Department of Economics

To Make a Living out of Coffee Conventional versus Sustainable Coffee

Kristin Sinclair Master Thesis August 2005

Supervisors: Dr Dick Durevall Dr Alberto Julca Otiniano

SUMMARY ................................................................................................... 1

RESUMEN EN ESPAÑOL.......................................................................... 2

1. INTRODUCTION .................................................................................... 3

METHODOLOGY.............................................................................................................. 5

2. THEORETICAL FRAMEWORK.......................................................... 8

MARKET STRUCTURES................................................................................................. 12

3. THE COFFEE MARKET...................................................................... 13

PRODUCTION AND TRADE ......................................................................................... 13 THE COFFEE COMMODITY CHAIN............................................................................... 16 SUSTAINABLE COFFEE ................................................................................................. 16 THE PERUVIAN COFFEE MARKET ............................................................................... 19 THE SWEDISH COFFEE MARKET ................................................................................. 22

4. ANALYSIS OF THE COFFEE CHAIN PERU-SWEDEN................ 22

THE COMMODITY CHAIN FROM PRODUCER TO EXPORTER....................................... 23 SUSTAINABLE COFFEE FROM PERU ............................................................................. 28 THE COMMODITY CHAIN FROM IMPORTER TO CONSUMER....................................... 31 THE MARKET FOR SUSTAINABLE COFFEE IN SWEDEN............................................... 33 THE DISTRIBUTION OF INCOME................................................................................... 36 COMPARISON BETWEEN CONVENTIONAL AND SUSTAINABLE COFFEE ...................... 39

5. CONCLUSION ....................................................................................... 41

APPENDIX 1: QUICK REFERENCE ON PERU .................................. 45

APPENDIX 2: LIST OF INTERVIEWS.................................................. 46

REFERENCES............................................................................................ 47

LIST OF TABLES

TABLE 4.1 PRODUCTION COST PER HECTARE USING TRADITIONAL FARMING METHODS………………………………………………………………………24 TABLE 4.2 PRICE PAID TO THE PRODUCER 1994-2004……………………………...25 TABLE 4.3 COFFEE EXPORTS PER FIRM 2004….…….………………........…….…....27

TABLE 4.4 PRICE PREMIUMS FOR SUSTAINABLE COFFEES IN SWEDEN (2004)…………………………………………………………………………………………...34 TABLE 4.5 SHARE OF FINAL SALES VALUE ACCRUING TO DIFFERENT LINKS IN THE COMMODITY CHAIN FOR CONVENTIONAL COFFEE (2004)……...……. 36 TABLE 4.6 SHARE OF FINAL SALES VALUE ACCRUING TO DIFFERENT LINKS IN THE COMMODITY CHAIN FOR SUSTAINABLE COFFEE (2004)………………..38

LIST OF FIGURES

FIGURE 2.1 THE COFFEE COMMODITY CHAIN……………………………...….…11 FIGURE 3.1 COFFEE PRICES (OTHER MILDS) 1986-2005.………………………….. 14 FIGURE 3.2 TOTAL COFFEE PRODUCTION (1975-2004)……………………....….... 15 FIGURE 3.3 COFFEE EXPORTS FROM PERU (TONS) 1984-2004.……………......…..20 FIGURE 4.1 PERU’S EXPORT OF SUSTAINABLE COFFEES 2000-2004……….…... 28 FIGURE 4.2 PRICE PREMIUMS FOR SUSTAINABLE COFFEES 2000-2004……...... 30 FIGURE 4.3 MARKET SHARES OF ROASTERS/IMPORTERS IN SWEDEN (2004)..31 FIGURE 4.4 THE DISTRIBUTION OF INCOME FOR CONVENTIONAL AND SUSTAINABLE (FAIR TRADE) COFFEE (2004)……………..…………………………..40

SUMMARY About 25 million farmers – mostly smallholders – in more than 50 developing countries

depend on coffee for their livelihood. Coffee producers are faced with a number of

difficulties. They are based in rural areas in poor countries; infrastructure is poor and

service provision low. Their income is highly insecure because of fluctuating

international coffee prices. Furthermore, the share of final retail price that is retained in

producing countries has decreased during the last years.

Some producers have been able to take advantage of the trend in the specialty coffee

industry toward “sustainable” coffee. Sustainable coffee includes fair-trade, certified

organic and eco-friendly coffee. These coffees fills a market niche that is not only

rewarded with a premium price but can also provide other benefits that help farmers

improve their sustainability.

The aim of the study is to analyse the markets for sustainable and conventional coffees

that are produced in Peru and consumed in Sweden. Sustainable coffee is a niche market,

albeit increasing, and will continue to be relatively small in the foreseeable future. The

limit to the growth of the niche coffees is the demand in the consuming countries.

Sustainable coffee is more expensive than conventional coffee; the price of conventional

coffee in Swedish shops 2004 was on average 40.62 kronor (US$ 5.53) per kilogram,

whereas organic coffee cost 44.60 kronor (US$ 6.07) per kilogram, giving a premium of

3.98 kronor (US$ 0.54). One kilogram of fair trade coffee cost 78.40 kronor (US$ 10.67),

which means the premium was 37.78 kronor (US$ 5.14). The main reason for the

premium is a higher purchase price of sustainable coffees. To find out whether the price

difference really benefits the farmers and the environment, this study has compared the

commodity chains for sustainable and conventional coffee.

The principal finding from the commodity chains for conventional and sustainable coffee

is that incomes are higher in the importing, roasting and retailing links than they are in

the growing and coffee processing stages.

1

Another finding is that although the customer pays more for sustainable coffee, the

farmer does not receive a larger part of the total value added in the commodity chain. In

the commodity chain for conventional coffee, the farmer receives 28% of the final sales

value, and in the case of sustainable (fair trade) coffee, the farmer receives 27%.

However, looking at absolute values, sustainable coffee has a clear advantage for the

farmer. In 2004 the fair trade price was US$ 2.78 per kilogram and the price of organic

coffee was US$ 1.70 per kilogram, compared to US$ 1.43 per kilogram for conventional

coffee from Peru. Even though the premiums for organic and eco-friendly coffee are

modest, they make an appreciable difference for the producers, since coffee in many

cases provides their sole source of cash income.

RESUMEN EN ESPAÑOL Cerca de 25 millones de agricultores - la mayoría con pequeñas chacras - en más de 50

países en vías de desarrollo dependen del café para su sustento. Los productores de café

enfrentan muchas dificultades. Viven en áreas rurales en países pobres; la infraestructura

es pobre y hay pocos servicios. Su renta es altamente insegura debido a los precios

internacionales del café que fluctúan. Además, en cuanto al precio de venta al público

que se conserva en los países productores ha disminuido durante los últimos años.

Algunos productores han podido aprovechar las nuevas formas de production y comercio

en la industria cafetalera que es el café "sostenible". El café sostenible incluye comercio

justo, certificado orgánico e eco-amigable. Estos cafés llenan un nicho en el mercado que

recompensa no solamente un precio superior sino que también proporcionan ventajas que

ayudan a agricultores a mejorar su sostenibilidad.

El objetivo del estudio es analizar los mercados para el café sostenible y convencional

que se produce en el Perú y se consume en Suecia. El café sostenible es un mercado del

nicho, no obstante aumentando, y continuará siendo relativamente pequeño en el futuro

próximo. El límite al crecimiento de los cafés sostenibles es la demanda en los países

consumidores.

2

El café sostenible es más costoso que el café convencional; el precio del café

convencional en las tiendas suecas del año 2004 estaba en 40.62 kronor (US$ 5.53) el

promedio por kilogramo, mientras que el café orgánico costó 44.60 kronor (US$ 6.07)

por kilogramo, dando un premio de 3.98 kronor (US$ 0.54). Un kilogramo de café del

comercio justo costó 78.40 kronor (US$ 10.67), que significa que el premio era 37.78

kronor (US$ 5.14). La razón principal del premio es un precio de compra más alto de

cafés sostenibles. Para descubrir si la diferencia del precio realmente beneficia los

productores y el ambiente, este estudio ha comparado las cadenas del café sostenible y

convencional.

El resultado principal del análisis de las cadenas del café convencional y sostenible es

que las rentas son más altas en los eslabones de importación, tostado y venta que en los

eslabones de crecimiento y proceso del café.

Otro resultado es que aunque el cliente paga más por el café sostenible, el agricultor no

recibe una parte más grande del total del valor añadido en la cadena. En la cadena del

café convencional, el productor recibe el 28% del valor de ventas final, y en el caso de

café sostenible (comercio justo), el productor recibe el 27%. Sin embargo, mirando

valores absolutos, el café sostenible tiene una ventaja clara para el productor: en el año

2004 el precio del comercio justo era US$ 2.78 por kilogramo y el precio del café

orgánico era US$ 1.70 por kilogramo, comparado a US$ 1.43 por kilogramo para el café

convencional. Aunque los premios para el café orgánico y eco-amigable son modestos,

hacen una diferencia apreciable para los agricultores, como el café en muchos casos

proporciona su fuente única de ingresos en efectivo.

1. INTRODUCTION The idea behind this study comes from an ongoing discussion that I have had with my

mother for many years. It started when I lived at home and wanted her to buy organic and

fair traded products, which she refused to do. The reason she gave is that organic and fair

traded products are much more expensive and you cannot trust the labels anyway; she

argued it is just a trick from the business in order to gain more money. I believe there are

3

many like my mother, who are sceptical towards organic and fair traded products,

wondering where the money goes.

