such as illycaffè hoped that no proprietary design would dominate the industry, and that there would be a well-accepted open standard. Brewed Coffee Brewed coffee is made with an autodrip machine and is the most popular preparation method in the United States. For brewed coffee, illycaffè provided its Ground Coffee product



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(decaffeinated, dark roast, and medium roast). The coffee was more coarsely ground than illy espresso ground coffee. Moka In Italy, many people enjoyed a moka pot of coffee each morning. Moka pot coffee is prepared by a steam pressure moka coffee pot (often called a stovetop espresso pot or macchinetta). Illycaffè’s research and development group used their experience with espresso to optimize coffee for use in moka pots to deliver the same consistent, distinctive illy flavor and aroma. It also collaborated with the Bialetti company to develop an improved moka pot that eliminated the residue that could produce unpleasant aromas in conventional pots. Away-from-Home Market Illycaffè’s away-from-home market consisted of franchising the café chain “espressamente illy,” other cafés, restaurants, and hotels. The café was a social network and a daily ritual for most Italians. By 2010, there were 230 espressamente illy cafés in 34 countries on 5 continents. Each café provided “an authentic Italian coffee experience starting with its design where the art of Italian café culture meets the love of all things beautiful. In other words, the ultimate coffee experience.” 15 Two internationally renowned Italian architects 16 created the models for the cafés. Product offerings at the cafés included cappuccinos, espressos, and various Italian foods. Beyond espressamente illy cafés, illycaffè also offered a larger 3-kilogram pressurized tin of coffee beans for use in commercial establishments. The pressurized tin (unopened) allowed users to preserve the coffee for at least three years. Illycaffè also marketed its Metodo Iperespresso system to commercial establishments for espresso preparation, since it was an easyto-use machine with no mess and easy cleanup. For the small to medium-sized office market, illycaffè provided the E.S.E espresso pods and an E.S.E.-compatible espresso machine. Illycaffè also had a program called Artisti del Gusto or “Artists of Taste,” where cafes in Italy and the abroad agreed to serve illy exclusively, while allowing the company to have an influence on quality and many other details. Instead of opening its own branded coffee shops in the U.S., illycaffè aligned itself with coffee shops such as Caffe Greco in San Francisco and Café Nineteen in Atlanta, Georgia. Illycaffè supplied the coffee shops with espresso machines, coffee cups, artwork, drink recipes and training; in return, the shops agreed to serve only illy coffee for at least three years. In the case of Caffe Greco and Café Nineteen, sales increased due to the exclusive illy offering. 17 By early 2010, 28 U.S. coffee shops operated with the Artisti del Gusto certification, and illycaffè planned to add 100 more over the next three years, as well as to launch the program in Canada and Mexico. Illycaffè personnel regularly visited certified coffee shops to monitor quality.

15

Illy website, “The Project,” http://www.illy.com/wps/wcm/connect/us/illy/away-from-home/espressamenteilly/the-project/ (accessed June 8, 2010). 16 Claudio Silvestrini and Luca Trazzi. 17 Julie Jargon, “Illy Uses Backdoor to Take on Starbucks in the U.S.,” The Wall Street Journal, November 3, 2009, http://online.wsj.com/article/SB10001424052748704112904574475722260947260.html (accessed June 8, 2010).



