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 ESPAOL .......................................................................... 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 METHODS24 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 PERUS 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.

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 ESPAOL
Cerca de 25 millones de agricultores - la mayora con pequeas chacras - en ms de 50 pases en vas de desarrollo dependen del caf para su sustento. Los productores de caf enfrentan muchas dificultades. Viven en reas rurales en pases pobres; la infraestructura es pobre y hay pocos servicios. Su renta es altamente insegura debido a los precios internacionales del caf que fluctan. Adems, en cuanto al precio de venta al pblico que se conserva en los pases productores ha disminuido durante los ltimos aos. Algunos productores han podido aprovechar las nuevas formas de production y comercio en la industria cafetalera que es el caf "sostenible". El caf sostenible incluye comercio justo, certificado orgnico e eco-amigable. Estos cafs llenan un nicho en el mercado que recompensa no solamente un precio superior sino que tambin proporcionan ventajas que ayudan a agricultores a mejorar su sostenibilidad. El objetivo del estudio es analizar los mercados para el caf sostenible y convencional que se produce en el Per y se consume en Suecia. El caf sostenible es un mercado del nicho, no obstante aumentando, y continuar siendo relativamente pequeo en el futuro prximo. El lmite al crecimiento de los cafs sostenibles es la demanda en los pases consumidores.

El caf sostenible es ms costoso que el caf convencional; el precio del caf convencional en las tiendas suecas del ao 2004 estaba en 40.62 kronor (US$ 5.53) el promedio por kilogramo, mientras que el caf orgnico cost 44.60 kronor (US$ 6.07) por kilogramo, dando un premio de 3.98 kronor (US$ 0.54). Un kilogramo de caf del comercio justo cost 78.40 kronor (US$ 10.67), que significa que el premio era 37.78 kronor (US$ 5.14). La razn principal del premio es un precio de compra ms alto de cafs sostenibles. Para descubrir si la diferencia del precio realmente beneficia los productores y el ambiente, este estudio ha comparado las cadenas del caf sostenible y convencional. El resultado principal del anlisis de las cadenas del caf convencional y sostenible es que las rentas son ms altas en los eslabones de importacin, tostado y venta que en los eslabones de crecimiento y proceso del caf. Otro resultado es que aunque el cliente paga ms por el caf sostenible, el agricultor no recibe una parte ms grande del total del valor aadido en la cadena. En la cadena del caf convencional, el productor recibe el 28% del valor de ventas final, y en el caso de caf sostenible (comercio justo), el productor recibe el 27%. Sin embargo, mirando valores absolutos, el caf sostenible tiene una ventaja clara para el productor: en el ao 2004 el precio del comercio justo era US$ 2.78 por kilogramo y el precio del caf orgnico era US$ 1.70 por kilogramo, comparado a US$ 1.43 por kilogramo para el caf convencional. Aunque los premios para el caf orgnico y eco-amigable son modestos, hacen una diferencia apreciable para los agricultores, como el caf en muchos casos proporciona su fuente nica 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

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?

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 respondents 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 governments export board, a certifying agency and an export firm. In Sweden, all interviews were conducted in Swedish and over the telephone. I interviewed

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

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.

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

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 macromicro 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
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.
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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 labourintensive 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, Gereffis 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

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, Gibbons 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

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Figure 2.1 The coffee commodity chain Fresh cherry Farm Dry process: dry cherry Wet process: washed parchment Washed green beans
Farm gate costs

Producing Country

Factory

Unwashed green beans Beans for export Export duty Freight and insurance Import duty

Factory door costs

Exporter

FOB

CIF

Import agents

Beans cleared for market

Wholesale costs

Consuming country

Dealer Processing company Factory Coffee house

Factory door costs

Roasted ground Commercial Instant coffee coffee and catering

Retail

Shop retail for home

Commercial and catering

Retail costs

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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

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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 100year lows in real terms. Currently, prices are recovering.

Figure 3.1 Coffee prices (other milds) 1986-2005

200
US cents per lb

150 100 50 0 1985

1990

1995 Source: IMF database, 2005

2000

2005

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

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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)

130000000 120000000 110000000 100000000 90000000 80000000 70000000 60000000 1975 1980 1985 1990 1995 2000 2005

60 kg bags

Source: ICO database 2005

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.

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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). Talbots (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 producerconsumer country chains (the Cte dIvoire-France and Costa Rica-Germany chains). In 1994, Pelupessy finds that the growers share of final retail price was 13.8 per cent in Cte dIvoire 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

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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 fr 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

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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.

