Coffee
Break

Since Real's steep depreciation in 1998, the amount of money that coffee farmers are collecting for their harvests has been declining in absolute terms. Also, the oversupply of coffee for the first time in many years has also pushed lower the prices for coffee. And the current speculation that the Brazilian government will impose exporting taxes on coffee will reduce even more the purchasing power of local farmers.

Basil M Karatzas

Coffee beverage, a widely consumed beverage around the world, is derived from processed coffee beans (green beans). While the cultivation of coffee trees and production of coffee beans is spread among sixty countries worldwide, there is an increasingly smaller number of buyers and roasters of green coffee. Brazil and Colombia are the largest coffee producing countries, while over 70% of all coffee contracts are traded in Switzerland.

The production of coffee beans is a labor intense industry since it requires handpicking of ripe beans. The production of coffee is also highly correlated to weather conditions, since the coffee tree is sensitive to low temperatures. Therefore, annual production of coffee is unpredictable until the end of the harvest season. In addition, production is characterized by the presence of many small familial businesses with traditional means of production that depend heavily on coffee prices in the world markets.

There are currently six intermediaries in the distribution channel between the farmer and the end consumer. In the last decade there has been a trend toward consolidation and globalization, and it is expected that during this decade the number of intermediaries will decline to just three.

The coffee industry is becoming more competitive as bigger players (roasters and manufacturers) are attempting to have predictable margins and stable coffee prices. On the other hand, there is a trend toward consolidation on the production side of the equation; this trend is still very slow but widely expected by analysts of the coffee industry. Besides a trend toward initiating bigger coffee plantations, there is also an obvious preference toward a more technologically advanced forms of coffee culture over the traditional means. This is clear by efforts of the Colombian Institute of Coffee to utilize genetically engineered coffee plants and the initiation of large coffee plantations with state-of-the-art irrigation and support means in the state of Bahia in Brazil.

Brazilian
Coffee

Brazil is world's biggest producer of green coffee beans with approximate market share of 30%. Depending on weather condition, approximately 30 million bags of coffee beans are exported annually from Brazil while domestic consumption is approximately 9 million bags, which makes Brazil the world's third largest coffee-consuming country. Approximately 85% of Brazilian coffee exports are Arabica coffee, which is considered to be of higher quality than Robusta coffee and which demands higher prices. Coffee exports are the third largest Brazilian exporting product, which generated $2.74 billion dollars in 1997. It is estimated that 3.5 million hectares (1.3 million acres) are used for the production of coffee by 320,000 coffee farms (fazendas de café), 75% of which are less than 10 hectares (25 acres) in size. (See The Holland Company, http://www.hollandcoffee.com/brazil.htm, March 19, 1999.)

Brazilian coffee is characterized by diversity in tastes depending upon geographic regions of the coffee's origin. Arabica coffee from Santos is considered to be the top grade Brazilian Arabica coffee and therefore there is brand awareness and increased demand for this grade. Overall though in the international coffee markets, Brazilian coffee is considered of lower quality than the Colombian coffee which is preferred for its aroma and flavor. Although each coffee producing country exports certain brands that are of the outmost quality, such as Java coffee from Indonesia, when comparing generic Arabica coffees, Colombian coffee has a higher demand in the market place. In addition, Colombian coffee is more recognizable than Brazilian coffee partly because of the orchestrated advertising campaigns the Colombian Coffee Institute undertakes from time to time.

Retail Market
Conditions

The United States and Germany are the world's largest coffee consuming countries, while Brazil in the third place, consumes 20% of its own domestic coffee production. In the United States the average coffee beverage market has been declining steadily. Per capita coffee consumption dropped from 3.2 cups per diem in 1962 to 1.4 cups in 1998, according to the National Coffee Association (See "US regular coffee consumption near 50-year low-NCA; Reuters, http://biz.yahoo.com/rf/990228/bv.html, February 28, 1999.) However, within the coffee market are niche markets that are growing significantly higher. Demand for organic coffee (coffee producing without the use of insecticides, herbicides, fertilizers, cleaners, etc) has been increasing since 1991 at 10-15% annually. However, the organic coffee market is less than 10% of the overall market.

