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Coffee Crisis:  TechnoServe Releases Fact-Based Industry Analysis
Press release from Technoserve, Date: December 4, 2003
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December 4, 2003 -- Producers of coffee and their employees continue to endure a profound economic and humanitarian crisis.  For many of the world's 25 million growers, coffee prices remain lower than the cost of production for the third straight season.

An imbalance between supply and demand has led to the current coffee crisis.  This crisis of record-low prices, however, is different from those of the past in several important ways:

There has been a systemic shift in the coffee industry as a result of innovation in Brazil and the emergence of Vietnam as low-cost producer. The implications of this shift are that, while prices may increase somewhat in the short term, long-term prices will likely fluctuate in a range that will leave many marginal producers unprofitable.
The systemic shift is also the result of processors developing ways to reduce the acidity of Robusta coffee beans and increase their use in blends and in increasingly popular "flavored" coffees that mask the harsh taste.  Robusta coffee plants have higher yields than Arabica plants; in addition, they are stronger plants that grow at lower altitudes, enabling them to be mechanically harvested.  For these reasons, Robusta coffee is cheaper to produce than the Arabica variety and so is also becoming increasingly popular among consumers in more price-sensitive countries, further eroding the market share for Arabica.

The current crisis is severely impacting millions of small-scale coffee growers, their families and communities in many developing world producer countries. A less publicized but equally devastating fact is that it is the large farms and their workers who are among the hardest hit.  Large farms enjoy few economies of scale and generally do not use non-cash family labor to the extent that smallholders do.  As a result, they are forced to lay off workers.  In Guatemala, for example, 250,000 coffee workers have been laid off ? approximately 30% of all coffee workers.1  Most coffee workers are landless or rent small plots, and they rely on seasonal coffee work as a major source of cash income.  In contrast, most coffee smallholders grow other crops for home consumption and sell any surplus in local markets.

These are among the findings released today by TechnoServe, the international non-profit organization, in the wake of a coffee industry analysis conducted pro bono by McKinsey & Company.  Over a 10-week period, a McKinsey team surveyed relevant literature; conducted nearly 200 interviews with representatives along the entire value chain, including producers, millers, roasters, exporters and industry experts; and traveled to four "representative" coffee-producing countries (Brazil, Guatemala, Tanzania and Vietnam) to develop a detailed understanding of the current situation in each country and in order to identify a set of factors that
could be applied to other producer countries. In addition, TechnoServe assembled an Advisory Council consisting of industry representatives to guide the McKinsey & Company team, assist with data gathering and provide other recommendations.

TechnoServe recognizes that there is no single answer to the coffee crisis and that resources are limited.  But based on McKinsey & Company's coffee industry analysis, which considered a wide range of possible solutions, on TechnoServe's discussions with the Advisory Council, and on TechnoServe's experience working with coffee growers and other industry stakeholders in Africa and Latin America since 1983, TechnoServe believes that the following three areas offer the highest potential for sustainable impact2:

1) Increasing coffee consumption in producer countries and emerging market countries;
2) Assisting unprofitable producers of high-quality Arabica to move into higher-priced "specialty" coffees; and
3) Helping regions with a high concentration of "marginal" coffee producers -- who cannot differentiate their product or compete on price -- to diversify into other products and industries.

Business Solution #1: Increasing coffee consumption in producer countries and emerging market countries.  In 1992, Brazil initiated a quality and advertising program that increased per capita consumption there by 40%, from 3.4 kilograms in 1992 to 4.7 kilograms in 2001.  Many in the industry believe that similar programs in producer and emerging market countries could achieve similar results.  TechnoServe estimates that a 25% per capita increase in a sampling of 27 producer and emerging market countries would increase global demand by 5 million bags annually (1 bag = 60 kilograms) and would increase revenue to coffee producers by $340 million/year (assuming a blended price of 52 cents/pound) at a cost of $60 million.

From TechnoServe's standpoint, this is an initiative best driven by the coffee industry, which has the experience and the resources to implement it. In terms of factors to consider, TechnoServe believes that Brazil's success may be difficult to replicate in countries without a history of high coffee consumption.  Also, increasing the demand may increase the volume sold without increasing the long-term price -- which was largely Brazil's experience.  This means that producers who are unprofitable now could remain unprofitable even as demand increases. Taking these factors into account, however, this could be an important initiative for the coffee industry as a whole.

