Escaping the commodity trap
From the day we opened the doors at our original location on Broadway in Chicago’s Lakeview neighborhood back in 1995, our business has been built on quality-based differentiation: we have always worked to deliver the best coffee and the most elevated experience in the marketplace. When we started traveling to origin and building our Direct Trade model a few years later, the same principle applied: we sought out estates, farmer associations and washing stations that shared our obsession with coffee quality and saw it as the most reliable and lasting source of value.
As it turns out, the promise of quality that resonated so clearly to us in the marketplace also resonated at the other end of the coffee chain with growers of all sizes. Our Direct Trade partner network is filled with them: more than 50 farms, farmer associations and washing stations whose commitment to quality has earned them awards and a privileged place in our supply chain.
Their eager embrace of a quality-first strategy is due in part to the fact that it represents an important hedge: their ability to earn quality premiums insulates them from low prices in the market.
As of this writing, May futures contracts are closing at less than $1.14 per pound, less than production costs in just about every coffee-growing country with the possible exception of Brazil. Few farmers earning these kinds of prices can turn a profit or continue to grow coffee for long, least of all the smallholder farmers who grow the majority of the world’s coffee. This is the commodity trap: competition on the basis of price alone in a market that rewards size, scale and efficiency and is agnostic on the issue of quality.
Quality premiums offer an escape from the commodity trap, helping to mitigate the risk of low prices. But premiums alone do little to protect growers from the extreme price volatility that characterizes coffee futures markets.
The free-hand scribble above roughly tracks coffee futures market prices over the better part of the past half-century. With so much uncertainty about what coffee prices will be like tomorrow, it is hard for coffee growers to reinvest in their farms with confidence today. That’s where our fixed-price contracts come in.
Unless we are explicitly asked to do so by our partners, we never contract coffee based on differential pricing. Our preference for fixed-price contracts is related to our central commitment to quality. We believe each of the first three tiers of quality in our model — A, AA and AAA, where A is the lowest and AAA is the highest — have an intrinsic value as defined in part by what the market will bear. We have settled into narrow graduated price bands for each of these tiers that remains stable year-over-year independent of what may be happening in the futures market.
Combined with the price premiums we pay for quality, our fixed-price contracts help to deliver prices that are high enough to ensure growers earn a profit on every pound of coffee they sell us and stable enough for them to be able to accurately predict their coffee earnings over multiple seasons and make business decisions accordingly.
Our approach to pricing and contracting gives coffee growers something that is invaluable in a marketplace characterized by uncertainty: the ability to plan confidently for the future.
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This post is the fourth in a series of seven summarizing our participation in the Sustainable Food Lab 2018 Leadership Summit and exploring the ways our Direct Trade model helps to reduce the risks faced by coffee growers.