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

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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 worlds 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 Caf 2004 a, p. 5). Figure 3.3 Coffee exports from Peru (tons) 1984-2004
200 000 180 000 160 000 140 000 120 000 100 000 80 000 60 000 40 000 20 000 -

Tons

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

Source: Junta Nacional del Caf 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 Caf, personal communication, February 16, 2005

20

2004

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 Caf 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 7

Mr Amilcar Buleje, Junta Nacional del Caf, personal communication, March 22, 2005 Mr Eduardo Montauban Urriaga, Camera Peruana del Caf, 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, Nestl and Lfbergs 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.

Consumer service at Kraft Foods Sverige AB, Zogas Kaffe AB and Lfbergs 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 Caf 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 Caf (the National Coffee Board)12, and a summary of their calculation of
The term no technology (sin tecnologa) 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 Agrara de la Molina, personal communication, February 8, 2005 12 Junta Nacional del Caf 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 Caf is one of the most important actors in the Peruvian coffee sector and it is the one that has the most extensive
10

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 Caf, the production cost has not changed during the last years.13

Table 4.1 Production cost per hectare using traditional farming methods Labour Indirect costs (financial costs, depreciation of machinery) Other inputs (plants, tools, materials) Transport Total cost/ha Yield/ha Total cost/kg
Source: Junta Nacional del Caf 2004

Cost (soles) 1 638 959 649 91 3 337 718 kg 4.65

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 Chvez, cooperative of coffee farmers, personal communication, March 15, 2005

24

The estimation of the production cost is a politically sensitive issue since the price paid to the producer minus the production cost equals the producers 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

Table 4.2 Price paid to the producer 1994-2004 Price paid to Price paid to producer in producer in soles per kilo US$ per kilo 3.20 1.45 4.10 1.82 3.38 1.38 6.41 2.52 4.28 1.46 3.60 1.07 3.32 0.95 2.32 0.66 1.95 0.55 2.35 0.68 3.38 0.99

Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Source: Junta Nacional del Caf 2005

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 Caf 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 Caf, 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 caf.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 intermediarys 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. Perus transportation system faces the formidable challenge

15 16

Ms Susana Schuller, Junta Nacional del Caf, personal communication, July 26, 2005 Mr Abdias Aliaga Ordoas, intermediary, personal communication, July 19, 2005 17 Mr Abdias Aliaga Ordoas, 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 (US$) 51 938 111 27 965 609 26 762 317 25 442 792 18 532 846 15 273 385 12 750 768 12 148 177 11 863 220 10 797 406 8 633 896 8 113 794 6 504 155 5 937 427 5 167 947 4 919 968 3 425 536 2 807 100 2 586 783 2 385 537 Market share (%) 17.9 9.6 9.2 8.8 6.4 5.3 4.4 4.2 4.1 3.7 3.0 2.8 2.2 2.0 1.8 1.7 1.2 1.0 0.9 0.8

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Firm PERALES HUANCARUNA COMERCIO & CIA CIA INTERNACIONAL DEL CAF PROCESADORA DEL SUR CENTRAL COCLA ROMERO TRADING AICASA EXPORT CAFETALERA AMAZONICA VALDIVIA CANAL HUGO LOUIS DREYFUS CECOVASA MACHU PICCHU COFFEE TRADING CAC LA FLORIDA LAUMAYER PERU SAC PRONATUR COEX (PERU) CEPICAFE ANTONIO RINALDI AZEXSA CAF PERU SAC

Source: Junta Nacional del Caf 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 countrys coffee production is composed of sustainable coffee, and Peru has become the worlds second largest producer of organic coffee (after Mexico) (Junta Nacional del Caf 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

350000 300000 250000 60 kg bags 200000 150000 100000 50000 0 2000 2001 2002 2003 2004
Organic Fair Trade Eco-Friendly

Source: Junta Nacional del Caf 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 cooperation 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 21

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

1,5 5 1,4 7

1,6 1,4 1,2 1 US$/kg 0,8 0,6 0,4 0,2 0 2000

0,5 3 0,5 5 0,9 8

1,5 5

1,1 6

Organic Eco-Friendly Fair Trade

0,3 3

0,2 2

0,1 5 0,1 5

0,1 2

2001

2002

2003

2004

Source: The elaboration is based on data provided by Prompex and Junta Nacional del Caf (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 Caf, February 16, 2005

30

0,0 5

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 Nestl), who had an overall market share of 60 percent. Figure 4.3 Market shares of rosters/importers in Sweden (2004)

Lindvalls 2% ICA Others Coop 3% 3% 4% Arvid Nordquist 11%

Kraft Foods (Gevalia) 43%

Lfbergs Lila 17%

Nestl (Zoegas) 17%

Source: Svensk Kaffeinformation 2005

23

Mr Jos 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 Swedens 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 brands campaign offers.

