Specialty Coffee has lost it's Mojo

Date Posted:1 December 2019 


It was bound to happen - a loss of interest in the "noise" around the term "specialty coffee".

 

 

 

 

Around 18 months ago, I wrote about how attention seekers within the Australian coffee industry were questioning, or rather agitating, whether the term "specialty coffee" was being abused, diluted and lost it's meaning or relevance.

Surprise, surprise, seems back then that every man and his dog brand of coffee had pinned "we are specialty" badges to their chests.

Trying to drive a stake in the ground about the definition of specialty was always going to be a pointless exercise.

There is no complete or end-to-end traceability, regulation or compliance in the global coffee market, except for certified FAIRTRADE coffee and there are so few of us playing in that space we are in the small minority and less than 2% of global production, hence attempting to place parameters around the use of the term specialty coffee was never going to fly.

Companies will continue to source whatever they want, including the worst of the worse and cheapest of the cheap, place it into an attractive looking bag and then market with exuberant claims.

You only need to take a look at the re-branding of Coles private label coffee - playing catch-up of lost ground in the bottom-feeder game with Aldi and Woolworths, Coles is obviously seeking to leverage buzzwords generally associated with higher quality offerings such as craft roasted, Artisan made in Melbourne, sustainably sourced.

The reality might indeed be quite different as it serves to highlight claims on packaging may not live up to the promise.

Beyond the confusion of what is specialty and putting aside for a moment any exploitive tactics employed by larger commercial players, the inertia and drive by roasters to climb even higher mountains in the pursuit of quality or "perfection" has significantly waned with the peak well and truly behind us.

Coffee roasters are still focused on constantly improving their quality, but it's within a much narrower band of variables. Indulgent leaps to extravagant and exotic lots that sell for 300+% above the market are less common compared to just a couple of years ago.

There has also been declining levels of interest in Australia for the Cup Of Excellence programs, Barista competitions and even the roasting championships have become a complete farce with $300/kg lots up against every day coffees. These elitist events are taking place inside a really small bubble that few of us now acutally care about and only serves to distort the reality for what is applicable or relevant to the average Australian coffee drinker - how many of us are going to wake up in the morning to brew a $30 cup of Geisha ?

But what's really behind the retreat of specialty coffee - is it just the natural cycle of market maturity and stabilization ?

We think that's only a small part of the greater forces at play.

There are fierce underlying economic factors influencing the behaviour and trends for many Australian coffee brands as they reset their strategies around the pressures of a competitive and saturated Australian market - and this also extends beyond coffee to almost every industry.

The new game in town is about margin control and stronger commercial discipline as it's clear the consequences of rising costs and selling price deflation take a big bite into operational models.

To illustrate how the coffee market has stalled in the last decade, we only need to look at some comparative examples in other industries.

2 weeks ago we engaged the same roofing contractor to obtain a quote for the same work 5.5 years apart, e.g. in 2013 they quoted a roof replacement for a warehouse, a project which did not proceed at the time. It's now time to do this work and with identical scope and materials we again in 2019 need the exact same job done by the same contractor.

The price was 60% higher over that 5.5 years for identical materials and labour. In fact, there are less penetrations in the roof for the 2019 quote, so you'd expect the price to be slightly reduced in scope, yet it was 60% higher for exactly the same specification - just 5.5 years apart.

There is no doubt materials rise and so does labour, but according to the boffins that trumpet economic statements, wage growth has stalled in the last 5 years.

If we'd done the same with our coffees, our Suuweet, Barista and Espresso blends would be selling for $39 a kilo instead of $25 per kilo today. Some might argue the comparisons are not the same, but a coffee company has exposure to a greater number of input cost variables. Take for example 300% higher price for gas and 100% higher for electricity in the same period and of course the space occupied by a coffee company compared to a roofing contractor that works on sites is vastly different.

This example highlights the very real danger Australian retailers have been battling against - price deflation.

Coffee brands are experiencing tighter margin squeeze each year as competitive pressures force them to hold the selling price firm. You'd think this was a universal symptom across all commodity items, however it's not....... cardboard cartons always rise around 5% per year. They can because there are just 2 main suppliers in that industry, they are able to collude (indirectly) on pricing and get away with it by ensuring they raise prices above CPI to account for natural rises in cost inputs inside their business.

