Farm Profitability Q&A — Janina Grabs

Farm Profitability Q&A — Janina Grabs

The Sustainability webinar series on Farm Profitability and Prosperity generated great discussion and many questions from viewers. This post is the first of four in which the panelists from the second webinar, which took place September 25th, will answer your questions. You can watch a recording of webinar #2 here.

Janina Grabs is a postdoctoral researcher of the political economy of sustainable commodity production at the University of Münster, Germany, and currently a visiting researcher at Yale University. Her thesis examines the effectiveness of private standards in providing incentives and support to smallholder coffee farmers that allow them to improve their production practices. She also analyzes the coffee sector’s reorganization (through mergers and acquisitions) for its sustainability implications. Her work can be found on her website, blog, and she is active on Twitter.

What is the role of coffee consumers? Should we invest in raising consumer awareness so that they value coffee more, and is there a contradiction between the falling C price and rising retail prices for coffee?

In my opinion, consumer demand is very important in driving the industry forward. Coffee roasters tend to be very brand conscious and closely follow consumption trends. If consumers signal that there is a strong demand for either sustainably certified or directly traded coffee with certain minimum price guarantees, and reward roasters and retailers that offer such coffees accordingly, such entities would likely increase the volumes of sustainable coffee they buy from producers. Currently, only between 30 and 50% of certified coffee that is produced actually gets sold under the respective certification, leaving producers with large volumes they need to sell as conventional coffee. Equating demand with supply would contribute to marketing strategies that cover the whole harvest of a producer group or cooperative, leaving them with greater planning certainty and funds for reinvestment.

It is true that the retail coffee price has risen to a much greater extent than the commodity coffee price, which has basically remained within the same price range – between $0.50 and $2 at current prices, without adjusting for inflation  – since the 1960s. In comparison, retail prices have increased sevenfold in the same period. On the one hand, this reflects add-on costs that occur after the green coffee reaches the exporting harbor – anything from shipping to insurance, marketing, roasting, and packaging – which have increased in line with inflation. On the other, coffee farmers have also needed to grapple with rising input and labor costs that are not reflected in current prices. What is more, the short-term linkage between retail and green coffee price is basically in the hands of roasters and retailers. Sometimes we see them lower prices or extend special sales offers to consumers, but more often than not, consumer prices at the retail level remain constant even when green coffee prices dip. Then again, they don’t always pass on price spikes either.

Would an international agreement between buyers and sellers be possible? Can we find common ground between buyers and sellers on the need for more stable market prices that reflect the costs of production? Would that require regulation?

In short, yes, that would be possible! We actually have historical precedence for this in the International Coffee Agreement, which was in place from 1962 to 1989. Through their governments, producing nations agreed to respect output quotas, while participating consuming nations committed to only buying coffee from nations within this scheme. Output quotas were periodically renegotiated with the aim of maintaining the price within an acceptable price band. Despite occasional quibbles over quotas and other details, the agreement worked reasonably well in stabilizing prices and supply. However, in 1989 the agreement broke down for a number of reasons (notably, the end of the Cold War along with divergent interests of producing and consuming nations).

It is interesting to reflect on the possibility of re-establishing a similar agreement in today’s world. Most likely, it would still require supply management, so the largest producing nations would need to be on board. On the demand side, either consuming countries or – at the very least – a significant amount of private buyers would need to credibly commit for such a scheme to work. Unfortunately, a new inter-state agreement would appear difficult given that the United States – the largest single consuming nation – just withdrew from the International Coffee Organization. Historically, we have also seen unilateral attempts at ‘coffee cartels’ where producing nations collaborate without the support from the demand side – all of these efforts failed, though.

Could coffee be removed from the commodity market altogether? What do you think about the idea of a specialty minimum price floor?

The commodity market as it was initially intended does provide important functions to the working of the global coffee trade. First, it allows for price discovery and the alignment of prices across regions and markets – for better or for worse. Second, it also gives market actors a way to manage risk by locking in prices through hedging (for a simple explanation of hedging, see Hedging and Other Operations – the Context). It is unlikely that the global coffee trade at current volumes would be able to work completely without commodity markets. However, in my view there are a number of improvements that could make such markets work better. First, restricting coffee futures trading activity for speculators to a larger extent than currently done would prevent a bet on price drops such as the one that occurred in August, alongside other types of speculative activities which exacerbate price volatility. Second, subdividing the current C-market into more narrow types of coffee futures markets – for instance, by using regional or quality characteristics, with a special futures market for specialty coffee – would allow for better price discovery and a de-linkage of types of coffee that have little in common. Third, we need to remove financial and implementation barriers to allow producers to use futures markets to hedge effectively as well. Under such circumstances, commodity markets could actually fulfill their functions instead of contributing to price volatility and other sectoral challenges.

