Coffee Industry Research Paper

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The coffee plant is a woody perennial evergreen belonging to the Rubiaceae family. There are two types of coffee, arabica (Coffea arabica ) and robusta (Coffea canephora ). Arabica, which accounts for about two-thirds of global output, is grown at high altitudes in Latin America and northeastern Africa. It has more aroma and less caffeine than robusta, which is grown in humid areas at low altitudes in Asia and western and southern sub-Saharan Africa. The coffee plant can grow up to 10 meters high, but it is usually kept at about 3 meters. It takes two to three years for the coffee plant to produce cherries. Scientific evidence indicates that arabica is indigenous to Ethiopia, while robusta is indigenous to Uganda. It appears that coffee was produced in Ethiopia at a larger scale and then spread to other parts of Africa. Coffee cultivation was introduced to Java by Dutch traders in 1699. A few years later the French introduced coffee to Martinique. Coffee was first cultivated in Brazil in 1727.

Although the origins of the coffee drink are unknown, the usefulness of coffee beans was probably recognized as early as 1000 CE by Arab traders who chewed coffee beans in order to suppress their appetite and stay awake, thus helping them cross large distances in the desert. The world’s first coffee shop reportedly opened five centuries later in Constantinople (now Istanbul, Turkey). Coffee was introduced to the West by Italian traders in the early seventeenth century, with the first coffee shops opening in London and Paris later in that century.

The processing of coffee involves several steps. After harvesting, the skin of the cherry is removed, and the bean is cleaned to become a green bean, the internationally traded commodity. The green beans are roasted, giving them a dark brown color. Following the grinding of roasted beans, consumers use various brewing techniques to convert the ground beans into a beverage. In Europe, most coffee is consumed in espresso-like form, whereas in North America coffee is mostly consumed in drip form (although that practice has been changing since the beginning of the “Starbucks revolution” during the 1990s). In Asia, most people drink instant coffee. Scandinavian countries lead the world with per capita consumption of almost 10 kilograms of coffee per year from 2000 to 2005. The European Union average during this period was 5.0 kilograms, followed by the United States (4.1 kilograms), and Japan (3.2 kilograms), according to U.S. Department of Agriculture estimates (USDA 2006).

Production, Trade, and Prices

Most tropical countries produce coffee. Latin America accounts for 60 percent of global output, followed by Asia (24%) and Africa (16%). From 2001 to 2006, more than half of world output was produced in three countries: Brazil (35%), Vietnam (11%), and Colombia (10%). Other significant producers were Indonesia (5%) and Ethiopia, India, and Mexico (4% each). Coffee in some countries, notably Brazil, is produced on large farms with modern equipment, including irrigation, tractors, and even coffee harvesters. In other regions, especially Central America, Africa, and Asia, coffee is produced by smallholders. In some Africa countries, smallholders own as little as one-quarter of a hectare of land. In this setting, the key input is labor and, to a limited extent, chemicals. In some East African countries there are also coffee estates that use large numbers of permanent workers.

More than 80 percent of coffee is traded internationally and consumed mainly by high-income countries. In some years, coffee is the second most-traded commodity after crude oil, generating about $15 billion in export revenue. The United States accounts for about 18 percent of global consumption, followed by Brazil (13%), Germany (9%), Japan (6%), and France and Italy (5% each).

Coffee is traded in green bean form. Although there are numerous coffee trading companies, most coffee trade is handled by five or six large multinationals. Coffee prices are determined in futures exchanges. Highly-liquid coffee futures contracts are traded at the New York Board of Trade for arabica and at the London International Financial Futures and Options Exchange for robusta. Less-liquid contracts are traded at the Commodity Exchanges of São Paulo, Singapore, and Bangalore.

Coffee prices are generally highly volatile (much more so than other commodity prices). This volatility reflects the fact that Brazil, the dominant supplier, suffers occasional frosts, thus subjecting its coffee output to considerable fluctuations. Hedge funds also play a role in price volatility, especially in the short term. Beginning in 2000, coffee experienced one of the most dramatic price declines in the history of the industry (an episode referred to as the coffee crisis). In October 2001 arabica averaged $1.24 per kilogram, a nine-year low, while in January 2002 robusta dropped to $0.50 per kilogram (the lowest nominal level since the price of $0.49 per kilogram set in May 1965). The main factor behind the price collapse was oversupply, especially in Brazil, which averaged a record output of thirty-three million bags of coffee during the previous four seasons, and in Vietnam, which emerged as the dominant robusta producer, overtaking Colombia as the world’s second-largest coffee producer. The oversupply, caused by lower-cost producers, led some to argue, convincingly, that the coffee crisis was a market-driven outcome of the coffee industry adjusting to new global market realities (Lindsey 2003).

The Policy Environment

The coffee market has been subject to considerable policy interventions both at national and international levels. Takamasa Akiyama (2001) reported that only fifteen of the world’s fifty-one coffee-producing countries had private marketing systems in 1985. Twenty-five countries sold coffee through state-owned enterprises, while another eleven had mixed state- and private-sector marketing bodies. By 2007 the coffee sectors of most countries were operating with private-sector marketing arrangements.

The coffee market has also been subject to a series of coffee agreements administered by the International Coffee Organization (ICO), which was established in 1962 to stabilize coffee prices by dictating how much coffee each producer could export. Research has shown that coffee prices were higher under the ICO than they would have been otherwise (Gilbert 1995). There were likely political reasons behind the ICO’s supply measures. According to Robert Bates (1997), the United States, a powerful ICO member, used the organization during the 1960s and 1970s to increase the income of Central American coffee-producing countries in the hope that this action would contain the spread of communism in the region. Similarly, western European countries viewed ICO-induced high coffee prices as a way to provide aid to their former African colonies.

