I wanted to give one last update in 2011 on my running commentary on the Commodity Price for arabica coffee. I have been predicting a drop in price all year and expected the price to approach $2.00 by the end of the year. As I type, the price is $2.2090 and pushing up against the resistance set up at $2.20. Time will tell when it breaks through and accelerates down, but the main reason for my post is to shed some light on the conditions within the BRIC nations (Brazil, Russia, India, China) who were credited early in the year by many "experts" as being the reason demand for arabica was exceeding supply. While I completely disagree with this characterization of their current influence (rather than their potential) I thought I should share some actual data which reduces even their potential impact on the price.
Year to Date, the BRIC nations economic vibrancy as expressed through their Equity Indexes have shrank by the following percentages:
Brazil: -18%
Russia: -23%
India: -23%
China: -18%
Given that discretionary consumption is fed by increases in wealth, and that the relative prosperity of those wealthy enough to invest surplus cash in equities has diminished in BRIC nations, the likelihood that coffee will be able to significantly increase market penetration under these conditions is doubtful. While I have read many experts and publications are predicting coffee will again test the $3.00 level, I'd be very happy to invest against that prediction based on current crop predictions and current consumption levels.
Monday, December 12, 2011
Monday, November 21, 2011
Peak Coffee and other BS
Recently there have been a couple of articles (and here)referencing Peter Bakers claim that we are on the cusp of exceeding our planets capacity for coffee production, or Peak Coffee. The term Peak Coffee itself is a nod to M. King Hubberts 1956 paper which suggested that man had discovered all of the oil reserves which were viable, and that mankind was inevitably destined to run out of fossil fuels before long. Of course, the notion of running out of something depends on the levels of consumption which are never fixed, and don't always rise. But coffee is a very different commodity than fossil fuels because it is a crop, and is replenished every year with some regularity.
Lending credence to the idea of Peak Coffee is distasteful and even this blog post gives it more attention than it deserves. For Peak Coffee to be even remotely possible in context the following must be true:
1. Coffee is grown and harvested at levels of efficiency so high as to be impossible to improve. Of course we know that coffee growing is notoriously inefficient, and massive gains in productivity are possible with even small changes in farming techniques.
2. All available land suitable for coffee growing is presently engaged in coffee production. As advances are made in understanding how to grow coffee in a truly sustainable way thanks to organizations such as Rainforest Alliance, more land for sensible, sustainable and productive coffee farms becomes viable
3. Coffee consumption is inelastic to price movements, and higher prices will not effect the volume required. Coffee prices are relatively inelastic, but consumers look for alternatives at prices rise beyond historical level, most often choosing lower cost options. Coffee has always been considered a loss leader in many retail chains feeding support to the elasticity argument
4. There are no improvements to be made through genetic modification of coffee. (Distasteful but a factor non the less) While this option is likely a nuclear option, if sustained prices and increasing demand were not compensated for by other advances, this would be explored
5. The demand curve volume for coffee will be fed by developing nations who have yet to discover coffee as a beverage, but will eventually overwhelm the marketplace. This is predicated on the assumption that consumers in developing nations consumption habits are particularly inelastic to high prices. Coffee is not tobacco, and overcoming cultural preferences is more difficult than we are being led to believe.
6. Consumption growth in the Specialty Coffee segment has no ceiling, and will surpass commodity coffee in commercial importance. Of course Specialty Coffee can be proud of being the fastest growing segment, as did Fair Trade at one point in recent history. But Fair Trade has never achieved wide acceptance even in markets highly sympathetic to Fair Trade such as The Netherlands and there is no reason to believe that Specialty Coffee will enjoy better results. The idea that Specialty Coffee is somehow impervious to price spikes over the long run is foolish and dismissive of the power and influence of the large commodity operators. Even taking wildly inflated figures of 20% of all coffee sold being Specialty Grade, commodity speculators could quite easily commoditize the Specialty Grade trade by purchasing in quantity should stocks somehow approach Peak. For example: If ALL Specialty Grade coffee in the world were to be commoditized, assuming it represents 20% of production, it would only move the commodity price by: ($2.35x.8)+(4.7x.2)=$2.84 or an increase of $0.47 per pound using todays close.(I am assuming a Specialty Grade Price 2x the "C" which is generous on average)
There is much to be said for the possible negative impact of climate change on harvest yields, but it is all speculation and statistically inconsequential on a macro level to date. Equally, there is much to be said about the impact of the possibility of capital markets freezing in Europe reducing liquidity in the commodity trades and increasing the spreads. I think it fair to say that financial markets and currency factors have moved the coffee market far more often than harvest or weather events in the past 2 years. For now, lets put the words Peak Coffee out of our lexicon, and stick with variables which are within the realm of the reasonable.
Lending credence to the idea of Peak Coffee is distasteful and even this blog post gives it more attention than it deserves. For Peak Coffee to be even remotely possible in context the following must be true:
1. Coffee is grown and harvested at levels of efficiency so high as to be impossible to improve. Of course we know that coffee growing is notoriously inefficient, and massive gains in productivity are possible with even small changes in farming techniques.
2. All available land suitable for coffee growing is presently engaged in coffee production. As advances are made in understanding how to grow coffee in a truly sustainable way thanks to organizations such as Rainforest Alliance, more land for sensible, sustainable and productive coffee farms becomes viable
3. Coffee consumption is inelastic to price movements, and higher prices will not effect the volume required. Coffee prices are relatively inelastic, but consumers look for alternatives at prices rise beyond historical level, most often choosing lower cost options. Coffee has always been considered a loss leader in many retail chains feeding support to the elasticity argument
4. There are no improvements to be made through genetic modification of coffee. (Distasteful but a factor non the less) While this option is likely a nuclear option, if sustained prices and increasing demand were not compensated for by other advances, this would be explored
5. The demand curve volume for coffee will be fed by developing nations who have yet to discover coffee as a beverage, but will eventually overwhelm the marketplace. This is predicated on the assumption that consumers in developing nations consumption habits are particularly inelastic to high prices. Coffee is not tobacco, and overcoming cultural preferences is more difficult than we are being led to believe.
6. Consumption growth in the Specialty Coffee segment has no ceiling, and will surpass commodity coffee in commercial importance. Of course Specialty Coffee can be proud of being the fastest growing segment, as did Fair Trade at one point in recent history. But Fair Trade has never achieved wide acceptance even in markets highly sympathetic to Fair Trade such as The Netherlands and there is no reason to believe that Specialty Coffee will enjoy better results. The idea that Specialty Coffee is somehow impervious to price spikes over the long run is foolish and dismissive of the power and influence of the large commodity operators. Even taking wildly inflated figures of 20% of all coffee sold being Specialty Grade, commodity speculators could quite easily commoditize the Specialty Grade trade by purchasing in quantity should stocks somehow approach Peak. For example: If ALL Specialty Grade coffee in the world were to be commoditized, assuming it represents 20% of production, it would only move the commodity price by: ($2.35x.8)+(4.7x.2)=$2.84 or an increase of $0.47 per pound using todays close.(I am assuming a Specialty Grade Price 2x the "C" which is generous on average)
There is much to be said for the possible negative impact of climate change on harvest yields, but it is all speculation and statistically inconsequential on a macro level to date. Equally, there is much to be said about the impact of the possibility of capital markets freezing in Europe reducing liquidity in the commodity trades and increasing the spreads. I think it fair to say that financial markets and currency factors have moved the coffee market far more often than harvest or weather events in the past 2 years. For now, lets put the words Peak Coffee out of our lexicon, and stick with variables which are within the realm of the reasonable.
Friday, September 16, 2011
Trading Coffee Options Part II
Identifying a "strike" price for your option is a fairly simple process of asking your broker for all of the price variations relative to expiry dates. The strike price can be thought of as a derivative of the volatility and probability relating to the "C".
The costs attached to purchasing options are affected by the amount of liquidity in the market (for coffee the liquidity is low and therefore expensive), the time period related to the contract, and the price volatility (volatility increases the price of the option).
Liquidity or lack of liquidity means the amount of active open interest in a series of option contracts. In practical terms, if you are offering something for sale and there aren't many buyers, the "spread" between the asking price and the bid price increases. This is important in situations where you may want to sell a position quickly and be forced to take a lower price than you paid because of a lack of buyers. This type of loss is referred to as "slippage", or the loss taken on the gap between bid and ask on a quick transaction. Conversely, as the price moves either up or down such that it approaches in the money, the spread between bid and ask narrows as interest spikes. Purchasing options on the "C" may be less attractive due to the fact that there is relatively low open interest in coffee options contracts and the price premium for many is unattractive.
Determining the value or cost of time attached to an option is as simple as identifying options with the same strike price, but different expiration dates and recording the value of the extra time. The more time left on the option, the more time for move to occur to put it in the money, the more expensive the option price is.
Volatility or conversely price stability affect the prices of options as well. Price movements which routinely alter the price of the contract in and out of the money, sometimes several times during the period of the contract, will be much more expensive than options on commodities or shares with stable pricing. Lately coffee has experienced some pretty wild fluctuations in relatively short periods of time and therefore the time premium can be expensive in these situations. Currently, the price premium on a coffee contract costs a premium of $0.10 over/under the "c" with a November expiry. For a $37,500 lb contract, the option will cost approximatley $3,750 before you get in the money. This contract works if we are confident that the price for coffee will either increase or decrease more than 10 cents per pound over the next 8 weeks or so.
Remember, as the contract approaches the expiration date, the value of the contract decreases if it is not in the money with each day. The key when trading options on goods with low open interest, high volatility is to stay on top of the pricing and get out of your position the moment you feel it is in the money with transaction costs plus your target premium. Also, with options, someone either wins or loses on every contract. With each option, there is always a counterparty who is betting the exact opposite of what you believe is going to happen will happen. Don't underestimate the intelligence of your counterparty!
I'll take a week and knock off another post on options trading, next time dealing with the process to place an actual order for purchase or sale.
The costs attached to purchasing options are affected by the amount of liquidity in the market (for coffee the liquidity is low and therefore expensive), the time period related to the contract, and the price volatility (volatility increases the price of the option).