About 25 million farmers – mostly smallholders – in more than 50 developing countries

depend on coffee for their livelihood. Coffee producers are faced with a number of

problems. They are based in rural areas in poor countries; infrastructure is poor and

service provision low. Their income is highly insecure because of fluctuating

international coffee prices. Currently, the prices are recovering after a four-year decline

in green coffee commodity prices. Furthermore, the share of final retail price that is

received by producing countries has decreased during the last years (Talbot 1997).

Some producers have been able to take advantage of the trend in the specialty coffee

industry toward “sustainable” coffee. Sustainable coffee includes fair-trade, certified

organic and eco-friendly coffee. These coffees fills a market niche that is not only

rewarded with a premium price but can also provide other benefits that help producers

improve their sustainability. These benefits are very much sought after in producing

countries; as the coffee industry experiences very low bean prices, sustainable and other

differentiated coffees are among the few receiving a good price and showing a substantial

growth. However, the limit to the growth of the niche coffees is the demand in the

consuming countries.

To find out whether the price difference between sustainable and conventional products

really benefits the farmers and the environment, this study looks at sustainable and

conventional coffee. The aim of the study is to analyse the markets for sustainable and

conventional coffees that are produced in Peru and consumed in Sweden. Some central

questions arise from these observations. Is sustainable coffee more expensive than

conventional coffee on the Swedish market, and if so, then why? What is the distribution

of income in the coffee commodity chain for sustainable and for conventional coffee? Do

farmers producing sustainable coffee receive a larger part of the total value added in the

commodity chain?

4

Methodology

I follow the coffee beans the entire way from the grower in Peru to the supermarket

shelves in Sweden, looking at conventional as well as sustainable coffee. By collecting

information on value added at every “node”, I am able to study the different markets and

the distribution of income along the chains.

My methods of data collection are informant interviews and secondary data analysis.

Doing research in a developing country can be a challenge, since official data might be

missing or inconsistent. When doing interviews there is also a risk of interviewer bias -

that the interviewer might influence the respondent’s answer - and barriers of language

and culture complicate matters further. To minimize the limitations of each method, it is

advantageous to triangulate methods, i.e. to use more than one form of data collection to

test the same hypothesis. Whenever feasible I verify the data through different sources of

information.

The interviews conducted for the study were semi-structured informant interviews with

centrally located interviewees. Informants were selected on the basis of their knowledge,

experience, or understanding of a given area. Informant interviews are often used when

exploring a less well-understood topic. When making informant interviews, the persons

interviewed serve as sources, and the information collected should to be analysed with

criticism of the sources. I have made 16 interviews in Peru and 7 in Sweden. In Peru,

interviews were conducted face-to-face in Spanish and all (except one, due to technical

problems) were recorded. In some cases additional questions were answered by e-mail.

The sampling of interviewees was made together with my supervisor at the agricultural

university, Dr Julca Otiniano, who has useful contacts in the coffee industry. I visited the

area of Chanchamayo, which is one of the three main coffee producing zones in Peru, and

interviewed producers of conventional as well as sustainable coffee, cooperatives and

intermediaries. In Lima I met with representatives from the agricultural university, coffee

organizations, the government’s export board, a certifying agency and an export firm. In

Sweden, all interviews were conducted in Swedish and over the telephone. I interviewed

5

people working for an importer, several roasters, a retailer, a certifying agency and a

coffee organization. (See appendix 2 for a complete list.)

The secondary data analysis is based on statistics that I received from firms and

cooperatives in the coffee commodity chain. I asked them to state mark-ups, production

costs and total sales in the part of the chain where they operate. Since this is delicate

information, I have guaranteed the participating firms and cooperatives full

confidentiality. With the acquired information I have calculated the distribution of total

income generated along the coffee chain. Official records on trade and prices have also

been used as sources.

Calculations

During the processing of coffee beans the weight is reduced. Since the calculations in the

commodity chain are based on the price of a kilogram of ground roasted coffee, the data

has been adjusted using the conversations:

1 kg of roasted coffee = 1.19 kg of green coffee = 1.65 kg of parchment coffee1

One problem when comparing the value added in different stages of the commodity chain

is that price levels vary greatly between countries, being in general higher in countries

where wages are higher (since labour accounts for most of the cost of non-traded goods

and services). One way to measure cross-country costs and incomes more accurately is to

use the purchasing power parity (PPP). PPP is a theory that states that exchange rates

between currencies are in equilibrium when their purchasing power is the same in each of

the two countries. This means that the exchange rate between two countries should equal

the ratio of the two countries’ price level of a fixed basket of goods and services. But no

measure is perfect: one of the key problems with the PPP method is that people in

different countries consume very different sets of goods and services, making it difficult

to compare the purchasing power between countries. Moreover, most of the commodity

1 Parchment coffee has the dried parchment skin still adhering to the bean. The farmer sells parchment coffee to the intermediary or cooperative. The parchment is removed in a milling process prior to roasting.

6

chain research has been done without using PPP exchange rates. Seeing that it is difficult

to use the PPP exchange rate in the commodity chain calculations I use the official

exchange rates instead. This should not influence the result: since I use the estimates to

make a comparison between conventional and sustainable coffee, the unit of

measurement is of minor importance.

Definitions

The following terms serve as brief definitions for the paper:

Sustainable coffee includes fair trade, certified organic and eco-friendly coffees.

Fair Trade coffee is purchased directly from cooperatives of small farmers that are

guaranteed a minimum pre-set contract price.

Organic coffee is certified to be produced with methods that preserve the soil and

without the use of synthetic chemicals.

Eco-friendly (or bird-friendly) coffee is certified to be grown in shaded forest settings

in a manner that is good for biodiversity, bird habitat, etc.

These categories overlap: much of the fair trade coffee is also certified organic and most

of the organic coffee is also shade-grown. Furthermore, increased cooperation between

the fair trade and the organic movements has been discussed since the concepts are based

on the same holistic principal of sustainable development. Therefore, the study looks at

the production of sustainable coffee in general; however, it discusses differences between

the labelling systems.

Terms of Reference

Peru has been chosen since the country is the largest supplier of sustainable coffee on the

Swedish market, and the Peru-Sweden coffee commodity chain has not been previously

analysed. The study covers the formal certification systems defined above and not the

corporate standards that are aimed at improving sustainability developed by the major

coffee companies and retailers. My intention was to collect data on the coffee commodity

chain dating several years back, to be able to discover changes and trends, but this

7

information turned out to be difficult to acquire. Consequently, the study of the

commodity chain is limited to year 2004.

Outline

The outline of the paper is as follows: In the second section the theoretical model is

presented. The third section contains an outline of the production and trade on the coffee

market. Section four gives an analysis of the coffee markets in Peru and Sweden and the

links between them. Section five, finally, concludes.

2. THEORETICAL FRAMEWORK In this section the theoretical framework, the commodity chain, is presented. I illustrate

the reasoning with a figure of the coffee commodity chain. Thereafter an outline of

different market structures is given.

Commodity Chains2

The commodity chain approach has been developed in the field of sociology as a way to

analyse the structure of the world economy (Hopkins and Wallerstein 1986; Gereffi,

Korzeniewicz and Korzeniewicz 1990, 1994). A commodity chain is defined as “a

network of labor and production processes whose result is a finished commodity”

(Hopkins and Wallerstein 1986, p. 159). In the commodity chain approach, the

international structure of production, trade, and consumption of commodities is

disaggregated into nodes. The systematic study of commodity chains seeks to explain the

spatial organisation of production, trade and consumption of the globalised world

economy (Gereffi, Korzeniewicz and Korzeniewicz 1994, p. 2). In this way, globalisation

and the restructuring of the world economy can be analysed through a series of macro-

micro links that allow a nuanced understanding of economic processes.

Gereffi (1994, p. 97) argues that commodity chains have three main dimensions: an

input-output structure (a set of products and services linked together in a sequence of 2 Some authors prefer the term “value chain” because the word “commodity” implies the production of undifferentiated products, which can be misleading since the approach is used to analyse any kind of products.

8

value-adding economic activities); a territoriality (spatial distribution or concentration of

enterprises in production and distribution networks); and a governance structure

(authority and power relationships).

Gereffi (1994) has sketched two ideal types of governance structures: producer-driven

and buyer-driven. The difference between these two types of commodity chains resides in

the location of their key barriers of entry. Producer-driven chains are those in which

large, usually transnational, corporations play the central roles in coordinating production

networks (including backward and forward linkages). This is most characteristic of

capital and technology-intensive commodities such as automobiles, aircraft, computers,

and heavy machinery. Buyer-driven chains, on the other hand, are those in which large

retailers, brand-name merchandisers, and trading companies play the central role in

shaping decentralized production networks in a variety of exporting countries, typically

located in the South. This pattern of industrialization is typical in relatively labour-

intensive consumer goods such as garments, footwear, toys, and house wares. Production

is generally carried out by tiered networks of third world contractors that make finished

goods for foreign buyers. The specifications are supplied by the large retailers or

marketers that order the goods. However, Gereffi’s work has focused primarily on

commodity chains for manufactured products, and it is not clear whether these ideal types

of governance structures are applicable to agricultural commodity chains such as the one

for coffee.

