Download The coffee market

The Marketing Environment
BBS-4-TME
Coursework Assignment 1
Referred
The Coffee Market: Case Study, LSBU, 2011.
1
INSTRUCTIONS
1. You are required to answer ALL the following TEN questions.
2. The answers in total should amount to approximately 2000 words.
3. You must submit you work to the Referred coursework turnitin on the
Marketing Environment blackboard site. Your work will not be marked unless
this plagiarism check has been completed.
4. You should submit your work by 4pm 20 August, 2012.
5. All the answers are covered in the case studies and in material from the
textbook. You may look for additional material but this is not necessary.
6. The requirements for the coursework are to be found on pages 14-15.
QUESTIONS
Answer ALL Questions
All questions carry equal marks (10% per question)
Questions relate to ‘The coffee market’ and the ‘The coffee market update 2012.
1. Describe how coffee price have changed since 2007. [See Figure 1 Coffee price update.
This question asks you to describe, no explanation of why prices have changed is
necessary.]
2. Explain what is meant by the own price elasticity of demand for coffee. Why is the own
price elasticity of coffee likely to be low?
3. What would you expect to happen to the price of green coffee in the future? Give reasons
for your answer.
4. Why is the coffee price so unstable? [Use a supply and demand diagram.]
5. What are the major factors influencing the retail demand for coffee in the UK?
6. Describe the market shares of the retail coffee makers.
7. How do coffee makers differentiate their brands?
8. What barriers to entry are there for a company considering entering the retail coffee
market?
9. Consider how supermarket own labels affect the branded coffee manufacturers?
10. Explain how are coffee producers trying to increase their revenue from coffee sales?
The Coffee Market: Case Study, LSBU, 2011.
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The coffee market update 2012
Brian Ardy
Coffee prices peaked at $2,7 in April 2011. Since then the price has fallen. There has
been a general fall in the price of commodities. This may be because commodity
speculators have changed their view of the market. There are also predictions of
bumper harvests for many agricultural products. Or the price fall may be the result of
concerns over a possible worldwide recession (Economist, 2012).
Figure 1 Monthly coffee prices 2007-12
3
US$ per pound
2.5
2
1.5
1
0.5
0
2007m01
2008m01
2009m01
2010m01
2011m01
2012m01
Source: IMF, 2012
References
Economist (2012) Buttonwood: Grains, gas and growth: Making sense of the fall in
commodity prices, The Economist, 23 June.
IMF (2012) International Financial Statistics, Commodity Prices, www.esds.ac.uk
The Coffee Market: Case Study, LSBU, 2011.
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Case Study
The coffee market
Brian Ardy
Introduction
Coffee is a tropical crop the seed of the coffee tree grown in tropical areas, but it is the
world’s favourite hot beverage. It is an important commodity being world’s seventh most
important agricultural export by value and for twelve countries it is their most important
agricultural export (FAO, 2011). This case study will examine the world market for green
(raw) coffee and the retail market for coffee.
The coffee price
Primary products such as green coffee often have very unstable prices and this is clearly
shown in Figure 1. For example the current price of coffee on the New York market varied
from less than 1 US$ per kilogram in the 1960s, to 5.9 US$ in 1977. In looking at a
complicated graph such as Figure 1 there are two crucial features you need to describe. First,
the trend, over the long term is the price rising or falling? Second, the peaks and troughs,
when was the price very high and when very low, what was happening to the price between
these peaks and troughs. To describe data you need some information from the graph but not
too much.
Figure 1 The price of Brazilian Coffee
3
US $ per pound
2.5
2
1.5
1
0.5
0
1960
1970
1980
1990
2000
2010
Source: IMF, 2011
Expressing prices in money terms over a long period is misleading because over time prices
rise (the value of money falls) with inflation. The higher line in Figure 2 is the
actual/current/nominal price of coffee. The lower line in Figure 2 deflates the coffee price by
the rise in US consumer prices, so as to provide a comparison between coffee prices and other
prices over time, to measure the real price of coffee. If the coffee price goes up more quickly
than other prices, then coffee is becoming relatively more expensive compared to other
The Coffee Market: Case Study, LSBU, 2011.
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products, the real price of coffee is rising. If the coffee price goes up more slowly than other
prices, then coffee is becoming relatively cheaper compared to other products, the real price
of coffee is falling.
Figure 2 Brazilian Coffee Prices Current & Real $
3
US $ per pound
2.5
2
1.5
Current
$
1960 $
1
0.5
0
1960
1970
1980
1990
2000
2010
Source: IMF, 2011; Commission, 2011.
