Coffee: Culture or Business?

   4 Minute Read

Andrés Agredo
CEO Café Trading Advisors
Commodity Trading Advisor, NFA Member

The last two years have been gruelling for coffee producers, many of whom have had to resort to selling their product below their cost of production. What we have seen is producers blaming this loss of competitiveness on market speculators, cafés, and basically any other player or component in the supply chain.

Many identify low prices as the problem, but in my opinion, they are far from it. Low coffee prices are a reflection, not just of the world coffee supply exceeding demand but also of the growing number and strength of competitors in coffee production that have the capacity to offer lower prices for their product while generating a profit.

Competitiveness can be defined as “the ability of a firm to offer products and services that meet the quality standards of a particular market at prices that are competitive and provide adequate returns on the resources employed or consumed in producing them”. Even though coffee production may be viewed as a cultural activity in several countries (perhaps nowhere more so than Colombia, whose national football team are nicknamed Los Cafeteros ), we must also remember that it is a business which must be profitable. Coffee consumers have a limited demand, which producers worldwide must compete to satisfy. When more competitors enter “the ring”, the most competitive producers will achieve the greatest market share and this, sadly, will be at the expense of those who are less competitive. In a globalized market, where quality is far from being the most desirable attribute within the 150 million bags of coffee consumed annually, the most obvious way to compete is through price.

The internal price for coffee is determined by the New York Stock Exchange’s international price. This is a market where coffee future contracts are negotiated by hedgers who produce and consume the raw material, as well as by speculators trying to obtain profits through price variation, a group which also is made up of individuals that form part of the physical market. At the Second World Coffee Producers Forum which was held in July in Brazil, I attended a speech looking at the role that speculation plays in the market. Using an objective, mathematical approach, it was demonstrated that although “speculative activity can exacerbate price movements in the short term, the fundamentals (supply and demand) always prevail in the long term”. It also concluded that “No significant evidence has been found, showing that speculative activity has affected the coffee market price in the recent market downturn that began in 2016”. The assertion failed to resonate with many, perhaps due to the technical nature of the presentation, or because this type of conclusion is something that many do not want to hear. This line of argument contradicts the flagship conclusion of some more subjectively reasoned speeches, namely that speculative activity is the problem. However, the real reason producers are losing income through low prices is that they have lost competitiveness, and although it is a hard reality to accept, this is way the market works.

A competitive advantage can be described as “a condition or circumstance that puts a company in a favourable or superior business position”. Each company can innovate in its own way. However, these competitive advantages cannot always be maintained in the long term as markets are constantly changing and companies must be proactive with these changes to remain on-trend. Let’s switch the word “companies” to “coffee producers” and see where we get to.

Over the last three decades, coffee production has evolved dramatically and today it is a very different place. New competitors have entered and developed advantages that have allowed them not only to capture a greater portion of the market, but also to offer their product at lower prices compared to their competitors, while remaining profitable. This ultimately results in those who cannot compete leaving the market. Businesses need to adapt to new market conditions through the development of competitive advantages if they want to persevere and be profitable; coffee producers are no exception.

What competitive advantages can a coffee producer develop?

While it is perhaps inevitable to think about quality, we must bear in mind that not all coffee consumption is of high-quality coffees. In fact, the market for quality coffee, although growing, is still comparatively a niche one, representing a small fraction of global consumption. Also, not all producers have the necessary infrastructure and knowledge to make “quality” their competitive advantage.
In terms of efficiency and productivity, we must acknowledge that Vietnam and Brazil possess a huge advantage; with production costs of around $0.70 per pound of coffee, this is a warning to anyone even considering making price their competitive advantage.

All producers should seek to improve quality, efficiency and productivity, but this is not the same as being the best at something, when it becomes your differentiating factor, making you more competitive and profitable.

Currently, risk control and financial income generation are competitive advantages without many dominant producer players. Financial revenues are not operational. They are not obtained through the sale price or volume of coffee produced. Instead, via the use of financial instruments derived from coffee, such as futures and options that are traded on the New York Stock Exchange and structured products offered by commission firms and banks. Although I have seen some Brazilian producers with a greater knowledge and use of these types of financial tools, in general the use of futures and options is still rare amongst coffee producers and is nothing like what is seen in North American corn, soy, cotton, wheat and livestock production.

The use of financial tools gives producers the opportunity to evolve and allows them to make “risk control” their competitive advantage. More than 1.5 billion dollars are traded daily on the New York and London stock exchanges – could this be the future for the most sophisticated and profitable coffee growers? Only time will tell. What I do know is that those that made efficiency and productivity their competitive advantage three decades ago are the ones dominating the market today.