Can a Nespresso Coffee Capsule indicate that the US Dollar is overhyped?
Deep-diving into the economics behind Nespresso capsules. Can they get you more than just caffeinated?
I had two types of motivation to research and create the Nespresso Index.
- To find where in the world one can find more affordable pods or capsules for the machine
- To understand whether I can derive interesting financial indicators from the variations in Nespresso capsule prices around the globe
Spoiler alerts: I now know where you can find the cheapest pods in the world. Nespresso fans traveling to any one of a specific set of countries can save a ton of money. You just need to know where to go.
More importantly, (well, depending for who), I discovered that the Nespresso Index¹ can be used as an interesting financial indicator. I’m not an economist by any means, but you are welcomed to follow my thinking process for more on this.
But first, some background.
The price difference in Nespresso pods
Nespresso is a coffee brand owned by Nestlé Nespresso S.A, which in turn is owned by the Lausanne, Switzerland based Nestlé Group. It was launched in 1986 and is marketed in at least 76 countries where the company is formally selling its coffee.
While also manufacturing coffee machines (in collaboration with home appliance makers such as Krups, Breville and DeLonghi), the vast majority of the company’s revenue and its business model are dependent on selling of coffee pods or capsules. While under patent, Nespresso could exclusively sell coffee pods for its machines, thus holding a de-facto monopoly on this defined market, since the expiration of Nespresso’s patent in selected markets, competitor manufacturers sell compatible pods that can be used on Nespresso’s machines.
Nespresso is selling dozens of pods in various degrees of strength, flavors and sizes. Recently, a new “protected” and, again, patent protected type of pod hit the market, that is available for a new line of Nespresso machines.
Nespresso pods sell in various prices in each market according to variables set by the company, but more importantly, prices vary very significantly across markets.
For example, one of the company’s best selling pods, Arpeggio, which contains intense and creamy coffee, is sold non-discounted in the US for $0.70. In France, the same pod goes for $0.4. That’s almost a staggering half price.
What stands behind the price difference for a similar product? Can changes in demand explain the difference? Are costs of selling in selected markets, taxation laws and transportation costs make up for such a huge difference? Possibly.
However, comparing the price of an identical product in different markets, opens an opportunity to index the difference and to measure purchasing power parity (PPP) between different markets across the globe.
Can Burgers predict a country’s purchasing power?
A very well known index for purchasing power parity is the Big Mac Index, created by the Economist in 1986. It serves as a way of measuring the PPP between two currencies and provide a tool to test if changes in exchange rate provide enough reasoning to explain difference in goods pricing in different markets. The goods chosen to be at the heart of the index is McDonald’s landmark burger, the Big Mac, which is sold in billions across the globe.
How is the Big Mac index calculated?
The basic calculation, which is good enough for the sake of this project, is to divide the price of 1 Big Mac in two markets in their respective currencies. Later, you compare the result with the exchange rate between the two currencies. According to Purchasing Power Parity theory, if the value is lower than the exchange rate, than the currency is undervalued. If it is the opposite, the currency is over-valued.
Let’s follow this calculation with a quick example.
According to the Economist’s research on January 15, 2020, a Big Mac in the UK goes for 3.39 GBP, while a Big Mac in the US goes for $5.67. Dividing 3.39 in 5.67, gives a calculated exchange rate of 0.60, which the actual exchange rate at the time was 0.77, yielding that the British Pound is undervalued by 22% according to that theory.
What’s even more interesting, is to measure the ratio between the real exchange rate and the Big Mac exchange rate over time, and data suggest that between 2000–2010, the British Pound was actually over-valued to the USD, and only at 2010 it became under-valued to it (a trend that started sometime at 2008).
The coffee lovers guide to whether currencies are at their right level is a fun tool. It can be used to bring up discussion about the differences in coffee prices around the world. It can also be used to save you some money if you travel abroad and want to stock up on Nespresso capsules. Can it be used for more than that?
Can Nespresso’s coffee pods be used in the same way as Big Macs?
Drinking too much of Nespresso’s coffee won’t get you obese, though it may get you over caffeinated, and in some markets, it may cost quite a lot. However, they are also good candidates to create a PPP research, as they are sold globally, and are 100% comparable, as in the product is exactly the same, they are sold in the same quantities, with a similar packaging, and with similar marketing methods.
To create this research, I have collected data from the 70+ markets operated by Nespresso. The data source was Nespresso’s different regional websites, and while one can get volume discounts on coffee, the base prices I assumed are the original pod prices for each flavor.