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ILLYCAFFÈ STRATEGY Illycaffè’s strategy focused on quality and consistency of the beans, technological innovation, and education. This strategy enabled illycaffè to have a more consistent quality in the cup when compared to competitors. Fea explained: Instead of focusing on just the quality of the beans (which I think we have indisputably the best quality beans in the world), we are also committed to quality in the cup. That means we have to take control of the quality of the machines being used, and the quality of the people who are transforming the coffee from location to location. Technology and education help us to achieve quality in the cup. In terms of technology, we’re one of the leading developers of patented technology in the world. We also started a Università del Caffè, where we send professionals and consumers to study how to properly prepare coffee. Focus on Quality According to Riccardo Illy, the company differentiated its products mainly by quality, saying: “What that means is that we must produce only the best coffee and products, and aim for perfection.” Andrea Applewick, project manager of the Ernesto Illy Foundation, elaborated: “Everything about illy is of the utmost quality—from the reception area, to the service that you receive at the bar, to the cafeteria. It’s not necessarily just the coffee itself, but after you enter into the gates of the company, you immediately feel that quality is the most important thing.” Illycaffè ensured the quality of the pre-roasted green coffee beans by purchasing all of its coffee beans directly from growers, testing each bag purchased; they did not buy a single bag on the spot market. They paid a 30 percent premium for coffee; the money went directly to the farmers, who avoided the middlemen and the spot market, and thus kept more profits to invest in their plantations to create higher quality beans and achieve a higher quality of life. Once purchased, the large jute bags of coffee were shipped to the roasting facility warehouses in Trieste, Italy as quickly as possible. Even during shipping, illycaffè was attentive to quality. The bags were placed in their shipping containers in a way that enabled air circulation and minimized mold, condensation, and other issues (as opposed to packing so as to maximize the number of bags in a given space). Upon reaching the roasting plant, the beans were removed from the bags and placed on a vibrating screen to remove the remaining foreign objects. An aspirator removed the smaller lighter impurities, a magnet removed any metal, and then the green coffee was stored in silos. The final selection stage was conducted by six bi-chromatic systems that electronically “photographed” each bean, detecting and eliminating any bean that did not meet strict color standards. According to the company website, “Illycaffè believes that this level of inspection is essential for natural coffees in particular and it is just one of many methodologies used



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exclusively by illy to approach its goal of ‘zero defects.’ Why does illycaffè go to such lengths? Because a single imperfect bean among the 50 in a cup is enough to spoil an espresso.” 18 The green beans were then roasted. Again, this process was done with a focus on quality. For instance, after drying and roasting the beans, the company used streams of cool air (although slower and more expensive than using water showers) to preserve the aromas of the coffee and to protect the beans from humidity. 19 Quality and freshness was an important part of illycaffè’s final packaging process. To ensure freshness, founder Francesco Illy invented pressurization in the 1930s. According to the company: Pressurization extracts the air from the can and replaces it with inert gases at a higher-than-atmospheric level of pressure. This method guarantees a longer preservation time, maintaining the coffee for over two years until it is prepared. At the same time it ‘ages’ the coffee, improving its aroma over time by causing its volatile aroma compounds to bind with the oils that are contained in the beans. Simple vacuum packing cannot achieve this flavor transformation…. The effect of the aging process is similar in many ways to the development of complex flavors when a fine red wine is aged under proper conditions. 20 Riccardo Illy added: “There are no other roasters that are able to produce our tins and to pressurize the coffee to age it in order to fix the flavors with the oil contained in the coffee. This is really unique and our consumers are able to detect the difference.” Fea reflected on the company’s focus on quality: We have a unique approach to quality, which you just don’t find in the world today. It’s not marketing hype; it’s what we do. Other companies tell us that we’re crazy because what we do is so expensive and laborious. It probably wouldn’t work for the big multinationals, because it would require too much technology and tedious work, but for us, it’s our mission. Focus on Scientific and Technological Innovation Since its founding, illycaffè had been a “research laboratory, where technological solutions for producing the best espresso have been designed, constructed, and patented.” 21 Coffee bean quality was highly variable, even between trees in the same plantation. In order to ensure the highest quality, illycaffè employed many technologies to control all aspects of production, from 18

Illy website, “Selection,” http://www.illy.com/wps/wcm/connect/us/illy/the-world-of-coffee/origin-andblend/selection/ (accessed June 8, 2010). 19 Illy website, “Roasting,” http://www.illy.com/wps/wcm/connect/us/illy/the-world-of-coffee/origin-andblend/roasting/ (accessed June 8, 2010). 20 Ibid. 21 Illy website, “Innovations,” http://www.illy.com/wps/wcm/connect/us/illy/about-illy/innovations/ (accessed June 8, 2010).