When the real price of coffee is calculated a very different picture emerges, in particular in
relation to the trend in the real price, the fluctuations, particularly more recently are less
pronounced. The coffee price has fallen relative to the prices of goods and services in general
and therefore, coffee has become relatively cheaper. Incomes have risen faster than prices so
this makes coffee even more affordable.
This data on coffee prices raises some interesting questions. Why are coffee prices so
unstable? Why has the real price of coffee been falling? The price of coffee is determined by
supply and demand in the world market. So the factors which determine supply and demand
and how these have changed will now be examined.
The demand for coffee
The demand for coffee depends upon its price, the price of substitutes, the price of
complementary products, incomes, population and preferences. The effect of these factors and
how they are changing will be considered in turn:
The price of coffee
As the price of coffee increases, other things remaining unchanged, the quantity of coffee
demanded should fall. The demand curve for coffee should slope downwards, the lower the
price the greater the quantity which will be demanded. This is expected for two reasons the
substitution and income effects of a price rise. As coffee rises consumers will be encouraged
to switch to alternative drinks, such as tea and chocolate. Switching to alternative drinks will
be difficult for consumers because they have strong preferences about foods. So the
substitution effect is likely to be weak in the short term but stronger over the long term as
diets change. If the coffee price rises and you choose to consume the same amount of coffee,
the income you have left to spend on other products is reduced. So coffee use will tend to
diminish because people can no longer afford it. Since coffee accounts for only a small
The Coffee Market: Case Study, LSBU, 2011.
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proportion of expenditure in high income countries the income effect of a price change will be
small. In low income countries this effect can be more significant.
A further effect limiting the impact of changes in green coffee prices on the quantity
demanded is the fact that the green coffee price only accounts for a small proportion of the
retail price of coffee. Transport, processing and distribution will account for a large
proportion of coffee prices. Green coffee accounts for only 12.5% of the retail price of the
best selling instant coffee, Nescafe, so a 40% increase in the price of coffee would mean that
the retail price of the product would only have to rise by 5% to cover the increased cost.
The sensitivity of the quantity of coffee demanded to changes in its price is measured by the
price elasticity of demand for coffee.
Price elasticity of demand for coffee = % change in the quantity demanded of coffee
%
change in the price of coffee
Assuming: the price of coffee is the only influence on the demand for coffee that changes.
The price of substitutes
Substitutes are products that perform similar functions, so the major substitutes for coffee in
consumption are other hot drinks such as tea and chocolate. The demand for coffee will be
positively related to the price of these substitutes. So if the price of tea fell, consumers would
switch from coffee to tea and the demand for coffee would fall (the demand curve would
shift).
The price of complementary products
Complementary products or complements, are products which are consumed together
together, such as a coffee and sugar. The complementary between coffee and other products is
likely to be limited so this effect will probably be weak.
Income
As incomes rise the consumption of a product is expected to rise because people are able to
afford more of it. It is usually the case that the demand for a product will rise as income rises.
The relationship between the demand for coffee and income is measured by the income
elasticity of demand:
Income elasticity of demand = % change in quantity demanded for coffee
% change in income
Assuming: that income is the only influence on the demand for coffee that changes.
With relatively low cost food products such as coffee, at lower income levels increases in
income increase the quantity demanded, but as income rises the impact of income on the
quantity demanded decreases. Thus the income elasticity of demand decreases as income
increases. One estimate is that at an income of US$ 19200 (£12226) the income elasticity of
demand for coffee becomes zero (Webb and Hall, 2009). So the effect of rising incomes on
the demand for coffee comes mainly from rising incomes income in developed countries,
where average income is lower, but even here the income elasticity of demand for coffee is
only relatively low at 0.3 (Webb and Hall, 2009).
Population
The number of possible consumers of food is obviously determined by the size of the
population, as the population grows the demand for food will increase. So an important factor
driving the demand for coffee is the growth of population. Population growth is largely
concentrated in the developing (middle and low income) countries (Figure 3).
The Coffee Market: Case Study, LSBU, 2011.
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Figure 3 World population 1960-2009
8000
7000
Million people
6000
5000
4000
3000
Middle & low income countries
2000
1000
0
1960
High income
countries
1965
1970
1975
1980
1985
1990
1995
2000
2005
Source: World Bank, 2011
Preferences
Consumption of coffee for food derives from consumer preferences which are not static. As
incomes rise in poorer countries diets become more eclectic over time and this has led to a
growth in demand for coffee, in countries where it is not a traditional part of the diet.