Liquidity or lack of liquidity means the amount of active open interest in a series of option contracts. In practical terms, if you are offering something for sale and there aren't many buyers, the "spread" between the asking price and the bid price increases. This is important in situations where you may want to sell a position quickly and be forced to take a lower price than you paid because of a lack of buyers. This type of loss is referred to as "slippage", or the loss taken on the gap between bid and ask on a quick transaction. Conversely, as the price moves either up or down such that it approaches in the money, the spread between bid and ask narrows as interest spikes. Purchasing options on the "C" may be less attractive due to the fact that there is relatively low open interest in coffee options contracts and the price premium for many is unattractive.
Determining the value or cost of time attached to an option is as simple as identifying options with the same strike price, but different expiration dates and recording the value of the extra time. The more time left on the option, the more time for move to occur to put it in the money, the more expensive the option price is.
Volatility or conversely price stability affect the prices of options as well. Price movements which routinely alter the price of the contract in and out of the money, sometimes several times during the period of the contract, will be much more expensive than options on commodities or shares with stable pricing. Lately coffee has experienced some pretty wild fluctuations in relatively short periods of time and therefore the time premium can be expensive in these situations. Currently, the price premium on a coffee contract costs a premium of $0.10 over/under the "c" with a November expiry. For a $37,500 lb contract, the option will cost approximatley $3,750 before you get in the money. This contract works if we are confident that the price for coffee will either increase or decrease more than 10 cents per pound over the next 8 weeks or so.
Remember, as the contract approaches the expiration date, the value of the contract decreases if it is not in the money with each day. The key when trading options on goods with low open interest, high volatility is to stay on top of the pricing and get out of your position the moment you feel it is in the money with transaction costs plus your target premium. Also, with options, someone either wins or loses on every contract. With each option, there is always a counterparty who is betting the exact opposite of what you believe is going to happen will happen. Don't underestimate the intelligence of your counterparty!
I'll take a week and knock off another post on options trading, next time dealing with the process to place an actual order for purchase or sale.
Saturday, September 10, 2011
The Event
I'm feeling more than a little frustrated lately at the direction the Specialty Coffee Association of America is taking our industry. This post was inspired by a visit last week to our roastery by a Montreal based packaging equipment manufacturer who sang a familiar refrain, "we don't do SCAA anymore because it's not worth it and we're not welcome". This statement reminded me that last year in Houston I had the opportunity to chat with several attendees of the Specialty Coffee Association annual trade show dubbed "The Event". These folks I would characterize as long time members of the SCAA and exhibitors who purchase booth space on the trade show floor to display their products. Their opinions about the quality of the show for exhibitors was uniformly negative owing in their opinion to the SCAA's focus on "vanity hall" where baristas display various coffee preparation techniques in competition. Others suggested that entire categories of exhibitors were considering pulling out of the show due to the lack of support or respect for their segment of the industry. Others still were disappointed in the actual paid attendance once complimentary, exhibitor, attendees below decision maker level, etc numbers were removed. Finally in Houston, the competition area was physically removed from the trade show floor and served to pull attendees away from the paying exhibitors, making matters worse. I believe the fact that the SCAA has received "an offer it can't refuse" relating to the facility in Seattle, makes the revenue stream from exhibitors less a concern going forward and will lead to further alienation of trade floor businesses.
I have been attending SCAA shows for approximately 14 years, and have observed changes that, in my opinion, make the show less of a compelling event for some. Certainly the training available now through SCAA is exemplary and full credit goes to the Professional Development staff. The addition of a comprehensive Instructor Development Program, standardized lesson plan formats and guidelines and engaged volunteers makes this part of the organization stellar and reason alone to attend any SCAA trade show. However, for the business directors and decision makers with established business plans and formats, there are better options and events to direct your resources.
Years ago, every sector of the coffee business was welcome, exhibiting and in attendance. Packaging machinery and products in abundance, many more green coffee brokers, authors, photographers, Chain Stores and Micro Chains, Tin Suppliers, Mints, Candies, espresso and coffee equipment manufacturers to name a few. It is not lost on the allied members and manufacturers who sell to the industry that the voices that are amplified by the SCAA within it's own publications, in executive positions determining policy, and directing the distribution of SCAA resources are invested in promoting the competition barista and the micro lot roaster/importer as the "Face of the Industry". The failure to recognize that most Specialty Coffee customers do not purchase their coffee from competition inspired baristas, and a complete lack of recognition for operator (collective) excellence within the SCAA leaves me wondering how long the organization can exist with such a narrow focus on the individual.
The SCAA itself will deny any bias, and claim that all segments of the industry are welcome. While this may be their intention, in practice what happens is the equivalent of inviting everyone to your house party, but speaking a language that most of your guests don't understand, playing party games they don't know how to play, and making them pay for the beer and nachos. The people at your party who speak the language, and know the games have fun, but the rest of the party goers eventually leave if they feel snubbed, or are not able or interested to learn to play the games.
I have been attending SCAA shows for approximately 14 years, and have observed changes that, in my opinion, make the show less of a compelling event for some. Certainly the training available now through SCAA is exemplary and full credit goes to the Professional Development staff. The addition of a comprehensive Instructor Development Program, standardized lesson plan formats and guidelines and engaged volunteers makes this part of the organization stellar and reason alone to attend any SCAA trade show. However, for the business directors and decision makers with established business plans and formats, there are better options and events to direct your resources.
Years ago, every sector of the coffee business was welcome, exhibiting and in attendance. Packaging machinery and products in abundance, many more green coffee brokers, authors, photographers, Chain Stores and Micro Chains, Tin Suppliers, Mints, Candies, espresso and coffee equipment manufacturers to name a few. It is not lost on the allied members and manufacturers who sell to the industry that the voices that are amplified by the SCAA within it's own publications, in executive positions determining policy, and directing the distribution of SCAA resources are invested in promoting the competition barista and the micro lot roaster/importer as the "Face of the Industry". The failure to recognize that most Specialty Coffee customers do not purchase their coffee from competition inspired baristas, and a complete lack of recognition for operator (collective) excellence within the SCAA leaves me wondering how long the organization can exist with such a narrow focus on the individual.
The SCAA itself will deny any bias, and claim that all segments of the industry are welcome. While this may be their intention, in practice what happens is the equivalent of inviting everyone to your house party, but speaking a language that most of your guests don't understand, playing party games they don't know how to play, and making them pay for the beer and nachos. The people at your party who speak the language, and know the games have fun, but the rest of the party goers eventually leave if they feel snubbed, or are not able or interested to learn to play the games.
Thursday, August 25, 2011
Trading Coffee Options Contracts
Everyone who roasts, buys, sells, wholesales, pours or grinds coffee needs to have an understanding of the factors that drive the commodity price for coffee. I have posted several times on my predictions for the price of coffee by the end of the year, and the factors that will make those predictions happen. As I type, the "C" has appreciated approximately 18% since the credit downgrade of US debt, and the realization that the likelihood of another recession is increasing. European sovereign debt issues and the search for safe havens for capital have contributed to the appreciation of the commodity price for coffee. These factors were all identified in my earlier posts as game changers for the price to move down, but fear not, what goes up, goes down again. It is with this in mind that I wanted to start a series dedicated to profiting from the volatility of the coffee market, focusing on Options Trading. The reason I want to focus on Options Contracts rather than futures contracts, is that there is much less risk associated with Options, and no need to employ leverage. Options contracts are also very useful when there is a lot of volatility in the underlying commodity. Coffee has been a very volatile market for the past two years, and promises to continue for the foreseeable future. The upside of a well executed options contract is nearly unlimited, but the downside is limited to the purchase price of the Options Contract, therefore you'll never receive a margin call.
Coffee Options are contracts written based on the commodity price of coffee and whose price is derived from the underlying value of the market price. This type of instrument is a derivative.
There are two different types of options, Calls and Puts. And understanding of these terms is crucial to participating in Options trading.
Option Owner Rights:
Call Option holder has the right, but not the obligation, to purchase a specific number of future contracts at a set price (strike price).
Put Option holder have the right to sell, but not the obligation, to sell a specific number of future contracts at a set price (strike price).
Option Seller Rights:
Call Option holder has the obligation to sell a specific number of future contracts at a set price (strike price).
Put Option holders have the obligation to buy a specific number of future contracts at a set price (strike price).
*Selling a Call Option (Put Option) on a Contract you don't own (Naked Call/Put) obligates you to sell at predetermined price and exposes you to unlimited loses if the Commodity Price increases (decreases). Example: Selling a Naked Call Option with a strike price of $2.39, and the commodity price moves quickly to $2.70, you are obligated to sell a contract for $2.39 when you are forced to purchase the contract to cover at $2.70 resulting in approximately $11,000 loss on a single contract. This effectively saddles the Seller with the same downside potential as if you were shorting the contract.
The important thing to remember is that Option Sellers have obligations, Option Purchasers have Rights, but not obligations.
I would recommend purchasing Options rather than Selling (Creating) Contracts. Purchasing Options requires less investment, less downside, with equal upside.
If you expect the price of coffee to increase over the course of time that the contract is valid, you would purchase a Call Option, which becomes more valuable as the price increases.
If you expect the price of coffee to decrease of the course of time that the contract is valid, you would purchase a Put Option, which becomes more valuable as the price decreases.
Options expiration dates occur on the Saturday following the third Friday of each month, which effectively means you have until the third Friday to exercise your rights. I would not recommend trading out of a contract on the last day before expiration as the value of an options contract reduces as it approaches expiration. Exiting an Options Contract is as simple as calling your broker and supplying them with instructions to sell your Option, or exercise your rights.
What I've covered in this post is by no means sufficient to arm you with trading skills, but try to grasp and understand these terms and definitions and we'll expand the topic in a comprehensive way over the next few posts. Next time I'll cover identifying strike prices and costing break even points for Options Contracts using current market prices, and follow some hypothetical trades in real time.
Coffee Options are contracts written based on the commodity price of coffee and whose price is derived from the underlying value of the market price. This type of instrument is a derivative.
There are two different types of options, Calls and Puts. And understanding of these terms is crucial to participating in Options trading.
Option Owner Rights:
Call Option holder has the right, but not the obligation, to purchase a specific number of future contracts at a set price (strike price).
Put Option holder have the right to sell, but not the obligation, to sell a specific number of future contracts at a set price (strike price).
Option Seller Rights:
Call Option holder has the obligation to sell a specific number of future contracts at a set price (strike price).
Put Option holders have the obligation to buy a specific number of future contracts at a set price (strike price).