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bean selection to packaging. Many of these practices were unique to illycaffè within the coffee industry. The pressurized cans were one technological innovation, as well as the illetta, the first coffee machine with automatic water dosing and a jet of compressed air—“the predecessor of all espresso machines.” 22 When Ernesto Illy joined illycaffè, he infused science and technology into the company, launching the internal research laboratory and collaborating with scientific centers and universities. One invention at this time was the sorting machine that analyzed the intensity of light from every bean so that the poor quality ones could be removed. Another invention was the E.S.E. pod for easily preparing espresso at home or in the office using an espresso machine. In 2008, illycaffè launched the Metodo Iperespresso capsules and machines, leading to a creamy rich and persistent foam topping, shifting the process away from the standard percolation method. Illycaffè’s internal research and development group focused on the study of coffee through agronomy, botany, physics, chemistry, biology, statistics, and computer science. It also partnered with universities in Trieste, Udine, Florence, Milan, Budapest, and Manchester. In 2010, the company opened a patent office in illycaffè for their proprietary recipes and technological developments and innovation. By 2010, illycaffè had developed the industry’s third-largest intellectual property portfolio, despite its small size. Focus on Education: Università del Caffè Another pillar of illycaffè and Gruppo illy’s strategy was its focus on education. The company established the Università del Caffè in 1999, to promote and establish the “culture of quality coffee in Italy and worldwide.” 23 UdC was headquartered in Trieste, and offered training and educational activities to producers of coffee on issues such as organizing a plantation, as well as to professionals in coffee shops on coffee and coffee shop business issues. UdC also offered courses for the consumers (connoisseurs) of coffee, and held tasting evenings and coffee-themed dinners for coffee lovers. By the end of 2009, over 41,000 students from around the world had attended courses at illy’s 16 Università del Caffè subdivisions. In 2008, of the over 11,000 students who attended the UdC, more than 800 were producers, 6,900 were professionals, and 3,500 were connoisseurs. ILLYCAFFÈ EXPANSION Geographical Expansion The company’s geographical growth strategy began with its founder, Francesco Illy, in 1933. Francesco was in a joint venture with a partner who was a roaster himself. The partner sold products in his territory, and the joint venture focused on the rest of Italy and foreign markets. Riccardo Illy said: “This strategy obliged my grandfather to invent pressurization to protect the 22

Ibid. Illy website, “Università del Caffè,” coffee/universita-del-caffe/ (accessed June 8, 2010). 23

http://www.illy.com/wps/wcm/connect/us/illy/the-world-of-



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freshness of the coffee, and also obliged him to focus on high quality, because in 1933 the cost of distribution was very high. So the only way to charge a higher price to the customers to make up for high distribution costs was to produce a higher quality product.” Francesco Illy sold coffee in Switzerland immediately. When Ernesto Illy entered the company, he developed the export market in the Netherlands, then France, then Germany, and finally, in the United States in 1980, “when espresso wasn’t well known at all,” according to Riccardo Illy. “We built an espresso market in the United States from scratch.” When Riccardo joined the company he initially focused on the Italian market, then became the commercial manager in charge of foreign markets. He started developing new markets, largely through independent distributors. Under Riccardo’s leadership, illycaffè launched its global initiative just prior to being elected city mayor in 1993. Andrea Illy then became CEO and rapidly developed the international markets, reaching nearly 150 countries worldwide by 2010. As illycaffè expanded into different geographical markets around the world, the company followed a strategy of converting consumers, according to Biviano: When we are thinking about entering a market, we always look at the market, we buy market research, and we investigate. We always do our best to understand consumer need. But at the end of the day, we are not driven by consumers, because sometimes they don’t know what they need. For example, everyone used CDs for music until Apple developed the iPod and now everyone is buying music from the web. We have the same concept for our products. Our goal is to get consumers to try espresso and start drinking espresso, maybe with an espresso machine. In some markets such as Africa, however, we are not strong because there simply isn’t enough purchasing power to buy our premium product. Geographical Expansion Example: North America In 1998, illycaffè’s North American business was operating at a stable revenue base of about $15 million, with an expensive structure, and no clear growth plan. Replicating the Italian strategy had not been effective, due to the differences between the two countries. The largest coffee market was the consumer segment, yet the company was concentrated in the HoReCa business segment. Rather than cut costs to those appropriate to a smaller business, they decided to grow the business. Over the next decade, the North American business multiplied by four times and became profitable. The first thing that the company did in North America was to expand into drip coffee—the preferred U.S. consumption method, as well as espresso and espresso preparation. “In the U.S., so much of the coffee consumption is drip coffee, and this had never been done at our company, so it allowed people in the U.S. to enjoy coffee the way they liked it,” said Fea. To support its North American strategy, the company did not use traditional advertising, but built the brand through “experiential marketing,” or ways in which consumers could not only shop, but also have a complete coffee experience. For example, illy opened a store for three months in