Gibbon (2001) has proposed a third type of governance structure, which, he claims, is

found in many “traditional” primary commodity chains: the international trader-driven

chain. The organizing firms in this case are giant transnational trading houses that

typically trade in a variety of commodities. They obtain supplies of commodities from all

over the world for other firms that process them into final form for sale to consumers.

They exercise a loose and indirect form of governance over their suppliers, based mainly

on price, volume and reliability. Traders’ main source of profitability is volume rather

than margins, which are low in most international primary commodity trade. They

specialize in logistics, including knowledge on where to find supplies of different

9

commodities, and on how to ship and insure them. They also specialize in financial

services, including access to large amounts of capital, and the ability to protect

themselves from risk and increase profits by playing the commodity futures markets.

However, Gibbon’s international trader-driven governance structure does not characterize

the governance of the entire chain, because the trading companies do not control the

manufacturing of the commodities into final form, nor the sales to consumers.

Talbot (2002) claims that the governance structure of the coffee commodity chain

incorporates elements of all three ideal types (buyer-driven, producer-driven and

international trader-driven). Figure 2.1 maps the major input-output relations in the

coffee commodity chain:

• Farmers pick and process the coffee cherries, in a dry or wet process, receiving a

farm-gate price

• The cherries are then processed in a factory, resulting in a factory gate price

• The beans then go to an intermediary for export, reflected in f.o.b. prices

• They are shipped to importing countries, landed at c.i.f. prices

• Importers then pass the beans on at wholesale prices

• Roasters process the beans and sell them at factory gate prices

• Retailers sell the coffee to the public (at retail prices) for domestic consumption, as

do restaurants, caterers and coffee bars for out-of-home consumption

10

Figure 2.1 The coffee commodity chain

Farm

Farm gate costs

Fact

ory

Factory door costs

Prod

ucin

g C

ount

ry

Expo

rter

Export duty

Import duty

Impo

rt ag

ents

Fact

ory

Con

sum

ing

coun

try

Ret

ail

11

Unwashed

green beans

Beans for export

Processing

company

Beans cleared

for market

Dry process:

dry cherry Wet process:

washed parchment

Fresh cherry

Washed green beans

FOB

CIF

Freight and

insurance

Wholesale costs

Factory door

costs

Retail costs

Shop retail

for home

Commercial oasted ground

coffee and catering

Coffee

house

Instant coffee

R

Dealer

Commercial

and catering

Market Structures

The theoretical framework of global commodity chains has been developed in the field of

sociology. As a consequence, a common critique directed towards the theory is that the

economic reasoning is inadequate or insufficient. In my opinion the commodity chain

analysis has a place in economics since economists are concerned with the study of

markets. The commodity chain is an approach which links markets that are spatially

separated, every node of the chain is in fact a market with at least one buyer and one

seller, and can be analyzed as such. In order to measure the division of surplus among

different nodes of the chain one needs to look at the degree of competition or

monopolization that characterizes the markets. What is the market structure like? How

many firms operate on the market? Who has the market power? Are there barriers to

entry?

In a competitive market, the economic agents take the market price as given, that is

outside of their control. Each consumer or producer is a small part of the market as a

whole and thus has a negligible effect on the market price. The competitive market gives

a Pareto efficient allocation (there is no way to make anybody better off without hurting

anybody else). A competitive industry operates at a point where the price equals marginal

cost.

A monopoly is a situation when the market is dominated by a single seller of a product. In

a monopsony there is a single buyer. When there is only one firm in a market, that firm is

very unlikely to take the market price as given. Instead, the monopoly or monopsony

would recognize its influence over the market price and choose the level of price and

output that maximized its overall profits.

In an oligopoly and oligopsony there are a number of competitors in the market, but not

so many as to regard each of them as having a negligible impact on price. The key feature

of an oligopolist industry is the interdependence of the decision-making by firms. There

are several possible ways for oligopolies/oligopsonies to behave depending on the nature

of their interaction: If the firms behave according to the Bertrand model, the market

12

produces the same equilibrium as a perfectly competitive market. In the Cournot model

the equilibrium produces a price and a quantity that are intermediate between the

monopoly and the perfect competition levels. Another outcome is the cartel, which is

when the firms jointly collude to behave like a single monopolist and maximize the sum

of their profits. A large number of markets have the structure of oligopoly/oligopsony.

Monopolistic competition shares elements of both competition and monopoly. Firms

compete by selling differentiated products, which are highly substitutable for one another

but not perfect substitutes. Hence, the firms must compete for customers in terms of both

price and the kinds of products they sell. On the other hand, the industry structure is

monopolistic in that each firm has some market power, since it can set its own price for

the product rather than passively accept the market price (as does a competitive firm).

Furthermore, there are no restrictions against new firms entering into a monopolistically

competitive industry. Monopolistic competition is probably the most prevalent form of

market structure.

3. THE COFFEE MARKET The purpose of this section is to describe the production and trade on the international

coffee market. Furthermore, previous research on the coffee commodity chain is

summarized and an outline of sustainable coffees is given. The last part of the section

presents the Peruvian and the Swedish coffee markets.

Production and Trade

Coffee is a major commodity in international commerce. It is produced in more than 50

countries, and total production in 2004 amounted to nearly 7 million tons. Some 25

million farmers, mostly smallholders with farms of less than 10 hectares, depend on

coffee for their livelihood. Coffee producers are faced with a number of problems. They

are based in rural areas in poor countries; infrastructure is poor and service provision low.

Their income is highly insecure because of fluctuating international coffee prices. For

many of them coffee is the only source of cash income. Coffee is a crucial source of

export revenue for many poor countries, accounting, for example, for 24 percent of total

13

exports from Honduras, 54 percent from Ethiopia and 79 percent from Burundi in 2000

(Gresser and Tickel 2002).

The coffee farmers have had considerable difficulties during the last years because of a

dramatic decline in the price of coffee. Figure 3.1 graphically illustrates the recent crisis

on the coffee market. In the beginning of the twenty-first century prices declined to 100-

year lows in real terms. Currently, prices are recovering.

Figure 3.1 Coffee prices (other milds) 1986-2005

0

50

100

150

200

1985 1990 1995 2000 2005

Source: IMF database, 2005

US

cent

s pe

r lb

One explanation of the coffee price volatility can be found in the inherent properties of

the market. The international coffee market is characterized by relatively low price

elasticities of supply and demand (McClumpha 1998). Supply elasticities are low in the

short run and higher in the long run because it takes at least two years for new trees to be

productive and several others before they reach full production levels. In the long run,

this leads to a higher than necessary response as new coffee trees mature. A period of

supply shortage may then be followed by one characterized by oversupply and low

prices. Supply is also slow to adjust downward during periods of overcapacity. Because

fixed costs (i.e. the cost of growing and maintaining trees) are a high share of the total

cost of coffee production, it is economically rational for farmers to continue to harvest

coffee beans as long as prices cover variable costs, even if prices are well below average

total costs. Demand elasticities are also low, with coffee demand dropping significantly

14

only at times of large increases in coffee prices. The peculiar characteristics of the price

elasticities of supply and demand lead to highly variable prices in the world coffee

market.

Historically, fluctuating coffee prices has been a fact of life because of weather shocks

(mainly in Brazil) and the market characteristics described above, but Giovannucci (et. al.

2004) claims the recent crisis has been caused by structural changes in the coffee market.

Coffee production is no longer managed by producing country boards or international

agreements (the International Coffee Agreement was dismantled in 1989), which has lead

to amplified price volatility.

Another area of structural change is in the nature of supply, particularly the increase in

both the quantity and quality of Brazilian and Vietnamese coffees. Other countries have

also expanded production due to periods of profitable prices in the 1990s. The result is a

production surplus of coffee (see figure 3.2).

Figure 3.2 Total coffe production (1975-2004)

60000000

70000000

80000000

90000000

100000000

110000000

120000000

130000000

1975 1980 1985 1990 1995 2000 2005

Source: ICO database 2005

60 k

g ba

gs

Roasters have responded to the shift in supply by adapting their technology to increase

their use of beans of lower quality. Furthermore, roasters and traders have concentrated

into large corporations, something that has increased the market power in this part of the

chain.

15

Another trend in the coffee market is a decline in the share of the final retail price that is

received by producing countries. The coffee roasting and retail industries (in importing

countries) have made profits by developing new products and by taking advantage of

various value-adding activities, such as marketing, branding, differentiation and

flavouring. (Giovannucci et. al. 2004)

The Coffee Commodity Chain

Previous research on the coffee commodity chain has been made by Talbot (1997, 2002)

and Pelupessy (1999). Talbot’s (2002) calculations on the value added in the coffee

commodity chain are based on weighted prices for all ICO member countries from the

early 1960s to the late 1980s. He finds that during most of this period, roughly half of the

value added in the chain was retained in the producing countries. After about 1986,

however, there was a massive shift of surplus from the coffee producing countries to

transnational firms, who used their market power to hold down the price of green coffee

while inflating the price of coffee processed for final consumption (Talbot 1997, p. 86).

Pelupessy (1999) has calculated the distribution of income along specific producer-

consumer country chains (the Côte d’Ivoire-France and Costa Rica-Germany chains). In

1994, Pelupessy finds that the grower’s share of final retail price was 13.8 per cent in

Côte d’Ivoire and 14.6 per cent in Costa Rica. Value added in consuming countries was

43.4 per cent in France and 71.5 per cent in Germany.

