MBA

CORE

MICROECONOMICS PROJECT
AN ANALYSIS OF THE COFFEE MARKET

CONTENTS
Sr. No.

Topic

Page No.

1.

Research Question

2.

Introduction

3.

Industry characteristics in India

4.

The economics of the coffee market

5.

Findings

6.

Conclusion

7.

Suggestions

8.

References

Research Question
How does weather drive microeconomic forces to affect the prices of coffee?

Introduction
Coffee is a brewed drink prepared from roasted coffee beans, which are the seeds of "berries" from the
Coffea plant. Coffee is a popular beverage and an important commodity. Tens of millions of small
producers in developing countries make their living growing coffee. Over 2.25 billion cups of coffee are
consumed in the world every day. Over 90% of coffee production takes place in developing countries,
while consumption happens mainly in the industrialized economies.
Coffee has its origins in the Horn of Africa, in the Ethiopian province of Kaffa, where in all probability
the first coffee tree appeared. Its been attested that coffee beans used to be chewed by African slaves
brought to Arab countries and coffee has been cultivated in Yemen since the 15th century.
Coffee was brought to Europe by Venetian traders in 1615, when hot chocolate and tea had already
become fashionable. Europeans then started to cultivate coffee in their freshly acquired colonies. The
Dutch started to grow coffee in India and in Java at the end of the 17th century. Eventually it spread to the
Caribbean islands and to Surinam from where it reached South and Central America. In 1825 coffee
culture started in Hawaii. In two centuries, coffee had spread around the whole world.
Coffee trade has grown since then to become the second or third largest commodity traded internationally,
mainly on the markets of London (London International Financial Futures and Options Exchange or
LIFFE) and New York (Coffee, Sugar and Cocoa Exchange or CSCE, which is a part of the New York
Board of Trade or NYBOT). It earns a lot of foreign exchange in many developing countries and some
countries still rely on coffee for up to 80% of their export revenues. Trade patterns have evolved over
time traditionally benefiting big exporters like Brazil, Columbia and now Vietnam. From 1957 to 1989
the coffee market was regulated by the ICA, which regrouped both exporting and importing countries.
Second only to oil, coffee is the worlds second most traded commodity. As the global third most
consumed beverage, after water and tea, coffee beans are in high demand everywhere. The top producing
nations each produce millions of kilograms of coffee beans that find their way into the hands of eager
consumers.
The top 10 producers of coffee beans in 2014 were:
1. Brazil 2,720,520,000 kg
2. Vietnam 1,650,000,000 kg
3. Colombia 750,000,000 kg
4. Indonesia 540,000,000 kg
5. Ethiopia 397,500,000
6. India 344,750,000 kg
7. Honduras 279,000,000 kg
8. Mexico 240,000,000 kg
9. Uganda 240,000,000 kg
10. Guatemala 210,000 kg
The two most common types of coffee beans used in making coffee are the Arabica bean and the
Robusta bean. These two beans are used more than any other variety of beans, either in their pure form
or in coffee blends.

Industry characteristics in India

Seasonal nature of the crop

Coffee production is seasonal as it is dependent on rainfall. The first monsoon showers help the
coffee plant to flower and showers thereafter are necessary for the development of the coffee
berries. The Arabica crop has a biennial bearing tendency. The domestic coffee season is between
October to September.

Regional concentration of plantation

Karnataka, Kerala and Tamil Nadu have highly concentrated coffee cultivations. 98% of the
countrys coffee production come from these regions. Andhra Pradesh, Orissa and North-eastern
India account for the rest.

Fragmented land holdings

There is a high level of fragmentation in the area under coffee cultivation and small growers
account for 99%. About 37% of the total area under coffee cultivation is made up of estates of
less than 2 hectares.

Limited corporate presence in plantation; end-product market dominated by companies

The Indian coffee industry is characterized by presence of big companies such as Hindustan
Unilever Ltd (HUL), Nestle, Tata Coffee. These players are primarily present in the branded
segment. For instance, Tata Coffee Ltd's (TCL) production of 19.1 million kgs in 2013-14
accounted for only 6 per cent of the country's total coffee production.

Southern India predominant consumer of coffee

The people in South India account for nearly 80% of the total coffee consumption in India.
Among the south-Indian states, Tamil Nadu accounts for 36% of consumption, while Karnataka,
Andhra Pradesh and Kerala accounts for 21%, 18% and 15%, respectively. People in the south
region, prefer filter coffee more than instant coffee and people in the north, east and west parts of
India, who account for about 20% of the total coffee consumption in India, prefer instant coffee
over filter coffee.

Manpower-intensive operations
Production of coffee is also has high intensity of labour. Labour costs account for 25-30% of the
total cost of production. Labour requirements vary depending on the type of coffee produced.
Arabica plantations require double the labour requirement per hectare compared to Robusta.

Distribution system
Indian coffee caters to both, the domestic and international markets. Approximately 70% of the
coffee produced in India is exported and the remaining is consumed domestically. Coffee beans
are sold either at farm gates or at auction centers. Only about 5-10% of the production is sold
through auction sales and rest is sold through farm gates (primarily to branded players).

Coffee export mechanism

Cured coffee seeds are exported on the basis of export sale contracts. Internationally, coffee seeds
are traded on two main exchanges - New York and London. The New York Exchange deals in
Arabica, where the prices are quoted in US cent/lbs. The London Exchange deals in Robusta,
where the prices are quoted in $/tonne.