*Selling a Call Option (Put Option) on a Contract you don't own (Naked Call/Put) obligates you to sell at predetermined price and exposes you to unlimited loses if the Commodity Price increases (decreases). Example: Selling a Naked Call Option with a strike price of $2.39, and the commodity price moves quickly to $2.70, you are obligated to sell a contract for $2.39 when you are forced to purchase the contract to cover at $2.70 resulting in approximately $11,000 loss on a single contract. This effectively saddles the Seller with the same downside potential as if you were shorting the contract.
The important thing to remember is that Option Sellers have obligations, Option Purchasers have Rights, but not obligations.
I would recommend purchasing Options rather than Selling (Creating) Contracts. Purchasing Options requires less investment, less downside, with equal upside.
If you expect the price of coffee to increase over the course of time that the contract is valid, you would purchase a Call Option, which becomes more valuable as the price increases.
If you expect the price of coffee to decrease of the course of time that the contract is valid, you would purchase a Put Option, which becomes more valuable as the price decreases.
Options expiration dates occur on the Saturday following the third Friday of each month, which effectively means you have until the third Friday to exercise your rights. I would not recommend trading out of a contract on the last day before expiration as the value of an options contract reduces as it approaches expiration. Exiting an Options Contract is as simple as calling your broker and supplying them with instructions to sell your Option, or exercise your rights.
What I've covered in this post is by no means sufficient to arm you with trading skills, but try to grasp and understand these terms and definitions and we'll expand the topic in a comprehensive way over the next few posts. Next time I'll cover identifying strike prices and costing break even points for Options Contracts using current market prices, and follow some hypothetical trades in real time.
Friday, August 12, 2011
New Location Design Exercise
It's been a little while since I posted last. This is not due to any lack of interest or subject matter, but a family illness that has almost completely consumed my mental attention.
Rest assured I have a cranium filled with relevant topics that I hope will benefit anyone out there interested in starting their own coffee shop.
What I've decided to do is to let all of you in on the exact details involved in the design and build out of my company's new location. The space was chosen after many failed attempts at securing lease that met the following criteria:
1. Affordable Rent
2. Minimum 10 years term
3. Geographically removed from our existing locations so as not to cannibalize sales
4. Located in what is to referred to as "downtown" in my city
5. A corner or equivalent location of high visibility and traffic
6. Existing interior features that would be attractive to customers
7. The possibility of fully operational windows to permit an indoor/outdoor feeling
8. A reputable landlord who cares for their buildings and chooses their tenants carefully
9. Minimum 800 square feet, maximum 1500 square feet.
10. Suitable masthead to accomodate visible outdoor signage
The space we chose is directly across from the oldest continually operating outdoor market in Canada, which serves as an outdoor skating rink in the winter. The square is also home to antique markets, concerts, outdoor movie nights, buskers, water fountain, Christmas tree in Winter and city provided free cafe tables. It is one block from the waterfront, and directly behind our historic City Hall which served as Canada's first capital. The location is not a corner, but the open space across the street permits broad visibility and prominence.
In addition to these features, the interior space has 14' ceilings, exposed brick on one wall, and exposed limestone on the other. The front of the building will be re-pointed this fall, and new operational windows and doors installed that meet strict historical standards enforced in our city.
I have included a JPEG of the layout of the raw space listed as "322" on the drawing, and am encouraging readers to copy the image and sketch out their own versions of what they think the space should look like. Each attempt should include 2 washrooms, seating for at least 20, a service counter (cash and espresso bar). The dividing wall between 318 and 322 is exposed red brick, and the angled wall is exposed limestone. The front windows swing in to open.
Have fun and please respond with your designs in the comments. Don't worry about doing anything overly technical, just draw on it, scan it, and submit it. I hope some of the submissions will spark interesting debate, and will ultimately end up in the finished drawings. As we progress I will produce an equipment list, and budget that will adhere as close to possible to my 50 Grand Business Plan. Impossible you say! Well let's see.
Tuesday, May 31, 2011
Structuring the Sale of a Company
I wanted to create a quick and timely post to fill in some blanks about how a company might structure an investment from say, a Private Equity Fund. Reading my description of a Balance Sheet may help.
First, let's assume that if you are large enough to attract the attention of a PE Fund, then you are already Incorporated with an existing Share Structure. This Share Structure typically has two classes of shares, Common and Preferred. Common Shares are voting shares and usually where the value of a company is reflected as price per share.
Preferred Shares are non voting shares, but in some instances (especially involving outside investors) can contain all of the company value in the form of asset backed interest bearing shares that must be paid before any dividends are paid to common shareholders.
If a PE Fund wanted to invest in an existing incorporated coffee company, they would set up a separate corporation with a common share structure that reflects the final ownership percentage. The fixed assets of the original corporation would be held within this company as security to offset the cash investment of the PE. For example, if the ownership is 50/50, and the value of the company is determined to be $1,000,000 and the PE fund wanted to invest a further $1,000,000 , the common shares would be split 50/50, and the preferred shares would be set up so the cash infusion of $1,000,000 would be offset by a balance sheet entry of equal Preferred Share Value, and the Fixed Assets brought into the new corporation would also be offset by $1,000,000 balance sheet entry of Preferred Shares.
If the PE fund wanted to invest more than the value of the company, but the existing owner didn't want to give up more than 50% ownership, the common shares could still be distributed 50/50, but the PE fund could have more (even all) Preferred Shares. The value of the Preferred Shares would be secured by the balance sheet assets and a Shareholder Agreement drawn up to protect the investment by precluding dividends until Preferred Shares are converted to Treasury Shares or retired. The original owner could also completely cash out the value of the original company balance sheet by selling the assets to the PE fund, and the transaction reflected by placing the whole value in Preferred Shares owned by the PE fund. The common shares could still be distributed 50/50. In this instance, the PE fund may also have provisions written into a Shareholder Agreement that would permit the conversion of Preferred Shares into Common Shares if some "triggering" event should occur. Last, some investors may look to have a "shotgun" clause written into a deal which permits either party to submit an offer to purchase the other party's shares which must either be acted upon, or the recipient of the offer becomes compelled to purchase the other party's shares under the same terms that were offered.
Believe me, the Devil in any deal is in the details. No matter what anyone says, only the parties involved actually would know how any deal is structured, but more often than not, the stroke of a pen leads to unintended consequences.
First, let's assume that if you are large enough to attract the attention of a PE Fund, then you are already Incorporated with an existing Share Structure. This Share Structure typically has two classes of shares, Common and Preferred. Common Shares are voting shares and usually where the value of a company is reflected as price per share.
Preferred Shares are non voting shares, but in some instances (especially involving outside investors) can contain all of the company value in the form of asset backed interest bearing shares that must be paid before any dividends are paid to common shareholders.
If a PE Fund wanted to invest in an existing incorporated coffee company, they would set up a separate corporation with a common share structure that reflects the final ownership percentage. The fixed assets of the original corporation would be held within this company as security to offset the cash investment of the PE. For example, if the ownership is 50/50, and the value of the company is determined to be $1,000,000 and the PE fund wanted to invest a further $1,000,000 , the common shares would be split 50/50, and the preferred shares would be set up so the cash infusion of $1,000,000 would be offset by a balance sheet entry of equal Preferred Share Value, and the Fixed Assets brought into the new corporation would also be offset by $1,000,000 balance sheet entry of Preferred Shares.
If the PE fund wanted to invest more than the value of the company, but the existing owner didn't want to give up more than 50% ownership, the common shares could still be distributed 50/50, but the PE fund could have more (even all) Preferred Shares. The value of the Preferred Shares would be secured by the balance sheet assets and a Shareholder Agreement drawn up to protect the investment by precluding dividends until Preferred Shares are converted to Treasury Shares or retired. The original owner could also completely cash out the value of the original company balance sheet by selling the assets to the PE fund, and the transaction reflected by placing the whole value in Preferred Shares owned by the PE fund. The common shares could still be distributed 50/50. In this instance, the PE fund may also have provisions written into a Shareholder Agreement that would permit the conversion of Preferred Shares into Common Shares if some "triggering" event should occur. Last, some investors may look to have a "shotgun" clause written into a deal which permits either party to submit an offer to purchase the other party's shares which must either be acted upon, or the recipient of the offer becomes compelled to purchase the other party's shares under the same terms that were offered.
Believe me, the Devil in any deal is in the details. No matter what anyone says, only the parties involved actually would know how any deal is structured, but more often than not, the stroke of a pen leads to unintended consequences.
Wednesday, May 25, 2011
10 Questions With BGA Chair Jason Dominy
Coffee Kings: You are very active in all areas of social networking and are a dogged promoter of Batdorf and Bronson, the BGA and manual brewing in and around the Atlanta area. To some it might seem that coffee IS your life. I know there’s a lot more to you than work. Tell me about the things in your life (family/friends/hobbies) that make working long hours easier.
Jason: I have to say that spending time with my wife is my favorite thing, and I mean that. She's really my best friend, and hanging out with her doing anything is pleasurable. I also own a MINI Cooper S, and we love taking rides in it, especially in the mountains on the curviest of roads, as fast as we can. We are members of a local MINI club, and do drives and scavenger hunts with them frequently. I also love playing disc golf, and do it every chance I get.
Coffee Kings: You’ve distinguished yourself among your peers for your skills, work ethic, knowledge and welcoming manner. Those are all skills that make not only great employees but also excellent owners. Do you have any aspirations for owning your own shop one day?
Jason: I started off in coffee by opening two coffee shops. I remember the amount of stress and challenges that came along with that, and I'm not interested in getting back into from that perspective. One of the great things about my position now, is that I take all of my coffee experience over the past 14 years, and use it to help others opening coffee businesses. Each one is a project with great consequences, so I take pride in helping them as best I can be successful in their coffee business utilizing the things I would be putting into practice as a shop owner myself.
Coffee Kings: I’ve been a little critical and skeptical about manual brewing, something you are deeply passionate about. Tell me about your participation in the US Brewers Cup Championship and whether you think it can achieve what the Barista Championships has relative to improving the quality of the products served across the industry.
Jason: I am a huge proponent of manual brewing for several reasons. One, I love the fact it brings back a level of focus and communication between the barista and the customer. Second, I love the taste of properly manually brewed coffee. Third, It's easy to do, and allows you to brew lots of different coffees quickly. I think currently there is alot more bad manually brewed coffee than there is good, but I know that you could say the same for espresso. And all we can do as coffee professionals is train as many fellow baristas as we can as how to properly brew it, and how extraction works.