To avoid miscalculations I used the Arpeggio capsule as the basic goods for the comparison. While Nespresso markets different capsules in each country, I found that the basic Arpeggio (along with a very few others) are sold in each and every market.
I calculated the item price (in local currency) for each market and created a chart with the calculated or forecasted exchange rate according to the Nespresso Index. Comparing that to the Actual exchange rate yielded some interesting results.
For example, an Arpeggio pod in the UK goes for 0.36 British Pounds. The same pod in the United States costs $0.70. Dividing the prices yield a forecasted exchange rate of ~0.51. The actual exchange rate is actually the opposite, it is about 0.81, suggesting the British Pound is 36.8% undervalued at the time of writing.
Just 3 months ago, pre COVID times, UK prices for coffee pods were slightly lower, with Arpeggio going for 0.34 British Pounds. The same pod in the US went for $0.70 like its current price. Dividing the prices yielded a forecasted exchange rate of ~0.49, While the actual exchange rate back then was about 0.78, suggesting the British Pound was 36.6% undervalued at the time of writing.
So what happened was that prices increased in the UK, while the actual value of GBP went down against the USD (meaning, you need more USDs now, to buy GBP). This evened out for purchasing power, leaving the PPP index about the same. Both before and after the price change, factoring for actual exchange rate change, the British Pound is about 36.6–36.8% undervalued to the USD. I believe that this reinforces the model.
Do burgers and coffee go hand in hand?
The question arises if one can, at all, use Nespresso capsules just like you would use the Big Mac as an index for PPP.
Lets consider the advantages of using Nespresso capsules:
- Global scope — Nespresso is sold in an impressive range of more than 70 countries. While Mcdonald’s do operate in more markets, the difference is insignificant. In fact, Nespresso markets its pods in markets that constitute 99% of the world’s population.
- Basic Item Distinction — Very much like the Big Mac, the Nespresso capsule, and especially if one chooses to research a basic capsule such as the Arpeggio (as we did) or the Ristretto, are identical all over the world and in all markets. They all look the same, taste the same and are sold in the same channels (online or in physical stores) and in the same packaging (10 capsule sleeves) .
Moreover, unlike the Big Mac which is prepared in each every country, All Nespresso coffee is roasted, ground and encapsulated in one of three factories in Switzerland (Avenches, Orbe & Romont). In fact, this makes the product even more comparable than the Big Mac. - Units sold — While the selling numbers aren’t public, it was estimated that More than half a billion Big Macs were sold globally in 2015. Nestlé does not report on its Nespresso business separately, however it did report more than 12 Billion USD of revenue on its “other” businesses which include Nespresso, and the Nestlé Health Sciences and Nestlé Skin Health units. If we modestly estimate that Nespresso accounts for 25% of the ‘other’ number, we get more than 3 Billion Dollar, the vast majority of which is attributed to coffee capsules. A very conservative estimate would be anywhere between 1.5–2.5 Billion capsules (of all ranges) globally sold in a year.
Whatever the number is, it is significant enough. Even if eventually smaller by a magnitude of order than the number of Big Macs sold, it is sufficient for our project.
On the flipside, Let’s consider some of the drawbacks of using Nespresso to index PPP:
- Market type — (or: perceived levels of premiumness) Unlike the Big Mac which is considered a common product, Nespresso do brand their product as “an affordable luxury product”. If that is the case, it may constitute a problem for the index. Nespresso capsules are indeed more expansive than their competition (whether in the Capsule coffee market specifically or the home coffee market as a whole), and thus aim for a more affluent target audience, thus skewing the index.
However, a similar remark can be made about certain McDonald’s markets. In some countries, such as the US, the Big Mac is mainly seen a poor man’s meal (though it’s hard to make such inclusions). In other markets, mainly poorer like Mexico or Indonesia, it is more consumed by higher social classes and tourists. - Product complexity — Nespresso capsules (not accounting for packaging, marketing, freight costs and sales costs) contain, well, just coffee. Unlike the Big Mac, which contains the bun, a sauce, meat and vegetables. One can argue that the more complex a product, and if it is obtained from different sources and origins, it can better reflect on local prices.
- Product origin — While I mentioned this also on the advantages list, one must admit that a product that is manufactured in a single market (Switzerland in this case) and is transported to all parts of the world, may also skew the index.
