5 Minutes Read

Alejandro Cadena
Co-founder and CEO

Coffee prices have been  trading  above  one  dollar/lb.  for  most  of the last  fifteen  years.  When compared  to  prices seen during  the previous decade, coffee farmers have fared much better in the last few years than they did in the early 2000’s:  between 2002 and 2003 prices failed to rise above  60 cents/lb.  Since  2005, prices have remained above  1.00/lb,  and in  May  of 2011 we reached  the highest point in the last 18 years at  $3.00/lb.  The average “C” price between 2002 and 2009 was $0.977/lb, while the average price between 2010 and September 30, 2018 was $1.59/lb.  Additionally,  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 growers  during much of this time were  even higher than the “C” price.  

To  examine the profitability of coffee farming in Latin America more closely,  I  decided to simulate the income  received  by farmers during the last 8 years, using the average “C” price per year and comparing it with an average cost of production of USD 1.20/lb  FOB.  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.  This model estimates costs of production using market prices of inputs needed (labour, fertilizers, etc.), plus assumptions about yields and  labor productivity tailored to each country.  The results of that model show us that in 2017 costs of production in the seven Latin American countries ¹  where we operate were between $1.20/lb  in Nicaragua and $1.80/lb  for Ecuador (see graph below).    

 Given these numbers and taking into account inflation over this  eight-year  period, for simplicity’s sake I decided to use an average cost of production of $1.20/lb FOB  for the eight-year period.  Using these basic assumptions, the graph below charts the profitability a farmer would have achieved every year since 2010.   

Profitability ranged between 53% in 2011 and -2% in 2018, whilst the average profit for the eight-year period was a very healthy 24%.  Any business owner or shareholder receiving a 24%  average  net profit margin  over the course of eight years  would be very happy.  So  why  is this profit margin insufficient for the vast majority of coffee growers in Latin America?  

It turns out that the majority of the world’s coffee farmers are smallholders owning less than 1 hectare  of land, producing  only an average about 5 bags (60 kg) per ha  every year – or less.  Unfortunately, coffee yields have  remained flat or even  decreased  over the last two decades in most coffee-producing countries,  except  for  Brazil and Vietnam (see graph below). 

Instead of looking at profit margin, let’s examine the absolute  profit  for three  different type of  small  coffee farmers with different farms sizes and yields:  

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

However, a  coffee farmer with 3 hectares and decent  productivity  (Farmer C) would have made a  $2,227-dollar  profit at the end of the year.  Although it’s still not a great profit, with this  substantially  larger sum of money, a farmer  would  be able  to invest in their farm and/or  his family.

Now, let’s  calculate  the price we would have to pay a farmer if we wanted him to achieve an annual profit of, let’s say 5,000 dollars.  As you can see in the table below, the price needed for a small, low productivity farmer would have to be extremely high  while the one in the middle group would also be quite high – 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.      

Clearly, the main issue facing coffee farmers around the world is not related exclusively to prices  or  profitability. There is a problem related to  the scale  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  inputs,  compounded by the lack of knowledge regarding optimal coffee farm management. 

Caravela has long recognized  that paying farmers high prices - especially  for just a small fraction of what they produce - is not necessarily enough  to provide  coffee growers with  economic  sustainability; that is why our model is built on three  basic pillars  which we  believe  are key to creating a sustainable coffee industry:  

• Buying all their quality  coffee – not  just the highest-scoring  microlots – starting from 83 points,  at differentiated premium prices according to quality,  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. 
• Providing  cupping feedback,  education and technical assistance  through our PECA program  to help coffee growers improve the  quality and quantity of their harvests, reduce phytosanitary risks, and better manage their farms, thereby reducing costs of production. 

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 – and income – to sustainable levels.

   In 2015,  a few coffee  entities  calculated  the cost  of production  for smallholders  were around USD 1.10/lb .