As far as the Brewers Cup, I think it's a good start. I had some issues with how it went down in Houston in terms of judges calibration, but this was their first year, and for the first year, I thought it was done well. It's definitely a great launching point for a competition that could be really cool to see. I'm all about seeing baristas pushing each other to brew better coffee. I really do think it will encourage baristas to learn to brew better coffee. I think the challenge is that baristas don't understand exactly what the judges are looking for in a cup of coffee, what a Q grader is looking for. I know it will get better, and the organizers will take a look at what went well, and what needed improvements and make positive changes.
Coffee Kings: I know you’ve conducted some research about the level of income baristas around the country are achieving. What do you hope to do with the results and what is your opinion of the barista income in the USA?
Jason: I wanted to show that baristas wages are relatively the same across the US, and baristas can improve their wages by investing in themselves. I believe that baristas don't make enough for what they do, what they put up with, and how much time they invest into themselves and their career.
Coffee Kings: One of the things I think is an obstacle to growing the BGA into an influential entity within the industry is an impression that unless you compete or intend on competing, there is nothing for you within the BGA. How do you address the concerns of working baristas and make them feel as valued as competitors.
Jason: I have never competed in a barista competition. I have no desire to compete in one. At one point, I was the only Executive Council member who was not either a US Barista Champion, or at least a Regional Champion. The BGA has always been for me a guild for all baristas, not simply ones who compete. I've never noticed a focus on competitors, it's just that most of our logos and branding shows up around competitions. I do not agree that if you're not a competitor there's no value for you. Because there has been for me in all my time as a BGA member, and being able to be more active in shaping the BGA, and now becoming the chair, proves that point. At Camp Pull-A-Shot, there were tons of great baristas who are not competitors, taking advantage of just one aspect of what the BGA has to offer. The BGA is for ALL baristas, and shows no favoritism.
Coffee Kings: I’ve noticed over the past 4-5 years especially that there appears to be a segmentation of coffee companies with several being promoted as either the best, freshest, most exclusive, highest quality, hippest etc, etc. I seems to me that most of the praise is focused on a few, where there are literally dozens achieving the same quality without recognition. Is this phenomena concerning to you? Tell me about one or two excellent companies who deserve more attention.
Jason: I will agree that historically, the roasters who speak the loudest get heard the most. I will also agree that there are tons of great roasters all around the country that don't get tons of attention. I blogged about this just today. I think roasters that should get more attention are PT's Coffee, Klatch Coffee, and Kaldi's Coffee.
Coffee Kings: What is the participation rate of BGA members in the election process? Do you think the rate of participation harms the ability of the BGA executive to move the association in new directions?
Jason: We had great participation in the past election, some of the best we've had. We also posted up a survey that allowed us to hear from the membership on a larger level, and we have taken all of the feedback to heart, and are acting on it. I feel like we totally understand what our members are looking for in the BGA, and are working as hard as we can as volunteers with full-time jobs and multiple other involvements in the industry, to make it happen.
Coffee Kings: As an international member I can vote for executive positions within the BGA but not regional representatives. Are there any plans to create a seat for international representatives on the executive board in the future?
Jason: We have spoken about an international BGA rep, and have been working on creating that position, who it would be, and what that would look like.
Coffee Kings: You’ve been supportive of the Coffee Common initiative held at the TED Conference in Palm Springs, something I’m less enthusiastic of. I see the Coffee Common as something dismissive and harmful to the SCAA, tell me where I’m wrong.
Jason: "The rising tide floats all boats."
Coffee Kings: If you could pick one thing that you hope to accomplish this year on behalf of the BGA membership, what would it be and how can we all help to make it happen?
Jason: The things I'm most passionate about are:
making sure that baristas all over feel valued and appreciated, no matter who they work for, or where they live.
I want to see the Certification thrive, and baristas and shop owners see the value in it.
I want to see us value and appreciate all the work that has been done before us on the BGA, and recognize it.
I want to see baristas take better advantage of the education the SCAA offers.
I want to see Camp Pull-A-Shot a complete success again.
I want to see regions better represented under our current Regional Chapter Reps through a new council.
And what can you do to help make it happen? You can volunteer your time mentoring others, helping to create community coffee events, and working hard to make specialty coffee more viable and appreciated where you live.
Jason: I have to say that spending time with my wife is my favorite thing, and I mean that. She's really my best friend, and hanging out with her doing anything is pleasurable. I also own a MINI Cooper S, and we love taking rides in it, especially in the mountains on the curviest of roads, as fast as we can. We are members of a local MINI club, and do drives and scavenger hunts with them frequently. I also love playing disc golf, and do it every chance I get.
Coffee Kings: You’ve distinguished yourself among your peers for your skills, work ethic, knowledge and welcoming manner. Those are all skills that make not only great employees but also excellent owners. Do you have any aspirations for owning your own shop one day?
Jason: I started off in coffee by opening two coffee shops. I remember the amount of stress and challenges that came along with that, and I'm not interested in getting back into from that perspective. One of the great things about my position now, is that I take all of my coffee experience over the past 14 years, and use it to help others opening coffee businesses. Each one is a project with great consequences, so I take pride in helping them as best I can be successful in their coffee business utilizing the things I would be putting into practice as a shop owner myself.
Coffee Kings: I’ve been a little critical and skeptical about manual brewing, something you are deeply passionate about. Tell me about your participation in the US Brewers Cup Championship and whether you think it can achieve what the Barista Championships has relative to improving the quality of the products served across the industry.
Jason: I am a huge proponent of manual brewing for several reasons. One, I love the fact it brings back a level of focus and communication between the barista and the customer. Second, I love the taste of properly manually brewed coffee. Third, It's easy to do, and allows you to brew lots of different coffees quickly. I think currently there is alot more bad manually brewed coffee than there is good, but I know that you could say the same for espresso. And all we can do as coffee professionals is train as many fellow baristas as we can as how to properly brew it, and how extraction works.
As far as the Brewers Cup, I think it's a good start. I had some issues with how it went down in Houston in terms of judges calibration, but this was their first year, and for the first year, I thought it was done well. It's definitely a great launching point for a competition that could be really cool to see. I'm all about seeing baristas pushing each other to brew better coffee. I really do think it will encourage baristas to learn to brew better coffee. I think the challenge is that baristas don't understand exactly what the judges are looking for in a cup of coffee, what a Q grader is looking for. I know it will get better, and the organizers will take a look at what went well, and what needed improvements and make positive changes.
Coffee Kings: I know you’ve conducted some research about the level of income baristas around the country are achieving. What do you hope to do with the results and what is your opinion of the barista income in the USA?
Jason: I wanted to show that baristas wages are relatively the same across the US, and baristas can improve their wages by investing in themselves. I believe that baristas don't make enough for what they do, what they put up with, and how much time they invest into themselves and their career.
Coffee Kings: One of the things I think is an obstacle to growing the BGA into an influential entity within the industry is an impression that unless you compete or intend on competing, there is nothing for you within the BGA. How do you address the concerns of working baristas and make them feel as valued as competitors.
Jason: I have never competed in a barista competition. I have no desire to compete in one. At one point, I was the only Executive Council member who was not either a US Barista Champion, or at least a Regional Champion. The BGA has always been for me a guild for all baristas, not simply ones who compete. I've never noticed a focus on competitors, it's just that most of our logos and branding shows up around competitions. I do not agree that if you're not a competitor there's no value for you. Because there has been for me in all my time as a BGA member, and being able to be more active in shaping the BGA, and now becoming the chair, proves that point. At Camp Pull-A-Shot, there were tons of great baristas who are not competitors, taking advantage of just one aspect of what the BGA has to offer. The BGA is for ALL baristas, and shows no favoritism.
Coffee Kings: I’ve noticed over the past 4-5 years especially that there appears to be a segmentation of coffee companies with several being promoted as either the best, freshest, most exclusive, highest quality, hippest etc, etc. I seems to me that most of the praise is focused on a few, where there are literally dozens achieving the same quality without recognition. Is this phenomena concerning to you? Tell me about one or two excellent companies who deserve more attention.
Jason: I will agree that historically, the roasters who speak the loudest get heard the most. I will also agree that there are tons of great roasters all around the country that don't get tons of attention. I blogged about this just today. I think roasters that should get more attention are PT's Coffee, Klatch Coffee, and Kaldi's Coffee.
Coffee Kings: What is the participation rate of BGA members in the election process? Do you think the rate of participation harms the ability of the BGA executive to move the association in new directions?
Jason: We had great participation in the past election, some of the best we've had. We also posted up a survey that allowed us to hear from the membership on a larger level, and we have taken all of the feedback to heart, and are acting on it. I feel like we totally understand what our members are looking for in the BGA, and are working as hard as we can as volunteers with full-time jobs and multiple other involvements in the industry, to make it happen.
Coffee Kings: As an international member I can vote for executive positions within the BGA but not regional representatives. Are there any plans to create a seat for international representatives on the executive board in the future?
Jason: We have spoken about an international BGA rep, and have been working on creating that position, who it would be, and what that would look like.
Coffee Kings: You’ve been supportive of the Coffee Common initiative held at the TED Conference in Palm Springs, something I’m less enthusiastic of. I see the Coffee Common as something dismissive and harmful to the SCAA, tell me where I’m wrong.
Jason: "The rising tide floats all boats."
Coffee Kings: If you could pick one thing that you hope to accomplish this year on behalf of the BGA membership, what would it be and how can we all help to make it happen?
Jason: The things I'm most passionate about are:
making sure that baristas all over feel valued and appreciated, no matter who they work for, or where they live.
I want to see the Certification thrive, and baristas and shop owners see the value in it.
I want to see us value and appreciate all the work that has been done before us on the BGA, and recognize it.
I want to see baristas take better advantage of the education the SCAA offers.
I want to see Camp Pull-A-Shot a complete success again.
I want to see regions better represented under our current Regional Chapter Reps through a new council.
And what can you do to help make it happen? You can volunteer your time mentoring others, helping to create community coffee events, and working hard to make specialty coffee more viable and appreciated where you live.