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a Soho New York art gallery that allowed consumers to enjoy the art, shop and also take seminars on coffee. At the gallery, illy had events such as film showings and art shows. “The illy brand has always been associated with the arts,” said Fea. “Consumers came to the Soho store and the store received a lot of press that helped to build the brand.” This approach was consistent with the global illy communications strategy, which favored public relations efforts and experiential marketing over traditional advertising. It continued a long-term illycaffè involvement with contemporary art, as exemplified by the company’s commissioning of artists to design espresso cup collections, and collaborations with major worldwide art institutions. Another marketing program that illyUSA developed was its e-store at illyUSA.com, where the company offered a coffee machine at a low price in return for a subscription of coffee. Because the company learned that American consumers were afraid of having espresso machines in their homes, as they did not know how to use them, they had company experts who were trained in machine functionality and troubleshooting. By 2010, the company’s North American revenue had grown to approximately $60 million from $15 million a decade earlier, and was available in 25 percent of the U.S. retail stores selling premium coffee, including stores such as Williams-Sonoma, Sur La Table, and Whole Foods. The company even sold its coffee in 800 of the 3,800 Safeway stores, selected by illy because their customers were predisposed to quality. In such Safeway stores, illy team members worked with the retailers to help them develop an effective program not only in terms of product, but also in terms of solutions for teaching consumers how to make coffee, how to make better coffee, and what product to put into a machine. Illy partnered with Williams-Sonoma to offer sessions on coffee at 30 of its stores that had training facilities. Fea said: “This is a great way to introduce people to our product, because we have their attention for more than two seconds so we can actually tell them something. If we only have someone’s attention for two seconds in a magazine, that’s harder.” Expanding into the Ready-to-Drink Canned Coffee Product In 2009, Coca-Cola and illycaffè partnered to create Ilko Coffee international, bringing a line of Italian canned coffees all over the world, in the $17 billion global ready-to-drink coffee market (dominated by Japan, with three-quarters of the global market). The partners offered three drinks in the “Illy Issimo” line: 1) Caffé (basic black with some sugar), 2) Cappuccino (with lowfat milk), and 3) Latte Macchiato. By 2010, Illy Issimo drinks were sold in 20 countries in addition to the U.S.—a $2 billion market dominated by the joint venture of PepsiCo and Starbucks. Coca-Cola and Illy’s drinks were priced 15 percent more than Starbuck’s drinks, and sold in upscale locations such as Whole Foods in North America. Riccardo Illy said: “Our ready-todrink product is made with our same blend, but just in a different preparation in order to allow our consumers to enjoy our products in different situations.” By 2010, the brand had captured nearly 20 percent market share in the 10 countries of its initial launch, with the goal of achieving at least 30 percent market share globally in the ready-to-drink coffee market. 24 Applewick recalled the initial interest from distributors in Japan: “We decided 24

“Coke CEO Sees Canned Coffee Growing Despite Recession,” http://www.reuters.com/article/idUSN2833611620090528 (accessed June 8, 2010).



