The coming specialty coffee supply crisis
How re-incentivizing the value chain can help mitigate the threat
A value chain analysis of the specialty coffee trade
(Resumen ejecutivo en español)
Master of International Business Thesis
Submitted by Hayden B. Kwast
August 2010
© 2010
Hayden B. Kwast
ALL RIGHTS RESERVED
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Abstract
Hayden B. Kwast: The Coming Specialty Coffee Supply Crisis, How re-incentivizing the
value chain can mitigate the threat, A value chain analysis of the coffee trade
(Under the direction of Laurent Jacque)
Specialty coffee in the United States has grown from an $8 billion sales industry in
2001 to $13.6 billion in 2008 and is expected to top $18 billion by the end of 2012.
Sustained growth in demand for specialty coffee at first appears as a positive sign for the
industry. But, as specialty coffee consumption grows in the mainstream, demand is
expected to outpace supply, which is more reason for concern than optimism. This
indicates that there are miss-incentives to produce specialty coffee somewhere along the
value chain. Can a re-orientation of the specialty coffee value-chain help incentivize coffee
producers to invest in higher quality coffee and meet growth in consumer demand?
This study examines recent and forecasted growth in the specialty coffee industry,
assesses research and successful case studies on value-added value chains, and then
reports on over twenty-five interviews conducted with organizations along the specialty
coffee value chain to identify the most critical gaps in efficiency and risk exposure. To help
illustrate the gaps in the value chain system, a system model is specified and analyzed.
Finally, from the results of the research, interviews and analyses, recommendations are
made as to how a new look at the specialty coffee value chain can help mitigate a possible
coming supply crisis.
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Acknowledgements
This study would not have been possible without the invaluable support and insight
from professors and research institutions at The Fletcher School, as well as professionals
within the coffee trade, including farmers, farmer associations, exporters, importers,
roasters, coffee shop owners, NGOs, certifiers and trade associations. It was a pleasure
working with all of you.
In particular, I thank my advisor, Laurent Jacque, The Walter B. Wriston Professor of
International Business, as well as the Center for Emerging Market Enterprises (CEME) at
The Fletcher School, Tufts University. My thanks also go out to those in the coffee business
that participated in this study and candidly shared their passion for all that is good in the
coffee trade and all that could be better. Finally, I appreciate and thank PJ Lamberson,
Visiting Assistant Professor at the MIT Sloan School of Management, for his contribution.
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Table of Contents
I. Executive summary
Resumen Ejecutivo (Spanish Translation)
II. Introduction
III. State of the specialty coffee market
IV. Specialty value chain trends and research
V. Specialty coffee value chain interview results
Producers
Exporters
Importers
Roasters
Industry views on value chain gaps
VI. Value chain system analysis
VII. Modeling the value chain system
VIII. Conclusions and Recommendations
Specialty coffee current growth trajectory
Target growth trajectory
How to achieve the target growth trajectory
Where the change is needed
IX. Appendix
Companies and individuals interviewed
Consolidated interview results
Works Cited
Page
6
9
13
15
19
24
34
41
49
54
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I. Executive Summary
Specialty coffee 1 in the United States has grown from an $8 billion sales industry in
2001 to $13.6 billion in 2008 and is expected to top $18 billion by the end of 2012.
Sustained growth in demand for specialty coffee at first appears as a positive sign for the
industry. But, as specialty coffee consumption grows in the mainstream, demand is
expected to outpace supply, which is more reason for concern than optimism. This
indicates that there are miss-incentives to produce specialty coffee somewhere along the
value chain. Can a re-orientation of the specialty coffee value-chain help incentivize coffee
producers to invest in higher quality coffee and meet growth in consumer demand?
This study examines recent and forecasted growth in the specialty coffee industry,
assesses research and successful case studies on value-added value chains, and then
reports on over twenty-five interviews conducted with organizations along the specialty
coffee value chain to identify the most critical gaps in efficiency and risk exposure. To help
illustrate the gaps in the value chain system, a system model is specified and analyzed.
Finally, from the results of the research, interviews and analyses, recommendations are
made as to how a new look at the specialty coffee value chain can help mitigate a possible
coming supply crisis.
The motivation for studying supply chains as value chains is to identify how to
change how actors along the chain perceive relations with each other, i.e. look at how
business relations can maximize value capture collectively, rather than view business as a
zero sum game. Past research on the specialty coffee value chain has provided analyses and
recommendations that target change within certain points in the value chain, as opposed to
a complete re-configuration of the value chain. The specialty beef value chain provides a
good example of a successfully reconfigured value chain.
Interviews conducted for this study reveal that the industry perception is that a gap
between producer value capture and the remainder of the value chain is the dominant
problem facing the industry. The four most commonly cited reasons that producers do not
capture sufficient value include poor market power and access, producers are not
“Specialty” refers to any differentiated coffee product. Ways to differentiate and thus
capture more value from coffee include, but are not limited to, origin country, region,
terroir, plant varietal, and certifications, such as Fair Trade and Organic.
1
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compensated commensurate with the amount of risk they bear, excessive commodity, or
“C” market volatility, and current efforts to help producers are insufficient. On the other
end of the chain, interview results show there is a gap between end-consumer demand for
specialty coffee and the ability of the entire tail of the chain to meet this demand. To a
certain degree, some see the entire industry as unable to fully capitalize on the value that
could be created from consumer demand for specialty coffees. And a notable number of
actors believe that a significant problem for the entire chain is a lack of IT adaptation.
Building upon the interview results in order to pinpoint how these gaps contribute
to supply and demand disequilibrium, analysis of the value chain, supported with the
illustration of a specialty coffee value system model, shows that the specialty coffee value
chain has two key problems that stifle production while industry demand continues to
grow. First, the current value chain system is a commodity system where actors are
primarily incentivized to buy low and sell high. Such an incentive structure leaves little
value capture for the farmer, which means little value is created to put towards investment.
Second, a long delay exists between producer investment and producer payoff in specialty
coffee production and profits. On the other end of the value chain, roaster marketing and
sales continue, which fuels industry demand and overall market growth. Industry demand
for specialty coffee is growing in a cyclical, accelerating manner and thus, is outpacing
production. This could potentially lead to a supply crisis.
Two outcomes are most likely, given a supply crisis. In one scenario, roasters slow
production even though reinforcing growth circles continue to accelerate consumer
demand. This means inventories are low compared to demand and specialty coffee prices
increase, most likely beyond price inelastic levels and, as a result, the quantity demanded
decreases, which has a stagnating effect on specialty coffee business growth. In the second
and more likely scenario, roasters continue to buy green coffee to meet demand growth,
but the supply of specialty coffee does not keep pace. This means specialty coffee producers
increasingly rely on inferior coffees that tastes badly. As a result, consumers will find it
more difficult to distinguish between commercial and specialty grade coffees, the industry
will become diluted and consumers will no longer believe in the legitimacy of “specialty”
coffee. In turn, they will prefer to buy cheaper, commercial grade coffees.
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Both scenarios lead to a phenomenon called “overshoot and collapse.” Overshoot
and collapse results when reinforcing industry demand loops are not met with
commensurate supply growth. Industries or products generally follow an s-curve growth
pattern in which demand increases slowly, then accelerates and plateaus. Specialty coffee
demand is arguably in the acceleration phase, but supply is reaching a plateau. In this case,
many consumers will abandon the specialty industry all together as they become
disgruntled with the product.
This study suggests that the industry needs to move away from a coffee sourcing
system that is based on a commodity product and, in doing so, decrease the influence of “C”
market price volatility on specialty coffee prices. Reconfiguring the specialty coffee value
chain, which would encourage more investment in specialty coffee and increase specialty
coffee supply, can achieve such a change. Two steps encompass how the specialty coffee
value chain should be adjusted so that supply grows with demand:
Step 1: Identify the value creation drivers for business along the entire value chain,
effectively managing these drivers can incentivize the agents in the value chain to
work together to produce, move, and sell specialty coffee.
Step 2: Reconfigure the specialty coffee value chain around these drivers through
increased partnerships between producers, exporters, importers and roasters that
involve three components:
•
•
•
Risk sharing
Information sharing
Revenue sharing
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I. Resumen Ejecutivo
Café de especialidad 2 en los Estados Unidos ha crecido de una industria de $8 mil
millones en 2001 a $13,6 mil millones en 2008 y está previsto que supere $18 mil millones
a finales de 2012. El crecimiento sostenido de la demanda de café de especialidad en un
principio aparece como un señal positivo para la industria. Pero, como el consumo de café
de especialidad crezca en la corriente principal, se espera que la demanda supere la oferta,
lo cual es más motivo de preocupación que optimismo. Esto indica que no existen los
incentivos adecuados para producir café de especialidad en algún punto de la cadena de
valor. ¿Podría una reorientación de la cadena de valor de café de especialidad ayudar a
incentivar los productores para invertir en café de mayor calidad y satisfacer el
crecimiento de la demanda?
