Many people who compare grower prices with retail prices for roasted coffee, particularly specialty coffee, wonder who benefits from the mark up.

The discussion over 'middlemen' often fails to recognise the many stages coffee  (and similar commodities) pass through between grower and consumer: Collection, primary processing, export processing, marketing, financing, transport to port, export clearing and shipping, import discharge and clearing, inland transportation to roaster, roasting, packaging, marketing, promotion, distribution/wholesale, retail to final consumer. All these are necessary stages that involve third parties, i.e. middlemen, because someone has to perform these functions, obviously at a cost that of course includes a profit margin.  Therefore, removing the 'middle man' does not remove the 'middle function'…

Put differently, everyone who handles coffee between the grower and the end-consumer, including the roaster and the retailer, is a middleman. But at the same time we would all agree that roasting and retailing are not functions a grower or a grower organization could easily undertake, if at all, and so people do not see roasters and retailers as middlemen. Yet, different value chain data indicate that over 80% of the mark up (costs and margins) on specialty coffee in fact goes to these last two sectors.

Internal marketing systems in individual producing countries have different intermediate marketing stages and layers so we will not comment on these. Similarly, it is relatively pointless to delve into roasting and retailing activities because these are functions most individual growers cannot undertake. This then leaves us with the functions performed in the transition between exporter and roaster.

Exporters and importers carry out specific service functions but, more importantly, they also assume a number of risks. Thus, whereas both growers (or roasters) wishing to deal direct can probably purchase the transitional services they need (shipping, clearing, insurance etc), they will also have to assume the additional risks this entails.

For a grower exporting direct some of these risks include:

• credit risk (the roaster does not pay - please see Q&A 018 and 035 that deal with precisely this), and
• quality risk (the goods are rejected on arrival, either by customs or by the roaster).

For the roaster importing direct some of the major risks will be

• performance risk (the goods are not shipped) and again
• quality risk (the goods are rejected by customs, or the quality is not what had been agreed).

These are typical examples of the risk-taking function exporters and importers assume as a matter of course. Other examples include

• currency risk (coffee bought in one currency, sold in another),
• shipping risk (goods are delayed or damaged en route),
• provision of extended credit and so on.

In our view there are basically no unnecessary functions in the value chain. But of course there are additional margins that could accrue to growers if they are prepared to extend the number of functions they carry out themselves, for example by exporting themselves. However, contrary to popular belief, the major costs and margins are not incurred by exporters and importers as evidenced by this example of a value chain for Kenya specialty coffee to the United States.

Percentages do not add up due to rounding; Conversion green/roasted -  ratio of 1.19 as per ICO rules; Source: various reports and own estimates

Although these calculations were made when coffee prices were quite low, the findings are corroborated by a recent study (ERR-38 - March 2007) released by the Economic Research Service of the United States Department of Agriculture. This found that, on average, a 10-cent increase in the cost of a pound of green coffee beans in a given quarter results in a 2-cent increase in manufacturer and retail prices in the current quarter. If a cost change persists for several quarters, it will be incorporated into manufacturer prices approximately cent-for-cent with the commodity-cost change. Given the substantial fixed costs and mark ups involved in coffee manufacturing, this translates into about a 3-percent change in retail prices for a 10-percent change in commodity prices. The study also noted that cross-sectional price differences were substantially larger at the retail level than at the wholesale level.

In our example some 87% of the retail cost of roasted coffee is incurred at the roaster and retailer level whereas the grower price represents around 7% of the retail value. However, this assumes a straightforward transaction but many smaller roasters regularly require importers to hold stocks on their behalf. Delivery then has to be spread over a number of months, at fixed prices and at extended credit terms, thereby of course increasing the 'middleman's' costs. Exporting smaller quantities (less than a container load) is quite difficult as well. This is the reason for example why roasters taking part in Cup of Excellence auctions (www.cupofexcellence.org) rely on exporters and importers to ship/import their purchases. Further proof that for many growers the number of 'middleman' functions they can assume is, in fact, quite limited…

A similar calculation for mainstream coffee** to Germany concluded that 84% of the roast and ground retail value accrued to the roasting and retail segments. About 6% went to processing cum export costs and intermediaries, leaving about 10% of the R&G retail value for the grower.
*  Current legislation in Kenya requires growers wishing to sell direct (i.e. bypassing the auction system) to employ a marketing agent. The need for this link between grower and exporter is not entirely clear.

** See QA 131 on differences between 'specialty' and 'mainstream'.

Posted 23 March 2007