To Market, To Market: What the New Economy Means for Sourcing Strategies

By Shanna Germain

Increased pricing. Decreased availability. Contract defaults. Closer relationships with producers…

The current market situation is having huge impacts all across the coffee industry, but perhaps nowhere more so than at the very source. While relationships with producers are ever-evolving, even in a stable economy, companies are currently finding themselves in a new spot on the map when it comes to sourcing strategies.

“It’s a whole new world,” says Peter Giuliano, director of coffee and co-owner of Counter Culture Coffee. “The current ‘C’ market is only a symptom—it underlies basic changes in the supply and demand of coffee at the global level. While this situation has emerged quickly, it didn’t surprise us, really. We have, in some way, been preparing for this eventuality for years.”

Companies like Counter Culture, which have worked to build long-term relationships with producers over the years, are finding that those close-knit ties are even more vital in a tough economy. “The kinds of relationships we have built with producers are valuable in times of both scarcity and oversupply—sort of like how a personal relationship is meaningful through thick and thin,” Giuliano says. “In that sense, the strategy of building and strengthening coffee relationships based on shared values, quality, sustainability, and prosperity hasn’t changed at all. What’s changed is the environment, and the challenges that we have to face in our partnerships with coffee producers.”

Importers, too, are finding themselves in a new place when it comes to managing their coffee sources, quantities and prices. “This market situation is affecting our strategy because of the high prices and volatility; we have limited funds and want to use it for top qualities which are even higher priced,” says Andrew Miller, president of Café Imports. “There has been a shortness of washed coffee and we have differential risk like we have never seen, so we have to be more conservative and we are not sleeping very well. We worked through $2.70 in 1994 and $3.17 in 1997, but nothing like this.”

Over the last year, Miller says he saw a lot of changes, including fewer specialty Colombians available, an extreme shortness of other washed milds and radical differentials. “Add in an 80 percent jump in the ‘C’ market with a lot of volatility and uncertainty, and from my experience over the last eighteen years, this is a new world,” he says.

Part of the reason for the difficulty in negotiating these changes has to do with their cause. While, in the recent past, significant spikes in prices could be strongly linked to Brazilian crop failures, current prices seem to be heavily influenced by commodity speculation. This means that managing price increases that aren’t directly connected to any apparent supply shock presents some new challenges — but it also opens some doors.

“For us, it provides an opportunity for us to prove the relevance of our Relationship Coffee business model in challenging market conditions,” says David Griswold, president of Sustainable Harvest. “For example–we’ve found that by providing financial literacy and risk management training for farmers, we can give them the tools to better understand and interpret market signals. This helps them compete despite the rising market prices and reduces the potential for defaults in periods of market instability.”

Negative Effects

It isn’t just the roasters, retails and importers who are feeling the pinch.  Right now, cooperatives are facing daunting challenges, not just in terms of coffee production and sales, but also in terms of communication and cohesion. “Many will not make it, or will shrink,” Giuliano says. “That’s the biggest problem I can imagine with this situation- the negative effect it will have on cooperatives, which are so important for the economic stability of small coffee producers.”

One of the long-term impacts of that could be a decrease in financial assistance for farmers. “We have seen that a lot of the farmer-owned cooperatives we work with are having difficulty securing the financing they need to pay their members at current market prices for beans since prices are rising so quickly,” says Griswold. “So we’re working closely with the cooperatives and the finance institutions that provide them with capital to try to resolve these issues. Those conversations have been key in the past few months, and have helped us avoid contract defaults in a number of situations. We’ve seen increased risk of default in many regions, and we have heard the same from others in the industry. As a result, we’re working hard to ensure that our suppliers have the tools they need to deliver the coffee they have contracted.”

On the purchasing side, there is another risk: that the differentials will go down while import companies are sitting on a warehouse full of coffee. “We cannot hedge differentials like you can hedge market pricing,” says Miller. “This forces us to be a little more hand to mouth. The downside is that good coffees are harvested once a year and you have to be there early to choose your quality for the entire year and then hold it for six months. Otherwise its like going to the farmers’ market at three in the afternoon and finding a few brown strawberries that everyone else squeezed and passed by.”