Este estudio provee un resumen del crecimiento reciente en la industria del café de
especialidad, evalúa las investigaciones y estudios de casos exitosos de las cadenas de
valor, y realiza más de veinticinco entrevistas con las organizaciones a lo largo de la cadena
de valor del café de especialidad para identificar las brechas más críticas en cuanto a
exposición a riesgo. Para ayudar a ilustrar las deficiencias en el sistema de cadena de valor,
se elabora y analiza un modelo del sistema. Por último, a partir de los resultados de la
investigación, entrevistas y análisis, se hacen recomendaciones a cerca de cómo un nuevo
enfoque de la cadena de valor de café de especialidad puede ayudar a mitigar la crisis de
suministro inminente.
El estudio de cadena de suministro como una cadena de valor pretende cambiar la
manera en la cual los actores perciben relaciones mutuas a lo largo de la cadena, es decir,
analiza cómo las relaciones de negocios pueden maximizar el valor capturado de forma
colectiva, en lugar de ver a la empresa como un juego de suma cero. Las investigaciones
anteriores sobre la cadena de valor de café de especialidad han proporcionado un análisis y
recomendaciones que sugieren que hacen falta cambios en ciertos puntos de la cadena de
valor, en lugar de una re-configuración completa. La cadena de valor de carne de vacuno
proporciona un buen ejemplo de una cadena de valor que ha sido reconfigurada con éxito.
“Especialidad” se refiere a cualquier producto de café diferenciado. Algunas formas de
diferenciar cafe incluyen certificaciones, el origin, la region, “terroir” y variedades.
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Las entrevistas realizadas para este estudio demuestran que la percepción de la
industria es que la diferencia entre el valor capturado por los productores y el resto de la
cadena de valor es el problema más importante enfrentando a la industria. Las cuatro
razones más mencionadas, y las que explican porque los productores no capturan
suficiente valor, son: falta de acceso al mercado, falta de compensación de acuerdo con la
cantidad de riesgo tomado, volatilidad excesiva del mercado "C" y falta de soluciones
actuales para ayudar a los productores. En el otro extremo de la cadena, las entrevistas
muestran que hay una brecha entre la demanda de los consumidores finales y la capacidad
de la cola de la cadena para satisfacer esa demanda. Algunos de los entrevistados
consideran que la industria entera es incapaz de aprovechar del valor que podría crearse a
raíz de la demanda para cafés especiales. Y un número importante de actores cree que un
problema importante para toda la cadena es la falta de adaptación de IT.
Basándose en los resultados de las entrevistas, el análisis de la cadena de valor, con
el apoyo de la ilustración de un modelo de sistema de valor del café de especialidad,
muestra que la cadena de valor del café de especialidad tiene dos problemas fundamentales
que suprimen la producción de café mientras que la demanda de la industria sigue
creciendo. En primer lugar, el sistema de cadena de valor actual es un sistema de
mercancía en donde los actores son incentivados a comprar barato y vender caro. Esta
estructura de incentivos hace que el agricultor capture poco valor, lo que significa poco
valor capturado para invertir en café de alta calidad. En segundo lugar, existe un gran
retraso en la inversión de café de especialidad. Como resultado, lo poco que invierten los
productores sufre de un retraso largo antes que la inversión de fruto. En el otro extremo de
la cadena de valor, la comercialización y las ventas continúan. Es decir, demanda de la
industria de cafés especiales está creciendo en una manera cíclica y, por lo tanto, está
superando a la producción. Es probable que esto a la larga resulte en una crisis de
abastecimiento.
Dos resultados son los más probables, dada la crisis de abastecimiento. En un
escenario, disminuirá la producción de tostadores a pesar de que los círculos de
crecimiento continuarán acelerando la demanda de los consumidores. Esto significa que los
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inventarios estarán bajos en comparación a la demanda y los precios del café de
especialidad aumentarán. Es probable que los niveles de precios se sobrepasen el precio
inelástico y, como consecuencia, disminuya la demanda, que tendría un efecto de
estancamiento general en el crecimiento del negocio de cafés especiales. En el segundo y
más probable escenario, los tostadores siguen comprando café verde para satisfacer el
crecimiento de la demanda, pero el suministro de café de especialidad no se mantiene al
ritmo. Esto significa que los tostadores de café de especialidad dependen cada vez más de
cafés de calidad y sabor inferior. Los consumidores tendrán más dificultades en distinguir
entre cafés de especialidad y cafés comerciales, la industria se diluye y los consumidores ya
no creen en la legitimidad de la "especialidad" de café. A su vez, ellos preferirán comprar
café barato y de grado comercial.
Ambos escenarios conducen a un fenómeno llamado "rebasamiento y colapso."
Rebasamiento y colapso resulta cuando la demanda sigue creciendo en una manera cíclica
mientras el abastecimiento no se mantiene a paso. Industrias y productos, por lo general,
siguen una curva de crecimiento “s” en el cual la demanda aumenta lentamente y luego se
acelera y mesetas. La demanda de café de especialidad está en la fase de aceleración, pero
la oferta está llegando a una meseta. En este caso, muchos consumidores abandonaran la
industria de especialidades porque se encontraran descontentos con el producto.
Este estudio sugiera que la industria necesita alejarse de un sistema de
abastecimiento de café que se basa en un producto mercancía y, al hacerlo, reducir la
influencia del mercado "C" y la volatilidad de los precios. Una reconfiguración de la cadena
de valor de café de especialidad puede llevar a cabo dicho cambio. Una reconfiguración
donde el productor puede capturar mas valor, fomentaría una mayor inversión en café de
especialidad y aumentaría la oferta. Dos pasos se abarcan demostrando cómo la cadena de
valor del café de especialidad debe ajustarse de manera que la oferta crezca con la
demanda:
Paso 1: Identificar los controladores de la creación de valor para los negocios a lo
largo de la cadena de valor. La gestión eficaz de estos controladores puede
incentivar la cadena de valor a trabajar juntos para producir, transportar y vender el
café de especialidad. Volver a configurar la cadena de valor alrededor de dichos
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conductores de valor incrementara la captura de valor por toda la cadena, y para
cada actor involucrado en la cadena.
Paso 2: Volver a configurar la cadena de valor de café de especialidad en torno a
estos conductores y a través de aumento de las asociaciones entre productores,
exportadores, importadores y tostadores. La nueva configuración de la cadena de
valor tiene que incluir tres componentes importantes:
• Reparto del riesgo
• Intercambio de información
• Participación en los ingresos
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II. Introduction
Sustained growth in demand for specialty coffee at first appears as a positive sign
for the industry. But, as specialty coffee consumption grows in the mainstream, demand is
expected to outpace supply, which is more reason for concern than optimism. There is
debate in the industry that the specialty coffee industry is on the verge of a growth plateau,
yet consumer demand is not the driving indicator for such speculation, instead it is a
supply- driven forecast. This means there are miss-incentives to produce specialty coffee
somewhere along the value chain.
In efficient markets, producers would have access to market information that
foresaw demand and value growth in the consumer market, and producers would make
appropriate investments in anticipation of such growth expectations. Some coffee analysts
attribute supply problems to changing weather patterns that decrease specialty coffee
yields, but available data does not indicate that weather can be the sole or primary
explanatory variable. Another explanation is that there is a limited amount of specialty
coffee production that the industry can support, but this justification seems excessively
simplistic. Closer analysis is required to help determine whether the growing
disequilibrium in specialty coffee demand and supply is a product of a miss-incentivized
value chain, an inevitable market correction, or can be blamed on bad weather.
Coffee is not the only food and beverage market that has experienced a transition
from a commodity to a value-added market in the past few decades, and meaningful
research has been done on the success drivers behind sustainable “value-added” value
chains. “Networked,” “quality focused” and “consumer-driven” value chains are a few of the
innovative terms to describe the revolution in specialty value-chains. i These changes have
been experimented with and implemented on a small scale in industries such as beef, pork,
cocoa and coffee. There are lessons to be learned from these small-scale innovative chains
that can be applied to an industry as a whole.
Can a re-orientation of the specialty coffee value-chain help incentivize coffee
producers to invest in higher quality coffee and meet growth in consumer demand? This
study defines recent and expected growth in the specialty coffee industry, assesses
research and successful case studies on value-added value chains, and then analyzes over
twenty-five interviews conducted with organizations along the specialty coffee value chain
13
to identify the most critical gaps in efficiency and risk exposure. To help illustrate the gaps
in the value chain system, a system model is specified and analyzed. Finally, from the
results of the research, interviews and analyses, recommendations are made as to how a
new look at the specialty coffee value chain can help mitigate the potential coming supply
crisis.
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III. State of the U.S. specialty coffee market
Over the past thirty years specialty coffee has grown from a niche market into an
industry with over $13 billion in sales that is forecasted to grow to $18 billion in by 2012. ii
The change is part of a greater consumer demand trend for higher quality food products
and food-chain traceability. Initially, budding demand for coffee quality and traceability
prompted trailblazing roasters and importers to take management of these coffee
attributes into their own hands, so they established “relationships” with producer groups
in coffee origin countries. Today, an industry is growing up around multiple interpretations
of the “relationship” business model.
The growth in relationship coffee has moved coffee ownership stocks from
producers to consumers. iii This means there is increasingly less stock of specialty coffee in
producer hands to meet growing consumer demand. With many specialty producers
engaged in relationship business models, there is little shared data to determine market-
based prices for specialty coffee differentials. As a result, specialty producers continue to
rely heavily on fluctuations in the commercial commodity, or “C” market to make
investment decisions.