Next Steps: The International Coffee Organization (ICO) has already undertaken a study to identify and document "best practices" in programs to stimulate consumption.  And the coffee industry plans to initiate targeted consumption programs in select countries.

Business Solution #2: Assisting unprofitable producers of high-quality Arabica to move into higher-priced "specialty" coffees.  Current market demand for specialty coffees is 6 million bags a year (1 bag = 60 kilograms). Based on 1992-2002 growth rates that averaged 10% annually, TechnoServe projects that the specialty market will experience a 5% to 10% annual growth rate going forward, reaching 8.6 million bags in 2007.

Certain roasters have already signaled their concern that at current prices, coffee growers will be unwilling or unable to make the on-farm investments needed to ensure consistent supplies of specialty coffee. TechnoServe believes that helping qualified coffee farmers in high-potential regions to meet an additional projected market demand of 2.6 million bags of specialty coffee over the next 5 years would generate $100 million a year in additional revenues for growers, assuming an average premium of 30 cents/pound, and could potentially return 50,000 to 60,000
coffee producers to profitability.

TechnoServe estimates that the effort to convert 2.6 million bags of commercial coffee to specialty coffee would cost approximately $50 million over a 5-year period, in order to: assess roaster needs; identify potential farmers; provide technical and business assistance; facilitate access to financing; and provide industry-level support.3  The effort would focus on supplying the gourmet/high-quality segment of the specialty market (which now comprises 93% of all specialty coffee sold), followed by Fair Trade-certified and other certified coffees, like organic, shade-grown and bird-friendly (currently 7% of all specialty coffee sold).  Specialty initiatives should focus on Central America, Colombia, East Africa and Mexico, which together account for 86% of all specialty coffees produced in 2002.4

Status: A portion of this $50 million projected cost has already been committed and a number of different specialty coffee initiatives are already underway in both the public and private sectors, involving the U.S. Agency for International Development, the Coffee Quality Institute, the Inter-American Development Bank, the Cup of ExcellenceŽ program, and TechnoServe with support from Procter & Gamble.  Private-sector initiatives -- to sell and market certified coffee, to establish specialty coffee "buying offices" in producer countries, and to create sustainability programs and standards -- are also underway.

Next Steps:  TechnoServe proposes identifying regions or activities that are not being addressed among the existing specialty programs, securing funding, and launching new projects to support them.  TechnoServe also proposes encouraging better coordination among organizations to share "best practice" learning.

Business Solution #3: Helping regions with a high concentration of "marginal" coffee producers -- who cannot differentiate their product or compete on price -- to diversify into other products and industries.  Many high-cost coffee producers are unlikely to return to profitability even if prices increase, because low-cost producers and/or new entrants are likely to increase production and squeeze them out. Regions with a high concentration of these "marginal" coffee producers are in-crisis and must diversify their economies.

TechnoServe's proposed diversification effort is not a matter of switching individual farmers or farmer groups from one crop to another.  Rather, it involves introducing new "high-value" industries in in-crisis regions -- or helping existing industries there to grow -- thereby offering coffee growers and coffee workers alternative sources of employment and income. Based on location-specific factors including suitability, market potential and country competitiveness, TechnoServe recommends developing a set of best alternatives for each in-crisis region. Possible examples of high-potential industries are: fruits and vegetables; ornamental plants; cocoa; cattle; forestry and timber; and eco-tourism.

To diversify regional economies and reduce the dependence on coffee, TechnoServe estimates that alternative industries with the potential to generate $500 million in annual revenues must be developed.  Successful implementation will require the coordinated involvement of the private sector, non-profit organizations and governments, at an estimated cost of $250 million over a 5-year period in order to: select promising industries; identify business opportunities; provide technical and business assistance; facilitate access to financing; and provide industry-level support. Diversification efforts should be focused on countries that are largely not cost-competitive and whose economies are highly dependent on coffee: this includes regions within Colombia, El Salvador, Ethiopia, Guatemala, Honduras, Nicaragua, Tanzania and Uganda.

