Coffee – This Is Why We Fail At Innovation

Where the hell is all the money going? The farmers are broke, our industry has failed to innovate, so what is holding us back? This article explores the value chain and identifies where most of the money is.

First let’s examine coffee’s value chain from origin to retail.

To start, 25M small farm holders produce 80% of the worlds coffee. Farmers are predominantly the investors in equipment, irrigation, land and seeds. The ICO (International Coffee Organization) has produced a report that details the struggle farmers face to make profit. Innovation at this level is challenged by the lack of funds farm holders have to invest. However, this is where I see the financial opportunity for investors, at the Origin and Farm level. Innovation to improve processing, equipment to create multiple vehicles of income by upcycling discarded coffee by-products, investments towards research to prevent disease, create plants with higher yields and potentially enhance cup quality. This is a part of the value chain that has sizable financial rewards, but more importantly huge humanitarian gains.

Trading organizations, these companies buy from the farms and sell to the roasters. Eight trading companies control 60% of the world’s coffee. To a measurable degree this has a significant impact on the prices farmers are able to sell at. The divide of coffee farms operating independently, as highlighted above, impedes a farm’s ability to negotiate pricing. For example, if you have 1 buyer and 20 sellers, the buyer is going to get a damn good price. However, most of the large trading groups have investments in coffee farms so this helps.

Ten roasters represent 40% of the world’s roasted coffee. As we will later see later in this article this is where the money is! But also note, the higher you climb up the latter of the value chain the more competitive it gets.

Next I wanted to see if the top ten roasters were investing into advancing the coffee sector. The below chart puts it into perspective.

Most of the key players are represented in the above chart with exception of companies owned by Jab Holding.

The x-axis of the chart compares a company’s investments made into R&D relative to their total sales for 2015/2016 (R&D Investment/Total Sales).

The y-axis is represents sales for 2015/2016. The $ value next to each of the company’s name is their 2015/2016 sales figure reported.

Within each circle is the company’s profit margin before tax. The size of each circle is proportionate to the sales of the 10 companies analyzed.

How did these companies stack up against others within the industry? CPG, an acronym for Consumer Product Goods, which all of these companies fall under is used as a metric for comparison.

The CPG Industry average is 2%, meaning the average company invest 2% of their total sales into R&D. The 10 coffee companies analyzed above averaged .6%, oh yes our roasters are on the very low end of the spectrum.

Another interesting fact, CPG companies spend 6x more on marketing and advertising than they do on R&D. Makes sense, but investment is needed at the other end of the value chain for the entire coffee sector to evolve.

Innovation, development, progress is not a high priority for our roasters. They must be doing something with the piles of cash the have. I went through each of their SEC fillings and didn’t find much. However, each of these companies publish Annual Sustainability Reports. Bingo, I read them all with caution. We learned above they don’t invest in R&D, they invest in spun advertising and marketing campaigns.

Several takeaways from their Annual Sustainability Reports

Nestle

• Invested $14.4M in plant science and soil management
• Distributed 28.3M coffee and 2.2M cocoa plantlets to farmers
• Empowered 1.3M women with technical assistance to date
• Invested $23.3M to provide access to safe water and sanitation to 513,345 beneficiaries in rural communities

Starbucks

• Donated more than 25M trees to coffee farmers
• Starbucks Global Farmer Fund made a $50M commitment to provide financing to coffee farmers
• Most impressive is that they issued a $500M U.S. Corporate Sustainability Bond which will be used to enhance  sustainability programs around coffee supply management

Kraft-Heinz

• Has committed to investing $200 million in an expanded corporate social responsibility program, including a pledge  to fight malnutrition and decrease the firm’s negative environmental impact.
• Committed to donating 1 billion nutritious meals to some of the world’s neediest by 2021 With the financial support from Gevalia and the Kraft Heinz Company, TechnoServe is working with smallholder coffee farmers in El Paraíso and Intibucá to increase the quantity and improve the quality of Honduran coffee

J.M. Smuckers

• 10% of their coffee is from certified sources, farms that are UTZ Certified, Rainforest Alliance Certified, or Fair Trade  Certified
• Invested $2M into loans for coffee producers

Other companies analyzed are investing in like projects. A pleasant surprise as these type of announcement make little noise. But they need to be doing a lot more, they have deep pockets as we will soon see.

It’s a known that coffee farmers are challenged to make profits. Let’s take a look at the profitability of the traders relative to the roasters/retailers.

For the love of Mary, what the hell is going on. I checked, doubled checked, and checked again. These numbers are accurate. Nestle and Starbucks are killing! Note for Nestle this is only their coffee segment they also sell numerous other consumer products. Traders are not making a lot at 1-2%, that’s nothing. The cash is being stock piled at the top.

What’s the incentive for those guy’s to innovate? Their competitors are pretty distant from catching up to them.

So what’s the solution? We need to get investors interested in investing in the lower tiers of the value chain to develop, innovate and create a disruptive movement that challenges the major players. It can be done, it will be done.