The commercial “C” market is not an accurate measure of return on investment for
specialty production. “C” market volatility has become as much a reflection of macro
economic market pressures, investment and divestment in agriculture commodities, as it is
a function of the demand and supply of coffee. Speculative institutional investors rather
than hedgers within the coffee industry conduct over 50% of the trades on the “C” market. iv
These institutional investors conduct trades based upon movements within the funds they
manage, which presumably are made by individuals without consideration to the
fundamentals of the specialty coffee trade.
Despite the trend towards relationship coffee, a gap in value capture still exists
between the producers, exporters, importers and coffee roasters. Aggregate data on the
number of producers and the percent of their product tied to relationship models, as well
as the price they receive is not available. In turn, conclusive analysis on the impact that
relationship trade has on producer value capture, whether positive or negative, is not
possible. To better gauge the effectiveness of current value transfer efforts in the specialty
coffee trade, this study takes the pulse in the industry through dozens of interviews with
15
actors along the entire supply chain. The consensus among coffee producers, exporters,
importers and roasters is that the value gap has not changed measurably. Specialty coffee
producers who are involved in relationship model business contracts continue to shift
production to alternative crops or abandon their farms all together as emerging economies
present more lucrative job opportunities. v These counterproductive trends in specialty
coffee production persist while demand for specialty coffee continues to grow.
The Specialty Coffee Association of America has used the available raw data on
specialty coffee to extrapolate growth trends, though precise data on specialty coffee
growth trends are difficult to accurately deduce from the disaggregated specialty market
information. The key drivers that the SCAA uses to measure specialty coffee growth include
specialty green coffee imports, the value of specialty coffee sales and the number of
specialty coffee houses. Between 1991 and 2008 the number of U.S. coffee houses grew
from 1,650 to 27,715. This is a compound annual growth rate (CAGR) of 82 percent. During
this period, large chain growth was significant; still, today 53% of all coffee shops are
owned by chains of 3 or fewer stores and 60% are chains of 9 or fewer shops.
Figure 1: Estimated number of specialty coffee operating units vi
As mentioned, the current value of specialty coffee sales (retail and online) is
estimated at $13.5 billion in 2008. This grew from approximately $8.3 billion in 2001.
Today, in volume of coffee imported this equates to approximately 17% of all coffee
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imported into the United States, or 3.8 million bags/501.6 million lbs. vii Looking toward the
future, the SCAA 2009 Retailer Survey revealed that 67% of their members reported
increases in whole bean sales (online and retail) and coffeehouse sales increased 3.5% in
the last quarter of 2009. These numbers indicate sustained growth through the
recession. viii
Figure 2: Size of the U.S. specialty coffee market ($ billions) 3ix
Weather is a frequently talked about cause of a supply and demand imbalance, but
variance in overall coffee production in the past couple years has been no greater than
year-to-year variance since 2000. Global production decreased 3.9 percent from 2008 to
2009, but larger decreases in production occurred from 2002 to 2003 and 2006 to 2007,
(14.6 and 7.8 percent, respectively). And, all the while, global production increased from
2000 to 2009 at a CAGR of 28.4 percent. Arguably, specialty coffee growing regions are
more susceptible to changes in climate than are regions that specialize in commercial
coffees. Even so, as Central American yields grew only 0.75 percent in 2009, production of
Arabica beans in Africa increased by 300,000 bags. Brazil and Colombia had a bad year in
2009, yet industry experts forecast increased production in Brazil, Colombia and East
Africa in the near future. x Taking past, current and future production numbers into
3
Years 2009 to 2012 are forecasts
17
consideration, weather may well have an impact on the specialty coffee market, but
currently does not appear to be the predominant cause of the specialty supply crisis.
Increased demand for specialty coffee is not unique to the United States; coffee
demand is also growing in emerging markets as disposable income increases, which begs
the question, why are more coffee farmers not making investments in anticipation of
increased demand? One answer is that a market correction in coffee prices is needed
because producers will not make further investments until global market prices increase
enough to keep pace with or outstrip increases in costs of living. Waiting for such market
corrections to occur naturally could be lengthy and painful for the specialty coffee industry.
Furthermore, as mentioned, global commercial coffee prices are not reliable indicators of a
coffee producer’s return on investment in specialty coffee production.
An alternative solution to the possible coming specialty coffee supply crisis is to
look closely at the current specialty coffee value chain. A properly distributed value chain
should incentivize producers to make investments that are consistent with forecasted
growth in consumer demand for specialty coffee. The next section takes a closer look at
current research and case studies on specialty value chains. Then, because hard data on
drivers of specialty coffee production is sparse, the results from dozens of semi-formal
interviews with actors along the entire specialty coffee supply chain will be analyzed for
gaps in value capture and risk exposure.
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IV. Specialty value chain trends and research
Food value chains have seen innovative change over the past twenty years as
specialty markets have evolved in response to increased consumer demand for certain
attributes, particularly higher quality and food traceability. Demand for higher quality food
has grown with heightened health awareness and disposable income among the upper
middle class, while food traceability is a byproduct of increased social consciousness and
concerns over food security. An overview of value chain and value chain systems along
with academic research on their adaptation to specialty markets, along with case studies on
successful re-engineering of entire chains can provide insight on specialty value chain best
practices.
The value chain and value chain system
To structure the analysis, this study builds upon the value chain and value chain
system basics as defined in Michael Porter’s text “Competitive Advantage: Creating and
Sustaining Superior Performance.” In describing value chain analysis, Porter outlines a
method for evaluating company and system-wide operations. At the company level, he
defines primary business operations. The primary business operations are: inbound
logistics, operations, outbound logistics, marketing & sales, and services. See Figure 3 for
an example of the standard value chain used to structure analysis in this report.
Figure 3: The value chain
Inbound
Logistics
Operations
Outbound
Logistics
Marketing
& Sales
Services
Next, value chain system analysis looks at the greater business ecosystem in which a
company exists. Porter generally defines a value chain system as having four stages:
suppliers, the company or channel 1, channel 2, and buyers. xi In the case of specialty coffee
and in this study, suppliers are considered the coffee producers, channel 1 includes
19
exporters, channel 2 includes importers, and the buyers are roasters. See Figure 4 for an
example of how the value system is defined for this purpose of this report.
Figure 4: The value chain system
Suppliers
• Independent
farmers
• Producer
organizations
Channel 1
• Integrated
Producer /
Exporters
• Private
exporters
Channel 2
• Coffee
importers
Buyers
• Coffee
roasters
The basic methodology for analyzing a value chain has three steps. First the value
chain and value chain system is identified along with the costs and revenues where value is
created. This stage is commonly referred to as “value mapping.” xii Second, the cost and
revenue drivers must be determined. Third, a company’s strategy should be adapted so
that their cost and revenue drivers are more efficient than the competition; alternatively
the value-chain should be altogether re-configured. xiii Understanding where value is
captured typically reveals where market power and chain governance lies. When market
power and chain governance are redistributed, so are value capture and value chain
sustainability. xiv
Value chain analysis can identify gaps between players that negatively impact
internal company operations, specific business-to-business (b2b) relations, or have
inhibiting secondary and tertiary effects across entire industries. Identification of such
inefficiencies and un-protected risk exposures can help business executives, trade
association professionals and policymakers adjust strategy or legislation to create a
sustainable differentiation for their company or industry. xv Market power and governance
of value chains typically lie with developed country firms, when dealing with global, NorthSouth value chains. This global value chain characteristic is an underlying cause of
economic inequalities. Value chain analysis carries an industry forward by systematically
identifying the value capture and risk exposure of companies at each point in the chain and
then documenting where shared risk can increase value capture for all parties. xvi
20
The motivation for studying supply chains as value chains is to identify how to
change how actors along the chain perceive relations with each other, i.e. discover how
business relations can maximize value capture collectively, rather than view business as a
zero sum game. To maximize value capture collectively, actors must look for the optimal
agreement where both parties win, i.e. find a win-win negotiated solution. This applies to
negotiations between points in a value chain within and outside a single firm. The
importance of identifying such win-win solutions has become increasingly important for
value chains to sustain continued growth and avoid collapse in consumer driven specialty
markets.
The emergence of a specialty coffee value chain
Consumer demand for product attributes that suit their tastes and social priorities
has driven growth in product differentiation across the food industry. This trend drove the
growth in the specialty coffee market. In the specialty coffee industry, consumer definition
of quality grew to include social, location and taste attributes. In order to meet demand for
these differentiated tastes, roasters/retailers first attempted to manage the full length of
the coffee value chain to guarantee quality and traceability. Importers quickly followed suit
to meet their roaster customer needs. xvii
More recently, exporters and producers are increasingly reaching upwards in the
value chain to take some of the market power back. As the entire value chain slowly adapts
to consumer demand, roasters should not feel the need to control as much of the value
chain. However, even though more producers are aware of consumer demand for quality
and traceability, investment in these attributes is slow, which perpetuates roaster and
importer need to manage down the value-chain. That said, certification programs have
helped incentivize small producers to organize and vertically integrate in order to gain
more control of the value chain.