Unlike the Big Mac Index and our Nespresso Index, the OECD uses a basket of more than 3,000 products to calculate PPP. This allows countries to identify goods and services which are representative of their domestic expenditures. - Pricing strategy and identity of seller — Unlike McDonald’s, Nespresso does not franchise or operate through third-parties in the vast majority of the world. As a rule of thumb, Nespresso owns directly, or through its subsidiaries, the business in all markets, and thus, also sets the pricing of its products.
McDonald’s operate both locally and globally via a franchise system and directly to consumer. It is not uncommon to find two nearby branches selling McDonald’s items in different pricing.
Whether or not this works better as an indicator for PPP is up for debate.
Possible causes of difference in pricing
While this is not the place to deep dive into pricing theory, we can speculate why Nespresso pricing differs so much between markets, even ones with similar characteristics.
As all capsules are manufactured in Switzerland (with the capsule cases manufactured in the Netherlands), some of the major contributors to the pricing differences are transportation costs and import Tariffs. This leads to an expected cheaper pricing in countries which are nearer and have free trade agreements with Switzerland, and may explain why the relative pricing of Capsules in France, for example, is so low.
Turkey, on the other hand, is a relatively close country (1,100 miles / 1,700 km), but far more expansive in Nespresso terms, than Colombia (5,650 miles / 9,050 km). So, other factors like regular economic market behavior, local demand and labor costs come into play.
Comparing the results of the Big Mac Index and the Nespresso Index
When looking broadly at the data, it is very apparent that on the January edition of the Big Mac Index, most of the currencies in the world seem significantly undervalued to the US Dollar (all, actually, except the Swiss and Norway currencies).
When comparing to the EURO, more currencies seems to be overvalued on the Big Mac index to the Euro, namely the currencies of Switzerland, Norway, the USA, Sweden, Canada, Israel, Brazil and Uruguay.
The Nespresso Index, also finds the vast majority of the currencies undervalued to the USD, but indicated different rates of overvaluation and different currencies which are marked as overvalued (with Lebanon, Egypt and Jordan that seem to be the with the higher values of discrepancy to their official exchange rates with the USD).
Very few currencies are undervalued to the EURO according to the Nespresso Index, and none very significantly as of January 2020. On the contrary, many currencies seem to be very overvalued to the EURO according to the Index.
One can definitely hypothesize that it relates to the eurocentricity of Nespresso, and because we don’t have this data over time yet, we can’t see if it relates to other contributors. I will try to gather more data over time to see if this trend continues.
The Nespresso Index is more of a though exercise or a mind experiment. It can’t be taken as a serious financial indicator, mainly because of its lack of broadness. The same reasoning can be applied to the Big Mac index, however the latter contains more years of data so it has an extra axis of data to review and analyze.
Should you buy Nespresso capsules abroad?
Well, that mainly depends on where you are, and where you are heading. Traveling specifically for the sake of self importing Nespresso capsules can be border-line in terms of profitability.
Arpeggio capsules cost $0.11 less in Canada, compared to the US, for example. If a family of 4 consumes 6 capsules a day for a year, or about 2,200 capsules annually, one may save $242 by going across the border and self-importing the coffee. However, bringing so much coffee across the boarder may require duty payments, especially if you are going to stay in Canada for less than 48 hours. Also, you need to account for Fuel and other travel expanses.
Overall, unless you are traveling to Canada for different reasons, and want to bring back a lower than tax-worthy amount of Nespresso capsules, it might not make sense to bother.
When does it make sense? If you live in an expensive Nespresso country (say, the United States, Japan or Lebanon) and travel to a very inexpensive country (say, any country in the European Union). You savings can be huge.
For example, a Lebanese visiting France, can bring back just 20 sleeves of Arpeggio and save more than a $100.
Playing with the data may save you a few dollars eventually, or just lead to an interesting conversation over a cup of Nespresso or (any other brand) of coffee.
[1] I should probably add like a million of disclaimers here, saying that I’m not affiliated, connected to, endorsing or am endorsed by Nespresso or Nestlé or anyone even remotely connected to them. This project was done because I found it interesting and no other reason. I gain no financial incentive from making this, publishing this article or the project, and this is strictly for fun. All the information gathered while working on this project was correct as of January 2020, and while I do update the data, I can’t vouch for its accuracy. Please make informed decisions before you make any type of purchase, and while I love drinking coffee, drink it responsibly, as it does contain Caffeine.