#22: Re:co Podcast - Andrea Illy on the Global Economics of Coffee

Well, I remember that 10 years ago I predicted that China in particular would become one of the 5 largest coffee-consuming countries in one generation. And this is— I'm not talking about per capita consumption, but the figures in terms of number of inhabitants is so gigantic that they really need to Just taste a few cups of coffee per year in order to really skyrocket to a gigantic coffee consumer. Yes, this is the power of numbers. And the same is true for India, you know, and Middle East is a lot under the, let's say, Asian influence as well through India. And they are also coming strong. Some of those countries are also coffee producing, so the cultural barriers are kind of much easier to overcome because it is true that their culture is mostly centered around tea, but coffee being a kind of a flanking product in their daily experiences. Mm-hmm. The 2 drivers to start consuming coffee are first of all globalization, this international culture which is resulting in a kind of a cross-fertilization. We become more Asian, they become more Western. Mm-hmm. And this is one driver. And the other driver is the internal production, which of course triggers some curiosity to try some produces of your own land. So all in all, Your question is what will happen? My opinion is that nothing really particular because if you consider that we have around 1.5 billion coffee drinkers in the world, still a very little number with something like 20% of the human civilization drinking coffee. So of course they will help accelerating that and for sure sustaining this 2% compound average growth rate that the coffee consumption had in the last 20 years.

Mm-hmm.

So they are contributing to growth. And I also must say that in my personal opinion is that Asian countries were kind of very as you say, suspicious about coffee consumption because it was kind of the opposite than tea in the yin and yang, you know?

Right.

Balance. And as a matter of fact, it's only thanks to a much better coffee quality, overall coffee quality, that they managed to start enjoying it. much better coffee quality in terms of taste, in terms of consumer experience, in terms of discovery of this wonderful coffee culture. You know, it's like they are becoming, for instance, in China, great wine drinkers. And of course, they started from the great French Bordeauxs, right? Mm-hmm. This has been the the, let's say, the educational partner which introduced the Chinese to the wonder of wine drinking. And now they also start growing wines in China, you see? And the same is happening with coffee as well. So I think it's a long-term trend which is— we are observing.

Okay, interesting. And so, okay, so you're drawing that connection between production and consumption, which is interesting. You mentioned, when you analyzed the market, you mentioned that the predominance of consuming countries is a problem, the predominance economically. And interestingly, the 2018 Coffee Barometer just came out, and it reported that 10% of coffee's total value is captured by producing countries. So what do you think we might do as an industry to change that predominance?

I think to make, to give a brief answer, product, increase the coffee value, okay, through differentiation and sustainability. The reason why I say that is that on one side, agricultural commodities are deflationary. It's amazing. And don't ask me why. But if you don't take in account the 4 years ago, the Arab Spring, which caused a significant, let's say, burst in agricultural commodity prices, without the one century ago, the prices were the same as today.

Right.

So this is really structural to all commodities. And this is something I showed in Seattle, a chart about that. Second, the value chain is very long, you know? And as far as growers are concerned, they are only the very first ring of a value chain which ends in a coffee shop serving your cup of coffee. And of course, if you are at the very beginning of the value chain, you only have one fraction of the total value chain. So you have a— The only possibility that you have to increase your value added would be to vertically integrate downward. So like wine growers decided to do when they shifted from simply wine grower to winemaker, you know, because they were in the same problem. There were the winemakers purchasing grapes Many times also squeezing wine growers. And because there were no relevant entry barriers, the wine growers decided to start producing their own wine. This is how the wine revolution did start. I believe that this is more difficult because we have a barrier, a geographical barrier, which is a geopolitical barrier like a wall, like a gigantic wall, which is the equator. You know, coffee is produced all in the south of the world in developing countries, and it is very difficult for them to get access to the coffee-consuming markets. So it is happening. You already have some first experiences of roasted coffee exported from producing countries. But I really consider it will be a little niche and very hard to distribute, et cetera. So all in all, with these 2, let's say, hurdles in mind, what can we really do? Instead of trying to increase that 10%, which is structural and will probably remain the same, Mm-hmm. What about simply increasing this $200 billion to $300 or $400 billion and having growers getting in absolute value a higher amount of money because the value added of coffee is higher? This is much easier if you make the value proposition to a final consumer much richer in terms of quality, experience, and uniqueness, you know, because In wine, for instance, you cannot find 2 bottles which are the same any longer. Right. Once upon a time, the only differentiation was by grape and by region. Now it's by bottle, you know? And this drives the price up. It might be consuming, per capita consumption down, but for sure it drives price up.