Status:  While diversification has the potential to have a large impact on in-crisis regions, few targeted programs have been initiated.  There are many ongoing projects to promote the development of new industries, but very few of these specifically aim to promote diversification in coffee-producing regions.  It appears that few diversification efforts exist to date because: there is a concern that diversification products will be abandoned if coffee prices rise; there is no single industry or public organization driving diversification; and there is a preconception
that there are no viable diversification alternatives.

Next Steps: TechnoServe proposes to identify specific regions for pilot diversification programs; secure funding for selected regions; and initiate programs and identify industry alternatives for each of the regions.

"Leadership in a time of crisis requires focus, objectivity and calm.  As with any crisis, this one is rife with emotion," said Peter A. Reiling, TechnoServe President and CEO.  "We're delighted that with the help of McKinsey & Company we've been able to focus on an objective and fact-based analysis of the root causes of this crisis, and to develop market-oriented solutions of benefit to the rural poor."

"Over the past few years I have observed an unprecedented drop in the incomes of the coffee farmers around Mount Kilimanjaro, and in northwestern and southwestern Tanzania, forcing them to almost give up," said the Honorable Basil P. Mramba, Minister of Finance, United Republic of Tanzania.  "They were saved from total collapse through TechnoServe's pilot programs in upgrading coffee quality, starting in the northeast around the Arusha and Kilimanjaro Regions, resulting in farm gate prices for specialty coffee up to 50% higher than neighboring coffee of lesser quality. TechnoServe has demonstrated that entrepreneurial farmers can earn more money by shifting to specialty coffee production.  Their model -- including establishing farmer-owned central pulperies combined with better marketing and timely advice to government on coffee policies -- is creating a new specialty coffee industry, leading to new hope for our rural poor and more foreign exchange for the country."

"TechnoServe's assistance in helping high-quality coffee growers in Tanzania to enter the specialty market came at just the right time," said Adolph Kumburu, Executive Director of the Association of Kilimanjaro Specialty Coffee Growers (AKSCG), which represents over 6,000 small-scale growers.  "As a result of TechnoServe's assistance, AKSCG members have started to earn premium prices at Tanzania's internal auction market. We are also very grateful for TechnoServe's work on policy issues, which was a factor in the Tanzanian government's decision to allow coffee growers for the first time to sell directly to roasters overseas."

About Technoserve:    

McKinsey & Company's coffee industry analysis is available in PDF format at http://www.technoserve.org/McKinseyAnalysis.pdf, 7 pages

TechnoServe's "Business Solutions to the Coffee Crisis" report and recommendations is available in PDF format at http://www.technoserve.org/TNSCoffeeReport_Master.pdf, 43 pages.

An 18-member Advisory Council -- including representatives from various countries, regions and entities in the coffee industry -- has guided the McKinsey & Company team, assisted with data gathering and reviewed McKinsey's findings and TechnoServe's report and recommendations. Independent anti-trust counsel also participated in all Advisory Council meetings.  See http://www.technoserve.org/news/CoffeeAdvisoryCouncil.htm for a list of Advisory Council members.

68 key stakeholders within the coffee industry enrolled in support of TechnoServe's and McKinsey & Company's global coffee industry analysis, including major roasters, small coffee producers, specialty companies, exporters, non-profit organizations and distributors. By enrolling, these stakeholders agreed to provide relevant information to and be interviewed by the McKinsey & Company team.  See http://www.technoserve.org/news/CoffeeIndustryEnrollees.htm for a list of Enrollees.

TechnoServe's coffee work is funded by the U.S. Agency for International Development, the Inter-American Development Bank, and private donors to TechnoServe.  For its coffee work in Latin America, TechnoServe also receives funding from the Procter & Gamble Company.

For more information please contact:
Mara Neville, Manager of Communications, TechnoServe/U.S., mneville@tns.org, 203-899- 3154 (direct line) or 203-852-0377.

Footnotes:

1 According to the World Bank, an estimated 600,000 coffee growers and workers in Central America alone are unemployed because of the crisis.
2 Based on TechnoServe's assessment of potential impact and ease of implementation.
3 $50 million projected cost is based on TechnoServe's and others' experience in Central America and other regions of the cost to convert 1bag of commercial coffee to 1 bag of specialty coffee.
4 In these countries/regions, coffee exports account for 5% or more of total exports and, based on average production costs, growers there are producing coffee at a loss at current prices.

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