Specialty coffee value chain research
Coffee certification programs success at organizing small farmers and enabling them
to vertically integrate are well documented. The most prominent certifications include Fair
Trade, Rain Forrest Alliance and Organic. These certifications incentivize farmers with
21
higher prices to organize and take control of value capturing stages in coffee production
such as wet milling and sometimes dry milling and exporting. Much of the research and
recommendations on improving specialty coffee value chain efficiency are focused on
improving coffee certification techniques. xviii Other recommendations include: empower
producer organizations through capacity building, vertical integration, increase producer
organization access to specialty market information, increase access to credit facilities,
invest in more certifications, involve producer groups in lobbying and advocacy, and
develop consumer markets for certified products. The most common agencies through
which these recommendations continue to be carried out are coffee cooperatives, Non-
Government Organizations (NGOs), development banks, as well as roasters that manage
their own corporate social responsibility departments. xix Still, many years after such
research and sustained investment in programs that supported these findings, consumer
demand for specialty coffee outpaces growth in specialty coffee production.
Past recommendations target change within certain points in the value chain, as
opposed to a complete re-configuration of the value chain. The following interviews with
actors along the value chain will seek to pinpoint continued gaps in the specialty value
chain to help assess whether the problems can be resolved through continued surgical
development projects or if a completely new approach to value chain configuration is in
store. First, the following case exemplifies how another previously commoditized food
industry successfully re-developed a value chain to create a sustainable specialty food
industry.
Lessons from the specialty beef value chain
High quality beef has developed into a large and growing market in the United
States. Change in the beef industry began in the early 1990s when consumer surveys
indicated that beef consumption was on the decline due to varied quality and increased
toughness. This was a result of poor investment in raising cattle, as the industry had
become commoditized. Cattle ranchers were subject to prices decided upon by large
processors that competed on price to the end consumer. As a result, there was no incentive
for cattle ranchers to invest in how their cattle were raised and fed.
22
Recognizing a change was needed, the global agribusiness firm and beef processor,
Cargill, began to negotiate with cattle ranchers, such as Friona Industries, that wanted to
realign price incentives paid for cattle. In this deal, Cargill would work with their
distributors and retailers, including large national grocery stores such as Harris Teeters, to
develop a market for premium beef. On the production end, cattle ranchers would invest in
cattle rearing so that choice parts of beef would taste better. In between, Cargill agreed to
pay cattle ranchers a price based upon predetermined standards for beef quality as well as
upon what Cargill was willing to pay given market price fluctuation at retail. In this way,
the entire beef value chain was re-negotiated so that value capture was shared between
each point in the chain, which incentivized the entire chain to produce, package, and
market high quality beef. xx
Understandably, re-configuring the specialty coffee value chain presents different
challenges than the domestic U.S. beef industry, first and foremost the international aspect
of the coffee chain. Nonetheless, lessons can be learned from how middlemen with large
market power were incentivized through the prospect of increased value capture to
negotiate revenue sharing agreements with their producers. At the same time, the
middlemen turned into self-proclaimed consultants to their buyers/retailers by providing
more detailed pricing information on costs of production and packaging associated with
different cuts of beef, which helped retailers forecast their cost of inputs.
Instead of acting as a purely buy low, sell high commodity middleman, Cargill, with
respect to the beef industry, decided to partner with suppliers and providers through
revenue and information sharing. In this way, a sustainable consumer driven industry was
created based on food quality and traceability. Similar value-driven partnership models
could be taken to the coffee industry and implemented between cooperatives, global
traders (i.e. importers) and roasters. The current cooperative movement is a step in the
right direction, but alone it is apparently not providing enough incentive for production to
keep pace with demand. The next section will report results from interviews with
producers, exporters, importers, and roasters, in which these actors discuss how they
perceive the inefficiencies, risks and solutions that face the specialty coffee industry.
23
V. Specialty Coffee Value Chain Interview Results 4
The interview results comprise primary data that was gathered via participant
observation and semi-structured interviews. Participant observation included visits in
Guatemala to three dry mills where day-to-day operations were observed. Observations
were also conducted at two coffee roasting facilities in Massachusetts where day-to-day
operations were also observed. Semi-structured interviews were used to record industry
leaders’ perspective on the most relevant issues that impact company and system-wide
value capture. Semi-structured interviews are guided conversations around specific topics;
however, the conversations are left open enough for respondents to take a topic where
they think it is most relevant. The interviewer is also free to ask impromptu questions that
are pertinent to the structured topics. Semi-structured interviews were conducted with
over twenty-five individuals that included producer groups, exporters, importers, roasters,
as well as coffee sector NGOs, and associations. 5
In the interviews, respondents were asked to identify where their company can
capture value, what risks they are exposed to, and current risk mitigation techniques they
use at the five points on the value chain: inbound logistics, operations, outbound logistics,
marketing and sales, and services. The two questions, “where can your company capture
value?” and “what risks is your company exposed to?” are two ways to identify a company’s
needs. Two approaches to a similar question were used to pull from respondents the
nuanced issues each company deals with. Then the report consolidates these answers to
facilitate the analysis. The complete consolidated results from these interviews are
included in this study as appendices.
At the end of each interview, respondents were asked to talk about the “big picture”
issues that are confronting the specialty coffee value system. These points are considered
“gaps” in the system. In the following value chain system analysis section, the system’s
needs, solutions, and gaps are analyzed to identify the key variables that influence the
system and that should be used in the system model.
All conclusions in the following summaries are taken from anecdotal interviews with
individuals in the specialty coffee value chain system.
5 See Appendix 1 for a full list of organizations and individuals interviewed
4
24
Producers: Summary of findings 6
The most significant producer needs have to do with operating and marketing
issues, including production costs, expected revenue and market information/access. There
is declining incentive for coffee farmers to stay in the business, as costs are increasing and
doubt and uncertainty surround revenue streams.
With respect to costs, three main areas are cause for concern. First the cost of
inputs, such as fertilizers and labor, are increasing. Many of the farm inputs are imported
from the United States, so their prices also increase as the USD appreciates against the local
currency. Labor costs are increasing as the minimum wage rises and manual labor becomes
scarce due to immigration to the cities or the United States. Second, producers lack
sufficient access to financing, particularly during harvest season, when a producer incurs
70 percent of their costs. Third, the costs required to meet respected certification
standards are high, while the price earned with the certification does not fully reflect bean
quality. Other operating issues are technical expertise on growing practices and weather
related risks. Poor weather can damage a coffee fruit while it is still on the plant or while
wet milled beans are drying and exposed to the elements.
Marketing needs have to do with global and regional market information and
market access to global buyers. Producer organizations lack adequate understanding of
global markets to know when they are receiving a fair price, whether they are negotiating
with middlemen, exporters, or through a direct relationship with roasters. Producers also
expressed concern about receiving constant margins based on region and certifications.
These margins help, but still do not fully reflect quality, which is a function of the different
amounts of time and effort each producer organization invests in their coffee. Producers
and certifiers that were interviewed mentioned that improved market access to global
buyers would help these problems.
Current solutions to these operating needs include financial support from integrated
producer organizations that have easier access to affordable financing. Financing can also
come from variety of partnership models with NGOs, banks and micro-finance institutions.
For a full list of the producer needs and solutions identified in the interviews, refer to the
producer value chain matrix. The text’s summary covers the most common issues raised in
conversations with two producer groups and a certifying organization.
6
25
A number of programs already exist, but the need is greater. A critique of these programs
from the certifier’s point of view is that the term “pre-payment” is commonly used to refer
to pre-financing. Pre-payment implies a forward payment on a sale, but these “payments”
generally carry interest. As a result, this practice is really a loan that is then paid back when
cash if received for the product.
Solutions to producer marketing needs are becoming more sophisticated as
producer organizations vertically integrate. With vertical integration, producer
organizations are developing marketing departments that hire individuals exclusively to
build sales relationships with importers and roasters. In firms whose marketing
department representatives were interviewed, the majority of sales go to importers.
26
Exporters: Summary of findings
Exporters face significant risks both downstream and upstream, along with
importers, and for this reason inherently put downward pressure on farm gate prices. This
means farm gate prices are depressed not just because of risk generated at the farmer level,
but also because exporters must compensate for upstream risk. The areas of risk that
exporters most frequently identified were quality control, price stability, supplier and
buyer reliability, market access, managing a good reputation while also looking for new
markets and price points, managing full containers and the need to vertically integrate the
origin country value chain.
Quality control is important for exporters to accurately take inventory of the value
of their product and in turn, receive an appropriate price. Price stability allows exporters to
more accurately forecast earnings and take additional risks to accelerate growth. Exporters
must manage their own expectations on what they will receive from producers as well as
what to tell buyers to expect. Increased market access is needed so that exporters can more
easily identify new markets and price points, while managing current relationships.
Exporters are careful when changing buyers because they do not want to be perceived as
disloyal, company reputation is paramount in the coffee trade. Also, a new and growing
need is to manage the logistical difficulties surrounding demand for small, high quality lots.