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to do a ready-to-drink product almost 10 years ago because a distributor in Japan asked us if we would make such a product. After 10 years of research, 10 years of understanding the market, and thanks to our partnership with Coca-Cola, we now have this drink available in Japan, Europe, and the United States. We are not a company that makes rash decisions when it comes to our coffee.” EXPANDING BEYOND COFFEE: THE FORMATION OF GRUPPO ILLY In 2003, illycaffè conducted a review of the long-term plan of the business, looking out 10 to 20 years. The company’s focus on producing “perfect coffee” resulted in high-end positioning, and a degree of exclusivity, which was inconsistent with growth through mass marketing of lower priced brands. At the same time, the company was constrained by the availability of beans that met its quality requirements. These considerations limited the company to less than 2 percent of the global coffee market—a size that would allow illycaffè to grow, but the growth would eventually be constrained. They then addressed the question of how to grow beyond the size possible within the market niche for “perfect coffee.” The other attractive growth prospect within the coffee business, given an eventual saturation of the premium niche and the limited amount of premium coffee beans, was to increase the value added—generating more revenue from the same number of beans. This was the basis for many of the new products previously described, such as espressamente illy coffee bars, single serve pods (and their associated coffee machines), and the Ilko ready-to-drink product. They then considered ways to grow by diversifying into new products. This would have an additional risk mitigation advantage, as Andrea Illy noted: “Coffee is not a primary necessity. One day, there could be a new fad, or an alternative product to coffee—it could happen. Nobody will die if coffee’s not around anymore. It would be risky for a family business to put all its eggs in the same basket.” The Illys believed that the company had assets that could be valuable to other businesses, specifically its unique blend of art and science. It applied art to selecting and blending coffee beans, to its recipes, and its activities surrounding connoisseurship. It applied science toward product innovation and quality, with its extensive research and development capabilities. These assets could be applied to other companies that shared illycaffè’s passion for perfection. As a result of this long-term review, the Illys decided to diversify. The diversification process began in 2004, when Gruppo illy SpA was formed as a holding company for illycaffè and the sister companies it would acquire. The company expanded into other products through strategic acquisitions of companies already known and regarded as “best of class” in their business sectors, that shared the same values as Gruppo illy, and that had the same “image of uniqueness,” as expressed by Riccardo Illy, who went on to say, “We looked at the quality and image of the products, brands and especially of the people leading these companies.” 25 In each of the acquisitions, the leaders with the primary product knowledge remained with the company after it became part of Gruppo illy. Andrea Illy 25

E-mail communication from Riccardo Illy, May 17, 2010.



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pointed to a third important characteristic: heritage. In its acquisitions, the company would add two products that had been part of its prior history: chocolate (which it had produced beginning in 1933), and tea (which it had produced in the 1960s). In 2005, the company acquired a 40 percent share 26 in Agrimontana, a leader in the production of top-of-the-line confectionary products, such as marrons glacés and jams. In 2006, it obtained a controlling 80 percent share of Domori, a luxury Genoa-based chocolate company; in 2007, the company acquired a stake in the high-quality French tea brand, Dammann Frères; and in 2008, it acquired a stake in Mastrojanni, a wine farm in Montalcino, Italy, an area famous for its Brunello red wine. Agrimontana brought innovation, experience, and aesthetic focus and attention. It innovated by packaging candied chestnuts in a modified atmosphere for longer shelf life and a softer structure. The company also innovated by packaging candied fruits with an “ad hoc” pasteurization in order to preserve the authentic taste and color of the fruits without using any artificial preservatives. Agrimontana focused on tradition in its cooking (long-lasting), selection, and candying (handmade). Aesthetically, Agrimontana had launched a new logo and new packaging that was consistent with Gruppo illy’s brand. Domori brought similar attributes. Domori innovated in two basic ways: botanic innovation and process innovation. Botanically, Domori cloned and saved fine varieties of cacao (the tree that produced the cocoa bean) that were nearly extinct, such as criollo. In its process innovation, Domori used machines, such as the ball mill, which maximized the aroma of chocolate. Experience was also an important reason why Gruppo illy acquired Domori. For example, Domori roasted cocoa beans at lower temperatures in order to keep a wider spectrum of the aromas. Aesthetically, Domori had launched a new logo, with corporate image and packaging that were aligned with Gruppo illy’s brand. Similarly, Dammann brought innovation, experience, and aesthetic focus and attention. In the mid-1980s, the company, in cooperation with a Japanese engineer, created the “sachet crystal,” an elastic filter made of nylon that enabled the expansion of tea leaves, which led to more intense aromas in the cup. In terms of experience, the company exclusively used natural processes in the aromatization of teas (dried flowers, petals, and essential oils), leading to a more natural, longlasting, and well-balanced taste between fruit and tea. Aesthetically, Dammann’s packaging was a part of the product, and in its flagship store in Paris, the architecture and furnishings were an integral part of the consumers’ tasting experience. 27 Riccardo Illy said that Gruppo illy hoped to “exploit all the possible synergies” between illycaffè and its sister companies while maintaining the autonomy and identity of each company. In essence, he said that Gruppo illy aimed at achieving the correct “equilibrium between full autonomy and responsibilities” for the sister companies in their own businesses and “integration to reinforce the competencies and actions through synergies with illycaffè and the other companies in the group.” Each acquired company retained its original name and brand. 26