Consumption of coffee
Figure 5 shows the consumption of coffee in importing countries these are mainly developed
(high income) economies, who account for over 80% of coffee consumption.1
Figure 4 Coffee consumption in importing countries
5
4.5
Million tonnes
4
3.5
3
2.5
2
1.5
1
0.5
0
1990
1995
2000
2005
2010
Source: ICO, 2011
Conclusion on demand
The demand factors considered above, indicate that the growth in coffee demand has been
driven by the growth of World population, growth of world income combined with falling
1
Data is not available for all countries for the whole period.
The Coffee Market: Case Study, LSBU, 2011.
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real prices. With demand in the developing countries growing slowly, it is rising population
and incomes in developing countries that is likely to generate future growth in coffee demand.
The supply of green coffee
There are two important coffee markets to be considered, the market for raw (green) coffee
and the retail market for coffee, which will be considered later. Coffee beans are produced by
millions of farmers around the world, although some of these enterprises can be large, they
are all small in relation to the total market. The quality of coffee will depend upon the variety
of bean and the conditions under which it is grown, but t simplify raw coffee will be
considered a homogeneous product.
The quantity of coffee supplied by farmers will depend upon the price of coffee, the price of
other agricultural crops, the price of the factors of production used to produce coffee, the
productivity of these factors, technology and natural conditions. The costs of factors of
production and their productivity will determine the cost of producing coffee. Productivity
over the long term will be determined by technology and the efficiency with which
agricultural production is organised.
The price of coffee
Normally it is expected that as the price of a product rises then the supply will rise. This is
because the higher price makes more intensive and more expensive use of production
facilities profitable and encourages producers to switch production from products. This should
be the case for coffee as the price of coffee rises, the amount of land devoted to coffee
production should increase.2 The production of coffee will intensify, yields will rise as more
fertiliser is applied. In the longer term research and development of techniques to raise coffee
yields will increase.
Figure 5 World coffee production 1990-2010
9
8
Million tonnes
7
6
5
4
3
2
1
0
1990
1995
2000
2005
2010
Source: ICO, 2011
The general trend in coffee production is upwards but since the prices rises of the early 1970s
the trend even in nominal prices is downward (Figure 5). There seems to be no relationship
between the current coffee price and coffee production (Figure 6). High prices do not seem to
lead to an increase in production. Figure 6 shows the relationship between this years
2
This assumes the price of coffee rises relative to other crops.
The Coffee Market: Case Study, LSBU, 2011.
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production and the price two years earlier. This lag between price and production changes it
introduced because it takes time to plant and grow new coffee trees. Part of the problem may
be that coffee prices are very unstable. This makes farmers cautious in responding to an
increase in price because when the production comes on stream the high price may be past. A
high price that persists may lead to increased production, but coffee production has risen
despite falling prices in the long term, so price does not seem to have much effect on coffee
production.
Figure 6 Coffee prices and coffee production
4
3.5
Price US$
3
2.5
2
1.5
1
0.5
0
5
6
7
8
9
Production million tonnes [lagged 2 years]
Source: ICO, 2011
The price of other agricultural products
All agricultural products are substitutes in production, the resources used to produce one
agricultural product could be switched to produce another. So if there are significant changes
in other agricultural prices this could affect the production of coffee. In practice there is a
tendency for agricultural prices to move together, so these substitution effects in production
are likely to be limited.
The price of factors of production
The cost of producing coffee depends upon the price of factors of production and their
productivity. So if factor prices rise then coffee prices will have to rise, to ensure that costs
are covered and farms earn a normal profit. Over time wages and capital costs rise so prices
will rise unless increasing productivity offsets these cost increases.
Coffee is produced with a finite resource, land. As Mark Twain said of land “They aint
making it anymore!” Although the amount of land is fixed the amount available for
agriculture is diminishing with urban growth and problems such as desertification. The
amount of land available for coffee production also depends upon what other crops are grown.
The area under coffee production shows no clear trend (Figure 7).
The Coffee Market: Case Study, LSBU, 2011.
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Figure 6 Land area used for coffee production
12
Hectares million
10
8
6
4
2
0
1961
1966
1971
1976
1981
1986
1991
1996
2001
2006
Source: FAO, 2011b
Technology
The amount of coffee grown on each hectare can also change, this is the yield or the
productivity of land. Over time yields have been rising, so more coffee can be grown on the
same amount of land. This rise in coffee yields is the result of science/technology such as
better varieties of coffee (disease, drought resistance), improved cultivation (more accurate
application of fertilizer, herbicides and insecticides). Besides technical change the adoption of
best practice can also raise yields, yields differ between farms even where the growing
conditions are similar, so yields can be raised by increasing the performance of the less
efficient farms. These factors have meant that coffee yields have risen, the yield in 2009 at
0.85 tonne per a hectare was an increase of 82.7% on the 1961 yield (Figure 7).