Most coffee-producing countries (accounting for 90 percent of global output) and almost all developed coffeeconsuming countries were members of the ICO (interestingly, communist countries, which were not members of the ICO, bought coffee under free trading arrangements). The last international coffee agreement was effective from September 1980 to July 1989, after which the ICO was abandoned. A more recent attempt to regulate supplies through another organization, the Association of Coffee Producing Countries, failed.

Factors Influencing the Industry’s Long-Term Outlook

In the absence of new international initiatives or domestic policies by dominant producers, the outlook for the coffee market depends entirely on supply-and-demand forces. Vietnam’s emergence as a major robusta producer is likely to influence robusta prices for many years. In 1980 Vietnam produced 140,000 60-kilogram bags of coffee—less than 0.2 percent of world production. In 2001 Vietnam exceeded 13.3 million bags—more than 11.4 percent of world production. Vietnam is a low-cost producer, and as of 2007 its coffee trees were very young and had yet to reach maximum yields. Brazil has been able to maintain unprecedented output levels, averaging more than 39 million bags during 2003–2006. Extensive mechanization of coffee harvesting has lowered production costs, while better varieties with higher yields have been developed and adopted. Shifting production north, away from frost-prone areas in the south, has reduced the likelihood of weather-related supply disruptions. And the extensive use of irrigation has stabilized and sustained yields.

On the demand side, the coffee industry faces growing competition from the soft drink industry. For example, the 1970 annual per capita consumption of soft drinks in the United States was 86 liters; by 1999, annual per capita consumption had exceeded 200 liters, according to U.S. Department of Agriculture data.

Numerous other factors are likely to influence the coffee industry’s long-term outlook. First, new technologies enable roasters to eliminate the harsh taste of some coffees, essentially achieving a higher level of quality from lower-quality beans. Second, roasters have been more flexible in their ability to make short-term switches between coffee types, implying that the premia of certain types of coffee cannot be retained for long. Third, a small segment of the market has emerged that focuses on product differentiation, such as organic, gourmet, and shade coffee. The implication of these developments is that the demand outlook is likely to differ from one coffee producer to another. Specifically, any expansion in coffee demand is likely to occur at the two ends of the spectrum: lowerquality beans (reflecting improved technology) and specialty coffees (reflecting expansion to niche markets).

Several new patterns have emerged in coffee promotion and distribution as well. Coffee promotion used to take the form of national brands, represented by the familiar Juan Valdez campaign of the National Federation of Coffee Growers of Colombia. Other types of promotions were undertaken by coffee-trading companies, such as Maxwell House’s “Good to the Last Drop” campaign. The market and trade setting has shifted considerably since the mid-1980s.

In 2007 as much as 10 percent of coffee is branded according to such characteristics as subnational origin (e.g., Kilimanjaro coffee rather than Tanzanian coffee, or Harare coffee rather than Ethiopian coffee); social aspects (e.g., fair trade coffee, which ensures a minimum price to growers); and organic, shade, or bird-friendly production (which ensures compliance with certain environmental criteria).

A second emerging pattern is the development of direct relationships between major coffee retailers, such as Starbucks, and producer organizations that can ensure that the coffee these retailers sell adheres to certain social criteria. Initially, it was believed that, in addition to offering more choices to consumers, these new marketing and branding mechanisms would provide a boost to the income of small coffee growers. While this was the case initially, research has shown that the premia received by coffee growers have declined and are likely to shrink even more as increasing numbers of producers join the specialty coffee marketing channels (Kilian et al. 2006).

Bibliography:

  1. Akiyama, Takamasa. 2001. Coffee Market Liberalization since 1990. In Commodity Market Reforms: Lessons of Two Decades, eds. Takamasa Akiyama, John Baffes, Donald Larson, and Panos Varangis, 83–120. Washington, DC: World Bank.
  2. Baffes, John, Bryan Lewin, and Panos Varangis. 2005. Coffee: Market Setting and Policies. In Global Agricultural Trade and Developing Countries, eds. M. Ataman Aksoy and John C. Beghin, 297–310. Washington, DC: World Bank.
  3. Bates, Robert H. 1997. Open-Economy Politics: The Political Economy of the World Coffee Trade. Princeton, NJ: Princeton University Press.
  4. Gilbert, Christopher L. 1995. International Commodity Control: Retrospect and Prospect. Policy Research Working Paper 1545. Washington, DC: World Bank, International Economics Dept., Commodity Policy and Analysis Unit.
  5. Kilian, Bernard, Connie Jones, Lawrence Pratt, and Andrès Villalobos. 2006. Is Sustainable Agriculture a Viable Strategy to Improve Farm Income in Central America? A Case Study on Coffee. Journal of Business Research 59 (3): 322–330.
  6. Lindsey, Brink. 2003. Grounds for Complaint? Understanding the “Coffee Crisis.” Trade Briefing Paper no. 16. Washington, DC: Cato Institute Center for Trade Policy Studies. http://www.freetrade.org/pubs/briefs/tbp-016.pdf.
  7. United States Department of Agriculture. 2006. Tropical Products: World Markets and Trade. Foreign Agricultural Service, Circular Series, FTROP 4-06. http://www.fas.usda.gov/psdonline/circulars/tropical.pdf.

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