Sunday, May 15, 2011
Dropping Off The Table
I can't think of another Macro Economic topic which affects our industry, from grower to consumer, more than the Commodity Price for coffee. I blogged earlier this year in support of the possibility that prices still had room to move up, and listed many reasons I believed contributed to increased prices. I feel that we touched the top of the market last week and that we will see a weakening of prices throughout the year. As part of an ongoing series of personal opinions and observations I want to express my belief that coffee prices are due to fall significantly this year for the following reasons.
1. The market price for coffee is to be viewed within the context of commodities in general. Commodities are an investment class which has been on a Bull Run for several years due in large part to the low returns to be had in bonds and notes and the devastation of the equity markets beginning in 2008. Commodities have attracted huge sums of speculative investors employing permissive leverage ratios to force the market up. Recently exchanges have increased the capital requirements for leveraged accounts, which will reduce the participation, thereby reducing the liquidity in the markets. Reduced liquidity means lower prices. The other thing about leverage is that while it is very lucrative in a contango market, when things go backwards, margin calls come in which necessitates selling. The more the price drops, the more margin calls, the more the price drops, the more margin calls...
2. Reports have been surfacing of brokers and exporters hoarding coffee at origin in an effort to keep prices high. While it is impossible to determine how much coffee is being hoarded, what I can predict is that when the hoarders start selling, they will all sell. More sellers than buyers moves the price down at an accelerated rate which feeds developing panic should things turn bad.
3. I perceive a disconnect between a natural price for Commodity Coffee, and the current price. Those of us who've been around the block a few times remember the spikes and valleys, but through the process gain an understanding of what price is a fair representation of the value of commodity coffee. That fair value is not $0.45 or $3.05, but somewhere in between. My guess, and it is a guess, is that an equilibrium price for coffee is approximately $2.00 per pound. In my view, this is not so high as to encourage new and inefficient participation, but not so low as to discourage participation. We can all find a price that feels right to them, but to me $3.05 is not it.
4. As I've blogged about in the past, the relative weakness of the US Dollar is responsible for at least 30% of the current "C" price. If the USD shows any real strength, (not a spike resulting from a flee from the euro) the commodities will drop very quickly. The USD has been weak since the government began printing money in an effort to provide needed liquidity once the credit markets seized. We already know the program referred to as Quantitative Easing will end in June of this year, reducing the money supply. When a government reduces the amount of currency circulating, the value of that currency rises, which is a bad thing for commodities. Also, North America currently has very low interest rates set by each government as a "Key Interest Rate". Those rates are one tool the Federal Reserve or in the case of Canada, the Bank of Canada, control economic activity. If the rates are low the Reserve thinks it needs to encourage economic activity. Moving the rates higher is a sign that activity is picking up and the Reserve needs to control activity by making it more expensive to finance things. The rates also are reflected in the Bonds issued by each government. When interest rates increase, the attractiveness of American Bonds increases making the USD rise. This is of course a very different situation from some Euro Countries that need to raise bond rates to encourage someone to buy them accounting for the risk of default. If the US Dollar index moves into more historical range as a result of any of these factors, the price for coffee will drop to close to the $2 level.
5. I may be wrong, but I think the market participation of the BRIC countries is overstated. Brazil, Russia, India and China are not doubt huge markets, but while they will need rare earths, raw materials and fuel to grow, coffee will need to destroy well entrenched cultural preferences to gain any traction. I understand that Brazil has made great efforts to increase coffee consumption which is intended to support a domestic industry, but there will be no similar efforts on the part Russia, India and China to alter beverage habits of their citizens. When markets like coffee increase unexpectedly it is easy to point the finger at the huge populations across the Pacific Ocean and expect the general public to accept it as plausible. I just don't believe it.
6. Coffee right now is not a good buy, it's a good trade. For the vast majority of participants buying a contract is a trade they expect to sell before taking delivery. In some particularly volatile sessions, traders hold a contract for less than an hour, and in some cases less than 5 minutes. These are the individuals setting the price, and when they feel the better trade is to short the market, that's the way it will move. Reduced liquidity resulting from margin calls will feed the fire.
For these reasons I think we can expect the "C" to find a level somewhere near $2 by the end of the year except in the case of unforeseen weather events. Time will tell if I'm right, but my feeling is when it starts to move down, it will drop off the table.
1. The market price for coffee is to be viewed within the context of commodities in general. Commodities are an investment class which has been on a Bull Run for several years due in large part to the low returns to be had in bonds and notes and the devastation of the equity markets beginning in 2008. Commodities have attracted huge sums of speculative investors employing permissive leverage ratios to force the market up. Recently exchanges have increased the capital requirements for leveraged accounts, which will reduce the participation, thereby reducing the liquidity in the markets. Reduced liquidity means lower prices. The other thing about leverage is that while it is very lucrative in a contango market, when things go backwards, margin calls come in which necessitates selling. The more the price drops, the more margin calls, the more the price drops, the more margin calls...
2. Reports have been surfacing of brokers and exporters hoarding coffee at origin in an effort to keep prices high. While it is impossible to determine how much coffee is being hoarded, what I can predict is that when the hoarders start selling, they will all sell. More sellers than buyers moves the price down at an accelerated rate which feeds developing panic should things turn bad.
3. I perceive a disconnect between a natural price for Commodity Coffee, and the current price. Those of us who've been around the block a few times remember the spikes and valleys, but through the process gain an understanding of what price is a fair representation of the value of commodity coffee. That fair value is not $0.45 or $3.05, but somewhere in between. My guess, and it is a guess, is that an equilibrium price for coffee is approximately $2.00 per pound. In my view, this is not so high as to encourage new and inefficient participation, but not so low as to discourage participation. We can all find a price that feels right to them, but to me $3.05 is not it.
4. As I've blogged about in the past, the relative weakness of the US Dollar is responsible for at least 30% of the current "C" price. If the USD shows any real strength, (not a spike resulting from a flee from the euro) the commodities will drop very quickly. The USD has been weak since the government began printing money in an effort to provide needed liquidity once the credit markets seized. We already know the program referred to as Quantitative Easing will end in June of this year, reducing the money supply. When a government reduces the amount of currency circulating, the value of that currency rises, which is a bad thing for commodities. Also, North America currently has very low interest rates set by each government as a "Key Interest Rate". Those rates are one tool the Federal Reserve or in the case of Canada, the Bank of Canada, control economic activity. If the rates are low the Reserve thinks it needs to encourage economic activity. Moving the rates higher is a sign that activity is picking up and the Reserve needs to control activity by making it more expensive to finance things. The rates also are reflected in the Bonds issued by each government. When interest rates increase, the attractiveness of American Bonds increases making the USD rise. This is of course a very different situation from some Euro Countries that need to raise bond rates to encourage someone to buy them accounting for the risk of default. If the US Dollar index moves into more historical range as a result of any of these factors, the price for coffee will drop to close to the $2 level.
5. I may be wrong, but I think the market participation of the BRIC countries is overstated. Brazil, Russia, India and China are not doubt huge markets, but while they will need rare earths, raw materials and fuel to grow, coffee will need to destroy well entrenched cultural preferences to gain any traction. I understand that Brazil has made great efforts to increase coffee consumption which is intended to support a domestic industry, but there will be no similar efforts on the part Russia, India and China to alter beverage habits of their citizens. When markets like coffee increase unexpectedly it is easy to point the finger at the huge populations across the Pacific Ocean and expect the general public to accept it as plausible. I just don't believe it.
6. Coffee right now is not a good buy, it's a good trade. For the vast majority of participants buying a contract is a trade they expect to sell before taking delivery. In some particularly volatile sessions, traders hold a contract for less than an hour, and in some cases less than 5 minutes. These are the individuals setting the price, and when they feel the better trade is to short the market, that's the way it will move. Reduced liquidity resulting from margin calls will feed the fire.
For these reasons I think we can expect the "C" to find a level somewhere near $2 by the end of the year except in the case of unforeseen weather events. Time will tell if I'm right, but my feeling is when it starts to move down, it will drop off the table.
Friday, April 29, 2011
Eleven Questions for Paul Stack of Marco
I have posted several times on the subjects of manual brewing and equipment purchasing as they apply to financial statements and profitability modelling. As a special feature heading into the Specialty Coffee Association of America annual trade show and conference in Houston Texas, I have posed some questions to Paul Stack of Marco located in Dublin Ireland. Marco is on the leading edge of technical innovations in hot water delivery systems suited to shops and roasters alike.
Coffeekings: Marco and Uber project may be something unknown to many in the North American coffee business. What core business was the company founded on?
Paul: Marco is 30 years old this year, which is surprising to some. The core business is the design and manufacture of hot water delivery systems for the food and beverage industry. This is embodied in the design and production of both hot water systems and automatic filter (drip) coffee machines. However we only sell hot water systems in North America for now.
Coffeekings: Innovation, research and development, and entrepreneurship are extremely challenging at the best of times. Do you perceive Marco in an R&D/building phase or approaching a marketing/management phase of the business cycle?
Paul: Both, to be honest. Innovation and R&D is incessant in Marco. It is our future. Parts of our business are very much on the marketing/management side but probably more so in the more traditional mature Marco markets.
Coffeekings: There are plenty of examples within the coffee industry that support the notion that great talent is attracted to great companies. Marco is also blessed with some knowledgeable and skilled staff. Tell me about some key staff and what they contribute to the company.
Paul: People are attracted to companies which will offer them an experience aligned with their own personal and professional ambitions. To be part of something they believe in. We have a lot of great people and I am loathe to single any out. An exception- Drewry Pearson, our Managing Director is something of a visionary and singular in the drive for innovative product offerings with an underlining belief in continuous education. We have very knowledgable and caring people looking after customer service including after sales care. To use sporting parlance, they play in a position to which they are suited. They give the business a solid spine. Our R&D team is a great mix of abilities from mech eng to software design to industrial design to innovation and research into market need. I could go on but it's a bit trumpet-blowing. In short, we have a good team.
Coffeekings: Ireland is undergoing a very challenging time for businesses and finance due largely to banking and real estate collapses. Describe for me the sentiment among Irish businesses regarding access to needed credit, availability of willing buyers for your products, and prospects for the future.