Sustainable Coffee

The international coffee market is driven exclusively by economic factors and, like all

commodity markets, does not recognize, much less internalize into its pricing, the real

environmental and social costs of production.

In recent years there has been a growing concern in Europe, North America and Japan

about the working conditions and the environment in the South. Alternative trade can be

seen as a labelling project where consumers are given information about the social and

environmental conditions under which commodities are produced and then asked to pay

16

to support a more sustainable production and trade. Voluntary labelling is being

promoted by consumer groups, corporations, governments and the World Bank as a

means to broaden consumer choice and give producers a market incentive to improve

their social and environmental performance (Raynolds 2000). The coffees that are often

called “sustainable” (that is, organic, fair trade, and eco-friendly) are predominantly

produced by small farmers and characterized as paying farmers reasonable prices,

providing incentives toward organic production and rewarding farmers for practicing

good natural resource stewardship. Though the international trade in organic and fair

trade products represents a relatively minor share of the global market, this trade is

growing rapidly, creating important new North-South linkages.

However, the idea that paying a higher price for certain products from developing

countries will help them has been criticized. Maseland and de Vaal (2002) argue that the

practice by alternative trading organizations to pay a higher price can lead to market

distortions that cause adverse effects. Leclair (2002) sees two significant shortcomings;

firstly, alternative trade differentially assists one set of producers, potentially at the

expense of others, and secondly, that alternative trade promotes continued reliance on

products that are arguably poor prospects in the long run.

The level of the guaranteed fair trade price is a much-debated question. Some argue that

the price difference between conventional and fair trade coffee becomes too large at

times of low world market price on coffee. It has been suggested that the producers

receive a guaranteed mark-up over the market price instead of the guaranteed market

price. For the farmer, the argument goes, selling the coffee with a smaller mark-up would

be better than not selling any coffee at all at the current fair trade price.

One large evaluation of fair trade has been published: Miseror, Brot für die Welt and

Friedrich-Ebert-Stiftung (2001). The evaluation concludes that there is no automatic link

between fair trade and development; in addition to trade, support and education in areas

such as exports, administration and organizational capacity building is needed. Reports

on the impact of fair trade on the producers involved have generally concluded that the

17

money reaches the poor and marginalised, and that the system has a positive influence on

the life situation of those benefiting from it. These impact studies are all primarily

interview based and include case studies from Tanzania, Ghana, Costa Rica, Mexico,

Peru, Bolivia and Nicaragua. (Milford 2004).

Organic Coffee

In organic farming, no chemical pesticides or fertilizers are allowed. The farming system

depends on maintaining a healthy crop through soil fertilization practices, such as

recycling and composting, and enhancing the natural control of pests. Each step in the

processing chain is audited and certified as following the organic principles. The cost of

certification is regarded as one of the largest constraints in promoting organic production

to small farmers in developing countries. Certification from an internationally accredited

certification body such as IMO Control can cost around US$ 1500.3

Fair Trade Coffee

Fair Trade is an alternative approach to conventional trade that aims to improve the

livelihoods of small producers by improving their market access, strengthening their

organizations, paying them a fair price, and providing continuity in trading relationships.

The producers are guaranteed a minimum contract price, currently US$ 1.26 per pound

(US$ 2.78 per kg) for washed Arabica. For fair trade coffee that is also organic, farmers

receive an extra premium of US$ 0.15 per pound (US$ 0.33 per kg). (Giovannucci 2003,

p. 40)

Eco-friendly (or Bird-friendly) Coffee

This category is not homogenous and includes different certifications – primarily those of

the Rainforest Alliance and the Smithsonian Migratory Bird Center – that share a primary

concern for biodiversity.

3 Eng Ezio Varese Zeppilli, IMO Control, personal communication, June 21, 2005

18

Private or Corporate Standards

There is a growing interest from the major coffee companies and retailers in meeting

some sustainability criteria, and some have developed their own guidelines to improve

sustainability. The best of these production standards promote – and pay for – fair labour

practices, the minimization of agrochemical inputs, environmental biodiversity

management, and traceability. These initiatives are an important trend because they can

quickly introduce some sustainability standards to the mainstream industry that provides

most of the world’s coffee supply. However, for these standards to be credible, they must

be independently verified which is overlooked by many corporations today. Some are

criticized for setting the criteria so low that they present only modest improvement for the

farmer. Another risk is that corporate driven guidelines could be imposed upon farmers as

a criterion of doing business, thereby becoming another burden for the producers. These

questions pose an ethical dilemma for companies involved with private standards: they

might be free riding on the established certifications, such as fair trade and organic, and

ultimately eroding the ability of these to provide benefits for producers. (Giovannucci et.

al. 2004, p. 103-104)

Credibility of Certification

The credibility of the certification schemes is an important aspect, any sign of doubtful

practices would seriously harm the industry, something which the organizations and firms

working with sustainable coffee are aware of. The risk is rather that the rigorous controls

become an impediment for producer and export organizations that do not have sufficient

resources and administrative capacities. In the case of organic coffee that is exported

from Peru to Sweden, the production is controlled on the farm by an internationally

accredited certifier, when entering the EU by the customs, and in Sweden by the certifier

KRAV.4

The Peruvian Coffee Market

Peru, with its high altitudes and warm climate, has very favourable conditions for coffee

production. Coffee is grown in three zones in Peru; all situated in the heavily forested

4 Mr Hans Huiskamp, KRAV, personal communication, June 9, 2005

19

north eastern slopes of the Andes, and nearly all coffee is shade-grown under trees. The

coffee produced is washed Arabica.

As much as 94 percent of the Peruvian coffee production is exported. (The domestic

consumption is very low with an annual per capita consumption of 380 grams, compared

to about 9 kg per capita in Sweden5). The Peruvian coffee production has grown

considerably during the last years – export has risen from 55 000 tons in 1984 to 189 000

tons in 2004 (see figure 3.3). This has brought Peru to position number nine of coffee

producing countries in the world, with 2.9 percent of world production (Junta Nacional

del Café 2004 a, p. 5).

Figure 3.3 Coffee exports from Peru (tons) 1984-2004

- 20 000 40 000 60 000 80 000

100 000 120 000 140 000 160 000 180 000 200 000

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Tons

Source: Junta Nacional del Café 2005

There are several causes of the growth of Peruvian coffee production: One is the

dismantling of the International Coffee Agreement (ICA) in 1989, which for Peru implied

that the country was no longer restricted to limit its production in accordance with the

agreement. On the micro level, the lack of alternative employment in the rural areas and

the lack of other profitable crops result in coffee being the only feasible source of cash

5 Mr Lorenzo Castillo, Junta Nacional del Café, personal communication, February 16, 2005

20

income for many farmers. Production is expanding most in the north of Peru, where

poverty forces people to descend from the mountains and start cultivating land in the

jungle. Furthermore, the security in the rural areas has improved compared to the 1990s

when terrorists were threatening farmers and intermediaries and thereby limited the

possibilities of production and trade. Peru has also been successful in the transition from

conventional to sustainable coffee, which has created an economic basis for the output

growth.

The shift from illicit drugs to coffee production is claimed to be a ground for the

increasing coffee production, since coffee is being promoted by the government as a

profitable cash crop that can replace coca (Giovannucci et al. 2004, p. 71). However, the

assertion has been contradicted in this study. According to Junta Nacional del Café it has

proved to be very difficult to decrease the production of coca, as the price of coca is

much higher than that of coffee, coca is easier to cultivate than coffee and the risk of

getting punished for growing it is minimal.6

Competitiveness

All interviewees stressed the high quality of Peruvian coffee as an important factor for

competitiveness. One person stated: “Peruvian coffee has the same quality as Colombian

coffee but a lower price.”7 However, Colombian coffee has a better reputation thanks to

marketing campaigns, whereby the Colombian government has created a demand for

gourmet coffee from Colombia. In Peru, the government and some non-governmental

organizations have worked together in order to raise the quality of their coffee, since the

quality is directly linked to the price it commands on the world market. Their work has

been successful: Peruvian coffee used to be punished in price on the New York stock

market, but in 2004 Peruvian coffee did not get a discount when sold on the world

market.8

6 Mr Amilcar Buleje, Junta Nacional del Café, personal communication, March 22, 2005 7 Mr Eduardo Montauban Urriaga, Camera Peruana del Café, personal communication, March 4, 2005 8 Dr Alberto Julca Otiniano, Universidad Agraria de la Molina, personal communication, February 8, 2005

21

The Swedish Coffee Market

The total size of the Swedish market in 2004 was 83 923 tons roasted coffee equivalent,

giving a per capita consumption of 9.31 kilograms, which is one of the highest in the

world. Almost all coffee consumed is the type Arabica. Robustas have about 1 percent of

the market, yet this share is increasing due to the espresso trend. The overall Swedish

coffee market has been stagnant over the last decade despite growth in the differentiated

and speciality segments. (SCB 2005)

Brazil and Colombia are the main suppliers to the Swedish market, accounting for two

thirds of imports. Third comes Peru with a supply of 96 817 bags, or 6.5 percent of the

Swedish coffee import in 2004. (SCB 2005) The major roasters in Sweden – Kraft

Foods, Nestlé and Löfbergs Lila – all have Peruvian coffee in their blends9.