Certain specialty and gourmet coffee blends, such as Indonesia's Java, are also growing at more than 10% per annum. Overall, the International Coffee Association (ICO) (See http://www.ico.org/  March 7, 1999) has projected a 5% annual increase in worldwide coffee consumption, a view that has been shared by many analysts. On the other hand, this slightly increased demand will be met by oversupply, reflecting modern cultivation techniques and recuperation of the Brazilian coffee plantations from the 1994 frost . Plantations that had to be replaced then are now reaching their production years and are expected to reach maximum productivity within the next three years.

At least in the United States, the price elasticity of demand for coffee should be close to zero (by empirical data) since in 1997 and 1998, when coffee prices skyrocketed due to low supplies because of inclement weather conditions and the El Niño effect, both manufacturers (Maxwell House and Folger's) were able to pass to the end consumer most of the price increases and coffee retail shops (i.e., Starbucks, etc) increased prices accordingly without reporting loss of sales. It is especially noteworthy that Starbucks increased prices despite the fact that they had already entered long term agreements and had arranged other financial instruments (hedging, etc) and they were buying coffee at the old lower prices, so they were not affected by the new higher prices.

In Brazil, however, there is obviously a positive elasticity of demand for coffee. According to Nathan Herszkowicz of the Trade Union of Coffee Industry of São Paulo (Internal consumption: 15 million bags/year are the goal, Coffee at the turn of the millenium, p 45, Associação Comercial de Santos, May 1998.), since the Real Plan was implemented in Brazil in 1994 and as a result boosted the purchasing power of the average Brazilian consumer, thirteen million new consumers entered the market increasing domestic consumption from 3.2 to 8.2 million bags in 1997.

Coffee
Globalization

The world coffee bean market is characterized by the presence of sixty coffee producing countries. Brazil and Colombia together command approximately half of the world market while the remaining countries have small market shares. In addition to the wide distribution among coffee producing countries, there is also a wide disparity of coffee producing farmers who are on average small familial businesses with relatively traditional means of production. Only recently efforts have been made to bring the coffee agronomy to state-of-the art technological standards, especially in areas where there are new coffee plantations such as the Bahia area in Brazil. The Colombian Coffee Institute has also taken organized efforts to introduce genetically engineered coffee plants that are not only disease resistant and less sensitive to weather conditions but they also yield higher rates of annual harvest.

In contrast, the demand curve is characterized by the presence of a relatively small number of significant buyers of coffee beans in the international markets. These buyers, also known as manufacturers or roasters, are processing coffee beans usually for their own account as subsidiaries of multinational companies. The most notable North American coffee roasters are Procter & Gamble and Phillip Morris which sell their coffee products under the brand names of Folger's and Maxwell House, respectively. In Continental Europe, two Swiss companies, Nestlé and Jacobs Suchard, are the biggest buyers and Swiss companies trade 70% of the world's coffee production.

In the last decade, a noticeable consolidation and globalization has taken place in the roaster industry where the top five global buyers have increased their market share from 40% to 52% of the world market from 1988 until 1998. This trend is even more obvious in the coffee dealer market where the global ten dealers in 1988 were commanding 55% of the market while in 1998 the top five dealers had a cumulative market share of 45%. There is also a trend toward reduction of the intermediaries between the producer (farmer) and the end consumer. For example, eight intermediaries were involved in 1988 between the farmer and the end consumer while this number has decreased to six in 1998 and it is expected to further decline to three intermediaries in the year 2008.