Figure 7 Coffee yield
0.9
Tonnes per hectare
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
1961
1966
1971
1976
1981
1986
1991
1996
2001
2006
Source: FAO, 2011
Shocks
Coffee production depends upon natural conditions, the weather and pest and diseases. This
random element in production is shown by the fluctuations in production (Figure 8).
The Coffee Market: Case Study, LSBU, 2011.
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Figure 8 Coffee production annual changes
% change on previous year
40
30
20
10
0
-10
-20
-30
1962
1967
1972
1977
1982
1987
1992
1997
2002
2007
Source: FAO, 2011b
The retail coffee market
The market for green coffee is characterised by many sellers, relatively homogeneous
products, unstable production and prices. The retail coffee market is very different it is
dominated by a few seller, differentiated products, stable production and prices. Coffee is
mostly used for instant coffee which accounts for 80.7% of household coffee sales (Mintel,
2011), so this is the market which this analysis will concentrate upon.3
The volume of sales did increase 3.7% in 2010 but this was due to heavy discounting of some
brands (Mintel, 2010). The volume of sales are unlikely to increase more, the value of sales
should increase with rises in price and consumers moving to premium brands. But the value
of sales will be under pressure from the difficult economic circumstances find themselves in.
This is a mature market with consumption in decline. Younger people are moving towards
fresh ground coffee, and once people retire their instant coffee consumption declines
significantly. So the instant coffee market is being squeezed from both ends of the age
spectrum. Coffee pods such Nespresso have failed to gain significant market share in the UK,
on 2010 they only accounted for 3.3% of the market, but they could in the future further erode
the instant coffee market.
The rising price of beans and other cost pressures are tending to push instant coffee prices up,
prices rose 8.2% in 2009 (Mintel, 2011). Instant coffee is a commoditised product and its low
price per cup is one of the great attractions for consumers.
Market Structure
Number of firms and market shares
The market for instant coffee has many brands but one dominant firm, the Swiss multinational
Nestle, which in 2010 had 40.9% of the market by value. Other important players in the
3
Instant coffee is losing market share to fresh ground coffee and coffee pods.
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market are Kraft which had an 18.7% share, the supermarkets whose own brands accounted
for 11.9% of the market, with the remaining 28.6% of the market accounted for by smaller
players.
Table 1 UK coffee market shares by value of sales, 2008-10
%
Nestle
Kraft
Own label
Others
2008
43.0
16.5
9.0
31.5
2009
41.3
17.5
12.0
29.1
2010
40.9
18.7
11.9
28.6
Source: Mintel, 2011
Nestle and the smaller players in the market (others) are losing market share to Kraft and own
label coffee. Although the data is only available for a short period, so care needs to be taken
in assuming these are well established trends.
Brands
The market is characterised by plethora of brands. The biggest brand Nescafé Original and the
smaller brands (others) are losing market share (Table 2). Premium brands such as Nescafé
Gold Blend, most Kenco brands, Douwe Egberts are gaining market share, as are the
supermarket own-label coffees.
Table 2: Brand market share of the in-home coffee market, in value sales, 2008-10
2008
Nescafé Original (Nestlé)
Nescafé Gold Blend (Nestlé)
Kenco Smooth Roast (Kraft)
Kenco Rich Roast (Kraft)
Douwe Egberts Pure Gold (Sara Lee)
Kenco Decaffeinated
Carte Noire (Kraft)
Nescafé Cappuccino (Nestlé)
Nescafé Decaffeinated (Nestlé)
Kenco Rappor (Kraft)
23.5
13.7
4.8
3.8
2.8
3.1
2.9
2.8
3.0
1.9
2009
% share
21.4
14.7
5.4
4.3
2.9
3.1
2.9
2.7
2.5
1.8
2010
20.7
15.2
5.8
4.8
3.1
3.1
3.1
2.8
2.2
1.8
2008-10
% change
-8.8
15.6
24.4
30.7
16.9
3.9
11.0
3.7
-23.9
-1.7
Own-label
8.9
12
11.9
37.2
Others
28.7
26.2
25.5
-8.0
Source: Mintel (2011)
The proliferation of brands serves several purposes for firms. The differentiated brands may
meet the different preferences of consumers. These may be for clear product differences such
as decaffeinated coffee, they may relate to quality or they may be aspirational. Thus different
brands will appeal to different consumers. For example Nestles has a large market share but
its brands are not very appealing to younger consumers, so Nestle has introduced the Dolce
Gusto brand of coffee pods. Kraft markets its coffee primarily under the Kenco brand
avoiding the rather staid image of the parent company. These brands are supported by heavy
advertising and product support. Kraft has invested heavily in 2008-10 its expenditure on
advertising the Kenco instant brand was £12.5million.
