Is direct trade the answer to farmer sustainability?
Often seen as a way of rebalancing the supply chain, does it really fulfil the promise of returning more income to farmers?
This is a the first of 4 posts examining the coffee supply chain. I wanted to start by examining direct trade. What it is and how it is perceived. In furthers posts I and going to take a closer look at both supply and buy sides of the market to show how it works. In the fourth and final post I will look at how digital market places attempt to close this gap between coffee buyers and sellers.
The coffee supply chain, like many food based supply chains is complex. There are multiple parties involved. It has to be handled with care and many people involved in its cultivation, nurture, process, logistics, roasting and consumption.
From outside looking in, it looks ridiculously complex and needless.
There is a strong movement within The Third Wave of Speciality Coffee to ensure a fair deal for coffee farmers, by concentrating on single origin coffees and using direct trade as a means of passing more of the transaction value back to the farmers. Direct trade is often hailed as the solution to improving the lives of farmers.
How big is the global coffee market?
In 2022, the global coffee market, was valued at $127 billion. The size of the market in green coffee in 2021 was valued at $35.5 billion. From these figures you can see the supply side of the market is worth about 30% of the overall market.
Some argue this is unfair.
Coffee is priced in many different ways. But the overriding factor influencing coffee pricing is the C-Market. It is the commercial coffee price index and it dictates pricing and overall market sentiment. Outside of the C-Market, such as in Speciality Coffee trading, other factors, such as quality and quantity are taken in to account to a much greater degree.
The most recent squeeze on the farmers is the cost of production. The cost of living, inflation and bottlenecks in the supply chain post Covid-19 and the Suez blockage, have all contributed to the rise in these costs. When the C-Market is down, the margins for the farmers are reduced.
Additionally in 2023 trading is also heavily influenced by the inverted market. This occurs when the price of the coffee is up, but due to pressure on the buy side of the supply chain, pricing expectations are down over the longer term. This means coffee is not shifting because the buy side is waiting for the sell side to drop their prices.
One solution, to avoid many of the complexities of trading, is to go direct to a farmer to buy their coffee. The idea is, if (say) a roaster buys coffee direct from a farmer, more of the costs (usually eaten up by the supply chain) can instead, be passed back to the farmer.
If this was the case, how would it look?
What does direct trade look like?
Coffee is a traditional business and in some ways, innovation is slow. Each country (or origin) has its own set of export rules and customs that have to be followed. And importing countries also have rules and regulations to manage what comes into their country and under what circumstances it may do so.
More often that not a coffee roaster will buy their coffee from an importer. The importer will have choice of coffees to choose from at various price and quality points. The coffee will also be landed in a warehouse and easily accessible for the roaster to make a purchase.
Let’s just say at this stage the buyer decides he wants to stand out from his competitors, and decides they want to buy something unusual or different. They may also feel they can get a better deal by working direct with a farmer.
The roaster may go to trade shows and start building relationships with farmers. They will be able to obtain samples for coffees and get to know the farmers values and their business’s structure. To build confidence on both sides, they may even travel to the farm and see for themselves how the farm operates and cup their range of coffees.
Once he has decided which coffees he wants to buy, what happens next?
How could they buy the coffee?
Let’s say the roaster wants to make all this investment worth while, so he decides to buy a container of coffee. This would be investment of around $150,000. Which for a 20ft container, would be 19,100kg, or around 318 x 60kg bags of green coffee.
The roaster can see he is at the start of something new and exciting and it will relate well in their marketing. He can talk about the farmer, their values, and how he values his relationship with them. And he feel this will give him a competitive edge in maintaining his own existing relationships, and also developing new opportunities in his own market.
There are number of elements in the purchase process he is going to have to manage himself. He will need to think about logistics, contracts, shipping, insurance, finance, quality control and warehousing.
So where does he start?