Sweden is a net exporter of roasted coffee, in 2004 the export amounted to 11 729 tons.

The destinations were USA (more than half of the volume), Finland, Norway, Denmark

and the Baltic countries. (SCB 2005)

4. ANALYSIS OF THE COFFEE CHAIN PERU-SWEDEN This is the section where the research questions are answered: Is sustainable coffee more

expensive than conventional coffee on the Swedish market, and if so, then why? What is

the distribution of income in the coffee commodity chain for sustainable and for

conventional coffee? Do farmers producing sustainable coffee receive a larger part of the

total value added in the commodity chain? I start with the production and trade within

Peru, thereafter follows the Swedish part of the chain. Since the commodity chain is

composed of vertically linked markets, I describe the different markets throughout the

section. Finally the distribution of income in the coffee chain is analyzed.

9 Consumer service at Kraft Foods Sverige AB, Zoégas Kaffe AB and Löfbergs Lila AB, January 24, 25, 26, 2005

22

The Commodity Chain from Producer to Exporter

Producer

Peruvian coffee producers are generally small growers, with farms between 0.5 and 5

hectares, producing on average 662 kilograms of coffee per hectare and year (Junta

Nacional del Café 2004 b). It is estimated that only 30 percent of the producers are

organized in any form (Ministry of Agriculture 2004, p. 20). The low level of

organization among the producers adds to the vulnerability of the sector. 70 percent of

the coffee producers use no technology10, which means that they use traditional farming

methods without pesticides and fertilizers, 28 percent have a low level of technology and

only 2 percent produce with a high level of technology.11

The main tasks in coffee cultivation are to harvest the coffee berries and to eliminate

weeds. The coffee is usually processed on the farm using the “wet” method. First the

skins of the berries are removed by crushing them in a special device. Thereafter the

beans are washed and left to dry in the sun. The producer then brings the bags of coffee

down to the village, on foot, on a donkey or by truck, where he or she sells it to an

intermediary or to a cooperative. The price the farmer receives depends on the quality of

the beans (degree of dryness and cleanliness), and on whether the produce is certified as

sustainable coffee.

What is the production cost on farm level? The production cost is difficult to estimate

since it depends on various aspects like location, production technique and yield, but in

the calculations in the coffee chain I use a mean value for all coffee production in Peru.

Claims of the production cost vary widely: from below 3 soles per kilogram to 4.65 soles

per kilogram (US$ 0.88 to 1.36 per kilogram). The higher figure is an estimate from Junta

Nacional del Café (the National Coffee Board)12, and a summary of their calculation of

10 The term ”no technology” (“sin tecnología”) is misleading since everybody has some technology, but I use it here since the definition is widely used among Peruvian scholars. 11 Dr Alberto Julca Otiniano, Universidad Agraría de la Molina, personal communication, February 8, 2005 12 Junta Nacional del Café must be considered a source with a tendency since the organization is formed by producers’ cooperatives and aims to improve the producers’ conditions. However, Junta Nacional del Café is one of the most important actors in the Peruvian coffee sector and it is the one that has the most extensive

23

the production cost using traditional farming methods is shown in table 4.1. In the

traditional farming there is no input of chemical fertilizers or pesticides; hence the

production cost for organic farming can be approximated to be the same. According to

Junta Nacional del Café, the production cost has not changed during the last years.13

Table 4.1 Production cost per hectare using traditional farming methods

Cost (soles)

Labour 1 638

Indirect costs (financial costs, depreciation of machinery) 959

Other inputs (plants, tools, materials) 649 Transport 91 Total cost/ha 3 337 Yield/ha 718 kg

Total cost/kg 4.65

Source: Junta Nacional del Café 2004

data (used as a reference by the agricultural university as well as the World Bank). Therefore I have decided to use their estimations in the study. 13 Eng Pablo Vargas Chávez, cooperative of coffee farmers, personal communication, March 15, 2005

24

Table 4.2 Price paid to the producer 1994-2004

Year

Price paid to producer in soles per kilo

Price paid to producer in US$ per kilo

1994 3.20 1.45 1995 4.10 1.82 1996 3.38 1.38 1997 6.41 2.52 1998 4.28 1.46 1999 3.60 1.07 2000 3.32 0.95 2001 2.32 0.66 2002 1.95 0.55 2003 2.35 0.68 2004 3.38 0.99

Source: Junta Nacional del Café 2005

The estimation of the production cost is a

politically sensitive issue since the price paid to

the producer minus the production cost equals

the producer’s income. An average production

cost of 4.65 soles per kilogram implies that the

Peruvian producers have been paid less than the

production cost during the last years. The price

paid to the producer fluctuates every year since

it is based on the world market coffee price that

is set on the New York stock market (see table

4.2). The producer receives between 40 and 50

percent of the world market price.

Intermediary

A number of intermediary firms, both Peruvian and foreign, buy coffee in the area of

Chanchamayo. There are about 50 firms acting on the market: in district capitals 30-50

intermediaries are represented and in smaller villages there are about 3 intermediaries.

According to Junta Nacional del Café there is competition between the intermediaries

operating in the same area; to some extent they compete with the price they offer and the

quality they accept.14 However, imperfect competition is a common problem in rural

areas in developing countries. Imperfect competition means that farmers are paid less for

their produce compared to what they would get paid in a competitive situation. Milford

(2004) has shown the prevalence of collusive behaviour among coffee purchasers in

Chiapas, Mexico.

In Chanchamayo, some characteristics that (according to economic theory) will lead to

oligopsony are present: there are many barriers to entry in the processing and exporting

business. Transport costs make it easier for purchasers to have their own territories and

reduce competition. There are considerable information asymmetries in the relationship

between the farmer and the intermediary since producers often lack information on

14 Ms Susana Schuller, Junta Nacional del Café, personal communication, July 26, 2005

25

international prices and coffee quality requirements. (The vast majority of the farmers do

not know the stock market price of coffee, even though there are transmitters that

broadcast the information and every village has an Internet café.15)

The prices offered for the coffee beans by the intermediary firms are almost identical.

This could be due to perfect competition, but the more likely explanation is that of tacit

collusion or price leadership. It is in the interest of all intermediary firms to keep the

price paid to producers low. However, individual intermediaries can benefit even more by

raising their price, assuming others do not follow suit, so collusion is only probable on a

short-term basis.

The intermediary firms do generally not give credits to farmers, only to middlemen so

that he or she can buy coffee from farmers. The farmers buy the bags of polypropylene

that are used to transport the coffee beans in for 2 soles (US$ 0.59) each.16

The intermediaries are not affected by the volatility of coffee prices, since their mark-up

per kilogram of traded coffee is constant, about 0.10 soles/kg, or US$ 0.03/kg17. This

means that the intermediary’s income is only dependent on the amount of coffee he or

she buys and sells. However, the trend on this market is towards higher concentration and

a larger presence of transnational export firms in the areas of production; the commodity

chain is thereby shortened and the intermediaries are cut out. The exporting firms want to

have control over the chain in order to reduce inefficiencies and to enhance the quality of

the coffee beans.18

The next part of the coffee commodity chain is the transport to Lima, where the coffee is

processed in large factories. Peru’s transportation system faces the formidable challenge

15 Ms Susana Schuller, Junta Nacional del Café, personal communication, July 26, 2005 16 Mr Abdias Aliaga Ordoñas, intermediary, personal communication, July 19, 2005 17 Mr Abdias Aliaga Ordoñas, intermediary, personal communication, March 13, 2005 18 Mr Ivan Romero Cieza, intermediary, personal communication, March 16, 2005

26

of the Andes and the complex Amazon River system, which add to the high cost of

transport: 0.10 soles/kg or US$ 0.03/kg19.

Exporter

There are a number of exporting firms operating on the Peruvian coffee market. The four

largest firms had an overall market share of 46 percent in 2004. The market share of the

ten largest firms was 73 percent, and the rest of the market was held by 70 smaller export

firms (see table 4.3). Four of the ten largest firms are transnational. Since there are so

many firms it is reasonable to assume that there is some degree of competition on the

market.

Table 4.3 Coffee exports per firm 2004

Value FOB Market share

Firm (US$) (%) 1 PERALES HUANCARUNA 51 938 111 17.9 2 COMERCIO & CIA 27 965 609 9.6 3 CIA INTERNACIONAL DEL CAFÉ 26 762 317 9.2 4 PROCESADORA DEL SUR 25 442 792 8.8 5 CENTRAL COCLA 18 532 846 6.4 6 ROMERO TRADING 15 273 385 5.3 7 AICASA EXPORT 12 750 768 4.4 8 CAFETALERA AMAZONICA 12 148 177 4.2 9 VALDIVIA CANAL HUGO 11 863 220 4.1

10 LOUIS DREYFUS 10 797 406 3.7 11 CECOVASA 8 633 896 3.0 12 MACHU PICCHU COFFEE TRADING 8 113 794 2.8 13 CAC LA FLORIDA 6 504 155 2.2 14 LAUMAYER PERU SAC 5 937 427 2.0 15 PRONATUR 5 167 947 1.8 16 COEX (PERU) 4 919 968 1.7 17 CEPICAFE 3 425 536 1.2 18 ANTONIO RINALDI 2 807 100 1.0 19 AZEXSA 2 586 783 0.9 20 CAFÉ PERU SAC 2 385 537 0.8

Source: Junta Nacional del Café 2005

19 Mr Juan Loayza Bellido, Peruvian coffee export firm, personal communication, Ferbruary 21, 2005

27

Sustainable Coffee from Peru

Sustainable coffee has become a distinguishing feature of the Peruvian coffee production

(see figure 4.1). Organic production started in 1989, with the OCIA certification. In 1994

fair trade was initialized. Today, 13 percent of the country’s coffee production is

composed of sustainable coffee, and Peru has become the world’s second largest

producer of organic coffee (after Mexico) (Junta Nacional del Café 2005). Peru is also by

far the dominant supplier of sustainable coffees on the Swedish market.