Tariff and
Barriers

The coffee bean market is relatively a low tariff industry since most importing countries impose none or minimal trade barriers. In particular, the United States does not impose taxes on any form of coffee imports (See US Code, Title 19, Chapter 4, Subtitle II, Part III, Sec. 1356 k.: Importation of coffee under International Coffee Agreement, 1983; Presidential powers and duties) except for "coffee substitutes containing coffee" which has $0.021/Kg. (See US Customs, Department of the Treasury; http://www.customs.gov/imp-exp/rulings/harmoniz/hrm15.htm, March 19, 1999.) However, the European Union (EU), in an effort to assist South and Central American countries to combat drug trafficking problems has imposed since 1991 a 9% tariff (10.1% since 1997) on Brazilian instant coffee. (See "Commodities: Brazil-EU Dispute over Instant Coffee Goes to WTO," InterPress Service, February 16, 1998; http://www.oneworld.org/ips/feb98/brazil_coffee.html, March 4, 1999.)

As a result, Brazilian instant coffee exports to the European Union have declined from 12,000 tons in 1992 to 5,800 tons in 1998. Consequently, Brazil has been losing market share in the instant coffee market in Europe in favor of tariff-exempt instant coffee from Colombia and Ecuador. The issue is even more important for Brazil since domestic consumption of instant coffee is minimal and 95% of its production is intended for exporting. Currently, the Brazilian government, under the pressure of the Brazilian Instant Coffee Association (ABICS), is considering requesting from the World Trade Organization (WTO) that a special panel examines whether such policy involves discriminatory policy by the EU.

Coffee exports are financially significant for the Brazilian economy since they represent Brazil's third largest group of exporting products (3.6% of all exports in 1996) while generating $1.7 billion in revenues. In addition, the coffee industry is labor intense and employs approximately six million workers. However, the Brazilian government has been following a haphazard policy toward the coffee industry. While it gives generous subsidies to coffee farmers—approximately $800 million in 1998 ("Government keeps up flow of financing to farmers"; http://www.commodityexpert.com/Archive/98_05_28br.htm, February 3, 1999.) at a time when the country's foreign reserves were as low as $10 billion— and has lifted exporting taxes on coffee since 1995, it is now considering the re-activation of coffee export taxes to alleviate lost revenue due to its domestic currency's (Real) steep depreciation and overall economic deterioration in 1998.

Recommendations

In 1998, Brazil collected the biggest coffee harvest ever of 36 million bags. This was partly due to favorable weather conditions and partly due to the new plantations replaced after the frost of 1994 that now are reaching harvest time. For 1999, the projections are less optimistic. Coffee as a commodity is traded in USD, although domestic farmers and suppliers are getting paid in local currency (Real). However since Real's steep depreciation in 1998, the amount of money that farmers are actually collecting for their harvests has been declining in absolute terms. Also, the oversupply of coffee for the first time in many years, has also pushed lower the prices for coffee.

The current speculation that the Brazilian government will impose exporting taxes on coffee will reduce even more the purchasing power of local farmers, the majority of whom are small operators. The government should need a more comprehensive approach toward the coffee industry, especially given the importance of coffee exports in steadily generating hard currency revenue year after year.

Direct subsidies might not be the most responsible approach of supporting the coffee industry, but the Brazilian government will need a well rounded program to assess the coffee industry as an agricultural commodity business that is heavily dependable on weather conditions. Instead of direct subsidies, the government should establish funds to support farmers who have been inversely affected by inclement weather conditions. Also, the Brazilian government should encourage and fund organizations similar to the Colombian Coffee Institute which has sought in coordination with several North American universities new improved species of coffee and modern techniques of cultivation.

The fruition of a new plantation takes at least five years, and therefore considerable market research is required in order to predict market trends. The majority of the coffee market is dominated by Arabica and Brazilian coffee production is approximately 85% Arabica coffee. However, given the slow growth rate of the coffee market internationally and the expected oversupply of coffee over the next five years, it should be appropriate that Brazilian farmers diversify their plantations to incorporate new species of coffee, namely coffee plantations for production of gourmet and specialty coffees. These coffees not only demand a premium in the market place, but also the market is growing at 15%. Brazil with its diverse geography is especially suited for cultivation of specialty coffees.