Pricing
Although various varieties of clean coffee seeds are available, the prices quoted on exchanges are
only for Robusta and Arabica. The prices for individual varieties are arrived at by adding a
differential, which is the premium or the discount for that variety. The differentials keep
fluctuating based on various market factors such as demand - supply dynamics and quality of the
bean.

The economics of the coffee market

A little over half of the worlds Arabica variety of coffee is grown in Brazil. Brazil along with Colombia,
Kenya and Ethopia is facing the heat from places like Vietnam, Indonesia and India and their Robusta
coffee beans. Arabica is tastier, pricier and more aromatic compared to its cousin Robusta beans, and has
historically seen steady growth in demand thanks to the coffee culture of Northern America and Western
Europe backed by the ability of the people from these regions to pay for these premium beans.
Substitution Effect and Income Effect

Figure 1: illustrates the leftward shift of the supply curve due to the reduction in supply.
With Arabica coffee, which is more prone to crop disease and is more sensitive inclement weather,
suffering a 40% loss of crop due to roya or coffee rust in Columbia and 30% loss of crop in Central
America; the prices of Arabica Coffee rose up as is illustrated in Figure1. The Supply curve moved from
S0 to S1 and this caused the price for Arabica coffee to just from P0 to Pt.

Figure 2: illustrates the effect of a change in price of Arabica (Y Axis) have on the quantity demanded of
Robusta(X axis)
With the traditional Arabica coffee markets of North America and Western Europe already saturated and
with consumers of emerging markets of India, China and Brazil, where coffee is an affordable luxury for
the middle class, moving to the less expensive Robusta Coffee bean; we see a substitution effect in
motion. Even major food firms such as Kraft and Nestle have responded to the price rise by blending the
cheaper Robusta beans with Arabica in their products.
Figure 2, shows us how the rise in price of Arabica caused the units consumed of Arabica (illustrated on
the Y axis) to fall and the unit consumed of Robusta Coffee to increase (illustrated on the X axis).

Figure 3: illustrates the effect of income effect on Arabica bean (Y Axis) with respect to Robusta bean(X
axis) in the long run
However with the rapid economic development in the emerging markets of India, China and Vietnam, we
are also witnessing a rise in the disposable incomes of its citizen. As illustrated in Figure 3, we see that in
the long run with the rise in the income level of the affluent class in these emerging markets from U1 to
U2 will cause the consumes to shift their consumption preferences and demand the more luxurious and
aromatic variety of coffee: Arabica. This will cause a rise in the quantity demanded of Arabica (A to B)
and fall in the quantity demanded of Robusta.

Findings - How weather affects prices

Global scenario
Crop Season 2013-14 saw a sharp increase in coffee bean prices owing to lower production,
especially in Brazil.
Production declined in 2014-15 and recovered thereafter
This was mainly due to Brazils bad weather. This caused a lowering of output to 9,108 million
kg in the crop season 2014-15.
There was a nearly 6 per cent decline in the output of Arabica coffee in the country, which
brought the global production down by nearly 3.5%.
For Robusta however, the global production rose by 3%.
Prices declined 2.5-3.0% as production improved. Arabica prices dropped 4.0-4.5% as weather
conditions in Brazil improved and the Brazilian real remained weak vs the US dollar. Robusta
prices also edged lower.

Figure 4: Global Coffee production of Robusta and Arabica variants

Indian scenario
During 2013-14, Karnataka recorded an 8% YOY decrease in coffee production to 211 million kg
as coffee areas witnessed a long period of drought after receiving blossom showers, followed by
an extremely harsh monsoon.
Adverse effect of weather was less pronounced in Kerala where production declined by 0.9%
YOY to 64 million kg in 2013-14.
Even though there was a 4.3% decline in India's coffee production in CS 2013-14, production in
CS 2014-15 rose about 8.5% to 331 million kg.
The production decreased in CS 2013-14 because of Robusta production (70% of
India's production) slipping 7.5% due to an extended drought followed by a heavy monsoon
season, especially in Karnataka.
In CS 2014-15, Robusta production grew 14-15% due to favourable weather conditions in
Karnataka and additional areas sown in CS 2006-07 being harvested; the plant has an 8-year
gestation cycle.

As compared to the other states, the share of Tamil Nadu in the country's total production is fairly
small. This region is known more for the Arabica variety of coffee. During 2013-14, coffee
production marginally declined by 1 million kg to 18.7 million kg.

Figure 5: Indian coffee production and the corresponding impact on price

Conclusion
We can conclude that weather does affect the pricing of coffee.
Bad weather decreases production which affects the supply of coffee which in turn increases the
equilibrium price of coffee. This causes a substitution effect, wherein people will consume another
beverage like tea in place of coffee.
Similarly, good weather will ensure better yield, thus, increasing supply and bringing about a decrease in
equilibrium price.

Suggestions
In order to maintain the demand for coffee and to maintain the price at an affordable level, the following
can be done:
Usage of better fertilizers, pesticides and other cultivators to further support growth and increase
yield, thus, bringing down prices
Government led initiatives to ensure farmers use optimal farming practices to increase production
in light of unfavourable weather conditions

REFERENCES
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4. Kohler, P. (2007, June 1). The Economics of Fair Trade Coffee: For Whose Benefit? An
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7. Rising coffee production to lower prices (2015, May 29), CRISIL Report