Pod of Gold

  • Guido Krzikowski / Bloomberg / Getty Images

    A wall of Nespresso coffee capsules is seen in one of the company's shops in Munich. Each color represents a different brew

    Mike Radlauer stumbled across the Nespresso machine during a demonstration in a gourmet shop in SoHo in New York City. The customer next to him was rhapsodizing. "She said, 'Tomás just loves the crema,'" he recalls. "I had no idea what she was talking about, but I said to myself, Hell, if the crema is good enough for Tomás, it's good enough for me." (Crema, by the way, is the tan foam that floats atop a well-made espresso.)

    Count Radlauer as another Nespresso convert. He now pops at least one 55 cents single-serving espresso pod into his machine every day. "The price of the pods is ridiculous, but it's still the best contraption I've ever bought," says Radlauer, a New York City software developer. "Fifteen seconds, and you've got as close to a barista espresso as you can get at home."

    That, in a demitasse, explains Nestlé's remarkable patented crema-crankin' money machine — fast, tasty, idiotproof espresso under a generous layer of marketing froth to make the steep prices seem less daunting. How steep? At 55 cents for a 4-g capsule, Nespresso coffee works out to a nerve-jangling $62 per lb. ($137 per kg).

    The result is that Nespresso now dominates the fastest-growing part of the global coffee industry: single-serving coffee made at home, whose worldwide sales are up an average of 28.6% a year, compared with 5.9% for drip. In Nespresso's stronghold of Western Europe, its pods account for only 1% of total fresh-coffee volume but 7% of its $11 billion value, according to Euromonitor International. Nestlé doesn't break out profits, but a former executive puts gross margins at about 85%, compared with 40% to 50% for regular drip-coffee brands.

    Nespresso's hefty markup doesn't seem to bother its fans, who can go pretty gaga over a cuppa joe. "I bow down to the artists in Switzerland!" wrote Berlin's Bianca Melanie Jahn on Nespresso's Facebook page when the brand hit 500,000 friends. Nespresso says raves like that from its 7 million customers generate half its sales. For the past decade, the brand has grown an average of 30% a year, steaming straight through the recession. Sales in 2010 were expected to exceed $3 billion, making it Nestlé's fastest-growing brand.

    There are other single-serving coffee makers, of course, but so far, Nespresso has enjoyed a comfortable lock on the top end of the market, where the big profits are. The machines, licensed to several small-appliance manufacturers, start at about $130, but even the much pricier models don't make much money for anybody. Their niftiest feature — for Nestlé, that is — is that they accept only Nespresso capsules.

    It's the classic razor/razor-blade business model. Nespresso calls its captive audience "club members," and it lavishes perks on them accordingly. Capsules can be delivered by courier within 24 hours — at no extra charge for sizable orders. Liveried personnel in Nespresso's 220 jewel-box boutiques around the world offer customers a monogrammed china cup of the company's latest exotic blend, or grand cru in Nespresso's flowery winespeak. At the Nespresso store on Paris' elegant rue du Bac, there's almost always a long line to buy capsules, and no one looks remotely grumpy about it. But the fact is, they've got no choice; it's Nespresso or nothing.

    At least it was until recently. Since last summer, two competitors have been trying to rattle Nespresso's gilded cage. There will undoubtedly be others leading up to 2012, when Nespresso's daunting 1,700 patents begin to run out.

    Giant Sara Lee, which makes the mass-market Senseo single-serving system, and a small Swiss-based outfit, Ethical Coffee Co., have brought out Nespresso-compatible capsules that sell for a quarter to a third less than Nespresso's. Nespresso promptly sued for intellectual-property infringement. "We don't mind competition — we counted 31 competitors at the end of last year — but when someone comes into your home and uses your bathtub, you are certainly going to say, 'Hold on! That's my bathtub!'" says Richard Girardot, Nespresso's chief executive.

    It particularly galls Nestlé that one of the intruders built the bathtub in the first place. Ethical Coffee's Jean-Paul Gaillard was Nespresso's CEO and spent 10 years tending the product's transformation from unloved start-up to Nestlé's crown jewel. "However much they loved me back then, I understand, that's how much they hate me now," says Gaillard, who has recently been working out of an office in Lausanne, Switzerland, with no name on the door and the curtains drawn.

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