One effective strategy exporters pursue to minimize risk exposure is moving toward
vertical integration between producer groups and exporters. A number of integration
models are practiced in Guatemala. One model is full integration between producer groups
and a cooperative federation. In this case, the cooperative federation dry mills the coffee
from a number of different cooperatives. The federation also manages quality control, and
reserves the right to reject cooperative coffee if it does not meet the communal standard.
The federation also controls international marketing, price setting, and provides pre-
financing to their producers via partnerships with banks and/or development institutions.
Other vertical integration models include producer groups that hire a common marketing
agent to gain additional international access, and/or partner with an exporter that
provides dry milling at a discount rate. Producers and exporters alike express need for
further market access and the ability to negotiate a price that more accurately reflects
coffee quality.
27
Other solutions include wider establishment of cupping facilities at exporter
facilities so exporters and producers can better manage quality control. Some exporters,
particularly those integrated with producer groups, have taken steps to improve product
traceability in response to growing consumer demand for this information. However, even
integrated producer / exporters admit that the depth and accuracy of the type of
information gathered could and should be improved upon, but the institutions lack the
resources to do this alone. Additionally, some exporters said they had recently hired
personnel to deal with managing small shipments of high quality lots, again in response to
growing demand for such orders. Finally, all exporters mentioned that a lot of effort is
expended managing relations with buyers, while at the same time delicately trying to feel
out the market for new opportunities and better price points.
28
Importers: Summary of findings
Similar to exporters, importers face high risks downstream and upstream in the
value chain, which necessitates them to also put downward pressure on price. Variables
that drive the buy low, sell high mentality are the upstream industry standard to offer
roasters the right to reject coffee shipments and the downstream threat that the quality of
coffee origins changes annually, as is the case with any agriculture product. A compounding
problem is that importers are highly competitive and proprietary with regards to market
information. This makes it difficult for the market to assign a value to highly differentiated
coffees. Instead, the market must rely on inadequate industry norms that assign uniform
regional margins.
Together these market inefficiencies create high risk for importers, along with
exporters. Due to high risk and tough competition importers often continue to treat the
buying and selling of specialty coffee as a zero-sum game. This is reflective of how
commodity products are bought and sold. The commodity market business model puts
downward pressure on exporters and producer groups, which disincentives producer
investment in specialty coffee.
Not only do importers need to maximize gains with zero-sum tactics, they must also
minimize risk. To minimize risk, importers use insurance, quality control standards, and
build strong relations with exporters and roasters. They also offer roasters as many options
as possible, particularly with regards to coffee varieties, storage and freight possibilities. At
the same time, they hire and train personnel that understand commodity trading, customer
preferences, and coffee quality. It is the importer trader and salesperson that are
responsible for best allocating resources based on negotiating prices with exporters and
assessing roaster willingness to pay. Importers do the best they can, given the commodity
nature of their business, to assess demand, negotiate prices, and allocate scarce resources
so that both exporters and roasters are content.
29
Roasters: Summary of findings
Like the rest of the value chain, roasters are subject to “C” market volatility and
general market risk, but they must also be most responsive to evolving consumer demands
for certain coffee attributes and the price these attributes receive in the consumer market.
Second to market price volatility, roasters face quality risk, i.e. the risk that a shipment is
spoiled. The causes of a spoiled shipment are varied, but the result is the same, the roasters
are forced to return the coffee, losing valuable time and potentially not meeting customer
demand. The third key roasters’ need, in addition to mitigating price and quality risk, is to
be able to meet rising consumer demand for coffee traceability. Since roaster risks are
directly correlated to consumer needs, roasters prefer not be reliant on intermediaries and
to attempt to control as much of the value chain as possible.
Large roasters continue to experiment with business models that develop long-term
contracts with farmers, while at the same time sourcing coffee via traditional methods in
order to acquire the necessary volume. Small to medium-sized roasters unanimously would
like to source directly, but today it is not economically viable for most to do so. Many small
to medium-sized roasters have experimented with direct sourcing and highly value its
benefits. However, any significant shift towards direct sourcing apparently requires a
complete realignment of a company’s business model around the direct sourcing method.
This is to say, today a small to medium-sized roaster either fully embraces the direct
sourcing business model and uses this to differentiate their company, or direct sourcing is
unsustainable beyond the occasional trip to origin, which is better defined as a passionate
hobby than a serious component to a business model.
As importers re-align how they source coffee in order to meet roaster demand, both
importers and roasters increasingly vie for the same relationships with producers and
exporters. This additional level of competition creates value chain inefficiencies. Roasters
incur high costs building direct souring expertise, which is an importer competitive
advantage. This takes roaster resources away from focusing on immediate customer needs,
while importers are forced to compete with a new competitive force. Also, importers
negotiate prices with producers based on how much they believe they can mark the coffee
up to roasters, while roasters negotiate with producers based in part on how much they
can force importer margins down.
30
In addition to mitigating sourcing risks, roasters must raise market awareness for
their product. Most roasters interviewed mentioned marketing as high risk because the
returns are not calculable, but their industry as a whole is dependent on raising awareness
that coffee can be high quality and socially responsible. The complexity of specialty coffee’s
marketing message and the importance effective marketing has on industry sustainability
and growth further emphasizes that roaster attempts to manage down the value chain are
highly inefficient for the industry as a whole. The roaster’s first priority is to meet the
consumer’s every immediate need.
Given the split priorities between sourcing and marketing risk, it is not surprising to
learn from interviews that the roaster community is split when it comes to industry
solutions. The dividing line is between those who believe that more and stronger long-term
roaster-farmer relationships are the solution, and those that think long-term / direct
relations depress farm gate prices and should be the importers’ responsibility. Whether or
not roasters or importers hold the competitive advantage with regards to producer
relations, roasters seem to unanimously agree that for the value-chain to grow in a
sustainable manner there must be more partnering, revenue-sharing, and improved
producer access to the global marketplace. Roasters also agree that specialty coffee is price
inelastic in small increments and many said they would be willing to increase prices
marginally, if producers were the key beneficiaries and the supply chain became more
sustainable.
This is not new information and many roasters already accept higher prices in order
to transfer more value to producers. Still, there is a supply shortage, which could cause
coffee prices to increase enough to significantly damage roasters’ sales. Efforts to mitigate
specialty coffee marketing risk are proving more effective than sourcing risk mitigation.
Despite industry efforts to improve farmer value capture, why change has not happened
more quickly, in pace with consumer demand, will be the focus of the next section that
analyzes the value chain system as a whole.
31
Industry views on value chain system gaps
When asked at the end of each of the twenty-six interviews conducted, respondents
identified four key gaps in the specialty coffee value chain: (1) the producer situation is not
sustainable, (2) consumer demand is outpacing supply, (3) the specialty industry lacks
information technology (IT) and the efficiency gains that come from improved information
and technology, and (4) the industry as a whole is not effectively capturing value potential
of specialty coffee products. Figure 5 identifies these gaps and the percent of times each
gap was mentioned in the interviews as the primary industry gap.
Figure 5: Key gaps in the specialty coffee value chain
Looking at these gaps from a value chain perspective, the overwhelming perception
is that a gap between producer value capture and the remainder of the value chain is the
dominant problem facing the industry. On the other end of the chain, there is a gap
between consumer needs and the ability for the entire tail of the chain to meet this need. To
a certain degree, some see the entire industry as unable to fully capitalize on the value that
could be created from consumer demand for specialty coffees. And a notable number of
actors believe that a significant problem for the entire chain is a lack of IT adaptation.
32
Speaking only about producer sustainability, interviewees most often mentioned
four reasons for producers’ inability to capture a sustainable amount of value from their
specialty green coffee. The four reasons are, in order of the frequency each was mentioned
during interviews:
1. Poor market power and access
2. Producers are not rewarded appropriately for the risks they assume
3. “C” market price volatility
4. Current solutions, such as certifications and direct trade, are insufficient.
One interviewee noted, with regards to improving producer value capture, “any change
that is useful needs to be phenomenal.” Using the research and interview results, the
following section analyzes producer, exporter, importer and roaster needs and the
corresponding solutions currently used to mitigate these needs. This analysis is used to
identify the key drivers that facilitate and inhibit industry growth. A system model is then
specified to help show how reinforcing or changing these drivers impacts the entire value
chain system.
33
VI. Value Chain System Analysis
Power in the specialty coffee value chain is shifting from roasters to consumers, as they
demand higher quality and traceable coffees. As a result, coffee roasters are turning to their
value chain for greater access to high quality and traceable coffees. However, the bulk of the
value chain is not built to properly incentivize high quality and traceability. Nor does the value
chain provide for efficient market access and communication between roasters and
producers. To identify and emphasize the gaps in the value chain that keep roasters from
meeting their needs and that force them to inefficiently manage down the value chain, this
value chain analysis was conducted.
34
Consumer demand drives the value chain
Consumer
Need
Quality
coffee
Information
on farmer
Easy access
to great
coffee
Reasonable
price
Current
Solution
Specialty coffee
roasters.
Gap
Industry demand is growing 17% annually,
but industry experts say that access to
quality coffee is declining.
