220.127.116.11. Costaleo Case Study
An estimated 25 million farmers worldwide produce coffee, most of them smallholders with plots of 1-5 hectares. The country of Costaleo exports roughly $300 million in coffee per year. Though agriculture currently makes up only a small portion (7 percent) of Costaleo’s economy, potential exists to expand and enhance the quality of coffee production in the mountainous regions in the south of Costaleo, where soil and weather conditions are ideal for producing Arabica coffee. Coffee is among Costaleo’s most important agricultural crops, along with staple commodities such as corn, wheat, beans and rice. In the 1980s, coffee had become Costaleo’s most valuable export crop, with as many as 2 million farmers involved in the sector. However, falling international prices combined with the elimination of many government subsidies at the end of that decade reduced export income from coffee in Costaleo and drove down production. In Costaleo, there are around 73,000 farmers with total of approximately 220,000 hectares of coffee land. About 75 percent of coffee farmers are smallholders (2-4 hectares) whose primary income source is coffee sales. Costaleo currently operates in the global coffee market in which supply greatly exceeds demand, driving prices down. However, there is a growing demand for specialty coffees, a term which refers to exceptional Arabica beans grown only in ideal coffee-producing climates (high-altitude, mountainous regions under a shade canopy). Newer concepts to differentiate include environmental and social benefits at the point of production, categorized together broadly as “sustainable coffees.” Organically certified coffee is an example of this segment and does sell at a premium price, although certification can be an expensive process and source of origin protocols need to be enforced. Although there is a growing demand for organics, it is still smaller compared to the market for specialty and commodity coffee.
Given the high degree of product differentiation, specialty coffee’s original and still predominant characteristic is quality, which is influenced by proper production and husbandry practices at the farm. After harvesting, it is rather hard to change the level of quality. Costaleans have the ideal climate for specialty coffee and the potential to compete on the global market, but they lack economic incentives to invest in product quality. Although specialty coffee commands a higher price than undifferentiated commodity bulk coffee, it does not earn the farmers a higher price from local distribution channels. In addition, the low-priced sales of international bulk commodity coffee leave farmers with little or no extra cash to purchase required inputs or carry out the more labor-intensive practices necessary to produce higher-quality specialty coffee consistently.
The coffee value chain consists primarily of:
- Four large input suppliers, who provide seed and chemicals (fertilizer, insecticide, etc.) to producers through nurseries, farmer associations, or in some cases directly (to the medium-scale farmers).
- The farmers produce coffee, which they market through farmers’ associations or sell directly to traders who then sell it to medium- to large-scale processors.
- Exporters, who purchase the coffee from processors and sell it to large and small trading companies (roasters), who then sell to multinational roasters.
- Multinational roasting companies, who sell to domestic and international markets including hotels, supermarkets, and coffee shops
There are four large input supply companies in Costaleo. They all sell directly to medium-scale farmers and to nurseries, although some are attempting to target the smallholder market. Despite the marketing of seed and fertilizer in small packets and bags, however, these vendors’ clientele remains largely commercial. Smallholder farmers usually buy seedlings, chemicals, fertilizers and other planting materials from small shop nurseries which are located in nearby towns close to production areas. These nurseries also provide information on how to use these inputs. The nurseries have very limited access to specialty varieties of seedlings.
In Costaleo, coffee is grown by smallholder farmers with 2-4 hectares of land and medium-scale farmers with more than10 hectares of land. Smallholder farmers purchase seedlings from nurseries and plant them on their own farms. Coffee is harvested in the form of cherries from the tree, and smallholder farmers undertake the first stage of processing to remove the coffee beans from the cherries, a process called pulping, and then dry them. They do not sort the cherries or beans for quality. The medium-sized commercial farmers comprise about 25 percent of the total farmers and they focus primarily on bulk commodity coffee rather than specialty coffee. Coffee producers are removed from the major final product markets, both in terms of geography and number of links in the value chain. Producers have little leverage for negotiating higher prices because most of the product qualities that determine price premiums are enshrined in the brand, which is owned by the roasting companies In addition, this distance from the export markets limits producers’ access to information on product standards and buyer quality requirements.
Local traders or buying agents of processing companies purchase the dried coffee directly from producers at the farm gate. These local traders buy dried coffee at prices based on current market price, but factoring in transport costs and the advance payments they may have provided. While these advance payments inject much-needed cash into the household, they also lower farm gate prices for the farmer as the traders charge high interest rates on these advance payments. Local traders sell the dried coffee to medium- to large-scale processing/trading companies.
Most farmers are members of a cooperative to which they may sell some of their beans. Cooperatives will pay a flat price—based on market price—for all beans with very little grading and no premium payments for higher quality. The cooperative sells members’ beans to medium- to large-scale processing companies, thus acting mainly as a consolidation/bulking intermediary rather than providing services (such as pulping or drying) or warehouse facilities.
Medium- to large-scale processing companies undertake milling, a second processing stage that consists of removing the coffee bean skin (parchment) and sorting and grading for quality based on bean condition, as defined by trade standards. At this stage, beans that meet requirements for specialty coffee are sold as such. However, because most producers lack information about buyer requirements, the coffee that they are producing often does not meet stringent quality requirements for specialty coffee. In this case, the coffee must be sold as undifferentiated bulk coffee. The processors sell the beans as green coffee to exporters who give them the product specifications. Processors would like to purchase better-quality green coffee, but have no way of communicating quality requirements to producers or cooperatives. Additionally, price schedules based on premiums for higher quality have not been introduced. Volume requirements force processors to buy all coffee at a set price. Local traders value quantity more than quality, and thus are not willing to spend additional time or resources to teach farmers how to grow specialty coffee.