Right.

And I think it's the most accessible and immediate strategy in order to give relief to this, Okay,

very interesting. Now, shifting gears a little bit, you mentioned at the beginning of your talk that some elements might be a little bit provocative. And there was one moment that provoked a reaction among the audience, which is when you mentioned that slavery, malnutrition, and poverty are not existing on coffee plantations anymore. And that conflicts with most people's perception of coffee plantations, that though conditions have improved, that we haven't completely eradicated social problems like those that you mentioned. I'm wondering maybe a little bit more detail about that and your perspective on this.

Well, my statement is that coffee was able to strengthen its 3 virtues in the last 2 decades. The first virtue is pleasure, the second is health, and the third is sustainability. And as far as sustainability is concerned, there is still a long, long way to go, but we are definitely in a much better place compared to where we used to be maybe 3, 4 centuries ago. 3, 4 centuries ago, one good reason not to talk about coffee to consumers was about because there was a lot to to be ashamed of, you know?

Mm-hmm.

There was slavery, there was deforestation, there was pollution, there were even worse related to coffee. If you read this Uncommon Ground book, which is a kind of a reference book by Mark Pendergrast, you will find so many bad stories which are really, really belonging to the past. So nothing so bad still occurs in the coffee plantation. It has been now at least 2 decades that the total coffee production increases only thanks to a productivity increase and no more deforestation, at least not substantial deforestation. The agronomical practices did substantially improve involving less, for sure, consumption and also less water consumption. And the working condition did improve overall. Of course, you still have criminals. In a community of 25 million coffee growers, you can have a few percentage of criminals which are still exploiting. And we probably never will be in the capacity to totally eradicate the phenomenon. But what I was commenting is that the trend is quite positive. I visit plantations in tens of coffee-producing countries, and I must say that in general, I find a much better, let's say, sensitivity from coffee growers to all this situation. With sadness, I must say that there is sometimes less respect for workers compared to respect for the environment. And this might sometimes cause by temporary labor or so, but this is something occurring in some certain countries, not necessarily in others. So this is my explanation to that statement.

Okay. Shifting our focus to climate change for a minute, you discussed climate change, of course, which is a huge issue for us as an industry. You mentioned a possible new initiative called the Global Coffee Adaptation Plan, and you described it as a multi-stakeholder initiative to drive coffee's adaptation to climate change. Could you tell us a little bit more about how, like, an ambitious project like this might work?

