Sustainable Values Combined with Market Tools: A Future for Specialty Coffee

Photo by Travis ModisetteSCAA

by Chad Trewick of the SCAA Board and INTL FCStone

Today, more than ever, with the increasing volatility of the coffee market and our growing understanding of the challenges faced by our partners at origin, we must seek the next level of mutually beneficial commercial relationships as we buy our green coffee.

Too often, because of limited understanding of how we can more positively contribute at origin, our sourcing behaviors result in the need for corporately driven charities and organizations. These efforts are designed to help address the hardships we know of in coffee producing communities at the beginning of our supply chain. More than 20 years of experience in our industry working to understand a wide range of stakeholders — from farm to boardroom — leads me to believe this stems from relatively little understanding of the true economics of coffee production. And, because that information is difficult to ascertain and study through validated and trusted means, it is easier and more practical for coffee companies to create and support charities, programs, and projects than it is to understand the economics of their raw material. Even though we may be beginning to understand the unsustainability of supporting a cycle of poverty and charity dependence in our value chain, we lack critical information today, making it seem impossible to pay a price based on production economics that would ensure an ongoing supply of green coffee and support the livelihoods at the start of our supply chain.

Simply put, we want the businesses that support the livelihoods of the people who produce coffee to thrive. Yet most coffee companies themselves are neither prepared nor responsive enough to efficiently accommodate revised costs for raw materials without causing irreparable damage to themselves, or even jeopardizing the livelihoods they hope to support. This creates the impression that many coffee companies are unable or unwilling to understand the true economics of the production of the raw material they require. And without accurate information on which to base important business-guiding decisions, the industry’s purchasing behaviors have struggled to evolve.

So, what do we do? We need to pursue two simultaneous strategies. Coffee companies are not willfully blind to the economic challenges in the value chain, they simply lack information that could expand the value assigned to the raw material within their business models. Strategy one is to prioritize the gathering of information about coffee production economics. Second, we must confront what is our nascent understanding of different market tools that exist to provide opportunity for more economic benefit. When market tools are considered an “insurance policy,” to help limit volatility and potentially access improved economics for our entire value chain, we can begin to see their potential. Both concepts are intimidating propositions for how they will change our businesses, but increased volatility of the market and the economic hardship often faced by our origin partners merit a pragmatic response that will lead to new behaviors deeper thinking in our industry.

Step 1: Understand Coffee Production Economics

Information circulates about what the cost of production is in various origins today, but there is little trust surrounding those figures. As an industry — and particularly as a specialty industry whose existence depends on a differentiated, high-quality product — it behooves us to improve our understanding of what it will take to maintain future supply.

We need a meaningful and validated study of the economics of coffee production coming from various key origins and, further, the regions within those origins. As our collective understanding of these economic equations broadens, we can begin to examine how we may need to evolve our business models. A critical part of that work will be to increase consumer perception of the value of coffee to ensure customers support necessary changes in our value chain — i.e., potentially having to pay higher retail prices — by continuing to celebrate quality and building understanding of what it should cost.

As we do this, we need to continuously remind ourselves that the information we are seeking should be used to evolve our businesses in order to maintain access to the raw material we depend on. Without addressing the fundamental economic challenges on the supply side of our value chain, we will have to sit by and watch as more and more farmers from upcoming generations flee coffee production in search of more lucrative opportunities, thereby further jeopardizing our access to supply.

The chart below illustrates the slow increase in the value of green coffee traded over the past generation. Due to averaging prices over entire decades, the pricing for green coffee appears much smoother than it felt in reality, but the important fact here is that over the course of the past 35 years, the costs of basic household goods — using U.S. prices — have increased much more steadily than the value of green coffee, indicating increased hardship for livelihoods supported solely by coffee farming. It is important to note that the average price for roasted and ground coffee has exponentially increased beyond that of green coffee.

While the coffee industry must encourage and support the study of this critical information for our value chain — it is presently being discussed within the Specialty Coffee Association of America and its Sustainability Council — those on the consuming or roasting end of the value chain must begin to ask suppliers and partners for this critical economic information. We need to collectively demonstrate an appetite for the facts and a willingness to evolve.

