• QA 019
    Can one use differentials to quantify the real impact of quality or marketing improvement measures?
    Many initiatives and programs aim at improving grower returns but, often the impression is that these only have limited impact, or only cover small tonnages. How would one measure overall progress of a particular coffee? Is there some kind of neutral indicator one could use?
    Asked by:
    Roaster - United States

    We cannot comment on the effectiveness or otherwise of grower support or marketing programmes.

    However, your question is pertinent in that it is entirely possible that higher returns in fact mask declining fortunes vis-à-vis comparable origins. A general increase in green coffee prices may lead to an assumption that a particular initiative has been successful - "our prices have risen". But, in a good market prices for comparable coffees from elsewhere rise as well and so the real question is: "Did our price rise more? To the same extent? Less?"

    In a volatile market the timing of sales can greatly affect results: sales may be made early or late in a year, for example due to harvest patterns or strategic decisions. If country A marketed most of its coffee in the first half of a year when international prices were low, and country B sold most in the second half when prices rose, then it is relatively meaningless to compare the two as, most likely, B would have done better.

    From a commercial perspective the simplest measurement would appear to be the differential. See 01.04.02 for more on this but: the differential is the difference, plus or minus, between the price for a particular physical (green) coffee and a given trading position on the futures markets of New York (NYBOT - arabicas) or London (LIFFE - robustas).

    Briefly, the differential takes into account (i) differences between that coffee and the standard quality on which the futures market is based, (ii) the physical availability of that coffee (plentiful or tight), and (iii) the terms and conditions on which it is offered for sale.

    By combining the New York or London futures price and the differential, one usually obtains the FOB (free on board) price for a particular type of green coffee. This enables the market to simply quote, for example, 'Quality X from Origin Y for October shipment at New York December plus 5' (US cts/lb). Traders and importers know the cost of shipping coffee from each origin to Europe, the United States, Japan or wherever, and so can easily transform 'plus 5' into a price 'landed final destination'.

    Improved quality and marketing do lead to increased demand for certain coffees. This in turn causes the differential for such coffees to rise. But a word of caution: if the improvements are accompanied by increasing supply, then the differential by itself might in the end not always reflect the impact of those measures.

    Logically though, when the quality or the presentation of a particular coffee improves markedly vis-à-vis competing origins, then over time (a few years, a few seasons?) the differential should reflect this. It could rise more than the others or, conversely, fall to a lesser extent. Of course many factors play a role, for example: differentials may be lower when futures prices are high, and higher when futures are low although this is not always so. Seasonality, availability and the global supply-demand pattern also strongly influence differentials. But, most regularly available coffees are subject to the same influences and so over time the effects mostly tend to even out. However, for some really expensive coffees, for example top Kenya AA etc, the differential can be so high that it becomes meaningless.

    Growers and others in producing countries should constantly monitor differentials for their own and similar coffees, i.e. a basket of comparable origins, and record them - in the end patterns will emerge. Some trade houses regularly publish differentials as do some daily market reports. Green coffee brokers and importers are another source.

    NB: In January 2007 The New York Board of Trade (NYBOT) merged with  InterContinental Exchange (ICE) - see ICE Futures US at www.theice.com

    Posted 15 May 2005

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