Yes. So basically, everything starts from this, let's say, generally accepted assessment that 50% of the currently suitable land for coffee agriculture will be gone by 2050. And if— of course, suitable land is more than the cultivated land. But also this cultivated land will be in the same percentage will be impacted. So currently there are 11 million hectares cultivated, and might be that 5.5% needs to be made resilient. In order to make, let's say, land resilient to climate change, you need the 3 sequential, let's say, actions. The first being improving the agronomical practices with whatever necessary, precision agriculture, irrigation, plant replacement, shadowing, agroforestry, plenty of the possible solutions which are wide available in agriculture. Even for cultivating in deserts if necessary. Second action, if this is not enough, is developing new resistant cultivars, particularly the Arabica coffee. Biodiversity is very narrow with only 33 species cultivated, all deriving from the same mother plants. And this is a risk because it can even be risking kind of a pandemic. So we need to boost genetic variability of coffee, and this requires another type of project. And last but not least, if both these initiatives have not been— will not be sufficient, we will also need to develop new production areas, new, you know, move plantation from one place to the other, either at higher altitudes or higher latitudes, you see. So all this will require substantial investment that, really kind of an educated guess, we could imagine an average of $10,000 per hectare, including a portion of cost of land. If this is the case, we would need to invest in the decades ahead few tens of billions of dollars in order to not only, let's say, to improve coffee production beyond 225-230 million bags. So far in the last 2 decades, coffee production has been increased by 2 countries only, mostly I would say Brazil and Vietnam. And the total of the remaining countries, in total they remain flat. Some did grow, some did decrease, diminish production, but the sum of them was the same. So the bet is that Brazil, which is such a huge agricultural land, And Vietnam, which is such a young coffee-producing country, will be able to double production once again. And if the other countries will remain flat, we would basically, with no investment, we will be able to maybe produce something like 50% more than we are producing now. But then we will be kind of cutting off And in order to avoid, let's say, a shortage of production and a relevant price shock, we would need to make investments already now. Because if the shortage will start around the end of 2030, beginning 2040, And the investments needed, that will really need to have a ramp-up and a learning curve and all the necessary time to become fully productive, we will need to start investing very soon amounts of money which are significantly higher than compared to what we are investing now. The best educated guess is that we are investing now around $100, $150 million dollars per year in sustainability, not necessarily related to climate change. And this money is probably 10 to 15% of what should really be invested in the long term. The CGAP is to only address investment and provide the already existing NGOs like World Coffee Research for new variety development, like Coffee and Climate, like Conservation International, like the Global Coffee Research. All these NGOs which are very well organized to transfer know-how and technology to producing countries, but they only needed more funds for investment. And so the idea of Sigap is to be kind of a broker, an international broker, allowing the money from investors to flow into the coffee plantations and accelerate investment. This is what we are trying to do.

All right, that's fascinating. Well, speaking of the future and investments in the future, this year the Ernesto Illy Foundation sponsored the Ricoh Fellows Program, which is the program at Ricoh that invests in new leaders in our community. Including, you know, new scientific leaders and policy leaders and coffee leaders, etc. How was— I was curious what— how your experience of interacting with the RICO fellows were. Did you have any takeaways from that experience?

Well, I had an impression about this RICO of an initiative which is very dynamic and very inclusive and oriented to provide a significant improvement to the coffee industry. So, I really support and I must I encourage the Specialty Coffee Association to continue with that initiative because also it's creating awareness for the challenges that we have ahead. I was able to meet many people with a high level of competence in what they are doing. This is also important. Way ahead where we were maybe 10 years ago or more.

Well, I agree. And on that note, let's go ahead and listen to the audio of your talk. Andrea Illy, thank you so much for your participation in our program and for all the discussion. Thanks so much.