Step 2: Understand the Too-Often Dreaded Commodities Market

Another viable and already tenable strategy for us to pursue, as we wait for studies on the economics of coffee production, is the use of financial hedging tools that can help us withstand the increasing volatility of the market that trades our raw material. See the below chart, which captures the volatility of the coffee market for the past five years:

It is important to remember that the answer to the challenges we face in our value chain is not as simple as just paying prices that take into account the cost of production in an educated way. We have nearly an entire generation’s worth of damage to undo related to how coffee has been commercialized, so we should use what tools we can to create more economic resilience to make up for lost time. When averaged out to smooth volatility, coffee off the farm trades at levels roughly around those of the 1970s. How much more is a bag of fertilizer? A gallon of gas? An education? A house? Considering this, how can we blame our partners at origin when they default on contracts in favor of higher prices when the market will bear them? The pent up demand has led, in some cases, to poor decisions that can seem to convey a lack of producer loyalty. But those of us on the consumer side need to remember that conditions have been desperate for producers. Debts are high. And, in most cases, we have a disaggregated smallholder population that lacks the financial resources to manage. The result is a need for widespread strengthening of financial literacy for so many of our farmer partners.

To ensure longevity, we need to educate our entire value chain on how to use the commodities market and the tools it offers in ways that extend options for producers to hop back into the market when higher prices on the exchange arise within the timeframes defined in their contracts — even if that means contracts are structured in a way that says the roaster will pay for these tools. Conversely, roasters can use instruments that will allow them to enjoy a similar benefit from downward trends in the exchange price. By educating our industry on how to use the tools the market can offer as “insurance,” and then encouraging their adoption in future contracts, we can better safeguard the interests of both parties.

Many of the market tools we can apply will expire before they reach a value at which the volatility they protect against does not occur, but investing in an “insurance policy,” can greatly reduce the risk that producers will default when the market rallies. Again, think about the economic situation for most producers and try to empathize with the tendency. Similar tools provide a type of insurance that can allow coffee roasters to ride the market to lower levels in a downward trend to capitalize on lower fixations without compromising the price they pay their suppliers. It’s complicated, but these tools are important for us to understand. When this market jargon is articulated in ways that illuminate paths to navigate today’s market volatility, and sometimes even be used for gains across the value chain, it should be compelling.

A Future for Specialty Coffee

As a specialty coffee industry, we’ve worked for more than 30 years toward the appreciation and connoisseurship of this product, yet we’ve only just started to understand how to evolve the system of commercialization to ensure that prized coffees will exist in the future. Certification schemes that introduce environmental and social criteria and monitor trade and minimum pricing structures have taken hold in a meaningful way and are having a positive impact, but there is much more we can do to improve the economic resilience of our entire value chain by using the tools the market has to offer.

The generation of farmers now approaching retirement age rode what has generally been a downward slide in coffee’s value — certainly in relation to their cost of living. And many, if not most, recall the earning potential that once existed in coffee. Their kids, however, who should be starting to take over farm management, too often can’t be persuaded to stay in the line of work they have watched their parents struggle through for most their lives. In some cases, growing up in the midst of coffee farming has limited their opportunities. This is especially true in countries where economies are developing and other income-earning options are emerging. Ric Rhinehart, executive director of the Specialty Coffee Association of America, reminds us often that we need to seek opportunities for our supply partners to thrive, not just survive, if we are going to have a hope of maintaining access to a differentiated supply for our industry.

In Costa Rica, where it has been hard for years to attract laborers for coffee, and where alternative opportunities exist as their economy develops, coffee is on a fast track to becoming a wealthy farmer’s hobby, provided said farmers find a market for the surely high-priced produce they will have after others have gone — that is if housing developments don’t replace all of the coffee in the country first. In Colombia, where the average age of a coffee farmer is approaching 60, the Federación Nacional de Cafeteros has tried with little success to woo younger farmers into coffee. Again, how can we blame this next generation when we know the challenges they have faced already in their lifetimes?

An enormous challenge lies ahead for us in the coffee industry. A large part of it involves learning and absorbing new information to ensure our future viability. The most difficult part is going to be to accommodate the need for change, and then acting with meaningful and revolutionary actions that safeguard a more comprehensive and shared value chain. Since we are an industry that is so connected to our product and its storied supply lines, I am certain we will find our way forward.