Coffee-nomics
- Jimmy El Gemayel
- Oct 31, 2020
- 7 min read
Coffee has become a staple in our every day routine. Most people know exactly which coffee shop, the kind of roast, or the type of coffee they relish most. But, as you pay for your coffee at your favorite store, have you ever wondered who is taking the biggest share of the proceeds? Who are the biggest winners and losers in the coffee industry?
The exact origin of coffee remains a mystery, but one widely accepted theory is that it was first discovered in Ethiopia before the 9th century. According to legend, a shepherd noticed that his goats couldn’t sleep after eating red berries from a particular shrub—these berries were coffee beans. By the 15th and 16th centuries, coffee was being cultivated on the Arabian Peninsula and in the Middle East, with records of coffee drinking dating back to the 15th century in Yemen. It wasn’t until the late 17th century that coffee made its way to Europe through Dutch, Parisian, and Venetian traders, where it gained popularity and began to be planted around the world.
Since then, coffee has become a staple in our everyday routines. According to the National Coffee Association, over 2.25 billion cups of coffee are consumed globally each day. For many, a good day simply doesn’t start without a fresh “cup of joe.” The Pavlovian response coffee incites is so powerful that the aroma alone can sharpen one’s mind. Coffee is also one of the most common social activities, with the phrase “Let’s meet for a coffee” becoming nearly synonymous with “Let’s catch up.” Many favorite sitcoms are built around the social aspect of coffee, featuring iconic coffee shops like “Central Perk” in Friends, “Monk’s Cafe” in Seinfeld, and “Cafe Nervosa” in Frasier.
From Shrub to Cup
Coffee flourishes in subtropical and equatorial regions. The history of coffee harvesting is closely tied to colonialism, as coffee, like cotton, sugar, and other commodities, played a pivotal role in global trade. Consequently, today’s largest coffee producers are countries that were once colonized by European empires. For example, the Portuguese introduced coffee to Brazil, the French to Vietnam, the Spanish to Colombia, and the Dutch to Indonesia. Over generations, populations in these coffee-producing nations have become economically dependent on coffee and continue to supply raw beans to meet global demand.
Top producing countries of green coffee beans
Generally, as consumers, we rarely consider the evolution and process behind what we purchase. When it comes to coffee, we know how strong we like our roast, whether we prefer espressos over Americanos, and—if we’re really curious—the type of bean we’re consuming. Below, we’ll explore the journey of coffee from shrub to cup, summarized in four key steps:
On the Farm: Farmers grow and pick coffee beans, then process them to extract the raw green beans.
On the Ship: Coffee is packed, sold, and traded globally.
In the Roaster: Green coffee is roasted to various levels to bring out distinct flavors.
In the Cup: Coffee beans are ground, and the flavors are extracted into a delightful morning cup of sunshine.
1- On the Farm
Every coffee bean is ‘born’ on a farm. The coffee plant is a small tree or shrub with smooth leaves. It takes around five years to mature and produce its first harvest, with a productive lifespan of about 25 years. There is usually one major harvest a year, though this can vary depending on the type of coffee bean and climate. During each harvest, the plant’s fruits, known as coffee cherries, are picked, dried, and milled to separate the outer red shell from the sought-after green coffee bean.
Planting and harvesting coffee are tasks primarily led by small-scale growers. Around 80% of the world’s coffee beans are produced by 25 million small-scale farmers operating on farms typically ranging from 1 to 5 hectares. These farmers have limited bargaining power and control over prices, with their profits often squeezed by large coffee traders. To help protect the farmers, organizations such as the Fairtrade Foundation work to ensure fairer prices for raw coffee. If interested in supporting farmers’ welfare, consider purchasing brands that are Fairtrade Certified.
2- On the Ship
Green coffee beans are transported out of coffee-producing nations and traded worldwide. The stripped-down green beans are sold to intermediaries and shipped through a global coffee supply network. Intermediaries can include government agents who purchase raw coffee from local farmers, bundle it, and sell it at auction, large exporters who transport coffee beans globally, and suppliers who buy from exporters to sell to roasters. In 2018, around 7.2 billion kilograms of raw green coffee were exported, valued at over $19 billion.
3- In the Roaster
Green coffee must be roasted before consumption. At the roastery, coffee goes through the roasting process, where the chemical and physical properties of the green bean change, bringing out the complex coffee flavors that invigorate us each morning. During roasting, the coffee bean loses around 12 to 20% of its weight, mainly due to moisture loss and gases from chemical reactions. After roasting, the beans become darker and are ready for consumption; they are then packaged and sent to retailers and coffee shops.
Roasting often occurs on a large scale and rarely in coffee-producing regions. The top 10 roasting and exporting nations do not include a single coffee-producing nation. Advanced economies with higher GDP per capita control this part of the value chain, buying green beans at low rates from producers, roasting them, and exporting them at a premium. Switzerland exports, on average, the most expensive roasted coffee in the world, followed by Italy, Germany, and France. Compared to the minimum Fairtrade green coffee price of around $1.40 per pound, roasted coffee commands much higher prices, ranging from $3 to over $14 per pound for coffee roasted in Switzerland—up to 10 times the Fairtrade green coffee farmer prices.
