The dominant reference for coffee prices today is the commodities market or the New York Stock Exchange, a subsidiary of The Intercontinental Exchange (ICE). Also known as the C market, it determines coffee prices for Arabica using the macro-economics model of supply and demand, which assumes that all coffees are the same and therefore interchangeable regardless of origin, process, variety, quality, etc.
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In an undifferentiated market, coffee producers don’t get to define prices. For decades, farmers have been price takers, expected to shoulder risks and making losses when costs of production are higher than market prices.
Though there is a lack of data on this subject covering the more than 50 coffee-producing countries in the world, the industry has long suspected that costs of production have exceeded the average market prices more often than not.
As the industry becomes more aware of its own shortfalls and supply chain dynamics, sector organisations and private companies have sought to address the problem and answer the million-dollar question: how to set prices for coffee that support sustainable production?
In this article, we explore a handful of initiatives that try to do just that: the Fairtrade minimum price, the certifications Transparent Profit and Equal Profit, Algrano’s price makers approach, the Specialty Coffee Transaction Guide, Mercanta’s price guarantee, and Sustainable Harvest’s Verified Living Income.
The invisible hand of the C market
It’s widely accepted that the C market makes coffee transactions a lot safer thanks to hedging. To hedge means to take an opposite position in the futures market to protect oneself against price fluctuations.
The Exchange also created a standard contract that makes trading coffee easy. However, the C market has been equally criticised for its embedded volatility and speculation. It homogenised a product with very different costs depending on where it’s produced.
While many specialty coffee buyers believe to be removed from the C market, they are invisibly tied to it. Aggregators like cooperatives and exporters need to fulfil large volume contracts signed early in the harvest, using international prices to determine local market rates. Large-volume buyers also have price-setting power over smaller mills and cooperatives.
Take a specialty coffee lot produced by a micro-mill in Latin America. In 2021 and 2022, C market prices have hit record highs. At the same time, production declined. Local cherry buyers hiked up their prices to fulfil (futures) contracts.
As a result, smaller or independent mills also had to increase their prices to compete for cherries, increasing their costs for that specialty coffee even if big and micro-mills work with different qualities and client segments.
Initiatives that go beyond the C market
The C market has obvious limitations. Price predictability and stability are nearly impossible. Quality, origin, and costs of production are ignored. It doesn’t consider product differentiation and varying infrastructure and conditions in each origin. All this can have a detrimental impact on producers’ profitability, especially for smallholders. This is why some of the following initiatives were created.
The Fairtrade minimum price
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Fairtrade is the best-known organisation to come up with a successful alternative pricing model to the C market. The organisation sets a minimum price so that producers can “cover the average costs of sustainably producing their crop” and be shielded against volatility, acting “as a safety net when market prices drop”.
Fairtrade prices consist of two parts:
- The Fairtrade Minimum Price of US$ 1.80/lb (US$ 0.40/lb more if the coffee is organic).
- The Fairtrade premium of US$ 0.20/lb.
The FT minimum is the base price that cooperatives are guaranteed to receive. No matter what the market price is, there is a floor. The FT premium, on the other hand, is an extra paid to cooperatives, who decide how it will be invested. Sometimes it goes to producers’ pockets, sometimes it’s used to fund projects.
Fairtrade helps to ensure that decent working conditions and access to credit are provided to cooperative members. The initiative has been applauded for providing a greater sense of predictability to farmers. Nonetheless, the incoterm of the Fairtrade Minimum Price is FOB, so the price paid to farmers can vary and often remain linked to local market rates.
The model has also been criticised due to the certification costs, altitude constraints and other barriers that prevent it from becoming an accessible alternative to conventional pricing. The costs of fulfilling membership requirements have been questioned, as they might outweigh the premium. Also, the Fairtrade model works fairly and equitably only when the cooperatives or groups have democratic governance.
Opportunities
- A price floor ensures a minimum price no matter the market conditions.