He first has to decide how he is going to contract for the coffee. There are a range of ways to do this based around the European standard coffee contract. And within this, there are important terms called Incoterms defining the responsibilities of each party involved in the sale. This is an important step and the buyer must fully understand what the terms mean, and the impact it will have on his own costs and responsibilities in executing the contract.
The contract will also set out the payment terms, the cost of the shipping and a description of the coffee being bought and sold by the two parties.
First and foremost in the mind of the buyer will be any concerns about how he is going to pay the farmer and ensuring the quality of the coffee matches is original expectations.
Samples are sent from the farm to the buyer prior to shipment. These are called pre-shipment samples (PSS). The buyer will cup the PSS and see if they match the samples he received during the sale process. If they do, he goes ahead and proceeds to the next stage. The shipping can go ahead. They will also cup the coffee when it lands to verify what he has bought has been shipped correctly. At either point they can reject the samples and renegotiate (or end) the sale.
The coffee will usually be in a warehouse, in the farm, at this stage. Depending upon the agreed Incoterms, either the roaster or the farmer will need to contract with an exporter to ensure the coffee moves from the farm to a warehouse and processed for export. From there it will need to be moved to the port where the coffee will depart.
The buyer will also need to engage a shipping agent to make a booking for the shipment, manage the entry of the container to the port and be loaded on to the vessel.
If the farmer or exporter is managing the process, as defined in the contract, they are going to include these costs in the sale of the coffee. If the buyer manages these logistics, he will buy the coffee on the main contract and then contract and manage all those extra services themselves.
How do you finance a contract like this?
At some stage the issue of finance is going to be raised. Broadly speaking the farmer will want to be paid before the coffee leaves his farm. At the very least he may want a deposit. In some cases the exporter may pay him and then collect payments from the buyer. In other cases part of the payment will be made before the coffee ships, and the rest will be paid upon landing at port, or within 30 days of doing so.
Our roaster has a problem at this stage. Can they afford to tie up $150,000 in stock before they have sold the coffee to their own customers? They could presell some or all of the coffee. Or they could finance the purchase in advance using trade finance.
It all comes down to their access to working capital.
If the buyer has a good relationship with their bank, they can arrange to fund it through trade finance. If they have a good trading record, they could borrow the funds to finance the purchase.
Alternatively, they can partner with a larger coffee company who can offer them finance for buying the coffee on their behalf. There are a lot advantages to this, including the management of the sale, insurance, storage and payment terms.
When the coffee arrives at the destination port, the buyer will need to arrange for an import agent to liaise with the port authorities for the coffee to be removed and taken to a warehouse. The roaster will also need an import license or EORI to do all of this in their own name.
Once the coffee has been landed it will need to be moved to a permanent place of storage. As a medium size regional roaster, where would this be? The coffee needs to be stored in a cool dry place. So where are they going to put 318 bags of coffee?
They will need to calculate how quickly are you going to roast and sell that coffee? And this will depend upon the size of their client base and any pre-sales they agreed prior to contract?
The pressure is now on to sell the coffee before the trade finance facility matures and interest and other charges start to apply. There are of course services and facilities to manage this and we will examine these in subsequent posts. In any case, these are costs the buyer will need to work in to their business model.
What are your core competencies?
By now it should be apparent the process is complicated. There are many skills required to get the coffee from the farm to the buyer.
How much time would a roaster need to invest in the management of this purchase? And from his own business perspective, does it represent an efficiency benefit to his business? And how much of the value in the sale was actually passed back to the farmer?
If this was going to be the buyer’s strategy for every coffee they buy, is this really where their core skills lie? Would it be better to trust an importer to do this for them?
There comes a point where the buyer has to decide what their core expertise is and where they think success for their business will come from. Perhaps their time is better spent attending to their own core business, and leaving areas of specialism to others? Or perhaps they can see a path to growth by managing the purchases themselves and roasting on a larger scale?
In my next post I will take a look at the role of the importer and other services on the buy side, and explain why they are important parts of the supply chain and how using them can add a lot of value and opportunity to the buyer’s business.