Regarding the second question, I think that the specialty market is small enough and has a customer base willing to pay enough that a minimum price floor should definitely form part of the sectoral discussion. As Ed mentioned, however, even today nothing prevents specialty buyers from introducing minimum floors in their one-on-one contracts with producers. Such safeguards further improve business relations and supplier loyalty and set the stage for longer-term relationships, which are also key for quality advancements.

Is increasing production a good strategy for farms worldwide, or do different farmers and contexts require different strategies? Does direct sourcing/direct trade have an effect on the profitability of farms?

I feel ambivalent about the proposed solution of increasing production and productivity in order to improve farm-level profitability. On the one hand, it is true that on many farms, productivity can be further advanced, and that productivity is strongly linked to gross income. On the other, we also need to consider the efficiency of input use – if farmers spend a lot of money on external inputs such as fertilizers and pesticides, their net profit (income minus expenses) might be lower than under a less input-intensive strategy. Furthermore, if all farmers simultaneously improve productivity, global output increases and may lead to lower long-term prices unless demand simultaneously picks up a lot. Thus, it definitely depends on the context. Some farmers might find it relatively easy to improve yields by adopting better agricultural practices; others might want to focus on high quality rather than quantity, and others again might feel it more prudent to diversify into other crops such as cocoa or avocado.

Anecdotally, direct trade tends to provide higher farm-gate prices to farmers than using regular commercial channels. However, we are still only at the beginning of assembling data to figure out whether it has a direct effect on profitability. Frequently, the directly traded coffee is at a much higher quality grade than commercially traded coffee, making it difficult to attribute effects correctly to either the quality or the marketing channel. Also, there is some concern that participating in high-end quality markets leads producers to specialize more and/or spend more time on tending to their farms and processing their coffee, which creates opportunity costs for other types of work. Finally, there is still no consensus over what the term ‘direct trade’ actually means, leading to a wide variety of approaches in practice, not all of which show strong concern for arriving at higher farm-gate prices. Still, the initial evidence is promising overall, and a number of researchers (including our group, as well as the Transparent Trade Initiative) are working with direct traders to provide even greater transparency and understanding on that matter.

Shouldn’t producers be able to choose the prices they receive? What are the roles of national organizations that represent producers, such as the Colombian Coffee Federation (FNC)?

In agricultural markets, single producers are considered ‘price-takers’ – that is, they have very little individual power to affect prices. Coffee growers in particular frequently live in isolated rural areas with few marketing options – at best, a local cooperative, a multinational trader, as well as traveling, independent intermediaries (which in Latin America are called ‘coyotes’ for their tendency to defraud producers). This leaves producers with two options to choose prices: 1) choose between buyers and 2) choose the time at which to sell their coffee. The second option is complicated by the fact that only dried, green coffee can be stored for larger periods of time. If producers don’t own processing equipment or do not have the skills to transform coffee cherries to dried, green coffee, they sell coffee either in its cherry form or as wet parchment (where the bean is removed from the cherry, but is not yet dried). Both of these forms tend to spoil or ferment easily, leaving producers with a small window (24-48 hours) to actually sell coffee onto the next step of the processing chain. This limits their bargaining power.

In theory, institutions such as cooperatives or national organizations such as the FNC allow producers to overcome these problems by collecting and pooling supply, providing adequate processing and storage, and leveraging size for bargaining power. The FNC has done an impressive job at expanding marketing channels into the countryside and providing a guaranteed purchasing price that sets an effective floor to local prices. Through the Colombian government, it is also able to provide price or input subsidies in times of crisis. However, when bringing Colombian coffee to market, there is still very little even the FNC can do to affect world market prices, besides picking the right time to sell and astutely negotiating contracts. The external marketing responsibility is furthermore shared with cooperatives and private traders, making more radical policies (such as an export ban of coffee until prices recover) difficult and politically costly to implement.