- A greater sense of stability for producers and cooperatives.
- Additional investment incentives improve processes, infrastructure, and services for farmers.
Challenges
- Barriers such as certification costs and altitude constraints prevent smallholders from joining Fairtrade.
- Paperwork is laborious, potentially surpassing the premium earned from the certification.
- No visibility on farm gate prices as the incoterm is set as FOB.
- The distribution and use of premiums depend on the transparency and democracy of each organisation.
Transparent Profit and Equal Profit
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Equal Profit Sàrl, a Swiss social enterprise founded in 2019, created two certifications. The first one, Transparent Profit, provides full transparency of profit distribution among supply chain actors. By scanning a QR code on the coffee’s packaging, consumers see who earns what.
The second certification is Equal Profit, built on transparency to ensure equity. In this model, each actor in the supply chain agrees to distribute profits proportionally to their costs in each transaction. Information is shared both ways and the selling price is negotiated collectively.
The great thing about this model is that production costs are collected and analysed for each supply chain. Equal Profit also ensures that each actor earns an equitable profit. Actors disclose their financial data and a machine learning algorithm processes the declared costs. This model attempts to combat inequitable earnings based on the power differences between buyers and sellers.
The company is developing a standardised cost calculation methodology and an easy-to-use platform. This will digitise the two processes, which generally represent a high cost. Each stakeholder will enter its data into the system that verifies that standards are respected. The platform will disclose the profit distribution or calculate how profits should be split.
The first roastery to have implemented the Equal Profit certification was Xalala in Switzerland. They partnered with Mexican exporters Ensambles de Cafés Mexicanos. The results are available here.
Opportunities
- Challenges the traditional pricing model based on unequal power distribution (e.g. North-South divide) by bringing production costs into price-setting.
- Data collection on production costs.
- Third-party verification brings accountability.
Challenges
- All actors within a supply chain should be willing to participate.
- Requires that producers or organisations can calculate their costs.
- Restricted implementation when data on costs of production is not available.
Algrano’s price makers approach
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As Algrano is not a coffee buyer, it doesn’t enforce a pricing model. Instead, it creates an environment where producers can set their prices according to their own calculations of cost, risk and profitability. Roasters then decide on the proposed price, quality, and other elements such as producers’ stories. The platform makes it possible to negotiate and facilitates direct linkages between the producers and buyers.
This model challenges the inherent power dynamics in today’s industry as producers become price makers and have the opportunity to further differentiate their products through branding and storytelling. The platform gives sellers complete freedom and agency to set prices. They can also view the prices of other coffees and evaluate performance reports to better price coffee.
Here, producers get exposure, enjoy pricing agency and learn about the market. However, challenges may exist if producers don’t fully understand their costs. As there’s no benchmark, they might propose low prices to be competitive.
If buyers are not sensitive and attentive to the varying factors affecting production costs, smallholders can shoulder more of the risk. Nonetheless, the platform facilitates a space for conversations that can aid mutually beneficial relationships to be formed.
Opportunities
- Shifts the power dynamics between buyers and sellers. Producers are price makers.
- Transparency supports producers in price discovery not directly linked to the C price.
- Challenges the traditional pricing model based on unequal power distribution.
- Creates learning opportunities for both ends of the supply chain.
Challenges
- Accessibility to smallholders, as sellers must export or work with exporters.
- Difficulty in price-setting due to absence of a benchmark or data on production costs.
- The absence of a benchmark can lead to a race to the bottom as producers strive to remain competitive.
Specialty Coffee Transaction Guide
Widely known in the specialised segment of the industry, the Specialty Coffee Transaction Guide (SCTG) analyses over 50,000 coffee contracts of roughly 100 importers, exporters and roasters globally to set benchmarks for differentiated coffees.
The report provides key data on specialty coffee prices according to their qualities and lot sizes across varying producing regions. It’s a reference in price discovery for buyers and sellers alike.