It's my pleasure. Good morning, all of you. And I'm pleased to be here with you. And congratulations for your 10th anniversary and for what you have been able to accomplish so far, because this kind of discussion and then the follow-up creates a lot of value. So my assigned topic is the complex global economy of coffee. As a scientist, of course, I love complexity. But I will try to give you a simple picture as much as possible. What I will say is very much my personal interpretation of the economics of coffee. I will be also a little bit challenging and provocative for the discussion. So let's see. Thank you, Andrea. So I will cover 4 topics: market, consumption, production, and the way forward. As far as the market is concerned, here is a little snapshot just to give you some figures. It's the best educated guess that this is a market around $300 billion. At cap level, one of the problematic numbers is this one, which is this is a very small number compared to the aggregated value. But this is the problem: if you divide 25 million growers community, you get only $1,000 per year, which is. But if you then apply the ABC distribution, you will know that 20 million of those 25 will only get $200 per day. And you know that United Nations have a $2 per day, less than $2, $200 per year, and the United Nations has $2 per day as the threshold of poverty. That's right. So as we will see, we did a good job in improving this situation, but we are not there. Problem is that this is— and we have to be, let's say, as we will see, honest in acknowledging this is only the first ring of a long value chain. So it can get only a smaller portion of the value, of course. And we will see some possible strategy how to address this imbalance. Another important figure here is what's going on. 1.5 billion consumers used to be 600 20 years ago. And this is a figure that it's interesting to be correlated with 2% compound average growth rate because 2% is not a big number. 2% is just the world demographic increase. But of course, because emerging countries, as we will see, have a per capita consumption much lower than we do have, then we have to conquer at least twice of them. And this is what we did in the last 20 years, have a compound average growth rate of 4%. The consumer base in emerging countries. 20 years ago, the OECD countries were accounting for 80% of the coffee consumption, now less than 50%. But 1.5 billion is nothing compared to more than 7 billion we are on the planet. And there is no reason why, with the growth of disposable income in all countries, everybody will eventually drink some coffee. So just to say that the 2% increase is, let's say, not realistic because nothing is realistic, but it's reasonable as an expectation referring to what has been said by the panel. Yes, we will need to produce more. Trends, very important. There is a substantial trend for differentiation and we will talk more about that. Sustainability has been already said. Globalization and the industry consolidation, which is a more recent trend but equally important. Finance. Troubling picture. Why this? First, already seen the predominance of consuming countries in the value chain. Second is the structural deflationary trend over centuries, because this graph, for all main commodities, starts in mid of 19th century, so it's over 150 years old. So there is no way that agricultural commodities can grow in value It didn't happen in the last century and a half. Why should we reasonably expect it will happen in the future? Maybe because of climate change. But then we will talk about the price shock. We'll talk about that. Volatility, as you can see, we all know that. The problem, one of the big recent problems since now a crop is traded 50 times at least on the marketplace, on the stock exchange, there is more and more a decoupling from the price made on the stock exchange versus the price commanded by the so-called fundamentals, which are production, consumption, and stocks. So in the last 2 decades, there has been, particularly in the last one, many times substantial, let's say, divergence between what the fundamentals of the coffee market, physical one, were commanding compared to what the stock exchange did. This very much depends on the fact that there is a heavy influence by other index commodities. The biggest one, of course, oil. So one of the problems we have in that room is now it's the American shale oil. Why this? Because in this index that funds, pension funds, hedge funds buy, there is 50% of oil. And the price of oil, as you know, is now flat as a consequence of the United States becoming the leader in energy production, in oil production, with a cost of production which is around $50, $60 a barrel. $50, $60 a barrel? a dollar per barrel. And this is reflected also on the price of coffee that, not surprisingly, is very low and flat. So these are structural issues that we can only hardly, let's say, change, as we will see. And finally, unreliable, totally unreliable statistics. Who knows really how much coffee is produced. Nobody knows how much really coffee is consumed. And for sure, nobody can guess stocks level in reality. So we have some numbers. What I do since 10 years is to make a weighted average of all these possible statistics I receive by reliable sources. But I can tell you, this is not the way of working. And I think there is a general interest to have kind of unreliability of those statistics because it makes the market more fluid. It's good for speculators. So consumption. This acceleration of coffee consumption— 20 years ago, it was growing at less than 1%, and it was the victim of soft drinks. Now the situation is inverted, and we grow— we grew up to 2.7%. Thanks to coffee becoming much more positive. These 3 virtues of coffee, which have been the— let's say the core strategy for the Coffee