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Rich Farmer, Poor Farmerโ€ฏ

With the recent fall in the market price of coffee, many of us in the coffee industry have worried about the consequences that low prices โ€“ prices well below costs of productionโ€ฏโ€“ โ€ฏwillย have on the millions of small- and medium-sized coffee growers that supply over 50% of theโ€ฏ worldโ€™sโ€ฏ coffee. โ€ฏIn an effort toโ€ฏ better understand the problem we are facing, I decided to dig deeper into the profitability of coffee farming in Latin America over the last decade.

ย ย ย 5 Minutes Read

Alejandro Cadena
Co-founder and CEO

Coffee prices have been โ€ฏtrading โ€ฏabove โ€ฏone โ€ฏdollar/lb. โ€ฏforโ€ฏ mostโ€ฏ of the last โ€ฏfifteenโ€ฏ years.โ€ฏ When compared โ€ฏto โ€ฏprices seen duringโ€ฏ the previous decade, coffee farmers have fared much better in the last few years than they did in the early 2000โ€™s: โ€ฏbetween 2002 and 2003 prices failed to rise above โ€ฏ60 cents/lb. โ€ฏSinceโ€ฏ 2005, prices have remained aboveโ€ฏ 1.00/lb, โ€ฏand inโ€ฏ May โ€ฏof 2011 we reached โ€ฏthe highest point in the last 18 years atโ€ฏ $3.00/lb.โ€ฏ The average โ€œCโ€ price between 2002 and 2009 was $0.977/lb, while the average price between 2010 and September 30, 2018 was $1.59/lb.โ€ฏ Additionally,โ€ฏ between 2009 and 2015, the rust crisis drove physical differentials for most Latin American origins above 30 cents/lb, meaning the average price received by coffee growersโ€ฏ during much of this time wereโ€ฏ even higher than the โ€œCโ€ price.โ€ฏโ€ฏ

To โ€ฏexamine the profitability of coffee farming in Latin America more closely, โ€ฏI โ€ฏdecided to simulate the income โ€ฏreceived โ€ฏby farmers during the last 8 years, using the average โ€œCโ€ price per year and comparing it with an average cost of production of USD 1.20/lb โ€ฏFOB.โ€ฏ Since no reliable figures exist regarding costs of production, I used the numbers Caravela calculated in 2017 using our internal cost of production simulation model.โ€ฏ This model estimates costs of production using market prices of inputs needed (labour, fertilizers, etc.), plus assumptions about yields andโ€ฏ labor productivity tailored to each country.โ€ฏ The results of that model show us that in 2017 costs of production in the seven Latin American countries 1 โ€ฏwhere we operate were between $1.20/lb โ€ฏin Nicaragua and $1.80/lb โ€ฏfor Ecuador (see graph below). ย  ย 



ย Given these numbers and taking into account inflation over this โ€ฏeight-yearโ€ฏ period, for simplicityโ€™s sake I decided to use an average cost of productionโ€ฏof $1.20/lb FOBโ€ฏ for the eight-year period.โ€ฏ Using these basic assumptions, the graph below charts the profitability a farmer would have achieved every year since 2010.โ€ฏ ย 



Profitability ranged between 53% in 2011 and -2% in 2018, whilst the average profit for the eight-year period was a very healthy 24%.โ€ฏ Any business owner or shareholder receiving a 24% โ€ฏaverage โ€ฏnet profit marginโ€ฏ over the course of eight years โ€ฏwould be very happy. โ€ฏSoโ€ฏ why โ€ฏis this profit margin insufficient for the vast majority of coffee growers in Latin America?โ€ฏโ€ฏ

It turns out that the majority of the worldโ€™s coffee farmers are smallholders owning less than 1 hectare โ€ฏof land, producingโ€ฏ only anโ€ฏaverage about 5 bags (60 kg) per ha โ€ฏevery year โ€“ or less.โ€ฏ Unfortunately, coffee yields have โ€ฏremained flat or evenโ€ฏ decreasedโ€ฏ over the last two decades in most coffee-producing countries, โ€ฏexceptโ€ฏ forโ€ฏ Brazil and Vietnam (see graph below).โ€ฏ

Instead of looking at profit margin, letโ€™s examine the absolute โ€ฏprofit โ€ฏfor threeโ€ฏ different type ofโ€ฏ small โ€ฏcoffee farmers with different farms sizes and yields:โ€ฏโ€ฏ