Exporters buy green coffee from the medium- to large-scale processing companies and export to importers in South America, the United States and Europe. Exporting in Costaleo is controlled by five main exporters. Most have long-standing relationships with one or more importers that last many years and enable the importers to fulfill their quantity requirements to the end-market buyers.
Importers buy export-quality green coffee. Importers are normally large trading companies such as Norman and Sons, Qualcafe and Crown Coffee, who then sell to large multi-national food companies in the global end markets.
Roasters determine the amount and type of coffee that is bought and the prices paid. Eighty percent of the worlds bulk coffee sales are handled by five main multi-national food processing companies: Koster, Georgia Allen, Sterns and Meyer, Richard Foods and Choice Product Group. These large firms have sourcing agents who buy from the import trading/brokerage firms, then roast and brand their own blends. The roaster blends the coffee to achieve the consistency and flavor profile determined for the brand. Most brands belong to roasters, who then sell the branded consumer products to retailers. There are a growing number of medium-sized roasters in the specialty market who are increasingly interested in the higher-end markets and are willing to pay premium prices based on quality. They also sell non-export-quality green coffee to smaller, local roaster, who supply the domestic market with cheaper brands for home consumption. They sell to supermarkets, grocery stores, hotels, restaurants and institutions.
End markets include domestic and international retailers. In the global end market supermarkets, restaurants and hotels buy from the major roasters and sell to consumers. CaféNuevo, a large, influential and well-resourced international coffee company, retails in consumer countries, but also roasts and brands coffee.
There are 250 coffee grower’s cooperatives in Costaleo, and most farmers belong to one of these. These cooperatives, although prevalent, lack business skills and transparency. Consequently, farmers tend to assume that everyone is trying to exploit them—a mindset that makes it difficult to build trust in new ideas and collaborations. Because of the lack of trust and minimal services they provide, cooperatives represent only a very weak horizontal linkage among farmers; there is considerable side-selling by farmers directly to local traders based solely on spot price (though this price is lower than what cooperatives pay). Buying coffee at the dried bean stage significantly limits the cooperatives’ ability to control quality, thus weakening their vertical linkage to buyers. If they purchased coffee in the earlier cherry stage, they could sort the cherry by grade. Within the dried beans, grades are mixed together, contaminating the high-quality product with poor-quality product. Control of the pulping and drying process by the cooperative would enhance capacity to ensure product quality standards and reliability for the higher-value market.
CaféNuevo has taken an interest in selling shade-grown coffee that is produced in Costaleo. However, CaféNuevo is not inclined to contract directly with cooperatives because of the large gap between the experience of the cooperatives and the requirements of exporting to a large specialty coffee company. Though CaféNuevo and Costalean coffee producers are both interested in this relationship, plans are currently at a standstill.
As with many rural enterprises, local traders undertake additional functions—such as informal credit provision—to compensate for the lack of formal local service providers. Most smallholder coffee producers live below the poverty line, and household cash flow is generally deficient.
There is significant need for financial products and credit availability for Costalean farmers and cooperatives. Farmers need small loans to buy better planting materials and to offset the labor-intensive cultivation techniques required for producing higher-quality beans. Cooperatives can use credit to expand value-added services for members and purchase equipment such as machines and drying trays. Although Costaleo has a vibrant financial sector, commercial banks impose restrictive collateral requirements when lending to the agricultural sector, and the majority of credit in the coffee sector made available through commercial banks goes to the medium- and large-scale processors/traders.
The government has stepped in to implement rural credit programs. However, these programs have been inefficiently executed and tend to result in a culture of loan delinquency, preventing financial service institutions from entering the market and consequently leading to a lack of credit availability.
The main source of financing for coffee producers is through local traders who often lend money to farmers and deduct repayment plus interest when buying the product, usually setting the buying price low and the interest rate high. Farmers refer to these traders as “Coyotes,” because they exploit the farmers’ lack of knowledge of the market. Sometimes farmers sell elsewhere because they could get a better price, despite holding an advance from a trader, thereby contributing to the indebtedness and mistrust that characterized many transactions in these poor communities.
In 2007, the government of Costaleo, with financing from the Inter-American Development Bank, began a program called Fondo Directo implemented through Banco de Costaleo, the national bank. The purpose of Fondo Directo was to provide low interest loans to the rural farming sector, and additionally, to provide some funding for technical assistance and training. Some farmers have begun to take advantage of these services, but outreach could still be improved.
Marketing, Extension and Training
As is the tradition in Costaleo, many coffee producers are members of cooperatives. In general, the coffee cooperatives lack basic capacity in business administration. Many of the cooperatives were formed not as business entities but as tax-exempt legal entities to promote social solidarity and well-being among members and their communities. Their officers have minimal education and no management experience. This situation causes their substantial dependence on technical staff that the state government subsidized and encouraged them to appoint.
Farmers require marketing services, access to agricultural training and extension, business planning training and financial services. All of these services could be provided through the cooperatives, but their capabilities are constrained. The failure of the cooperatives to provide effective horizontal linkages between producers presents two ongoing challenges: institutional sustainability and scale of impact. The government of Costaleo has introduced a program enabling the community promoters to become accredited extension service providers and charge for their services.
Many Costalean coffee farmers are located near the Naguana Biosphere Reserve. Relationships between the low-income communities around the Reserve and the local authorities are sometimes strained because the municipal officials consider agriculture a major threat to protecting wildlife. Yet, because specialty coffee has been very important to the economy of Costaleo, the national government has traditionally provided the sector subsidies (especially in election years) to cover occasional training, extension and financial services. This sporadic investment does little to increase the appearance of stability or attractiveness of the agriculture sector to private investors. The government sometimes supports the hiring of technical advisors for cooperatives, but cooperatives have difficulty effectively managing these people, leading to inefficiencies.