Australia's coffee industry is composed of more than 2,200 brands with around 80% of those brands having relatively small size of 5 or less employees. It may come as a surprise that a company of 5 can be regarded as medium, or slightly larger than medium in the Australian coffee market.

Coffee is a manufacturing business and as we all know manufacturing is a scale game, else it's not efficient or effective and will eventually fall victim when markets mature, consolidate and margins erode. It's only just a function of time - when, not if.

Much like the small baker or craft brewers, trying to compete against the automation of a production line, it's a hard slog to sell the value of artisan, hand-made products when consumers have eyes for just one prize. The current value of their real estate portfolio or hunting for their next asset acquisition.

Given the tough conditions, you'd think there would be a few coffee brands raising their hands to be sold or acquired, but it's not the case, especially here in Australia. We've been trying for 3 years to buy other coffee companies to bump-up scale as we have capacity, but the searching has yielded no willing sellers.

In the last 12 months, there have been more coffee companies close or fall into administration than in the previous 5 years, but it's still a really small number of exits compared to a higher number of new entrants. It's remarkable the gold rush mentality still exists and it seems always driven by a romantic notion rather than solid business fundamentals.

Whilst we continue to grow organically, the addressable size of the coffee market is only increasing by roughly 4% each year, yet the capacity increases ( from within existing and new coffee companies) is growing at roughly 20%. There are clearly too many mouths to feed on the supply side and it's going to become challenging over the next 5 years if there's no basis or simple consolidation.

A second headwind affecting specialty coffee in Australia is a dramatic change in fortunes for the tough hospitality segment.

Rocked by wage fraud scandals, insolvencies, disruption by food delivery portals, skyrocketing rents, higher food and ingredients costs whilst selling prices remain under pressure, cafes and restaurants are struggling to generate returns for the owners and as a consequence payments to their suppliers are stretching out terms into dangerous territories.

We have often mentioned the hospitality segment is notorious for using other people's money to fund the cash flow for their business - it's all about binging on supplier credit and when some of those suppliers tighten terms, it will crunch the segment.

Often closures are conveniently blamed on rent, but that's not the real reasons for failure as rent was already a known quantity before they launched, it's more often than not about whether suppliers rein in debt levels that squeezes cash flow.

For the last 12 years, hospitality/wholesale had been the engine room for the Australian specialty coffee market with astonishing growth rates each year, but it all peaked around 2016 and in particular the last 12 months has seen a sharp decline as consumers tighten their spending on discretionary items.

A popular urban myth that some everyday staples such as coffee are recession-proof, even in times of economic stress, historically people still treated themselves to coffee, but it seems that cafe patronage has indeed fallen.

In our neighbourhood, there were just 2 basic cafes in 2000, growing to 12 cafes in 2016 and now dropping to 8 cafes in 2019. We know for a fact that all but one of the cafes in our area are up for sale - either officially, or unofficially, most have been on the market for 2 years and a couple have closed down and replaced with different types of businesses not related to hospitality.

Whilst it's common knowledge cafes swap hands regularly, that's certainly not a new revelation, but the velocity has increased, the goodwill multiples have diminished and the prevailing optimism that was once a feature of hospitality has been replaced with a grim struggle for survival. Even the short-term pop-up trend has all but disappeared.

I'm not sure where to from here on the road ahead for Australian cafes........consumers and patrons slam them on social media if they put the slightest of feet wrong, reliable staff are difficult to secure, margins are slim and the effort versus the returns are now inverted - with many owners likening the experience similar to a prison sentence, locked into a lease until they can be released.

It's more likely the future strategy for cafes will involve a transformation into a food and beverage solutions provider operating extended hours to cover the needs of higher density living (apartment complexes) within a close-range delivery service, or physical radius hub, catering for convenience with a greater emphasis on localised loyalty incentives.

Specialty coffee has settled into our everyday norm - it's no longer new, different or evoking a sense of curiosity. Consumers expect specialty, so it shouldn't need to be called out as a differentiator in the marketing of quality coffee products.