Promotion and Market Development Committee at the International Coffee Organization, these 3 virtues are really solid. Pleasure: there is much better quality in the cup now. There is an enormous amount of differentiation. Consumers can find plenty of new stuff to try in the market. And this is, you know, it's fun. It's, uh, it's, it's— people love it. There is a much more sophisticated technology for preparation, specifically PortionAid system, make this convenient and consistency really Positive in terms of consumption, and we know that there are consumers drink more cups as thanks to this technology. And there are also much better places, including some of your own places or our places. Health, this is very important. I know you will talk about science. Twenty years ago, you know, people sixty percent of people consumers were thinking that coffee was so so. for human health. Now, it's exactly inverted. It's clear, thanks to at least, let's say, 10 significant epidemiological studies, that coffee is about longevity. It makes you live better because it's— thanks to its stimulant effects of caffeine, you are inspired. It's really the best way to live, to be social, to be brilliant, etc. But but also live longer, thanks to the antioxidant property of coffee, which makes coffee to be the most effective preventative cure against the elder age diseases, particularly the degenerative ones, but also diabetes too. So this is great, and it's official because the latest and most significant studies have been published by the International Agency for Research on Cancer. And last year, something enormously so important happened in the industry that the International Agency Research of Cancer, which is part of the World Health Organization, did reclassify coffee after 25 years as non-cancerogenic, not classifiable as cancerogenic. Used to be possibly cancerogenic. So it's the first time in history that one product is improves its classification. Thanks to what? Thanks to amazing work made by the scientific community. In the last 25 years, there have been 25,000 scientific studies accumulated, and there is an organization which is called EASIC, which is constantly monitoring these studies and classifying them per category and impact. So this is good. This is the proved that if we work together, we can address important challenges. Sustainability— things did improve substantially because there is more economic sustainability now. There is no more slavery. There is no poverty. There is no malnutrition. There is no— this kind of stuff that was existing is not existing in the coffee plantation any longer. Still, there is a long way to go, but we made a significant improvement thanks to growth. Social sustainability is much better than before thanks to responsibility. When you go at the United at the International Coffee Organization, you find two blocks: consumer countries, producing countries. No, we are all in the same field. We are all in the same market. We must love each other so we can create value. And this is what is happening also through thanks to a community like yours, visiting coffee plantations, exchanging knowledge, and so on. And finally, the environmental sustainability did substantially improve because in the last 20 years we have been able to double production with the same amount of hectares. So that means that no deforestation any longer, and you can hardly find pollution in a coffee plantation. So this led to growth. Where did the growth come from? If you can see, the big contributor to growth, which has been also a trigger in order to better promote coffee, have been coffee shops. 6% compound average growth rate in the next 10 years. 10 years of doubling the number of units. Amazing performance. And the food service in general did grow, let's say, more than the total average with a 2.7%. Off-premise, which is substantial to be seen, is that we have seen a 30% increase in per capita spending in coffee consumption. So that means that out of their Pockets, you know, consumer pay 30% more compared to 10 years ago for coffee. This is good. This is good because it means that value added in the coffee brings drives consumption, not the opposite. Usually you have a price, you know, volume relationship. The lower the price, the higher the volume. In this case, no. In this case, it's quality which. drives growth, which is great for our room. And interestingly enough, the big performer has been portioning systems, 14% compound average growth rate, quadrupling, nearly quadrupling the— or tripling, sorry, the— no, quadrupling nearly the market size. So over 20% of the households now consume coffee with a portioning system. And then finally, emerging markets. Emerging markets, big performance Asia Pacific. Asia Pacific is now the very first region, macro region in terms of coffee consumption. Look at Latin America, which has been the second best performing, and look at North America and Europe. Even Europe is smaller than Asia Pacific. So we have to take into account that also when we will talk about production. So production. So very more important concentration. The 2 first countries, only 2, went from 46% of the total world production to 53% in just 10 years. So now let's look into the next 30 years. Where will this coffee needed for doubling and growing 2% come from? Because we have this problem. Climate change is not a risk, it's a reality. It's already happening. And I insist saying it's happening since decades already. There have been already big, big investments and changes in the industry in order to make coffee production resilient to climate change. But we need to do much more. The challenge is that we will lose half of the suitable land, as you can see from this chart. Every blue area in this chart is a decrease of suitability for coffee production. And the red one is an increase. So some