24

Mr Calle kerstedt, 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 Conventional coffee Organic coffee Fair trade coffee Price (SEK/kg) 40.62 44.60 78.40 3.98 37.78 Premium (SEK/kg)

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, caf etc., the difference being that fair trade coffee is given a competitive pricing in these markets.26

25 26

Mr Calle kerstedt, Svensk Kaffeinformation, personal communication, June 17, 2005 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 1990s) and the market share is still small, an important question is how this market niche can be expected to develop. Wikstrm (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 Rttvisemrkt) (Wikstrm 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. Wikstrm 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 Wikstrms 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 Paid to growers Transport Factory Export firm, intermediary (FOB 180 cts/kg) Freight, insurance Import firm (CIF 192 cts/kg) Roaster Retailer Swedish state (VAT) Final price 12 157.4 5.0 7.5 10.1

Share of final sales value 28.4% 0.9% 1.4% 1.8% 2.2%

Data on the division of income between importer, roaster and retailer not available, but the sum is: 294.6 53.3% 66.4 553 12% 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 growers share of final retail price in 1994 was 13.8 per cent in Cte dIvoire and 14.6 per cent in Costa Rica. Talbot (1997) estimated the growers 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 Paid to growers Transport Factory Cooperative (FOB 314 cts/kg) Freight and insurance Import firm Roaster Retailer Swedish state (VAT) Final price 292 5.0 7.3 9.7 13.6 150 150 311.4 128 1067

Share of final sales value 27.3% 0.5% 0.7% 1.0% 1.3% 14% 14% 29.2% 12% 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.

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Figure 4.4 The distribution of income for sustainable (fair trade) and conventional coffee (2004)
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Conventional coffee Sustainable coffee Swedish state (VAT) Import firm, roaster, retailer Freight and insurance Cooperative/export firm Factory Transport Paid to growers

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 Caf 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

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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 Caf 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-

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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 Leclairs (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

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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.

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APPENDIX 1: QUICK REFERENCE ON PERU

Official name: Repblica del Per 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

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APPENDIX 2: LIST OF INTERVIEWS

Name Post Consumer service Consumer service Consumer service Agronomist Executive secretary Inspector Salesman Commercial manager General manager Administrator Organisation Zogas Kaffe AB Kraft Foods Sverige AB Lfbergs Lila AB Universidad Agraria de la Molina Junta Nacional del Caf IMO-Control (certifying organ for organic produce) Export firm in Peru Cooperative of coffee farmers Camera Peruana del Caf Date 24.01.2005 25.01.2005 26.01.2005 08.02.2005 16.02.2005 18.02.2005 21.06.2005 21.02.2005 23.03.2005 21.02.2005 04.03.2005 09.03.2005 11.03.2005 11.03.2005 13.03.2005 Export firm in Peru Cooperative of coffee farmers Export firm in Peru Junta Nacional del Caf KRAV Svensk Kaffeinformation General manager Cooperative of coffee farmers 13.03.2005 19.07.2005 15.03.2005 16. 03.2005 22.03.2005 09.06.2005 17.06.2005 23.06.2005

Ms Gun Nilsson Dr Alberto Julca Otiniano Mr Lorenzo Castillo Eng Ezio Varese Zeppilli Mr Juan Loayza Bellido Mr Jos Rivera Mr Eduardo Montauban Urriaga Mr Javier Martinez Ms Delia Lingan Rosas Mr Jorge Aucupoma Rojas Mr Sixto Taipe Coronado Mr Abdias Aliaga Ordoaz Eng Pablo Vargas Chvez Mr Ivan Romero Cieza Mr Amilcar Buleje Mr Hans Huiskamp Mr Calle kerstedt Mr Raul del Aguila

Prompex (the governments export promoting unit) Cooperative of coffee Coffee producer farmers Cooperative of coffee Coffee producer farmers Coffee producer Coffee intermediary Administrator Coffee hoarder Statistician Inspector

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Ms Susana Schuller Mr Jens Baagoe Mr Ingemar Hjelm Managing director Environmental manager

Junta Nacional del Caf Import firm in Sweden Retailer in Sweden

26.07.2005 23.08.2005 11.08.2005

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