Specialty coffee Only premium coffees offered at high-end
roasters offer
coffee shops and as “reserves” at some large
“terroir” coffee. chains occasionally have information on the
farmer and the growing practices and
environment or “terroir.”
Buy at a
Online sales is the fastest growing segment as
specialty coffee consumers become more educated on coffee
shop, grocery
quality and origins and can find this
store or online. information most readily on specialty coffee
roasters’ websites.
Other than
A large drop/rise in price is required to
McDonald’s $1
impact the coffee consumer. This means that
coffee and
the consumer is price inelastic in small
Starbucks $1.50 increments. Consumers do not react to small
blend, prices
decreases or increases in price. This is
have not
particularly true in specialty coffee, which
changed much
has actually seen continued growth during
during the
the recession.
recession.
Consumer Conclusions: The consumer is demanding higher quality and more information. The
consumer is unaware that specialty coffee roasters fear declining quality because demand is
outpacing access to quality coffee sources. These sources, some worry, are even on the
decline. Currently, only the very premium coffee market and large roasters have regular
access to full information on the coffee farmer. If high quality and detailed information were
more widely available, many roasters believe specialty coffee could have greater appeal to the
mass market and be able to capture more value. Consumer awareness of coffee quality and
origins would grow similar to consumer understanding of wine quality and growing regions.
35
Roasters exert upward pressure due to price inelasticity and downward pressure to cut costs
Roaster
Need
Quality
coffee and
service
Information:
coffee
traceability
Market
access to
quality coffee
Reasonable
price
Current
Solution
Source coffee
through a
specialty
importer or the
roaster sources
coffee directly
from producer.
Source coffee
through a
specialty
importer or the
roaster sources
coffee directly
from producer.
Source coffee
through a
specialty
importer or the
roaster sources
coffee directly
from producer.
Negotiate price
with importers
or producer.
Price discovery
is fragmented.
Gap
Importer market access and transparency is
limited. Those that specialize in full
transparency come at a price.
Sourcing directly from the producers is costly
and exposes roaster to quality risk, i.e. risk
that quality is affected during shipping.
Importers that provide good information
source from a small number of producers
because they rely on close relationships for
information. This means they have limited
market access. Also, many importers have
trouble sharing all information they have
because of a limited sales force.
Specialty coffee importers, individually,
provide a myopic view of the specialty
market. Together, they provide a fairly wide
selection of coffees. But, because it is difficult
to deal with many importers, most roasters
only deal with a few or even just one.
Procuring coffee directly from the producer is
costly and timely for both roasters and
importers. This method provides good
traceability, but causes inefficiencies when
multiple buyers source from the same
producers to sell to different roasters.
Through interviews with roasters, many have
indicated they are willing to pay more if the
coffee meets their quality and origin
information needs. This is b/c specialty coffee
is price inelastic.
Roaster Conclusions: The roaster needs more information, and greater market access to high
quality coffee beans, consistently. Some specialty importers can provide information at a
price, but have limited market access. A minority of roasters source coffee on their own to
guarantee high quality, but this is expensive, time consuming, and exposes roasters to quality
risk, i.e. risk that quality is affected when coffee is in transit from origin country to demand
country or that the producer has a bad harvest or even decides to stop growing coffee all
together.
36
Importers are incentivized to buy low and sell high because of a commodity value system
Importer
Need
Higher
quality
coffee
Current Solution
Work with NGOs
on farmer
education.
Develop direct
relations with
producer groups.
More farmer Develop direct
information relations with
producer groups.
Greater
Word of mouth
access to
marketing with
roasters and roasters.
Frequent trips to
quality
coffee
origin countries to
develop relations.
Finance
Buy low and sell
coffee at
high to avoid risk
fixed price
that quality
w/o
decreases en route,
guaranteed
or they can
quality or
hedge on “C”
buyer
market.
Gap
These services only reach a small portion of
the coffee producer market.
Importers can only develop a limited
number of relationships.
Importers said that word of mouth is
considered enough marketing with
roasters. Importers can only develop a
limited number of relationships. Thus, they
cannot grow much faster.
Importer incentive to buy low is
disincentive for producer to produce high
quality coffee.
Hedging specialty coffee only covers price
risk up to commodity price. Difficult to
hedge the full differential that can be
earned from quality coffee, which exposes
brokers to basis risk.
Importer Conclusions: Importers face similar problems as roasters with regards to sourcing
high quality coffee, gathering farmer information and gaining market access. Furthermore,
importers are required to take high risk moving coffee overseas and financing coffee without a
guaranteed buyer. This incentivizes importers to treat the business as a zero-sum game and
negotiate low prices with producer groups. Larger players with more market power that
negotiate low prices with producers, in order to mitigate quality and basis risk, discourage
producers from producing high quality coffee.
37
Exporters are incentivized to buy low and sell high because of a commodity value system
Exporter
Need
Higher
quality
coffee
More
informatio
n on farmer
Greater
access to
buyers and
quality
coffee
Finance
coffee
farmers at
fixed price
w/o
knowing
quality
Current Solution
Provide technical
training to
farmers.
Gap
Exporter scope is limited by the ability to
develop relationships with producer
groups, so there are still many uneducated
coffee farmers
Build relationships Exporters lack the resources to develop
with farmers.
detailed profiles on wide number of farmer
groups.
Recruit farmers to Exporters are only able to recruit farmers
supply exporter.
when they can offer farmers a higher price
Develop relations that somewhat reflects quality.
with importers
Relationship development with importers
and roasters when is via word of mouth. Exporters are rarely
possible.
able to develop relations directly with
roasters.
Vertically
Farmers have big incentive to sell to the
integrate with
street because exporter price is often not
farmer groups and much higher than the street price, and on
sign open profitthe street the farmer will get the cash
sharing contracts
immediately.
with farmers at
the start of season.
Exporter Conclusions: Exporters face similar problems as importers with regards to sourcing
quality coffee, gathering information on producers and gaining access to producers. In
addition, they must find a buyer, usually internationally, for their coffee, and finance some of
the coffee before the harvest season, before knowing the quality. To decrease exposure to the
quality and price risk this creates, some exporters have vertically integrated with producer
organizations, often through cooperative organizations. The exporter then serves as a
marketer and dry mill for the producer organizations and shares with the producer at the end
of the sales season any excess profit. Still, the exporter must consistently offer a higher price
than is offered on the street to keep their farmers from taking the street price and receiving
cash up front. The lure of cash up front is high because the exporter price is not much higher
than the street price. This is due in part because exporters, even those integrated with
producers, do not have much ability to negotiate price based on quality.
38
Producers must accept pre-determined commoditized prices that do not fully reflect quality
Producer
Need
Produce
higher
quality
coffee
Share their
story +
informatio
n on the
coffee
Greater
access to
importers
and roasters
Receive a
price that
reflects the
quality
Current Solution
Solicit training from
exporters, NGOs, or a
government agency.
Exporter shares some
info, and the few farmers
with direct relations
with roasters share their
story.
Most farmers rely on
their exporter’s contacts;
very few have direct
relations with a roaster.
Producers are given
price differentials for
certifications and the
region they are in.
Gap
Still, there are many uneducated
farmers.
Only a few detailed stories make it to
roasters and to their consumers.
Producers still have a very myopic
view of foreign buyers / importerroaster market
Standardized differentials for
certifications and regions are an
imprecise way to gauge quality.
Producer Conclusions: Coffee producers have very limited access to importers and more
importantly, roasters, who have the highest willingness to pay for quality coffee. Instead,
producers are given standardized differentials based on certifications or simply on the region
where they are located. A producer’s usual buyer is an exporter that sells to an importer, both
of which, when the exporter is not integrated with a farmer group, look to buy low and sell
high. Even when the producer/exporter is integrated, the importer is still incentivized to buy
low and sell high. This pricing structure provides little incentive for the producer to invest in
growing a high quality product. As a result, roasters and importers report they see more and
more producers of quality coffee leaving the industry and the overall supply of quality coffee
stagnating, even as consumer demand for high quality is increasing.
39
Value Chain System Analysis Conclusions
Consumers are demanding higher quality coffee and increased information on their
coffee’s origin, which means roasters need better access to quality coffee and information.
However, the current import system for specialty coffee is a commodity value chain, which
inherently creates a pricing structure that incents the producer to grow only a commodity
product. Exporters and importers are incentivized to treat price negotiations as a zero-sum
game. Exporters and importers must push down prices to compensate for the significant
amount of quality and price (i.e. basis) risk they must carry. As a result, producers do not
receive a price that fully reflects quality, so there is little incentive to invest in quality,
traceable coffee.
Additionally, a lack of information sharing between importers, and generally
throughout the industry, leads to inefficient pricing. For importers, specialty prices are
determined as differentials over the commodity exchange. This process is inefficient and
means actors along the specialty coffee value-chain can try to take advantage of
misinformation and engage in arbitrage. As consumer demand for quality and traceability
increases, specialty coffee production will not keep pace and the specialty industry will fail to
capture full value in coffee attributes, unless a systematic change in value transfer and coffee
procurement takes place.