In the end, Miller says, “We are still involved with the producers and programs we were last year and even some new ones but we just have to be a little more conservative with quantity because on quality, we will not budge.”

Staying Positive

In a time of financial upheaval, it is easy to focus on the negatives, but in truth, that is also a time for positive changes. This is especially true when companies can stay open-minded about the possibilities and use the uncertainty to improve their businesses and plan for the future.

“On the positive side, this market condition has motivated us to invest more effort than ever in consumer education and marketing efforts to help our wholesale customers better understand the real value of quality coffee and communicate their knowledge to their own customers,” Geoff Watts, Vice-President of Intelligentsia. “It is more important now than ever that coffee drinkers have the fundamental understanding about where all of the differences lie between top caliber specialty coffees and average commercial grades.”

Not to mention one other biggie: Coffee, perhaps for the first time ever, is being properly valued by the current marketplace. “The current coffee marketplace will cause smart roasters and retailers to price their coffee in a much more realistic way,” says Giuliano. “Great coffee is the result of a tremendous amount of skill, effort, and craftsmanship, and it shouldn’t be cheap. The current coffee economy won’t allow it to be cheap anymore, at least not for long. This is the best possible thing for the Specialty Coffee industry’s long-term sustainability.”

While a few companies are seeing defaults, just as many others haven’t and they don’t except to. “I think we would only arrive at a default in one of our relationships if we stopped communicating altogether,” says Giuliano. “We’ve done the opposite, and tried to stay in the closest communication we possibly can with our producer partners.  Sometimes, we’ve arrived at a solution that required some compromise on both sides, and in some cases our producer partners were able to take advantage of the price spikes without damaging our relationship. That’s a win-win!”

What it seems to come down to for many is long-term relationships, which are one of the key protections against economic down-turns. “Fortunately we’ve been shielded from most of the negative effects by the strength of our historical relationships,” says Watts. “The majority of the coffees we buy come from producers with whom we’ve worked closely for nearly a decade, and our value to one another has been proven over time. Many of these producers remember well the high prices we were paying throughout the ‘crisis’ years of 2000-04, and take that into account when negotiating pricing today.”

Because of these relationships, many producers made serious commitments to quality production. They’re less likely to lower their standards just because the market has risen. “They understand the big picture and have learned to take a long view when thinking about their farms, rather than to behave in a mercenary way and re-jigger every year,” Watts adds. “But it is absolutely true that in general quality does suffer in a market like this, most notably in smallholder contexts. There is clearly less incentive to invest the extra money required to produce a higher quality coffee when the street price for basic undifferentiated commercial grades is already so high. The average producer is inclined to just get the coffee off the trees and sell it for cash-money as quickly as possible, rather than spend more on labor to have more selective picking, segregate micro-lots and wait through a long process of sampling to evaluate the individual quality of coffees.”

Back to the Future

Despite the difficulties of the current markets for all sides of the industry, the overall outlook is positive. Roasters, retailers and importers are saying that, while this new market is certainly taxing and complicated, in the long-run, it actually has the potential to mean good things for coffee, in all segments.

“These markets certainly test the strength of relationships,” says Watts. “I think it’s a good thing in the long run…relationships need to be tested at some point, otherwise it is hard to know how reliable they actually are. Markets like this can help bring a lot of clarity to both roasters and the producers they work with—they force us to really examine why we make the choices we make.”

Griswold agrees, adding, “Farmer cooperatives are receiving a higher price for their coffee. As long as they are able to fill their contracts, they will earn more money than in previous years which represents an opportunity to deliver essential services–quality and productivity training, financial support, educational and health services, and infrastructure investments. It also means farmers will earn more, and that increases the likelihood that they can invest in their farm and in other essential services that require cash income like education and health care.”

And then there are the consumers, an often overlooked element of this brave new world of coffee prices and volatile markets. “For me, the most interesting aspect is that high quality producers are still getting a premium over standard coffees in a $2.50 market,” says Miller. “That is a testament to the awareness of roasters and consumers that a good cup is what matters.”