As demonstrated in the table below, a small farmer with very low productivity (Farmer A) - even with a 24% net profit - would have madeโ€ฏ a profit ofโ€ฏ only $21 dollars a month, orโ€ฏ $247โ€ฏdollars a year. โ€ฏAs you can imagine, with so little money remaining in their pocket at yearโ€™s end, that farmer has scant left over to invest in his farm orโ€ฏ improve โ€ฏtheir familyโ€™s quality of life.โ€ฏโ€ฏ Small farmers are barely subsisting, so itโ€™s no wonder that their childrenโ€ฏ are opting to seek out more viable alternatives in urban areas.โ€ฏ The situation improves should that farmer be able to produce at least 15 bags per hectare (Farmer B), but it still is not enough.โ€ฏโ€ฏ

However, aโ€ฏ coffee farmer with 3 hectares and decent โ€ฏproductivityโ€ฏ (Farmer C) would have made aโ€ฏ $2,227-dollarโ€ฏ profit at the end of the year.โ€ฏ Although itโ€™s still not a great profit, with this โ€ฏsubstantially โ€ฏlarger sum of money, a farmerโ€ฏ would โ€ฏbe able โ€ฏto invest in their farm and/or โ€ฏhis family.

Now, letโ€™sโ€ฏ calculate โ€ฏthe price we would have to pay a farmer if we wanted him to achieve an annual profit of, letโ€™s say 5,000 dollars. โ€ฏAs you can see in the table below, the price needed for a small, low productivity farmer would have to be extremely highโ€ฏ while the one in the middle group would also be quite high โ€“ prices that the vast majority of coffee roasters would not be willing to pay for coffees scoring below 86 points; meanwhile the price paid to the medium-sized, highly productive farmer (Farmer C) would be in a more reasonable price range.โ€ฏ โ€ฏ โ€ฏโ€ฏ

Clearly, the main issue facing coffee farmers around the world is not related exclusively to prices โ€ฏorโ€ฏ profitability. There is a problem related toโ€ฏ the scaleโ€ฏ of most coffee farms around the world, and the lack of productivity suffered by most small farmers due to lack of capital and/or financing to purchase โ€ฏinputs,โ€ฏ compounded by the lack of knowledge regarding optimal coffee farm management.โ€ฏ

Caravela has long recognizedโ€ฏ that paying farmers high prices - especiallyโ€ฏ for just a small fraction of what they produce - is not necessarily enough โ€ฏto provideโ€ฏ coffee growers with โ€ฏeconomic โ€ฏsustainability; that is why our model is built on threeโ€ฏ basic pillarsโ€ฏ which weโ€ฏ believe โ€ฏare key to creating a sustainable coffee industry:โ€ฏโ€ฏ

  • Buying all their qualityโ€ฏ coffeeโ€ฏโ€“ notโ€ฏ just the highest-scoringโ€ฏ microlotsโ€ฏโ€“ starting from 83 points,โ€ฏ at differentiated premium prices according to quality,โ€ฏ allowing producers to maximize their income, while incentivizing them to continue quality improvements.
  • Developing long-term relationships with coffee roasters to reduce risk. Coffee trees take at least 3 years to start producing, and the investment is not recuperated until 5 or 6 years after planting; having good prices for 1 year is not sufficient.โ€ฏ
  • Providing โ€ฏcupping feedback, โ€ฏeducation and technical assistanceโ€ฏ through our PECA program โ€ฏto help coffee growers improve the โ€ฏquality and quantity of their harvests, reduce phytosanitary risks, and better manage their farms, thereby reducing costs of production.โ€ฏ

A roaster who wants to help secure the future of coffee must start by putting their money where their mouth is: reward producers with good prices for all their quality coffee and commit to long-term relationships with those quality-minded producers to ensure they have income stability. Growers then know that roasters can be more than just clients, they can be true business partners. We have witnessed how coffee producers with long-term, fixed-priced contracts with roasters have been able to focus on producing quality coffee consistently, improving their quality of life and investing their profits to buy more land, thereby increasing their farm size โ€“ and income โ€“ to sustainable levels.

ย ย โ€ฏIn 2015,โ€ฏ a few coffee โ€ฏentitiesโ€ฏ calculated โ€ฏthe costโ€ฏ of productionโ€ฏ for smallholdersโ€ฏ were around USD 1.10/lb . โ€จ

ย 

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