Figure 4.1 Peru's export of sustainable coffees 2000-2004

0

50000

100000

150000

200000

250000

300000

350000

2000 2001 2002 2003 2004

60 k

g ba

gs

Organic

Fair Trade

Eco-Friendly

Source: Junta Nacional del Café 2005

One reason for the smooth transition to sustainable coffee production was the initial

circumstances: 80 percent of the Peruvian coffee farmers have never used chemical

fertilizers or pesticides.

The largest obstacles to sustainable coffee production are the cost of the certification and

the limited demand for this coffee. There are a number of different certification schemes

and the co-operatives that produce sustainable coffee have to have several certifications

28

in order to sell to different markets. The certifications are for different categories

(organic, eco-friendly, fair trade) and for different destinations (US, EU, Japan). As an

example, the co-operative COCLA is currently certified by OCIA, IMO, Naturland, JAS,

Rainforest Alliance, Utz Kapeh, Bird Friendly and Fair Trade.20 There is some co-

operation between the certifying organs since they share a common goal, but differences

in norms and methods of inspection complicate matters. The cost of certification depends

on the production volume and on the certification. For example, a cooperative with 100

small producers that wants the organization IMO Control to certify its coffee in

accordance with the EU regulation CEE 2092/91 (which then can be sold as organic

coffee labelled KRAV on the Swedish market) has to pay about US$ 1 500. This consists

of a fixed cost for inscription, US$ 400, and a variable cost which depends on the time

needed for inspection, about US$ 1 100 (including two days of travelling to the area of

production, two days of inspection and one day accomplishing the report).21 The only

certification scheme where the producers do not bear the cost is fair trade.

Premiums for Sustainable Coffees

The fact that sustainable coffee commands a higher price on the market is the most

important factor for the producer when deciding to produce sustainable coffee. Fair trade

coffee has a guaranteed minimum price (currently US$ 2.78 per kilogram for washed

Arabica) but in the case of other sustainable coffees the price is decided by the market.

Since the introduction of a market for sustainable coffee, organic and eco-friendly coffees

have received a higher price than conventional coffee, but in the last years the price gap

has decreased as the volumes have increased (see figure 4.2). The premium for organic

coffee was US$ 0.53 per kilogram in 2001, but only US$ 0.12 per kilogram in 2004. The

trend can also be seen in the price of eco-friendly coffee, which gave the producer a

premium of US$ 0.22 per kilogram in 2002 and US$ 0.05 in 2004.

The decrease of the premiums is seen as a serious threat to the production of sustainable

coffee by the Peruvian coffee institutions, since the premium is the most important

20 Mr José Rivera, cooperative of coffee farmers, personal communication, February 21, 2005 21 Eng Ezio Varese, IMO, personal communication, June 21, 2005

29

incentive for the producer. There is also a considerable amount of sustainable coffee

which is being sold as conventional coffee, without any premium, because the demand

for sustainable coffee is insufficient. The coffee producing countries in Latin America are

considering a common strategy to deal with the large supply of organic coffee on the

market.22

Figure 4.2 Price premiums for sustainable coffees 2000-2004

0,53

0,33

0,15

0,12

0,22

0,15

0,05

0,98

1,55

1,55

1,47

1,16

0,55

0

0,2

0,4

0,6

0,8

1

1,2

1,4

1,6

2000 2001 2002 2003 2004

US$

/kg Organic

Eco-FriendlyFair Trade

Source: The elaboration is based on data provided by Prompex and Junta Nacional del Café (2005). The price premiums are calculated as the difference in mean FOB between conventional coffee (exported by Perales Huancaruna) and the different types of sustainable coffees.

Uneven Distribution

Why do not all coffee farmers produce sustainable coffee? The critique towards

sustainable coffee production - that alternative trade differentially assists one set of

producers, potentially at the expense of others - touches upon a serious issue. Clearly, the

benefits from sustainable coffee are not evenly spread, for several reasons. It is difficult

for an independent producer to acquire a certification (because of the cost and

administration tasks involved) and only a small part of the Peruvian producers are 22 Mr Lorenzo Castillo, Junta Nacional del Café, February 16, 2005

30

organized in cooperatives. The commercial system limits the possibility to sell

sustainable coffee at a price premium; if the local intermediary does not give a higher

price for sustainable coffee there is no incentive for the farmer to produce it.23

The Commodity Chain from Importer to Consumer

Importer/Roaster

The Swedish coffee market has experienced a concentration in the roasting industry over

the last decade. The market shares of the roasters and importers are shown in figure 4.3. In

2004, four large roasters covered 88 percent of the market. Two of them were

transnational firms (Kraft Foods and Nestlé), who had an overall market share of 60

percent.

Figure 4.3 Market shares of rosters/importers in Sweden (2004)

Löfbergs Lila17%

Arvid Nordquist11% Kraft Foods

(Gevalia)43%

Nestlé (Zoegas)17%

Coop4%

Others3%

ICA3%

Lindvalls2%

Source: Svensk Kaffeinformation 2005

23 Mr José Rivera, cooperative of coffee farmers, personal communication, February 21, 2005

31

The Swedish coffee industry is a typical example of a concentrated market which occur

when technical barriers to entry are low and product branding, hence, must be supported

by aggressive marketing to maintain a given market share level (Sutton 1992).

Durevall (2004) has analyzed the market power of roasters on the Swedish coffee market.

Despite the high market concentration no clear indications of market power could be

found. The study shows that the level of coffee consumption is determined by other

factors than the price, implying that firms do not control prices. If firms had market

power, they would ensure that prices influenced the level of coffee consumption. If there

is any market power, it is only in the short run. The mark-up over marginal costs is 10

percent, but it is not clear whether this market power exists on the roaster or the retailer

level.

It is possible that large roasters have market power as buyers in the market for green

coffee, as argued by, among others, Ponte (2002). Ponte claims that since the breakdown

of the ICA regime, roasters have made strategic choices to shape entry barriers not only

in the roaster segment of the chain, but also in other segments upstream. First, new

requirements set by roasters on minimum quantities needed from any particular origin to

be included in a major blend can be interpreted as setting entry barriers to producing

countries. Second, roasters have been able to devise new technological solutions to be

less dependent on any type or origin of coffee. Third, roasters have set the terms of coffee

supply with the implementation of supplier-managed inventory (the supply management

is left to a network of independent traders) so roasters could concentrate on marketing

and branding. (Ponte 2002, p. 1112)

Retailer

Sweden is experiencing an ongoing concentration in the large-scale retail grocery trade.

Four retail groups (Ica, Axfood, Coop and Bergendahls) dominate the market and account

for up to 90 percent of Sweden’s total coffee sales. There is a high level of integration

between the purchasing department and the shops in all chains. According to the Swedish

32

Competition Authority, the competition on the market for perishables is imperfect and

more actors would lead to a price decrease (Konkurrensverket 2004).

The price of coffee is high in Sweden; according to a survey Sweden had the highest EU

prices for roasted coffee, with the exception of Great Britain, Ireland and Greece, which primarily

consume instant coffee and tea. Swedish prices were 7 percent above the EU average (European

Commission 2002).

The Market for Sustainable Coffee in Sweden

Both fair trade and organic coffees are increasing on the Swedish market despite a stable

or slightly decreasing overall coffee market. This reflects a positive trend for sustainable

products in general. There is an increasing commitment to sustainable products on both

roaster and retailer levels.

Sustainable coffee holds 1.6 percent of the total market for coffee in Sweden. Organic

coffee holds an equal share of 1.6 percent, of which 0.4 percent is also fair trade certified.

All roasters have at least one organic coffee in their product lines. Retailers increasingly

demand that sustainable coffees are both fair trade and organic certified, and as a

consequence many coffees bear both these labels. (Giovannucci 2003, p. 165).

Premiums for Sustainable Coffees

Is sustainable coffee more expensive than conventional coffee on the Swedish market,

and if so, then why? The sustainable coffees that can be found on the Swedish market are

organic and fair trade coffees. The price of organic coffee in Swedish shops in 2004 was

on average 44.60 kronor per kilogram (US$ 6.07), compared with 40.62 kronor (US$

5.53) for conventional coffee, which gives a premium of 3.98 kronor (US$ 0.54).24 The

higher purchase price of organic coffee beans is not fully reflected in the shop pricing,

but several large brands have the same price for organic as for conventional coffee, and

the organic coffee is generally part of the brand’s campaign offers.