40
VII. Modeling the value chain system
With a firm understanding of the variables that compose the specialty coffee value
chain and the areas of greatest inefficiency and risk exposure, as well as some of the current
solutions, an effective way to better understand how these functions are interrelated is to
model the stock and flow of green coffee and value capture. System dynamics parameters are
used to specify the model. System dynamics shows how creating, reinforcing and diverting
flows and stocks of variables can have a chain reaction throughout an entire ecosystem. In the
case of specialty coffee, the two key flows are the physical movement of green coffee and value
capture, i.e. the per pound value earned for green coffee at each point in the value chain.
Below, a series of diagrams show in step-by-step progression the current specialty
coffee value chain. First, the two flows, green coffee and value capture, are explained. Second,
the key variables that influence coffee movement and value capture from producer to
exporter, importer and roaster are identified and described. Third, the drivers behind
specialty coffee industry growth and roaster sales growth are explained. Fourth, the key gaps
are identified on the specialty coffee value system diagram. Fifth, a couple of the current
attempted solutions to the specialty coffee supply imbalance are described. 7 Finally, in the
recommendation section, a new approach to the specialty coffee value chain is proposed.
System dynamics primer
System dynamics is a method developed at the Massachusetts Institute of Technology
(MIT) to model private and public policy impacts on business, government or social
ecosystems. In the models, boxes represent stock variables (e.g. value and inventory) and
straight double-lined arrows represent rates of change (e.g. “price” in the case of value
transfer and “sales rate” in the case of physical movement of coffee). Curved, single-line
arrows represent positive or negative impact of variables other than stocks or rates of change.
A blue arrow means the two connected variables positively correlate, while a red arrow
means the two respective variables negatively correlate. An explanation for each diagram is
provided below. xxi
The system models are examples of standard specialty coffee value chain formations and are
meant to highlight the most influential drivers and gaps that contribute to and inhibit value
capture. The two “current solution” models are only a couple of many approaches that
multiple businesses have implemented in attempts to make the chain more sustainable.
7
41
Step 1: The movement of green coffee and value capture
To begin, there are two principal stocks and flows in the specialty coffee trade that must be modeled. The first is the
physical movement of green coffee (top line) and the second is the capturing of value (bottom line), which is defined as the
difference between the price paid for coffee, or coffee inputs, and the price received for coffee. The red indicates a negative
correlation between two variables, and blue means the two variables are positively correlated. For example, in the first chain
(movement of coffee), the “Investment rate” is positively correlated to “Producer inventory,” i.e. as the producer invests more in
production, their inventory goes up. On the other hand, “Producer sales rate” is negatively correlated with “Producer Inventory”
because as the producer sells coffee, their inventory falls. In the second chain (value capture), the arrow between “Input Price”
and “Producer Value Capture” is red because as input prices go up, the amount of value the produce can capture goes down.
42
Step 2: Producer, exporter and importer value capture
This step shows the key variables that impact value capture for producers, exporters and importers. During the
production cycle, access to credit has a negative correlation to input prices. As access to credit improves, input prices go down
because the cost of financing is cheaper. The contributing variables to “Farmers Price” all have a positive correlation to price
except for production risk. As the “C” market, bean quality and traceability premiums, or the regional reputation increases, then
the “Farmer Price” also increases. As the production risk (e.g. weather) increases, the price paid to the farmer decreases. The
“FOB Price” is a function of, again, the “Quality and Traceability Premiums” plus the service of the exporter, minus any downward
negotiation in price due to quality risk that is associated with shipping coffee overseas. The “Importer Price” to roasters also
considers the quality and traceability premiums along with the service the importer provides. Importantly, at each point in the
value chain there is strong downward pressure on price in order to compensate for high risk and strong negotiating power from
the next actor up in the value chain.
43
Step 3: Roaster value capture, industry demand and roaster sales rate
This step shows how the value capture and coffee movement chains connect. Roasters increase marketing expense as they
capture more value. Increased marketing expense raises awareness about specialty coffee, which has two effects. First,
awareness of specialty coffee increases overall industry demand for specialty coffee and a change in demand has an impact on
price. Second, increased awareness about a specific roaster’s product impacts that roaster’s market share, which increases
roaster sales. As roaster sales increase, there is a word of mouth effect, especially important in specialty coffee; this further
contributes to awareness, industry demand and the consumer price. These are both positive reinforcing loops that further
specialty coffee demand growth.
44
Step 4: Importer, exporter and importer sales rate and producer investment rate
The “Roaster Sales Rate” has a positive correlation to the “Importer Sales Rate.” As roasters sales increase, roasters
procure more coffee from their importers. Also, “Roaster Value Capture” has a positive correlation to “Importer Sales Rate.” As a
roaster captures more value, they are able to invest more and expand, which means buy more coffee from their importers. This
cycle continues down the chain. Importers buy more from exporters and exporters procure more coffee from producers. But, it is
important to point out the “Delay” at the left end of the chain. As producers’ sales rates increase and they capture more value,
they invest in more coffee production. Often investment in coffee production can take multiple seasons before any difference is
found in the crop. As a result, there is a much longer delay in coffee investment for the producer than any other point in the value
chain. Also, increases in “Inventory” of coffee have a negative correlation on consumer price. As supply increases, price decreases.
45
Step 4: The specialty coffee value chain system (key problems and gaps)
The specialty coffee value chain has two key problems that could stifle production while industry demand continues to
grow: The downward pressure exerted on “Producer Value Capture” (shown in red block arrows) and the long delay in the
producer “Investment Rate” (shown with a black block arrow). The current value chain system is a commodity system where the
actors are incentivized to buy low and sell high. This is illustrated with the red double-lined arrows that indicate that, for
example, when “Roaster Value Capture” increases, then the “Importer Price” decreases. Such an incentive structure leaves little
value capture for the farmer, which means little value is created to put towards investment and the little that is invested has a
long delay before the investment bears any fruit. On the other end of the value chain, roaster marketing and sales continue, which
fuels industry demand and overall market growth. As shown, industry demand is growing in an accelerating manner (this is
called a “reinforcing loop”), and thus, is outpacing production. This could eventually lead to a supply crisis.
46
Step 5: The Direct-trade and long-term relationship model (a current solution)
In the direct-trade and long-term relationship models, the roaster essentially takes the exporter and importer out of the
value capture equation by negotiating a price directly with the producer and paying the exporter and importer a constant margin.
This model attempts to transfer roaster value directly back to the producer, but it is not clear just how much value is transferred.
With a long-term contract, the roaster assumes the production and quality risk in addition to spending more on procurement
costs due to increased travel to coffee origins. To compensate for these risks and costs, the roaster, too, must negotiate low
“Farmer Prices.” Still, this method does provide increased traceability and perhaps more value to the producer. However,
roaster-producer business development is slow and whether there is net value creation, because importers lose, for the entire
chain is debatable. Ultimately, this solution has not been able to induce producers to invest fast enough to meet demand.
47
Step 5: NGO funding model (a current solution)
In the NGO funding model, roasters transfer some of their value capture to NGO / development organizations, or in some
cases their own development or corporate social responsibility departments, to carry out projects in the local coffee
communities. These projects target value creation drivers such as “access to credit,” “farmer production methods,” or
“certifications.” The purpose is to enable the producer to capture more value, which should in turn increase their “investment
rate” in specialty coffee. Many of these programs are effective for the targeted community, however, the need is great and as of
yet the projects do not incentivize producers to produce enough specialty coffee to meet consumer demand.
48
VIII. Conclusions and Recommendations
Specialty coffee current growth trajectory
Despite a number of business models that attempt to redistribute value along the
specialty coffee value chain, most notably direct-trade, long-term contracts, and NGO /
development programs, industry demand is outpacing production, which has real potential to
end in a supply crisis. The fall-out of a supply crisis could be disastrous for the industry. Two
outcomes are most likely given a supply crisis. In one scenario, roasters slow production even
though reinforcing growth circles continue to accelerate consumer demand. This means
inventories are low compared to demand and specialty coffee prices increase, most likely
beyond price inelastic levels and, as a result, the quantity demanded decreases, which would
have a stagnating effect on specialty coffee businesses.
In the second and more likely scenario, roasters continue to buy green coffee to meet
demand growth, but the supply of specialty coffee does not keep pace. This means specialty
coffee producers increasingly rely on inferior coffees that taste badly. Consumers will find it
more difficult to distinguish between commercial and specialty grade coffees, the industry will
become diluted and consumers will doubt the legitimacy of “specialty” coffee. In turn, they will
prefer to buy cheaper, commercial grade coffees.
Both scenarios lead to a phenomenon called “overshoot and collapse.” Overshoot and
collapse results when reinforcing industry demand loops are not met with appropriate supply
growth. Industries and products generally follow an s-curve growth pattern in which demand
increases slowly, then accelerates and plateaus. Specialty coffee is arguably in the acceleration
phase, but supply is reaching a plateau. In such a scenario, many consumers would stop
buying specialty coffee all together as they become disgruntled with the product.
Figure 6: Overshoot and collapse
49
Specialty coffee target growth trajectory
The target specialty coffee growth trajectory is for coffee supply growth to parallel
consumer driven demand growth. Specialty coffee production begins above demand, but as
demand becomes consumer driven, then producers invest in specialty coffee production
commensurate with forecasted consumer demand for specialty coffee. As seen in the specialty
beef industry, specialty markets require partnerships that take the industry away from a
commodity market and towards a value chain that is collectively incentivized to produce
higher quality products. Growing specialty industries with properly incentivized production
should have parallel demand and supply growth curves.