The SCTG is not a pricing model as the organisation doesn’t trade coffee. However, it’s a tool that can be used to understand price per quality band, origins and lot sizes, and can be used when making pricing decisions. As the data is based on FOB prices, producers who don’t have a full picture of the transport and export costs are not able to translate these benchmarks into farm gate.
Opportunities
- An alternative and more relevant benchmark to specialty coffee set on real data.
- Good overview of price trends and differentiated prices based on quality, volume and origin.
Challenges
- Data is based on the FOB incoterm and can only be fully used by producers with a full overview of transport and exporting costs.
Mercanta’s price guarantee
Mercanta, a green coffee importer based in the UK, claims to buy all their coffee without links to the C market. “Before this subject was topical, relevant, or much discussed, we had set a minimum FOB Origin price of US$1.80/lb for Arabica coffee, below which we will not buy coffee. We trade NO coffee on contracts connected to the New York C commodity market,” shared Mercanta’s founder Stephen Hurst in April 2019.
Mercanta’s price was calculated by adding 20% to US$1.50/lb, which they consider to be above the production costs of most of their suppliers. “On farms where the cost of production exceeds US$1.50/lb, we make that adjustment accordingly and in discussion with the producer,” they wrote.
Similar to the Fairtrade model, it supports producers in predicting earnings, helping them further invest. However, as with FT, if differentiation is not made between farm gate and FOB and social, political, and economic reasons are not considered to adjust the price guarantee, it might not be effective in the long term.
Opportunities
- More predictable prices for producers.
- Could meet production costs for origin businesses.
Challenges
- If differentiation is not made between farm gate and FOB prices and if social, political, and economic reasons are not considered to adjust the price guarantee, the model may not be effective in the long term.
- Keep producers as price-takers.
Sustainable Harvest’s Verified Living Income
In 2021, importing company Sustainable Harvest published a research paper on Verified Living Income in partnership with Heifer International and Bellwether Coffee. Adapted from Heifer’s Living Income Benchmark, their model determines a price that guarantees a living income for producers. It adapts a methodology developed by Richard and Martha Anker to estimate living incomes for households.
Living income is explained as a collective earning of a household that meets, or exceeds the cost of a decent standard of living (consisting of decent food, decent housing, essential needs such as school and clothing, and margin for unforeseen events) in alignment with international decency standards (e.g. WHO, ILO, and UNHabitat).
The VLI model hopes to determine the minimum prices for green coffee based on farmers’ livelihood needs. The initiative, in its pilot phase, collected data from 38 smallholder coffee farmers in Colombia on costs, productivity, and land size to develop what it calls a sensitivity analysis model, then overlaid it against a Living Income Benchmark.
In their pilot study with the Asociación de Productores Ecológicos de Planadas (ASOPEP), they found that US$1.89/lb farm gate (green coffee) has to be paid to a household solely dependent on coffee to achieve a living income.
If successfully implemented, the VLI model has the potential to help producers lead a more sustainable and thriving life beyond simply meeting their costs of production. However, challenges exist for the implementation at scale and when there’s no data on the costs of production for each farm.
Opportunities
- Goes beyond the costs of production and supports sustainable livelihoods.
- Verifiable model based on field research.
Challenges
- Implementation at scale can be challenging due to the complex collection and verification of data for multiple countries, regions and organisations.
- Restricted implementation when data isn’t available.
- Focus on price floors rather than profitability.
References:
- If the market price is higher than US$ 1.80/lb, the FT price will be the market price + the FT premium.
- Tellman, B., Gray, L. C., & Bacon, C. M. (2011). Not Fair Enough: Historic and Institutional Barriers to Fair Trade Coffee in El Salvador. Journal of Latin American Geography, 10(2), 107–127. http://www.jstor.org/stable/23209587
- Jaffee, D. (2007). Brewing justice: Fairtrade coffee, sustainability, and survival. Berkeley: University of California Press.
*The section "Transparent Profit and Equal Profit" of this article was updated on May 16th 2022.