24 Mr Calle Åkerstedt, Svensk Kaffeinformation, personal communication, June 17, 2005

33

When it comes to fair trade coffee the pricing is different. Since the farmer is guaranteed

a minimum price, which is independent of the world market price of coffee, the price

difference between fair trade and conventional coffees can become large. This has been

the case during the last years when the world market price has been very low, so the

purchase price of fair trade coffee has at times been twice as high as the price of

conventional coffee. Such price differences cannot be levelled out over the assortment so

the retail price is much higher for fair trade coffee. The average price of a kilogram of

fair trade coffee was 78.40 kronor (US$ 10.67) in 2004, which means the price difference

to conventional coffee was 37.78 kronor (US$ 5.14).25 See table 4.4.

Table 4.4 Price premiums for sustainable coffees in Sweden (2004)

Variety of coffee Price (SEK/kg) Premium (SEK/kg)

Conventional coffee 40.62

Organic coffee 44.60 3.98

Fair trade coffee 78.40 37.78

Source: ACNielsen 2005. The estimations are based on the average price of coffee bought in Swedish shops during 2004.

A spokesperson for a Swedish fair trade organization claims the retailers are the largest

obstacle for the development of the market for fair trade coffees, since they give fair trade

coffee a higher mark-up than conventional coffee. Most of the coffee sold in Sweden is

sold at a specially reduced price, but fair trade coffee is rarely sold as a special offer. The

development of fair trade coffee is faster in other markets like office, restaurant, café etc.,

the difference being that fair trade coffee is given a competitive pricing in these

markets.26

25 Mr Calle Åkerstedt, Svensk Kaffeinformation, personal communication, June 17, 2005 26 Mr. Jens Baagoe, Swedish import firm, personal communication, August 23, 2005

34

Willingness to Pay for Sustainable Coffees

Since sustainable coffee is a relatively recent phenomenon on the Swedish market

(introduced in the 1990’s) and the market share is still small, an important question is

how this market niche can be expected to develop. Wikström (2003) has made a choice

experiment to test Swedish consumers’ willingness to pay for sustainable coffee. He

shows that the average consumer is willing to pay the amount of 2.48 kronor (US$ 0.34)

extra for a package (0.5 kg) of organic coffee (i.e. certified by KRAV) and a premium of

1.49 kronor (US$ 0.20) for a package of fair trade coffee (i.e. certified by Rättvisemärkt)

(Wikström 2003, p. 27). Furthermore 65 percent of the consumers in the survey stated

that they would pay more for sustainable coffee, as long as the premium was not too high.

Wikström concludes that there exists a clear market for both fair trade and organic

coffees.

The results of the study may be questioned, since a person interviewed in a choice

experiment may answer in a way that does not coincide with his or her actual behaviour.

But the results of Wikström’s study is consistent with the actual demand for sustainable

coffee in Sweden, which is higher for organic than for fair trade coffee. Since the price

premium for fair trade coffee is much larger than 1.49 kronor per package, this might in

part explain the low demand for this type of coffee.

There is an ongoing discussion on how the Swedish government can promote the

consumption of ecological and fair trade products. A current report suggests halving

VAT for these products (Edman 2005). If the proposition would be implemented, and the

decreased VAT would have an impact on consumer prices (this depends primarily on the

look of the supply- and demand curves), the outcome would be lower prices of

sustainable coffees. As a theoretical example, using prices from 2004, organic coffee

would get a price reduction of 2.7 kronor (US$ 0.37) per kilogram and fair trade coffee

would become 4.7 (US$ 0.64) kronor cheaper per kilogram.

35

The Distribution of Income

It is time to analyze of the distribution of income in the commodity chains for

conventional and sustainable coffees. Table 4.5 provides the share of final sales value

accruing to different links in the commodity chain for conventional coffee. The estimates

refer to values in cents (US) for one kilogram of ground roasted coffee. The average retail

price gives the total value generated in the coffee chain, which is less for conventional

than sustainable coffee.

Table 4.5 Share of final sales value accruing to different

links in the commodity chain for conventional coffee (2004)

US cents/kg

Share of final sales value

Paid to growers

157.4

28.4%

Transport 5.0 0.9%

Factory 7.5 1.4%

Export firm, intermediary

(FOB 180 cts/kg)

10.1 1.8%

Freight, insurance 12 2.2%

Import firm (CIF 192 cts/kg)

Roaster

Data on the division of income between importer, roaster and retailer not

available, but the sum is: Retailer 294.6 53.3%

Swedish state (VAT) 66.4 12%

Final price 553 100%

Note: All figures are expressed in US cents per kilogram of ground roasted coffee, using the conversations 1 kg roasted coffee = 1.19 kg green coffee = 1.65 kg parchment coffee. Since it is not possible to identify Peruvian coffee on the Swedish market, the values in the second part of the chain are mean values of all coffee. The final price is the average retail price in Sweden.

36

In the Peru-Sweden coffee commodity chain incomes are higher in the importing,

roasting and retailing links than they are in the growing and coffee processing stages,

even when account is taken of differing costs of living. From table 4.5 it is evident that

around 35 percent of the final product price accrues in Peru.

Unfortunately, it has not been possible to acquire any detailed information about the

value added in the firms operating in Sweden. The figures stated in annual reports from

roasters and retailers imply that the business is doing well, but the large roasters do not

only trade with coffee, neither do the retailers, therefore little can be said about how

profitable the trade in coffee is for them.

About 28 percent of the final sales value is accrued by the farmer. It is important to note

that these figures are a snapshot in a particular period of time, in year 2004. This year the

world market price on coffee had risen and the producers received a better price for the

coffee beans than in the preceding years. This can partly explain the discrepancy between

my result and earlier research on the coffee commodity chain. Pelupessy (1999) found

that the grower’s share of final retail price in 1994 was 13.8 per cent in Côte d’Ivoire and

14.6 per cent in Costa Rica. Talbot (1997) estimated the grower’s proportion of total

income to 13 percent in 1994/95.

As for the division of income within Peru, the largest shares go to the coffee growers.

Intermediate traders, processors, and exporters, get relatively small shares of the income.

To put this into perspective, we also need to consider volumes. The estimates in this

paper are all based on the production and export of a kilogram of green coffee. But a

farmer producing 600 kg coffee a year and earning a large share of the value added per

kilogram is still worse off than a large exporter who ships 200 000 bags (9.2 million kg)

per year27, but earns only a small profit per kilogram.

27 Mr Juan Loayza Bellido, Peruvian coffee export firm, personal communication, Ferbruary 21, 2005

37

Table 4.6 shows the share of final sales value accruing to different links in the

commodity chain for sustainable (fair trade) coffee. Only fair trade and not organic coffee

is represented in the chain, since the price difference between organic and conventional

coffee at the farm level and in Swedish shops is too small to make a useful comparison,

the difference would only be within the margin of error.

Table 4.6 Share of final sales value accruing to different

links in the commodity chain for sustainable coffee (2004)

US cents/kg

Share of final

sales value

Paid to growers

292

27.3%

Transport 5.0 0.5%

Factory 7.3 0.7%

Cooperative (FOB

314 cts/kg) 9.7

1.0%

Freight and insurance 13.6 1.3%

Import firm 150 14% Roaster 150 14% Retailer 311.4 29.2% Swedish state (VAT) 128 12% Final price 1067 100%

Note: All figures are expressed in US cents per kilogram of ground roasted coffee, using the conversations 1 kg roasted coffee = 1.19 kg green coffee = 1.65 kg parchment coffee. Since it is not possible to identify Peruvian coffee on the Swedish market, the values in the second part of the chain are mean values of all coffee. The final price is the average retail price in Sweden.

The figures in table 4.6 supports the claim that it is the retailers that slow down

development of fair trade coffee with unreasonable mark-ups on fair trade coffee; they

accrue 29% of the total value added in the chain. The mark-up on conventional coffee is

38

not available for this part of the chain, but it is reasonable to assume that it is much lower,

considering the tradition of selling (conventional) coffee at special offer.

It should be remembered, though, that a large part of the coffee produced under the fair

trade scheme cannot be sold at the fair trade price, due to limited demand. In other words,

a large amount of high quality sustainable coffee is sold as conventional coffee on the

market. The cooperative from which the figures in table 4.6 are taken is only able to sell

12-15 percent of its produce on the fair trade market. This means that the farmer does not

receive the fair trade price for all coffee, although it is produced under the fair trade

scheme.

Comparison between Conventional and Sustainable Coffee

Do farmers producing sustainable coffee receive a larger part of the total value added in

the commodity chain? In the coffee chain for conventional coffee, the farmer receives

28% of the final sales value, and in the case of sustainable (fair trade) coffee, the farmer

receives 27%. Figure 4.4 shows the distribution of income for conventional and

sustainable (fair trade) coffee.

39

Figure 4.4 The distribution of income for

sustainable (fair trade) and conventional coffee (2004)

Paid to grower

100%

90%

80%

70% Swedish state (VAT)

60% Import firm, roaster, retailerFreight and insurance

50% Cooperative/export firm

Factory Transport 40%

s 30%

20%

10%

0%Conventional coffee Sustainable coffee

The figure shows two bars which are almost identical, which means the relative

distribution of income does not differ in the two chains. The part of the total value added

that belongs to the farmer is practically the same, around a quarter share. It should be

noted, though, that the final price of sustainable coffee is almost twice as much as the

price of conventional coffee, so in real terms the farmer receives almost twice as much

when he sells sustainable coffee. And 2004 was a good year for the coffee farmers with a

relatively high world market price. Had the comparison been made some years earlier it

is probable that there would have been a difference between the two commodity chains

(because the price of conventional coffee was lower but the fair trade price was the same

as today).