The Coffee Market: Case Study, LSBU, 2011.
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Instant coffee is not a product with significant nature barriers to entry, there are not large
economies of scale in production, the technology is not protected by patents. But the
proliferation of brands acts as a barrier to the entry of new firms. New entrants will find it
difficult to get consumer recognition for their product, they cannot finance large advertising
campaigns. Advertising is subject to economies of scale higher level of expenditure are likely
to be more effective. There will be churn in the market with consumers switching between
brands but the greater the number of existing brands the less likely it is that a new brand will
be chosen.
References
FAO (2011a) FAO Statistical Yearbook 2010, Rome: UN Food and Agricultural
Organisation, http://www.fao.org/economic/ess/ess-publications/ess-yearbook/en/
FAO (2011b) FAOSTAT, Rome: UN Food and Agricultural Organisation,
http://faostat.fao.org/site/339/default.aspx
ICO (2011) Historical Data, International Coffee Organisation (ICO),
http://www.ico.org/new_historical.asp?section=Statistics
Mintel (2011) Coffee – UK – April 2011, www.mintel.com
Webb, M. and Hall, V. (2009) Application of a dynamic panel estimator to cross-country
coffee demand: A tale of two eras, Journal of Economic Development, Vol. 34.1, pp. 117.
World Bank (2011) World Development Indicators 2011, accessed via www.esds.ac.uk
The Coffee Market: Case Study, LSBU, 2011.
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The key factors that will be taken into account in assessing the questions are as
follows:
Assessment criteria
Knowledge and understanding
a. Demonstrates a knowledge of the relevant aspects of the topic.
b. Shows an understanding of relevant economic theory.
Evidence base
c. Use of an appropriate range of resources from the case study and associated
material (articles, statistics)
d. Selection of relevant material from these sources.
e. Employing this material in the answers.
Intellectual skills
f. Demonstrates ability to describe developments in the relevant market.
g. Ability to evaluate and analyse the factors causing these market developments.
h. Use of independent thought in the answers.
Writing skills
i. Ability to write clearly
j. Use of an appropriate style of writing
k. Accuracy of grammar and spelling
l. Appropriate paragraphs
Presentation
m. Complete and accurate referencing
n. Complete and accurate bibliography
o. Use of tables and graphs
p. The layout of the answers.
General advice on the assessment:
Answer the questions: Make sure you organise your answers by individual question
this is not meant to be an essay. Refer back to the question when you are writing to
ensure relevance.
Organisation: plan your answers carefully, this will help you develop a logical
argument and to avoid repetition.
Try to write interesting first and concluding sentences.
Style: the way in which ideas are expressed. You should aim for a straightforward
and clear style, not over-elaborating or using convoluted sentences.
Evidence: the support of arguments by: references, examples and appropriate and up
to date statistics.
Referencing: the answers should be thoroughly referenced using the Harvard
system. This means that in the text will appear the Author’s surname/family name
and the year of publication (Simmons, 2006). If there is more than one reference for
the same author in a particular year add a,b,c etc. after the year e.g. (Simmons,
2006a). Every paper must have an author even if it is an organisation e.g. (European
Commission, 2008) (Economist, 2008). This applies to websites as well, if there is
no author the author is the organisation running the website e.g. (AA, 2008), if there
The Coffee Market: Case Study, LSBU, 2011.
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is no date use the current year. Website addresses must not appear in the text and
should only appear in the bibliography if this is the only way of referring to the
work. For example journal articles accessed electronically need only be referenced
to the journal, no web address is necessary.
Bibliography: this should demonstrate that an appropriate range of references have
been consulted, credit will be given where there the list of references has been
extended beyond the course reading list. Every author referred to in the text
should be referenced. Follow the style I use.
Your work should be organised in paragraphs, which are several sentences on the
same topic, paragraphs should be separated by lines or should be indented.
Individual sentences must not start on new lines.
You should check the spelling and grammar by turning on the Word system and
setting it to English (UK). You should proof read through your work carefully.
If you have any further questions about the assessment please ask your tutor.
The Coffee Market: Case Study, LSBU, 2011.
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