of the growers which went away from Paraná in Brazil will have to go back to Paraná. Because the 3 strategies to address climate change will be, first, to change agronomical practices, as they are already doing in some countries, not all, unfortunately. If it is not enough, we will need to develop new cultivars. As we will see, the natural genetic diversity of coffee is extremely narrow, extremely poor. This is a risk. And if— Colombia has been a benchmark for this kind of strategy. And last but not least, if not necessary, If not enough, we will also need to migrate plantations. Problem is that we will need to scale up investment substantially. The best educated guess is that we will need to spend $1 billion per year in the next 20 years in order to make coffee agriculture resilient to climate change. Now we spend $350 million. So there is a substantial lack of funds. The problem will be even earlier because before, even before impacting productivity, climate change impacts quality and due to water scarcity and increasing temperature. So we are trying together also with a, of course, under the leadership of the Swiss Coffee Trading Association, which consolidates over 50% of the coffee traded, together with the big corporations, and also with involvement, significant involvement of Rick Reinhardt, we are trying to lead this possible idea of a CGAP, Coffee Global Adaptation Plan, which would be— and we will have the go/no-go decision in October— will be a public-private initiative for fundraising, coordination, and knowledge transfer. The big opportunity is that there is a new emerging market of so-called impact investment. Which is already an $80 billion industry, so— and it's growing, 2 digits. So that means pulling out some resource, $1 billion or less, you know, for coffee will be feasible as long as we make projects which are bankable. So there is a lot of work to be done ahead, but I'm positive. So industry consolidation. Just to comment this figure, this column is about $43 billion in 5 years. Never in history how much, so much money in M&A has been spent in the industry. And the result is that we have a new big challenger, JAB, you know, with now second in terms of market share and first in terms of volume. But of course, this created also a movement, a reaction by all the other major companies to start M&A, changing the strategy from organic growth into external growth. Is it positive? Is it negative? Will it last for long? I think it's more or less indifferent because, as we will see, something very similar did happen in the beer industry, and together with the consolidation of the big industry, there has been also a an extreme, let's say, fragmentation and differentiation thanks to microbrewers. So the way forward in order to try to cope with this complex situation which I'm trying to make simple. I hope and I really dream that we pave the road to the future in Milan at the occasion of this greatest— great coffee celebration in 2015. At the Universal Exhibition. Because it was so inclusive, it was so great, we organized a global coffee forum and we did sign this important declaration which is the Milan Coffee Legacy. This is about acknowledging that there is a virtuous cycle combining the well-being that coffee delivers to consumers with the development it gives for those— for the producers. So— and committing to nurture, to strengthen this virtuous cycle as we have been able to do in the last 2 decades. And nurture this virtuous cycle with whatever it takes, starting from public partnership, public-private partnership, which are absolutely necessary in order to address the important endeavors that we have to address. Last but not least, so this leads me to identify 2 possible strategies in the way ahead. More differentiation. If you compare to what we have been able to accomplish, coffee now has— remember this chart that showed about the number of roasting exploding in the next 20 years or 30, I don't know how many. 10. We are now in the world an educated guess of 30,000 roasters. Look at beer. Beer, 300,000. Wine, over 1 million. Differentiation: 36 varietals in coffee. If you combine hop and barley, in beer you have more than 480 varietals. And in wine you have over 1,000 Different grapes. Differentiation leads— this is empirical— but leads to price increase. And the higher the price, consumer level, the higher the percentage of this price that we will pay to growers. So as you can see, the price of coffee is around $2.50, $3, whereas beer $5 or $7, and wine in the hospitality Around 10, 12 per glass. So why should wine be more expensive than coffee? Tell me. There is no reason why. And the other possible strategy— and I'm finished— vertical integration upward. I hardly can see any different strategy in terms of vertical integration than direct sourcing. I can hardly see big or small coffee company owning coffee plantations in producing countries. But through direct sourcing, you can do a lot. You can transfer knowledge, you can pay premiums, you can create loyalty, you can improve quality, you can have traceability, you can narrate the product to the consumer, and so on. This is really great. And downward, vertical integration could be an opportunity for producing countries. Some of them might start exporting roasted coffee, as they are already trying to do. And of course, for us in consuming countries, continue developing retails. So thank you very much and enjoy your nice conference.

That was Andrea Illy at Rico Symposium this past April. Remember to check out our show notes to find a link to the YouTube video of this talk and a link to the speaker bios on the Ricoh website. This has been an SCA podcast brought to you by the members of the Specialty Coffee Association and supported by Toddy. I'm Peter Giuliano. Thank you so much for listening. Talk to you next time.