Eventually, Gruppo illy boosted its share of Agrimontana to 75 percent in 2007. The rationale for the three acquisitions is mostly quoted from Riccardo Illy’s presentation on Gruppo illy at Stanford University in July 2009.

27



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The acquired companies were small compared to illycaffè. Despite growing from the time of acquisition, by 2010 they still only accounted for about 10 percent of Gruppo illy’s business— coffee was by far the largest share of the business. As independent companies, they were too small to be able to afford the extensive research and development capabilities developed by illycaffè. While the “sister companies” retained their operational independence, they had access to illycaffè for support. Andrea Illy described the arrangement as follows: They are free and independent. We give them the opportunity to access our customers, through our sales force or independently. They have access to the knowledge in our departments, such as scientific knowledge. Should they need to conduct a research and development project, whatever is needed is at their disposal. IT, administration, finance, research and development, quality assurance, production, any department is at their disposal for internal consultancy. He gave the example of Domori potentially wanting to evaluate the aroma of its products or raw materials: “You need the aroma lab to screen the cocoa aroma? We can make it. These things are totally out of reach for a small company.” Andrea further commented on their independence, saying: “If we pushed them for performance, and results, and deliverables, we would probably very, very soon destroy and destabilize the organization. That’s why it’s the correct mix between their independence and access to the illy system. We support them, as opposed to drive them.” Riccardo felt that strategic acquisitions provided four advantages for Gruppo illy: “1) reinforce positioning on the top quality segment; 2) strengthen internationalization; 3) cross-fertilization in the process; and 4) scale economies in the organization: sales force and marketing, logistics, warehousing, distribution and other fixed costs.” He also mentioned several advantages for its distribution customers, such as: 1) Gruppo illy represents a reliable partner on a wide range of products; 2) reduced business complexity: less suppliers, less administration; 3) the quality, the know-how, the service and the unmatched quality experienced with illycaffè are guaranteed also for tea, chocolate, pastry products, and wine; and 4) the Gruppo illy portfolio products reinforce the premium positioning of the customer and will increase the gap and the distinctiveness against price-competitors. While not a primary reason for the diversification, Riccardo noted that the company planned to exploit synergies throughout the value chain. These included: raw material supply; industrial processes, automation, quality control, and product development (such as frozen offerings in the coffee, chocolate, and tea product lines); logistics; and “marketing, sales, and post-sales services, particularly in knowledge transfer provided by Università del Caffè.” 28 As one sales example, he cited the sales organizations of Agrimontana and Domori, in which Agrimontana was selling Domori chocolate to its pastry chef customers, and Domori was selling the Agrimontana retail products to its customers. 28

Riccardo Illy e-mail, May 17, 2010.



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Gruppo illy planned to grow the sales of Domori Chocolate and Dammann Tea to the level of illycaffè in 20 years, “in order to produce a high level of cash flow that we could perhaps invest in the wine sector,” according to Riccardo. “The wine sector represents a return to the origins of my entrepreneurial family and to my grandfather as a farmer. It also represents the passion of my brother, mother, and father. But it is a long-term investment. I sometimes joke that it is for our grandson.” Riccardo felt that these new product areas reminded him of when he first started working for illy coffee in 1977. At that time, he felt like he was doing “missionary work.” For example, in the chocolate sector, Domori was using only Criollo cocoa and Trinitario cocoa, special high-quality cocoas. “Of course the cost is higher,” he said. “So our sales prices are higher, but we have to convince people through tasting sessions and training sessions.” THE FUTURE The Illy brothers, and their family, had helped to build illycaffè from a small business to a worldwide enterprise with multiple product areas beyond coffee. They now looked forward to the challenge of taking the company to a new level by growing their recently acquired brands. They saw a growing global market for premium coffee, which they considered themselves well positioned to address. The biggest risks appeared to be in the supply chain, due to the limited production of coffee beans that met their quality standards. Another risk was in the market for measured serving pods and machines, as described previously. Illycaffè hoped that no closed, proprietary system would dominate the industry. The newly acquired brands faced the challenges of growing beyond their extremely small size, in the face of competition. In a competitive market, it might be difficult for small brands to be noticed by consumers. However, illy had succeeded in meeting this challenge with coffee, and looked forward to overcoming it with its new products. Despite all of these different challenges, they looked forward to the future, a future where they hoped that quality and the perfect cup of espresso would prevail, and that quality could be successfully transferred to other products.