Top exporting countries of roasted coffee
Today, small-scale roasting is becoming more popular. Many specialty shops have started roasting green coffee in-house to reduce costs and maintain more control over the roasting process, ensuring consistency, quality, and freshness. When serving premium coffee, using freshly roasted beans is crucial since coffee beans "degas" about 1 to 2 weeks after roasting, losing some of their unique flavors and aromas.
4- In the Cup
Grinding and brewing the beans are the final steps before that first morning sip. Grinding breaks down the coffee into finer particles, with the level of fineness varying based on the roast type and brewing method. Whether the coffee is an espresso, siphon, or brewed, the objective remains the same: hot water extracts flavors, caffeine, and other compounds from the coffee grounds for the consumer to enjoy.
Who are the Biggest Winners and Losers in the Coffee Business?
To understand this, it’s helpful to examine the economics of a cup of coffee and how profits are distributed across the key players in the value chain.
Distribution of value in a $3.00 cup of coffee
The Biggest Losers. Coffee farmers are fighting an uphill battle. As small-scale growers in developing countries, they often receive little support from their local governments and are at the mercy of larger, profit-driven companies along the value chain.
For most farmers, making ends meet is a struggle. On average, the yield for a 5-hectare farm is around 10,000 pounds of coffee. For coffee farmers in Latin America selling at Fairtrade prices of approximately $1.40 per pound—higher than current market rates—and operating at a breakeven price of $1.20 per pound, they would only make a profit of $2,000 per year, or around $160 per month. Without Fairtrade protections, farmers often sell below breakeven prices. According to Reuters, many desperate coffee growers in Latin America have started switching to other crops, such as coca (the plant used in cocaine production), as a means of survival.
Green Coffee Market Prices Dollars per pound, ICE Futures Arabica Coffee
Coffee prices have been dropping steadily and are currently below the farmers' breakeven price Source: Bloomberg
The Biggest Winners: Roasters and retailers control over 90% of the value in the $200+ billion coffee industry. Large companies like Nestlé—known for Nescafé and Nespresso—and JDE, which owns brands such as Carte Noire and L’Or, benefit from economies of scale and exceptionally healthy profit margins. These margins are due to low raw material costs and the significantly higher price commanded by roasted coffee.
Coffee is often roasted in Europe, particularly in Switzerland, Italy, and France, as well as in North America. According to the Coffee Barometer report, the high profitability of this sector has recently led to a series of consolidations, where major roasters acquire smaller players to expand market share.
Roasters share of coffee volume export Top 10 largest roasters control 35% of the roasted coffee volume exported
Source: Coffee Barometer (2018)
Retailers are also some biggest winners in the coffee business. Starbucks is the prime example, with its meteoric rise from humble beginnings in 1971 to a $90 billion coffee empire with a commanding presence across the entire coffee value chain. Starbucks buys coffee from all around the world, but also owns its own farms in Latin America and roasteries around the world. The economics of controlling the value chain has allowed Starbucks to maximize margins while controlling product quality and building a brand that currently dominates the coffee retail sector, with a widespread presence of nearly 30,000 stores globally.
Starbucks stores count globally Starbucks was founded in 1971 in Seattle and expanded to a Coffee empire operating retail stores, roasteries and even farms all around the world
Source: Starbucks Website
Wrap-up — The Last Sip
I would like to highlight two key takeaways from this overview. Firstly, farmers have drawn the short end of the stick; they are not compensated enough for their hard work. The great coffee we drink every day is mainly thanks to their year-long commitment to the land. Secondly, coffee economics are indicating that owning a coffee shop can be an extremely profitable venture.
The coffee sector is not doing enough to protect farmers and ensure value chain sustainability. In the past, the coffee producing nation were required to produce crop for the colonizer. Nowadays, fueled by global demand, these countries seem to have a similar fate, however the hands of ‘Big Coffee’ companies. Many of these companies claim to have sustainable programs to promote sustainable coffee production and improve equity by distributing more value to farmers. However, that effort seem to be a drop in the ocean when compared to the profits and revenue generated. According to Hivos — a development aid organization — almost none of the profits of the big corporations are reinvested in sustainability.
Owning a coffee shop can be extremely profitable. While benchmarking, modeling the economics of the coffee value chain and estimating a coffee shop’s average profitability, I concluded through sensitivity analyses — which I am considering to publish in a subsequently article — that owning a coffee focusing on premium coffee and inhouse roasting can be a great idea in a location with sufficient demand. Nevertheless, profitability can vary greatly depending on the country where operated and local trends.
So, the next time you are sipping on a hot cup of morning brew — hopefully with beans that are Fairtrade certified to protect the hardworking and underpaid farmers — remember, you are paying more for the branding, marketing and fancy design of the highly profitable coffee shop than for the actual coffee beans that you are consuming.