9/19/2013 4:45 PM ET|
4 reasons you can't get a discount latte
The last time coffee prices were this low, General Motors had just filed for bankruptcy and Michael Jackson had just died. This drop won't be felt at the retail level.
The last time coffee prices were this low, General Motors (GM) had just filed for bankruptcy and Michael Jackson had just died.
Thanks to a good harvest this summer, U.S. warehouses are crammed with 734 million pounds of coffee beans. And rains in Brazil this week bode well for the crop that will be harvested next year.
But these record low prices are in commodity markets, not cafés. They relate to coffee in 132-pound bags, not the kind in grocery stores or grande-size cups. Odds are good the discounts won't trickle down to the retail level. Here's why:
The biggest retail coffee companies buy beans the same way airlines buy jet fuel, through a complex system of derivative contracts. For example, at the end of June, Starbucks (SBUX), a company with $808 million in profit for the first half of the year, had $835 million of coffee on hand and commitments to buy another $777 million of beans.
If they have hedged correctly, Starbucks and such competitors as Green Mountain Coffee Roasters (GMCR) are likely paying far more for beans right now than current market rates. That's the idea of hedging -- executives sacrifice the market dips to protect against the peaks.
No one likes to see coffee farmers starve, perhaps least of all public policymakers and elected officials who rely on the farmers for votes. That's why the government of Brazil -- where about one-third of the world's coffee comes from -- has started two programs to buy coffee beans and buttress prices. It's paying 8% to 20% more than growers currently receive.
No gain, no pain
People process financial losses differently than gains. Behavioral economists call it "loss aversion", and the general thesis is that the pain of losing $1 is greater than the joy of gaining $1. When it comes to coffee: The joy of a price cut would be brief and fleeting.
If the market turned and the coffee kings eventually had to raise prices, consumers would feel a much more jarring jolt. In other words, over the long term, customers would be more piqued than pleased.
This is why retailers love coupons; the practice lets them cut prices temporarily without having to raise them when the promotion is over.
It already happened (kind of)
Eventually the serious discount in coffee prices got too big to ignore. In April, benchmark coffee prices were roughly half what they were two years earlier. Consumers may not be very tuned into commodity markets, but that kind of drop was drawing attention. Correspondingly, J.M. Smucker (SJM), the company behind Folgers and bags of Dunkin' Donuts (DNKN), cut prices by about 6%, as did Kraft Foods (KRFT), which makes Maxwell House.
Starbucks responded by trimming its own coffee prices by 10 percent to 13%, but only on bags of beans in grocery stores. Starbucks knows there's little to be gained in giving discounts to customers already willing to pay way, way more for coffee from a barista. A few months later, after coffee continued to cool on commodity markets, Starbucks raised prices in its cafés by about 1%.
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