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Exhibit 1 illycaffè Mission, Values, and Vision (as Stated on the illy Website)

Mission Thanks to our enthusiasm, teamwork and values, we aim to delight people all over the world who value the 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. Values Seeking perfection is our main value. It is expressed in two cornerstones: passion for excellence, meaning love for beauty and well done, and ethics, meaning long term value building through sustainability, transparency, and people development. We wish to improve our stakeholders' quality of life driven by our passion for everything we do. Vision 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.

Source: Verbatim text from Illy website, “Mission, Vision, and Values,” http://www.illy.com/wps/wcm/connect/us/illy/about-illy/mission-vision-and-values/ (accessed June 8, 2010).



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Exhibit 2 Biographical Sketches of Riccardo and Andrea Illy Riccardo Illy, Chairman Gruppo illy SpA and vice-chairman illycaffè SpA Riccardo Illy joined the family firm in 1977. In his position as sales director Italy, he developed the marketing and public relations activity and produced the first important advertising campaigns to receive international recognition. In the second half of the 1980s, he began the development in the foodstuffs and office sectors. Subsequently, he held the post of international sales director and re-organized the structure of the subsidiary companies. In 1992, he became managing director, becoming vice-president in1995. He has been chairman of Gruppo illy since 2004. In 1993, he entered politics. From 1993 to 2000, he was mayor of Trieste, and in 2001 was elected MP in the Italian Parliament. From 2003 to 2008, he served as president of the regional government of Friuli-Venezia Giulia. In 2004, he was elected president of the Assembly of the European Regions. He has served in other civic organizations, and been the recipient of numerous honors. Andrea Illy, Chairman and CEO of illycaffe SpA Andrea Illy graduated in chemistry from the University of Trieste. He joined the family company in 1990 as the supervisor of the quality control department. He was appointed CEO in 1994, and chairman in 2005. He is the author of books detailing the scientific and technical aspects of the coffee business, and served in executive positions on scientific committees and organizations related to coffee and other food products. He has also been given awards for marketing and business excellence.

Sources: Riccardo Illy: Stanford Graduate School of Business website, “Executive Circle Summit,” http://www.gsb.stanford.edu/exed/executivecircle/faculty.html (accessed June 8, 2010). Andrea Illy: illycaffè.



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Exhibit 3 History of illy Coffee 1933: Francesco Illy founded the company in Trieste. 1935: Francesco Illy designed and patented both the “illetta,” the predecessor of modern espresso coffee machines, and pressurization, a revolutionary system for preserving the blend, which allowed coffee to be shipped right across Italy way back in the thirties. 1939: illycaffè introduced the espresso culture to Northern Europe. Holland and Sweden were the first countries to discover the aroma and delight of concentrated coffee in a small cup. 1947: The arrival in the company of Francesco’s son, Ernesto, a chemistry graduate, strengthened its passion for science and technology and alliances were set up with other businesses, science centers and universities. 1957: The can manufacturing unit was built, so that the preservation of the coffee aroma and flavor was also directly controlled and guaranteed by the company. The company's first chemistry laboratory was also established, as well as the initial production of coffee for home consumption in smaller-sized, round cans of ground illy coffee. 1965: The company moved to its current Trieste headquarters in Via Flavia, which houses the chemistry laboratory, the production of coffee and packaging materials and the packaging process. 1974: illycaffè was the first company in the world to produce portioned coffee servings – individual coffee pods for preparing café-quality coffee at home or in the office in the simplest, safest and quickest way. 1988: illycaffè patented the digital sorting machine, which guarantees bean perfection by “photographing” their shape and color. 1991: The designer Matteo Thun created the signature white illy espresso cup based on an idea by Francesco Illy, a synthesis of beauty and functionality. In this same year, the Brazil Award was instituted to reward, on a yearly basis, the Brazilian coffee growers who produce the best quality green coffee. A quality control laboratory, Assicafè, was also established in Brazil. 1992: The first series of illy collection cups was produced. 1996: The current illy logo – a red square with the brand name written in four soft white brushstrokes – was designed by artist James Rosenquist. 1998: illycaffè founded AromaLab in the Area Science Park in Trieste, where the individual aromas making up the flavor of coffee are identified, studied and mapped. 2000: The University of Coffee was founded, a place where baristas and coffee lovers learn the