Figure 7: Target “S” curve growth
How to achieve the target growth trajectory 8
The industry needs to move away from a coffee sourcing system that is solely based on
a commodity product and, in doing so, decrease the influence of “C” market price levels and
volatility on specialty coffee prices. Assuming weather is not the sole reason supply cannot
keep pace with demand (see section III, “State of the U.S. Specialty Coffee Industry), then
reconfiguring the specialty coffee value chain can have a meaningful impact on specialty
coffee supply. Two steps encompass how the specialty coffee value chain should be adjusted
so that supply grows parallel to demand:
These recommendations are not meant as a substitute to current practices that aim to
redistribute value capture, but rather build upon and offer additional solutions.
8
50
Step 1: Identify the value creation drivers for business along the entire value chain,
effectively managing these drivers can incentivize the value chain to work together to
produce, move, and sell specialty coffee.
Step 2: Reconfigure the specialty coffee value chain around these drivers through
increased partnerships between producers, exporters, importers and roasters that
involve three components:
•
•
•
Risk sharing
Information sharing
Revenue sharing
Where change needs to happen
•
Producer/Exporter: Vertical integration from producer to exporter needs to continue.
In some instances producers have already integrated with exporters. Through
integration both points in the chain are able to collectively capture and share more
value, instead of competing with one another for value control. Value is captured
through sharing wet and dry mill facilities, as well as sales and financial risk. Other
effective practices include collective marketing departments that help improve market
access, as well as improved credit ratings, so financing is cheaper. A few models for
producer-exporter integration have been successful, amongst others:
o Tiered cooperative system where farmer cooperatives supply a parent
cooperative federation. This model is in place in the Guatemala coffee sector,
in addition to others.
o Farmer cooperatives and a corporate parent structure with senior
management that is accountable to the cooperatives. This model has been
successful in the fruit juice industry in the United States.
o Farmer cooperatives develop their own marketing department, but continue
to outsource dry milling and/or exporting for a fixed per pound cost. This
•
model can be found in multiple locations.
Producer/Exporter-Importer-Roaster: Increase information sharing so producers have
better access to information on coffee attributes and availability of certain attributes.
Improved information sharing and market access will enable better forecasts of
51
demand trends in the specialty coffee market. This information will help producers
•
plan future investment in specialty coffee production.
Producer/Exporter–Importer–Roaster: Roaster willingness to pay for specialty coffee
should decide the price that producers receive. Provided producer and exporters are
integrated, roasters should decide the appropriate price, since they are closest to the
end consumer and have the best idea as to how much the consumer is willing to pay. In
such a system, as consumer willingness to pay for a high quality coffee increases or
decreases, so will the price the roaster is willing to pay. When the roaster is deciding
the price, then the price to the producer/exporter depends first on end consumer
demand and acceptable value capture for the roaster and second on commodity market
price, which measures the greater supply and demand balance across the entire
industry. In turn, the producer will have a better understanding of needed investment
•
in production and have the means to carry it out.
Producer/Exporter-Importer-Roaster: Importers should continue to procure and move
specialty coffee for roasters, since importer competitive advantage lies in their well-
developed networks in origin countries. Still, the roaster should have more influence
over the price to the producer and the importer earns a percent, rather than a fixed fee
per pound, on the coffee. This pricing system also incentivizes importers to source high
quality coffee and to recommend these coffees to their roaster clients. For such a
business model to function, importers need to develop close partnerships with
producer/exporter companies and engage in revenue sharing agreements.
52
Specialty coffee value chain re-configured
Increased
value capture
increases
investment
Producers
continue to
vertically
integrate
Roaster decides
price based on
end-consumer
willingness to pay
Price is a
% of the
value
This re-configured value chain system model highlights the four points where partnerships need to improve risk sharing,
information sharing and revenue sharing. In this system, a feedback loop is created between roaster value capture and integrated
producer/exporter price, which directly increases producer value capture. This feedback loop is directly correlated to growth in
consumer demand, which improves efficiency and maximizes value capture for the entire industry.
53
VIII. Appendices
Appendix 1
Companies and individuals interviewed (Company, Interviewee, Position; Date of Interview)
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Asociación Comunal de Desarrollo Integral Huehuetenango (ACODIHUE), Héctor Mejía,
Manager; January 14, 2010.
Asociación Unión de Pequeños Caficultores (UPC), Aurelio Gabón Lucas, Presidente;
January 14, 2010.
Barismo, Jaime Van Schyndel, Co-Owner / Roastmaster; March 2, 2010.
Boston Common Coffee Company, Patrick Mahoney, Roastmaster; February 26, 2010.
Federación Comercializadora de Café Especial de Guatemala (FECCEG), David Quintero,
Sales Representative / Lead Cupper; January 14, 2010.
Federación Comercializadora de Café Especial de Guatemala (FECCEG), Juan Francisco
González Menchu, Manager; January 14, 2010.
Cooperativa Agrícola San Pedro Necta (Huehuetenango, Guatemala), Junta Directiva
(Francisco Mateo Ramos, Gerente; Víctor Hugo Herrera Leparra, Presidente de Crédito;
Agosto Baudelio Gutiérrez García, Secretario del Consejo de Administración; Fausto
Martínez, Vocal de Educación; Eudin Gómez Aguilar, Para-técnico)
Dean’s Beans, Dean Cylon, CEO; February 5, 2010.
Federación de Cooperativas de Café de Guatemala (FEDECOCAGUA), José Ángel Reyes,
Técnico; January 12, 2010.
Federación de Cooperativas de Café de Guatemala (FEDECOCAGUA), Gerardo Alberto
de León, Gerente; January 11, 2010.
Federación de Cooperativas de Café de Guatemala (FEDECOCAGUA), Gustavo Adolfo
Galicia, Gerente de Producción y Exportaciones; January 11, 2010.
Federación de Cooperativas de Café de Guatemala (FEDECOCAGUA), Ing. Agr. Jesus
Adolfo Alvarado T., Director Asistencia Tecnica; January 11, 2010.
Federación de Cooperativas de Café de Guatemala (FEDECOCAGUA), Luis Alberto, Dry
Mill Manager; January 11, 2010.
Green Mountain Coffee Roasters, Winston Rost, Farmer Relations Manager; February
24, 2010.
54
Companies and individuals interviewed (continued)
•
•
•
•
•
•
•
•
•
•
•
•
•
Hogan Brother Coffee, Jim Hogan, CEO; February 5, 2010.
InterAmerican Coffee, Andrew Sargent, Former Coffee Trader; January 6, 2010.
Just Coffee Cooperative, Matt Early; March 9, 2010.
Manos Campesinas, Miguel Mateo Sebastian, Marketing Manager; January 15, 2010.
Red Barn Coffee Roasters, Bill Trull, Roastmaster; February 9, 2010.
Red Barn Coffee Roasters, Mark Verrochi, CEO; February 9, 2010.
Royal Coffee New York, James Schoenhut, CEO; March 4, 2010.
Specialty Coffee Association of America, Tracy Ging, Director of Marketing and
Communications; March 25, 2010.
Sertinsa, Mario Canon C., General Manager/CEO; January 12, 2010.
Sustainable Harvest, Katie Gilmer, Communications Manager; February 9, 2010.
UniTrade Coffee Trading Company, Roberto Stahl, Trader; January 17, 2010.
Utz Certified, Enrique Abril, Field Representative Mexico, Central America and the
Caribbean; January 12, 2010.
Volcafe Specialty, Alan Nietlisbach, CEO; February 12, 2010.
55
Appendix 2
Producer consolidated interview results
Producers Interviewed: Cooperative Agricola San Pedro Necta, independent farmers in
Huehuetenango, Guatemala; representatives from Utz Certified, Guatemala
56
Producer consolidated interview results (continued)
57
Appendix 3
Exporter consolidated interview results
Exporters Interviewed: Federación Comercializadora de Café de Guatemala
(FEDECOCAGUA), Sertinsa, Asociación de Cooperación al Desarrollo Integral de
Huehuetenango (ACODIHUE), Federación de Cooperativas Comercializadoras de Café Especial
de Guatemala (FECCEG), Manos Campesinas, UniTrade
58
Exporter consolidated interview results (continued)
59
Exporter consolidated interview results (continued)
60
Appendix 4
Importer consolidated interview results
Importers interviewed: Volcafe Specialty, InterAmerican (former employee), Royal Coffee
New York, and Sustainable Harvest
61
Importer consolidated interview results (continued)
62
Importer consolidated interview results (continued)
63
Appendix 5
Roaster consolidated interview results
Roasters interviewed: Dean’s Beans, Just Coffee Coop, Boston Common Coffee, Hogan
Brothers Coffee, Green Mountain Coffee Roasters, and Red Barn Coffee Roasters
64
Roaster consolidated interview results (continued)
65
Roaster consolidated interview results (continued)
66
Roaster consolidated interview results (continued)
67
Appendix 6
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