Paul: Ireland has been gorging in the greedy trough for too long and it's payback time. As always with these things, those who gorged and those who pay are misaligned. Established businesses like our own are lucky to have cash strength and a strong banking history, allowing us to continue to invest in our chosen strategic direction even in the face of market uncertainty and revenue dips in our home market in '09/'10. Newer companies with great opportunities are being hamstrung by the lack of credit available. Some banks in Ireland are money collection bureaux rather than financing institutions. Thus, the gears of Irish recovery are sticking as the lubricant that is fluid financial structures is lacking.The core economy in Ireland is strong. A stupid decision to make bank debt sovereign debt is the millstone we carry as a nation. For that, business sentiment is a mixture of simmering anger tinged with embarrassment as brand Ireland has taken a blow.
Coffeekings: Ireland is a touchstone for millions of Diaspora generations removed from the Island, and in many ways has always influenced the world well beyond their population. On my first visit I was struck by how advanced Bewleys on Grafton Street was compared to North American counterparts in terms of quality and traceability. To what do you credit the incredible depth of coffee talent in such a small population?
Paul: I'm not sure the coffee talent in Ireland is that deep, loud maybe...... Regarding coffee and Ireland, Patrick Bewley was at the forefront of a lot of what has become the Irish speciality coffee scene. He invested heavily in the SCAE, both personally and professionally. He was a founder member and is a past president of SCAE. In his own company he invested heavily in the training and education of his staff. Most of the coffee companies in Ireland with speciality leanings have either a founder or some of their team who is ex-Bewleys, including Marco. In the last five or so years Drewry Pearson has taken up the baton, more so from a patron viewpoint nationally while being at the forefront internationally, being a board member of the SCAE and WBC (now WCE). Nationally, he was the prodding stick behind 'internationalising' the Irish Coffee Championships, the SCAE Gold Cup and a strong education content in the Irish industry.
Coffeekings: I had been following the progress of Uber boiler online for some time before marveling in Anaheim at its beauty, advanced technology and logical solution to problems faced in manual brew methods. Please describe the problem it was designed to solve and some technological barriers to achieving success.
Paul: As most know, the Uber Boiler was the result of a one off project with a nascent London coffee company called Square Mile Coffee Roasters in 2008/2009, at the time comprising the impressive trio of James Hoffmann, Anette Moldvaer and Stephen Morrissey. Our challenge was to produce one under counter water delivery system with counter top font to deliver water to within 1 degree Celcius of a chosen temperature, which could pour directly onto a weighing platform. This would allow James et al cup coffees with accuracy allowing them highlight nuances. While we already had undercounter systems, their accuracy was approx +/-2.5C and there was no weighing platform. Tightening the accuracy was the key challenge. The rest was packaging and having a will to do it.
Coffeekings: Where are the uber boiler manufactured and how much time is required to take one from shop drawing to tabletop? Have you considered licensing the technology to larger manufacturers and focusing on marketing and distribution?
Paul: Uber Boilers are manufactured in our production facility in Dublin, about 7 miles from the city centre. We build four Ubers per run. Build time from punching steel to boxed Uber is 4 days. As the Uber Boiler is a constant work in progress I haven't considered licensing the technology. Is someone interested ?
Coffeekings: It seems to me that the past 5 years or so have become a period where companies are applying increasingly advanced technologies to address problems posed by increasingly simpler brewing techniques. One of the problems I see with manual brewing is the increased labour and wait time. How has the uberboiler addressed these problems?
Paul: It has and it hasn't. That's a bit Irish, eh? It has by giving the Barista a workstation from which (s)he need not move and can engage with a customer, thus maximising efficiencies and customer service. More importantly, it hasn't as it is not designed to decrease wait time. The ECOBOILER & ECOSMART series do that.
Coffeekings: The most visible elements of the high-end coffee market communicate at length about the subtle nuances and characteristics of their coffees cupping profiles. This sort of customer interaction can pay big dividends but only if the customer can distinguish the traits too. What about the uberboiler increases the chances of successfully brewing coffee to reveal the desired profiles.
Paul: Precision. At its heart is the UberBoiler's capability to allow the Barista change every brew variable, from coffee to water ratio (+/-0.5g) to contact time (+/-1s) to temperature (+/-0.1C) to turbulence (via flow rate and flow direction).
Coffeekings: Marketing and distribution are for me big black holes for profits and cash flow. What is the marketing strategy for Marco and how are you addressing distribution in North America?
Paul: Never a truer word spoken. We never targeted North America. The uber project dragged us there. It would have been too big a step for us to set up Marco USA when that opportunity presented. La Marzocco USA handle our brand and our product in North America, exclusively in the US. The alignment of both companies' brand positioning, strategic intent and vision coupled with the simple fact that we get on well made it an easy decision.
Coffeekings: One thing I like to repeat to staff is we don’t get to choose our customers, they choose you. Are there any customers using Marco’s products and services that surprise you by not fitting the target customer profile. Is anyone using the uber boiler for products other than coffee and do you market to any other industries?
Paul: It's a great question to which I am unsure how to answer. Our products are used widely in catering institutions where the need is often basic regarding brewing but crucial regarding reliability, ease of use and service. Cost of ownership and our products' energy-saving credentials are fast becoming as big a decision factor as the customary features of well-designed, well-made kit which do the job. Regarding Uber Boiler, it's main and happiest home is the cupping room or the Barista-driven brew bar. It is also used in gourmet tea shops.
Thursday, April 14, 2011
Ratios
I look at my P&L, Cash Flow and Balance Sheet almost daily out of habit, probably like a child checks to make sure their favourite toy is still on the shelf where they left it. This morning I noticed something out of whack after our bookkeeper made updating entries after some Green Bean purchases. Our ratios are off.
Normally my ratios are pretty close to the following: Cogs 40%, Labour 25%, G&A 20%, EBIDTA 15% with some minor seasonal changes resulting from the fact that I treat labour as a fixed cost since if we aren't busy, I don't send anyone home.
This morning my ratios showed: Cogs 51%, Labour 14%, G&A 13%, EBIDTA 22%.
So what's going on.
As most of you are experiencing first hand, green coffee prices have increased significantly and last years stock has pretty much been exhausted leading me to rely more on spot coffees which are carrying higher prices than last year's. In advance of this years bookings with the understanding that prices won't plummet any time soon I raised all prices across the board to accommodate the new reality. These two moves necessarily reduce the overall impact of labour and G&A while sometimes helping the bottom line. As I stated before, labour for me is considered fixed, therefore any price increase which doesn't reduce volume must make labour more productive and profit positive. Since we are increasing revenue without increasing traditional fixed costs such as rent, utilities, phone and legals other than what is predictable, those costs as a portion of sales are reduced.
While the exact impact of increased COGS and Prices cannot be known ahead of time, using a spreadsheet to quickly inject new costs and produce corresponding pricing is a great way to monitor profitability in a foolproof way. The spreadsheet I use employs fixed per pound costs which are adjusted semi annually to reflect increase/decreased G&A and labour. The inputs for COGS are changed almost weekly now, and once I push beyond a price by 5%, I make a change in our wholesale pricing. If you get nothing else from this post take this part to heart, look at your Financials every day and learn your own ratios. It is a great way to see trouble on the horizon well before anyone else notices.
Normally my ratios are pretty close to the following: Cogs 40%, Labour 25%, G&A 20%, EBIDTA 15% with some minor seasonal changes resulting from the fact that I treat labour as a fixed cost since if we aren't busy, I don't send anyone home.
This morning my ratios showed: Cogs 51%, Labour 14%, G&A 13%, EBIDTA 22%.
So what's going on.
As most of you are experiencing first hand, green coffee prices have increased significantly and last years stock has pretty much been exhausted leading me to rely more on spot coffees which are carrying higher prices than last year's. In advance of this years bookings with the understanding that prices won't plummet any time soon I raised all prices across the board to accommodate the new reality. These two moves necessarily reduce the overall impact of labour and G&A while sometimes helping the bottom line. As I stated before, labour for me is considered fixed, therefore any price increase which doesn't reduce volume must make labour more productive and profit positive. Since we are increasing revenue without increasing traditional fixed costs such as rent, utilities, phone and legals other than what is predictable, those costs as a portion of sales are reduced.
While the exact impact of increased COGS and Prices cannot be known ahead of time, using a spreadsheet to quickly inject new costs and produce corresponding pricing is a great way to monitor profitability in a foolproof way. The spreadsheet I use employs fixed per pound costs which are adjusted semi annually to reflect increase/decreased G&A and labour. The inputs for COGS are changed almost weekly now, and once I push beyond a price by 5%, I make a change in our wholesale pricing. If you get nothing else from this post take this part to heart, look at your Financials every day and learn your own ratios. It is a great way to see trouble on the horizon well before anyone else notices.
Friday, April 8, 2011
De-Linking with the "C" Part II
I've been thinking about my last post, and how the Specialty Coffee Industry might identify a baseline price for specialty grade coffee and de-link any association with the commodity price as established by the New York Mercantile Exchange.
The obstacles to creating a market where the grade can be established, and the price determined is perceptively prohibitive and would likely dissolve before any meaningful progress was made. So what if we established a system where we backed the price out from an industry average of price per pound sold at retail. (Ex: Specialty Grade Price 22.5% of average retail price) The average retail price would be fairly easy to establish with an online survey of selected industry participants selling specialty grade coffees. The retail price presumably is based upon the quality of the coffee, and therefore is not related to the vagaries of the commodity price and speculators. The elevated Specialty Grade posted price would provide immediate distinction between quality operators, and low grade supermarket brands by clearly displaying the price differential while still leaving room at the top to price super premium coffees. (Ex. Specialty Grade + $0.95) Establishing a Specialty Grade price would also remove the criticism often levelled at the industry when the disparity between the commodity and retail prices grow inexplicably large and we are forced to respond with figures relating to labour cost, rent, shipping and packaging as an excuse. A differential between Commodity and Specialty Grade prices would be a good story to tell in low market conditions and an opportunity to talk about why your local retailer is different.
I actually think this idea has some merit and needs to be considered by the industry under the umbrella of regional Specialty Coffee Associations. Obviously the weight of the calculations needs to be negotiated and agreed upon, the quality standards of the baseline green specialty grade needs to be established and a mechanism to track retail pricing, but these are pretty small details in relation to the hurt caused by fluctuating prices at the farm. Looking at the Commodity price right now, there's no urgency, but when the tide turns and we're all talking about low prices in a few years it will be too late for many of your favourite farms and their families.