Finally, the Brazilian Federation of Coffee Exporters and the local coffee industry should promote Brazilian coffee abroad (especially in the United States and Germany) with the same zeal they promoted Brazilian coffee in the domestic market with the Purity Stamp Program of 1989. The Colombian Coffee Association offers a unified effort by the local coffee industry with its widely publicized farmer and his donkey ("Juan Valdez y su burro"). No Brazilian coffee association or other organization has undertaken any efforts to promote a national and well-positioned image for the Brazilian coffee. As a result, consumers prefer the brand they are aware of, although Brazilian coffee can be as of high quality as Colombian coffee, and on certain occasions could be cheaper than Colombian coffee either because of financial events in Brazil (i.e., 1998) or lower labor cost and higher yields from certain plantation houses.

Basil M. Karatzas is graduating in May 1999 with an MBA degree in international Business from Rice University, in Houston, TX. Basil also serves as President for Platinum Holdings International, an international management and capital consulting firm, and can be reached at karatzas@rice.edu  

A LITTLE ABOUT COFFEE B.M. K. Coffee belongs to the botanical family Rubiaceae and it has approximately 500 genera and 6,000 species. The most commercially important species are Arabica Coffee (Rubiaceae Coffea arabica), Robusta Coffee (Rubiaceae Coffea canephora) and to a lesser extent Liberica Coffee (Rubiaceae Coffea liberica) and Excelsea Coffee (Rubiaceae Coffea dewevrei). Since Arabica and Robusta coffees consist more than 70% and 25% of the world's coffee production, respectively, any discussion on production of coffee is limited to only these two species without losing its practicality. Soil, temperature, rainfall, sunlight, wind and altitude are important factors for growing coffee plants. The coffee plant (biologically a tree) can grow to 4.6-6m (15 to 20 ft.) height, but to facilitate harvest by labor workers it is deliberately groomed to approximately 6 feet. The coffee plant grows optimally in tropical environments under the shade of taller trees where abundant rainfall conditions are followed by high temperatures. However, modern coffee plantations are grown under artificial canopies, or, even more recently, new genetically engineered species can be grown successfully under direct tropical sunlight. The coffee tree is sensitive to low temperatures when it can be totally destroyed and need replacement. Damaging frosts occurred in Brazil 31 times during the last 172 years, with the most recent "serious" frost occurring in 1994. There is more frequent occurrence of frost in the latter part of this century, which are attributable to the movement of the coffee culture to southern regions of São Paulo and Paraná. However, since the devastating frost of 1975, which decimated the coffee culture in Paraná, there is again a movement of coffee plantations to northern regions, especially Minas Gerais and even more recently to Bahia and Rondônia. In particular, the western Bahia highlands with altitude of 700-1,000m offer an ideal environment for coffee plantations. The topography along modern irrigation offer an ideal place for modern coffee plantations of low cost, high yield production of quality coffee where mechanization and new planting techniques can be employed. It usually takes 5 years to bring a young Arabica tree to fruition while the time required for the Robusta is slightly shorter. The tree thereafter produces fruits for 15 to 20 years bearing a yield of 0.9 to 1.3 kg (2 to 3 lb.) of marketable beans, but 0.45 kg is considered an average annual yield. It takes approximately 4,000 handpicked green coffee beans to make one pound of coffee. The majority of Arabica trees are grown in altitudes between 2,000-4,500 ft. while Robusta trees are grown from near sea level to 3,000-ft. altitudes. The first coffee trees were brought to Brazil by the French immigrants in the early eighteenth century. Coffee is today grown in Brazil in many states, most notably in Paraná, São Paulo, Minas Gerais, Mato Grosso do Sul, Rio de Janeiro, Espírito Santo and Bahia. These widely diverse geographic regions, from the high plains of Cerrado to coastal mountains of Espírito Santo, permit the growing of coffees with a wide range of tastes. Brazil represents 30% of the world coffee production and coffee from the Santos region with its mild, extremely rich and unique smooth taste and striking flavor is considered the top Brazilian Arabica coffee. The tree produces white flagrant flowers that blossom for only a few days and the following six or seven months the fruit develops changing in color from light green to red and ultimately to deep crimson when ready for harvesting. The mature fruit grows in clusters attached to the limb by very short stems and it usually contains two seeds, or beans, surrounded by sweet pulp. Coffee beans are surrounded by a red skin (exocarp) under which lies the pulp layer (mesocarp), which is over the endocarp. Below the endocarp lies a silver skin (seed coat) which includes two coffee beans. The beans (cherries) do not come to fruition at the same time and therefore cannot be picked mechanically. As a result, the production of coffee is a labor-intense industry since it requires each tree to be visited on average three times for harvest. Once harvested, coffee beans must be removed from these layers before they can be roasted. There are two such methods: the dry and wet method. This method is the most traditional and least evolved process of removing the coffee beans from the fruit. The coffee cherries are cleaned and left in the sun to be dried for about four weeks until they reach their optimal content of moisture content (about 12%). During this period, the cherries are raked and turned by hand to ensure an even drying. The drying process is very important in the sense that moisture in under-dried cherries will permit fungi and bacteria to grow and therefore destroy the taste. Over-dried cherries will be more prone to break and therefore reduce the rate of usable coffee beans. The dried cherries will be sent to mills for hulling, sorting, grading and bagging. The removal of the cherry skin is done by the hulling machine. Under the wet method, the cherry skins are removed mechanically while the cherries are still fresh. This is achieved by forcing the cherries between moving and fixed metallic surfaces which gradually peel off the cherries. The residue skin on the beans is further removed by soaking them in huge tanks where enzymes will break down the mucilage. Then, the beans will be washed thoroughly with clean water and in order to reduce their moisture content to 12% from a current 57% be dried up either in the sun or by mechanical means. The washed and polished beans (green coffee) are ready for blending and roasting. The wet method entails the use of machinery and substantial quantities of water; however, it yields coffee of homogeneous moisture and better taste and therefore it commands higher prices. The occurrence however of over-fermented beans ("stinker beans") that have remained trapped in the machinery or went undetected will contaminate any coffee ground and will make coffee foul and extremely bitter.