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art and culture of coffee, from bean to cup. 2002: The In Principio project, the collaboration between illycaffè and the photographer Sebastião Salgado, began in Brazil. It then went on to cover India, Ethiopia and other coffeeproducing countries. 2003: The “illy bar” concept, a chain of Italian-style illy cafés, was established. By the end of 2005 there were 50 in Italy and over 130 in seven countries worldwide, now known as “espressamente illy.” 2006-2007: After the coffee serving and the E.S.E system, an innovative new system Metodo iperEspresso was launched for preparing "next generation" café quality espresso at home or at the workplace. 2007: The Artisti del Gusto program is launched to create an international network dedicated to helping the best coffee shops expand and enhance their professional competence. By 2010, this program had involved more than 1,000 shops worldwide. 2008: illycaffè launches a ready to drink canned coffee, cappuccino and latte to drink cold, called “illy issimo,” in a joint venture with the Coca Cola Company. 2010: Mitaca is born. It is a joint venture between illycaffé and Itaca and it is aimed at producing capsules and machines for the Office Coffee Service. A brand new plant is opened close to Milan.

Source: Illy website, “The History of illycaffè,” http://www.illy.com/wps/wcm/connect/us/illy/aboutilly/traditions/the-history-of-illycaffe/, (accessed June 8, 2010). E-mail communication, July 1, 2010.



Exhibit 4 Gruppo illy SpA Revenue (Euros)

Source: Gruppo illy SpA.


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Exhibit 5 Strategic Acquisitions I. Domori a. Innovation i. Botanic: Clones selection to save and re-launch the rarest and finest varieties of cacao (such as criollo), close to extinction ii. Process: use of machines projected for the scope (to preserve in the chocolate bar the highest possible aroma profile deriving from the aromatic cocoa) such as the ball mill b. Experience i. Use of processes (i.e. roasting at lower temperatures) for a “mild” processing of the cocoa in order to keep a wider spectrum of aromas c. Attention for the aesthetic i. New logo, new corporate image and new packaging II. Agrimontana a. Innovation i. Candied chestnuts are packaged in modified atmosphere for a longer shelf life of the product and a softer structure of the chestnuts ii. Candied fruits are packaged with an “ad hoc” pasteurization in order to preserve the authentic taste and colors of the fruits with no need to use any artificial preservative b. Experience i. Traditional way of cooking (long-lasting), selection, and handmade candying in order to guarantee the correct absorption of sugars and the highest consistency in size and quality of the candied chestnuts c. Attention for the aesthetic d. New logo, new packaging III. Dammann a. Innovation i. Creation, in the mid 1980s (in cooperation with a Japanese engineer) of the “sachet crystal,” a filter made of nylon, smooth as silk, that with its elasticity, allows the expansion of the leaves that can in this way spread all the beauty and intense aromas in the cup b. Experience i. Use of exclusively natural processes in the aromatization of teas (i.e. dried flowers, petals, essential oils) for a result that turns into a natural, longlasting and well-balanced taste between fruit and tea c. Attention for the Aesthetic i. Packaging is part of the product. In the flagship store in Places des Vosges, Paris, the architecture and furnishing are an integral part of the tasting experience you can enjoy inside Source: Gruppo illy SpA.


Elli

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