The obstacles to creating a market where the grade can be established, and the price determined is perceptively prohibitive and would likely dissolve before any meaningful progress was made. So what if we established a system where we backed the price out from an industry average of price per pound sold at retail. (Ex: Specialty Grade Price 22.5% of average retail price) The average retail price would be fairly easy to establish with an online survey of selected industry participants selling specialty grade coffees. The retail price presumably is based upon the quality of the coffee, and therefore is not related to the vagaries of the commodity price and speculators. The elevated Specialty Grade posted price would provide immediate distinction between quality operators, and low grade supermarket brands by clearly displaying the price differential while still leaving room at the top to price super premium coffees. (Ex. Specialty Grade + $0.95) Establishing a Specialty Grade price would also remove the criticism often levelled at the industry when the disparity between the commodity and retail prices grow inexplicably large and we are forced to respond with figures relating to labour cost, rent, shipping and packaging as an excuse. A differential between Commodity and Specialty Grade prices would be a good story to tell in low market conditions and an opportunity to talk about why your local retailer is different.
I actually think this idea has some merit and needs to be considered by the industry under the umbrella of regional Specialty Coffee Associations. Obviously the weight of the calculations needs to be negotiated and agreed upon, the quality standards of the baseline green specialty grade needs to be established and a mechanism to track retail pricing, but these are pretty small details in relation to the hurt caused by fluctuating prices at the farm. Looking at the Commodity price right now, there's no urgency, but when the tide turns and we're all talking about low prices in a few years it will be too late for many of your favourite farms and their families.
Thursday, April 7, 2011
De-Linking with the "C"
Very recently I posted a piece describing how the Commodity Market for Coffee Traders functions as a backdrop to the recent historic highs reached a few weeks ago. One thing I hoped to make clear is the disconnect between those active in the commodity market and those of us consuming specialty coffee. Commodity traders employ leveraged margin accounts to "punch above their weight" and trade contracts exponentially larger than their investments without EVER taking delivery of a single pound of coffee. For these folks, trading coffee, sugar, oil or Swiss Francs is a way of making money, not securing a reliable supply of any of those goods. So why do we still buy and sell specialty coffee fixed off the "C" price?
I ask this question because it is relevant in not only a hot market, but one where the price is confusingly low. It is common to receive quotes for green specialty coffee priced "C" plus $0.75 or "C" plus $1.50 per pound but if the commodity price is fixed in a market controlled by speculative interests, the price will NEVER reflect the actual value to the end consumer. The current system of making a market for specialty coffee references baselines several steps removed from the true value depending on the motivation of the market participants.
The motivations of bidders in the commodity market for coffee is always the same no matter what season, time of year, harvest conditions, retail climate or weather conditions...profit. The market is set up for speculation and leverage which moves the market disproportionately to the amount of real dollars invested. (See my last post of the "C") Money flows into commodities when the yields on other asset classes are significantly lower, risk considered. Right now, purchasing commodities priced in USD, using foreign currency is a perfect hedge against a falling USD. The more the USD falls, the higher the commodities rise. These market movers have nothing to do with quality or consumption, just return on investment. Small moves downward like we've seen in the past week or so are reflective of end of quarter cash outs by large institutional investors, a normal seasonal dip related to coming Brazilian harvest figures, and inflation concerns which drives expectations of higher interest rates/yields on other investments.
So if the "C" is significantly influence by conditions unrelated to the price determinants of specialty grade coffee, why do we continue to reference it when pricing specialty grade coffee? The Cup of Excellence program has done wonders for creating a market for ultra premium coffees employing panels of cupping professionals and consistent criteria for judging plus an open auction. If we are as an industry seeking to improve our skills and offerings, shouldn't we also be moving towards de-commoditizing our pricing references and instead looking to price off a baseline specialty grade price. Creating a specialty grade pricing market would be too small for investors to participate but would reflect the factors we all want to positively influence, price, quality, growing conditions, social factors. I would think that the best way to elevate the condition of farmers in general is to provide an identifiable standard for specialty grade coffee and an active secondary market for it's products. Surely this is a model of democratizing the market for specialty coffee and eliminating the invisible hand with the brass knuckles we all know impacts our commodity prices. We all complained about the low commodity price for coffee, helped organize co-ops, joined Fair Trade, Coffee Kids, and Rainforest Alliance, but the institutional obstacles to fair and quality reflective pricing remained unchanged in the form of the commodity market.
I ask this question because it is relevant in not only a hot market, but one where the price is confusingly low. It is common to receive quotes for green specialty coffee priced "C" plus $0.75 or "C" plus $1.50 per pound but if the commodity price is fixed in a market controlled by speculative interests, the price will NEVER reflect the actual value to the end consumer. The current system of making a market for specialty coffee references baselines several steps removed from the true value depending on the motivation of the market participants.
The motivations of bidders in the commodity market for coffee is always the same no matter what season, time of year, harvest conditions, retail climate or weather conditions...profit. The market is set up for speculation and leverage which moves the market disproportionately to the amount of real dollars invested. (See my last post of the "C") Money flows into commodities when the yields on other asset classes are significantly lower, risk considered. Right now, purchasing commodities priced in USD, using foreign currency is a perfect hedge against a falling USD. The more the USD falls, the higher the commodities rise. These market movers have nothing to do with quality or consumption, just return on investment. Small moves downward like we've seen in the past week or so are reflective of end of quarter cash outs by large institutional investors, a normal seasonal dip related to coming Brazilian harvest figures, and inflation concerns which drives expectations of higher interest rates/yields on other investments.
So if the "C" is significantly influence by conditions unrelated to the price determinants of specialty grade coffee, why do we continue to reference it when pricing specialty grade coffee? The Cup of Excellence program has done wonders for creating a market for ultra premium coffees employing panels of cupping professionals and consistent criteria for judging plus an open auction. If we are as an industry seeking to improve our skills and offerings, shouldn't we also be moving towards de-commoditizing our pricing references and instead looking to price off a baseline specialty grade price. Creating a specialty grade pricing market would be too small for investors to participate but would reflect the factors we all want to positively influence, price, quality, growing conditions, social factors. I would think that the best way to elevate the condition of farmers in general is to provide an identifiable standard for specialty grade coffee and an active secondary market for it's products. Surely this is a model of democratizing the market for specialty coffee and eliminating the invisible hand with the brass knuckles we all know impacts our commodity prices. We all complained about the low commodity price for coffee, helped organize co-ops, joined Fair Trade, Coffee Kids, and Rainforest Alliance, but the institutional obstacles to fair and quality reflective pricing remained unchanged in the form of the commodity market.
Monday, March 28, 2011
Direct Trade: Who Gets the Upside?
The relationship between Roasters and Importers in Developed Countries and Growers has received plenty of review and critique. I don't want to dig too deeply into the social and environmental aspects of this relationship, but want to focus on an interesting idea that deserves consideration.
As we all know we are in a time of high green coffee prices and one would think this condition would provide fantastic cover for growers, but hot markets fed to a certain degree by speculative interests, can crash quickly if demand falls short of supply once new plantings begin producing in a year or so. In an effort to protect growers from catastrophic price shocks various schemes have been devised to provide a price floor. This price guarantee acts as a sort of crop insurance for growers who still must produce enough crop to cover production costs and G&A with the threat of ruin hidden in every weather forecast.
The price run up can also present problems for growers who may have sold early in the year, only to see the value of what they contracted increase wildly as experienced this year. This condition may encourage some to hold coffee off the market this year in the hope of higher prices, but like tulips and real estate, when there are no buyers, there's no market.
What I'm proposing for consideration is for interested direct traders to not only set a minimum price, but provide an upside for the grower should prices increase, eliminating for the grower the opportunity cost of selling early. (Opportunity Cost is the price difference between what was paid to the farmer, and what the farmer could have sold for later in the year if prices go up) This mechanism would also encourage farmers to sell instead of holding coffee off the market by providing the real chance of further revenue and zero chance of losing revenue. For all involved this would also provide more transparency and information in determining the actual amount of coffee available in any year by flushing out coffee being held back, also dampening the likelihood of significant price moves throughout the year. Essentially this would provide extra grower income should prices rise, while reducing the likelihood of significant price changes through greater transparency.
Roasters and Importers are in a much better position to adjust to higher prices by passing real per pound costs onto wholesale customers than are producers who's costs fluctuate vastly per pound harvested depending on yield. While this sort of scheme is anathema to all capitalist theory, any price scheme already offends those sensibilities. The form and function of this upside pricing scheme is something best determined by individual roasters and importers but is completely reasonable when considered alongside all of the factors and benefits we quote in support for direct trade.
I"m curious whether any roasters and importers are already using some sort of mechanism to provide extra revenue, and would be happy to learn the details.
Food for thought.
As we all know we are in a time of high green coffee prices and one would think this condition would provide fantastic cover for growers, but hot markets fed to a certain degree by speculative interests, can crash quickly if demand falls short of supply once new plantings begin producing in a year or so. In an effort to protect growers from catastrophic price shocks various schemes have been devised to provide a price floor. This price guarantee acts as a sort of crop insurance for growers who still must produce enough crop to cover production costs and G&A with the threat of ruin hidden in every weather forecast.
The price run up can also present problems for growers who may have sold early in the year, only to see the value of what they contracted increase wildly as experienced this year. This condition may encourage some to hold coffee off the market this year in the hope of higher prices, but like tulips and real estate, when there are no buyers, there's no market.
What I'm proposing for consideration is for interested direct traders to not only set a minimum price, but provide an upside for the grower should prices increase, eliminating for the grower the opportunity cost of selling early. (Opportunity Cost is the price difference between what was paid to the farmer, and what the farmer could have sold for later in the year if prices go up) This mechanism would also encourage farmers to sell instead of holding coffee off the market by providing the real chance of further revenue and zero chance of losing revenue. For all involved this would also provide more transparency and information in determining the actual amount of coffee available in any year by flushing out coffee being held back, also dampening the likelihood of significant price moves throughout the year. Essentially this would provide extra grower income should prices rise, while reducing the likelihood of significant price changes through greater transparency.
Roasters and Importers are in a much better position to adjust to higher prices by passing real per pound costs onto wholesale customers than are producers who's costs fluctuate vastly per pound harvested depending on yield. While this sort of scheme is anathema to all capitalist theory, any price scheme already offends those sensibilities. The form and function of this upside pricing scheme is something best determined by individual roasters and importers but is completely reasonable when considered alongside all of the factors and benefits we quote in support for direct trade.