Several conclusions can be drawn from the fact that farmers producing sustainable coffee

do not receive a larger part of the value added in the commodity chain. One is that the

trade in sustainable coffee is relatively small, and therefore does not have the economies

of scale that the conventional coffee industry has. Sustainable coffee has a lower price

40

elasticity of demand than conventional coffee, since the consumer buys this coffee for

ideological reasons and is willing to pay an extra premium for it, which gives the firms

selling sustainable coffee less incentive to lower the price.

One possible implication is that the trade on the coffee market is not unfair in the sense

that large trading firms and roasters appropriate an excessively large part of the value

added in the chain, but the structure of the coffee industry is unfavourable for the

farmers.

However, for someone living close to absolute poverty, as many coffee farmers do, the

issue is not how large the part of the value added one receives, but rather how much one

gets paid for the produce. Looking at absolute terms, sustainable coffee has a clear

advantage for the farmer: in 2004 the fair trade price was US$ 2.78 per kilogram and the

price of organic coffee was US$ 1.70 per kilogram, compared to US$ 1.43 per kilogram

for conventional coffee (Junta Nacional del Café 2005).

5. CONCLUSION The aim of this study was to analyse the markets for sustainable and conventional coffees

that are produced in Peru and consumed in Sweden. Alternative trade can be seen as a

labelling project where consumers are given information about the social and

environmental conditions under which commodities are produced and then asked to pay

to support a more sustainable production and trade. To find out whether the price

difference between sustainable and conventional products really benefits the farmers and

the environment, this study has compared the commodity chains for sustainable and

conventional coffee.

The principal finding from the commodity chains for conventional and sustainable coffee

is that incomes are higher in the importing, roasting and retailing links than they are in

the growing and coffee processing stages, even when account is taken of different costs

of living. In other words, the activities in the coffee chain that add most value take place

in Sweden. This is not surprising since the general pattern in world trade is that the gains

41

of trade are not equally distributed, and there is a growing concern about the position of

raw materials producers in the world economy.

The study further looked at the premiums for sustainable coffee (this coffee is more

expensive than conventional coffee). The price difference was 3.98 kronor (US$ 0.54) for

organic coffee and 37.78 kronor (US$ 5.14) for fair trade coffee on the Swedish market

in 2004. The main reason for the premium is a higher purchase price for sustainable

coffee.

Although the customer pays more for sustainable coffee, the farmer does not receive a

larger part of the total value added in the commodity chain. In the commodity chain for

conventional coffee, the farmer receives 28% of the final sales value, and in the case of

sustainable (fair trade) coffee, the farmer receives 27%. It is important to note that these

figures are a snapshot in a particular period of time, in year 2004. This year the world

market price on coffee had risen and the producers received a better price for the coffee

beans than in the preceding years (had the comparison been made some years earlier

there would probably have been a difference between conventional and sustainable

coffee). That the study is limited to year 2004 can partly explain the discrepancy between

my result and earlier research on the coffee commodity chain.

Looking at absolute values, sustainable coffee has a clear advantage for the farmer. In

2004 the fair trade price was US$ 2.78 per kilogram and the price of organic coffee was

US$ 1.70 per kilogram, compared to US$ 1.43 per kilogram for conventional coffee

(Junta Nacional del Café 2005).

The premiums for organic and eco-friendly (but not fair trade) coffee are modest, but

they make an appreciable difference for the farmers, since coffee in many cases provides

their sole source of cash income. The fact that sustainable coffee commands a higher

price on the market is further the most important factor for the producer when deciding to

produce sustainable coffee. Therefore, the decrease of the premiums that has taken place

during the last years is seen as a serious threat to the production of organic and eco-

42

friendly coffee. The reason for the negative trend is that the price of these coffees is set

by the market, and currently the supply is larger than the demand.

Fair trade coffee, on the contrary, gives the farmer a guaranteed minimum price. The

purchase price of fair trade coffee has during the period of very low world market price

been twice as high as that of conventional coffee. The level of the guaranteed minimum

price is a much-debated question, since the current price is high enough to limit the

demand of this coffee. The limited demand implies that a large amount of the coffee

produced under the fair trade scheme is sold as conventional coffee, giving the producer

no premium at all.

Sustainable coffee is a niche market, albeit increasing, and will continue to be relatively

small in the foreseeable future. The limit to the growth is on the demand side: many

consumers do not have information about the certification schemes and are unwilling to

pay a higher price for this type of coffee. However, the logic underlying Leclair’s (2002)

argument: as every producer cannot benefit from alternative trade, it is not worth

supporting, must be questioned. Even if only one farmer would benefit from producing

sustainable coffee, it would still be worthwhile, and indeed millions of farmers are

benefiting from the production of sustainable coffee today.

The current development of corporate and private standards is both promising and

alarming. Promising because the large corporations control the market, hence have power

to set the standards to make all coffee production sustainable. However, there are

alarming indications that corporations are not willing to pay a higher price for the coffee,

although it is produced according to their “sustainability” standards, hence the farmers

are burdened by the task of fulfilling the standards without getting any monetary

compensation.

As we have seen, coffee farmers are faced with a number of difficulties: they are based in

rural areas in poor countries and their income is highly insecure because of fluctuating

international coffee prices. Furthermore, the share of final retail price that is retained by

43

producing countries has decreased during the last years. It would be a mistake to think

that sustainable coffee production alone can solve the problems of the international coffee

market. The issues of over-production and poor countries’ reliance on a few export

commodities need to be addressed. Solutions require participation from both North and

South, since what is needed is a reform of the international trading system.

However, until then, the study has shown that one way that coffee drinkers in the North

can improve the living conditions for the coffee-producing farmers is by buying

sustainable coffee.

44

APPENDIX 1: QUICK REFERENCE ON PERU Official name: República del Perú

Surface area: 1 280 000 km2; Peru is the

19th largest country in the world

Situation: On the central western coast of

South America, bordered by Ecuador and

Colombia to the north, Brazil and Bolivia to

the east, and Chile to the south

Capital: Lima, population 7.5 million

(2000)

Population: 27.1 million (2003)

Annual population growth: 1.5%

Life expectancy at birth (years): 69.8 (2002)

GDP per capita (US$ at PPP): 5 180 (2003)

GDP growth: 4.0% (2003)

Present value of debt: US$ 29.8 billion

(2002)

Aid per capita: US$ 18.4 (2002)

Poverty: 54.8% of population was classified as poor and 24.4% as extremely poor (living

on less than US$ 1 a day) in 2001

Adult literacy rate (% of people aged 15 and over): 85 (2002)

Languages: Spanish and Quechua (official), Aymara, several dozen others spoken by

inhabitants of Amazon basin

Constitution: Presidential republic

Head of State: President Alejandro Toledo

Main trading partners: USA, Japan, Germany, China, Chile, Spain, Switzerland, Brazil,

Colombia and UK

Main exports: Minerals (copper, gold etc.), fishmeal, textiles, coffee

Source: World Bank 2004

45

APPENDIX 2: LIST OF INTERVIEWS

Name Post Organisation Date

Consumer service Zoégas Kaffe AB 24.01.2005

Consumer service Kraft Foods Sverige AB 25.01.2005

Ms Gun Nilsson Consumer service Löfbergs Lila AB 26.01.2005

Dr Alberto Julca Otiniano Agronomist Universidad Agraria de la Molina 08.02.2005

Mr Lorenzo Castillo Executive secretary Junta Nacional del Café 16.02.2005

Eng Ezio Varese Zeppilli Inspector IMO-Control (certifying organ for organic produce)

18.02.2005 21.06.2005

Mr Juan Loayza Bellido Salesman Export firm in Peru 21.02.2005 23.03.2005

Mr José Rivera Commercial manager

Cooperative of coffee farmers 21.02.2005

Mr Eduardo Montauban Urriaga

General manager Camera Peruana del Café 04.03.2005

Mr Javier Martinez Administrator Prompex (the government’s export promoting unit)

09.03.2005

Ms Delia Lingan Rosas Coffee producer Cooperative of coffee farmers 11.03.2005

Mr Jorge Aucupoma Rojas Coffee producer Cooperative of coffee

farmers 11.03.2005

Mr Sixto Taipe Coronado Coffee producer 13.03.2005

Mr Abdias Aliaga Ordoñaz

Coffee intermediary

Export firm in Peru 13.03.2005 19.07.2005

Eng Pablo Vargas Chávez Administrator Cooperative of coffee farmers 15.03.2005

Mr Ivan Romero Cieza Coffee hoarder Export firm in Peru 16. 03.2005

Mr Amilcar Buleje Statistician Junta Nacional del Café 22.03.2005

Mr Hans Huiskamp Inspector KRAV 09.06.2005

Mr Calle Åkerstedt Svensk Kaffeinformation 17.06.2005

Mr Raul del Aguila General manager

Cooperative of coffee farmers 23.06.2005

46

Ms Susana Schuller Junta Nacional del Café 26.07.2005

Mr Jens Baagoe Managing director Import firm in Sweden 23.08.2005

Mr Ingemar Hjelm Environmental manager Retailer in Sweden 11.08.2005

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49