Glossary Acidity: main characteristic of coffee tasting and evaluation; sharp, dry, clean taste like a typical white wine. Arabica Coffee: coffee produced by Arabica coffee trees Coffee (Rubiaceae Coffea arabica), grown at altitudes between 600 and 2,000m mainly in Latin America and East Africa; it represents approximately 70% of the world coffee production and is considered of higher quality than Robusta coffee. Aroma: main characteristic of coffee tasting and evaluation; odor of coffee that can range from acidic or sharp through spicy or sweet to earthy, musky and smoky. Body: main characteristic of coffee tasting and evaluation; heaviness or richness of taste comparable to characteristics of a typical red wine. Dry Processing: coffee bean processing method involving spreading of cherries out on the ground to dry under sunlight and heat for two to three weeks and mechanically removal of outmost pulp (mucilage) to yield clean coffee beans (green beans). Finish: main characteristic of coffee tasting and evaluation; the coffee aftertaste in the mouth; it can range from no aftertaste from light coffees to sweet, pleasant and bitter. Flavor: main characteristic of coffee tasting and evaluation; the taste that ignites in the palate; a rather subjective characteristic based on individual taste and perception; can take characteristics of the soil of origin as well as plants grown in the same region (cocoa, etc.) Gourmet Coffee: Arabica coffee that is grown in certain elevations and specific climate conditions, that was hand-picked and batch roasted. Organic Coffee: coffees certified to have been grown and processed without the use of insecticides, herbicides, pesticides, fertilizers, cleaners, etc.; there is an increasing awareness of North American consumers in the last two years toward such coffees; the fastest growing niche in the specialty coffee market with 5-7% current market share and projections of 10% by the year 2000. Robusta Coffee: coffee produced by Robusta coffee trees (Rubiaceae Coffea canephora) grown at altitudes of up to 800m in Indonesia, West Africa, Brazil and Vietnam; represents approximately 25% of the world coffee production and is considered of lower quality than Arabica coffee. Wet Processing: coffee bean processing method involving soaking ("fermenting") of ripe cherries in tanks with enzymes, mechanical removal of pulp (mucilage) and finally removal of parchment ("pergaminho") before coffee is ready for roasting and blending.

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