I"m curious whether any roasters and importers are already using some sort of mechanism to provide extra revenue, and would be happy to learn the details.
Food for thought.
Saturday, March 19, 2011
Copycats
If you've been following my blog you've figured out that I'm highly skeptical of business models built on following the latest trends and having the latest equipment. I've included mild criticisms of manual brewing, $20,000 espresso machines and extravagant leasehold costs. While I haven't expressed it in my blog, I've been personally dismissive of some of the coffee luminaries written and blogged about, but now I think I'm wrong in directing the criticsm at them and not giving them enough credit.
I read all the time, every spare minute I can, always non-fiction and mostly business/finance related. I don't know how I've overlooked it but recently I started reading ReWork by Jason Fried and David Heinemeier Hansson, the founders of 37Signals. It is a spectacularly simple book filled with excellent advice that would benefit every business. The Chapter that inspired this post is called "Don't Copy". The chapter articulates beautifully what I've struggled to get across, that is the idea that copying someone else's work/ideas/business model is not only lazy, but dangerous because you don't need to understand anything to copy an idea. Skipping the knowledge/skills/understanding necessary to successfully model Intelligentsia, Square Mile or Stumptown and simply parroting their words and actions is dangerous and foolhardy. In addition, your business will always be playing catch up because you are never leading, always following and satisfying yourself by creating a lesser model of what you admire. I can think of a dozen companies that are modelling the leaders, but just aren't quite as good at convincing us they're in the same league. They may very well be as good or better at delivering excellence, it's just that perception is everything when you're trying to displace an incumbent.
Remember: Mud Flaps follow the Big Wheels
Instead, try to admire, learn from and most importantly understand what industry leaders are doing, but use it as inspiration to carve out your own space and be the best version of your business. That first and foremost means the most profitable version you can be. Spend your "coffee time" learning how to be rigorous in your management and application of sound business principles. If you are walking into Intelligentsia, taking mental notes and copying the menu boards on your iphone, to replicate in your hometown...you're dead. You are missing the 99% of the work behind what gets presented to the public. The back office.
Despite what is portrayed to the public, the guys making money for Intelli et al are not wearing vests and serving capps in black and white videos, they are costing, analyzing P&L statements and negotiating better deals from vendors. Even companies like Stumptown, Square Mile and Intelli will be displaced by new inspirational leaders and only sound management will keep them on top. Losing your "cool factor" is inevitable and truthfully beyond control, losing your profitability is completely within your control.
I read all the time, every spare minute I can, always non-fiction and mostly business/finance related. I don't know how I've overlooked it but recently I started reading ReWork by Jason Fried and David Heinemeier Hansson, the founders of 37Signals. It is a spectacularly simple book filled with excellent advice that would benefit every business. The Chapter that inspired this post is called "Don't Copy". The chapter articulates beautifully what I've struggled to get across, that is the idea that copying someone else's work/ideas/business model is not only lazy, but dangerous because you don't need to understand anything to copy an idea. Skipping the knowledge/skills/understanding necessary to successfully model Intelligentsia, Square Mile or Stumptown and simply parroting their words and actions is dangerous and foolhardy. In addition, your business will always be playing catch up because you are never leading, always following and satisfying yourself by creating a lesser model of what you admire. I can think of a dozen companies that are modelling the leaders, but just aren't quite as good at convincing us they're in the same league. They may very well be as good or better at delivering excellence, it's just that perception is everything when you're trying to displace an incumbent.
Remember: Mud Flaps follow the Big Wheels
Instead, try to admire, learn from and most importantly understand what industry leaders are doing, but use it as inspiration to carve out your own space and be the best version of your business. That first and foremost means the most profitable version you can be. Spend your "coffee time" learning how to be rigorous in your management and application of sound business principles. If you are walking into Intelligentsia, taking mental notes and copying the menu boards on your iphone, to replicate in your hometown...you're dead. You are missing the 99% of the work behind what gets presented to the public. The back office.
Despite what is portrayed to the public, the guys making money for Intelli et al are not wearing vests and serving capps in black and white videos, they are costing, analyzing P&L statements and negotiating better deals from vendors. Even companies like Stumptown, Square Mile and Intelli will be displaced by new inspirational leaders and only sound management will keep them on top. Losing your "cool factor" is inevitable and truthfully beyond control, losing your profitability is completely within your control.
Saturday, March 12, 2011
50 Grand Business Plan
This week, after a protracted search, I've managed to secure a lease for a 3rd location for my company's espresso bars. I've been giving out lots of advice on this blog, but you know the definition of a consultant right?...A guy who tells you how to do something he has never had the guts to risk a penny on himself. Well at least in order to be an actual consultant, I'd have to be overpaid so I'm in the clear because I'm free.
Some of my favourite espresso bars are sparse, filled with recycled, repurposed and vintage fixtures, built with lots of sweat and toil on a shoestring budget. I can think of one in Toronto called Sam James Coffee Pocket which makes me smile every time I think about it, stunningly simple, awesome. So what I've decided to do is build this location as if I was just starting out, new to the business and on a super tight budget. I'm going to disclose the details of the lease, post a budget, keep you all posted on progress with photos, and tell you when I screw up. I'm going to prove to all you out there that I can build a cafe for less than $50,000 and make it look awesome. The process will begin with some preliminary drawings, and budget development complete with equipment and material list. The goal is to stick to my budget, no exceptions. If I find that something has come in over budget, I will cut money in another area, all real life decisions new owners must have the discipline to make.
Why would I do this? I want to show all of you baristas sitting on the sidelines, or folks who are looking for a new career as an entrepreneur that you don't need to go into massive debt to make it happen. The measure of a great coffee shop or espresso bar is the quality of the products and people, not the fixtures and fittings. That being said, I expect to install pebbled limestone flooring, marble counters and oak cabinetry, nothing cheap. Some of the products will be recycled or repurposed, but all of it will be first class finishes when installed and approved by the local health unit of course.
I'll use the label "50 Grand Business Plan" on all posts related to what I've just described, because I still intend to post on other financial issues as they pop into my head.
Please ask any questions you like and I'll answer them a completely as I can. Good reading and get building!
Some of my favourite espresso bars are sparse, filled with recycled, repurposed and vintage fixtures, built with lots of sweat and toil on a shoestring budget. I can think of one in Toronto called Sam James Coffee Pocket which makes me smile every time I think about it, stunningly simple, awesome. So what I've decided to do is build this location as if I was just starting out, new to the business and on a super tight budget. I'm going to disclose the details of the lease, post a budget, keep you all posted on progress with photos, and tell you when I screw up. I'm going to prove to all you out there that I can build a cafe for less than $50,000 and make it look awesome. The process will begin with some preliminary drawings, and budget development complete with equipment and material list. The goal is to stick to my budget, no exceptions. If I find that something has come in over budget, I will cut money in another area, all real life decisions new owners must have the discipline to make.
Why would I do this? I want to show all of you baristas sitting on the sidelines, or folks who are looking for a new career as an entrepreneur that you don't need to go into massive debt to make it happen. The measure of a great coffee shop or espresso bar is the quality of the products and people, not the fixtures and fittings. That being said, I expect to install pebbled limestone flooring, marble counters and oak cabinetry, nothing cheap. Some of the products will be recycled or repurposed, but all of it will be first class finishes when installed and approved by the local health unit of course.
I'll use the label "50 Grand Business Plan" on all posts related to what I've just described, because I still intend to post on other financial issues as they pop into my head.
Please ask any questions you like and I'll answer them a completely as I can. Good reading and get building!
Thursday, March 10, 2011
The "C"
I am amazed at how little some coffee luminaries know about the "C", how it functions, the factors that impact it and what strategies are useful in protecting your company from price spikes. The "C" is the widely accepted commodity price for Arabica coffee sourced from any of 19 approved countries and traded as contracts on the New York Mercantile Exchange.
The extreme lows of the "C" experienced in the recent past caused an expansion of coffee consumption and the introduction into many new markets at very low costs. The low market price acted as a disincentive to growers to plant more crops and expand capacity. As consumption surpasses production, the price naturally rises. This is not a new story, but a fact of life when playing commodities.
There are many things that separately and concurrently effect price moves in the "C". Traditionally most feel that scarcity or supply concerns are the main market mover. If you listen to news reports or read blogs all the talk is about increased consumption in developing nations plus China, Russia and India. While this does have some impact, there are other things at play which are pushing coffee higher.
As the world struggles to exit from the great recession, every developed country has injected borrowed money into their economies to boost economic activity and employment. This, along with ridiculously low interest rates is the perceived magic bullet for most economies. The thing about super low interest rates is that anyone with money to invest is not looking to place it where they can expect 0.25% on bonds. The lack of interest in the American Bond market leads to the US dollar weakening...when no one wants to buy what you're selling you reduce the price.
The result of a lower USD is that all commodities get an instant bump every time the dollar drops because the commodities and the "C" are priced in USD. For fun just watch how the USD behaves against major currencies, and watch what happens to commodity prices on the same day.
Equity markets over the past decade have not performed in a rational way, with two extreme bubbles forming as a result of irrational exhuberance attached to tech companies in the 90's, and a housing bubble collapsing the market most recently. This has caused people with money to look for actual things to purchase, rather than stocks. Commodities are things that people don't need advanced degrees in math to figure out. They are things where prices behave in a rational way in reactions to real world inputs that you can read about and understand. When the weather in Brazil is bad, the price goes up. When there is trouble in the middle east oil supply chain, the price of oil increases. No accounting scandal is going to bring down the value of your investment in any commodity.
The thing with the "C" is almost no one actually takes delivery of coffee purchased on the market although the final settlement of the contract can result in delivery. The coffee is purchased as a contract with a set delivery date in the future. As the delivery date nears, it is normal for the purchaser to role the contract into a new one with the appropriate adjustments to the account made at the time of the rollover.
An individual can participate in the commodity market in one of several different ways including Non-discretionary account, a Managed Account or Commodity Pools. The important thing to understand is most participants have no intention of ever taking possession of coffee, they are simply trading futures in the hope of making profit.
FYI: There is another cost attached to commodity trading referred to as Contango. This is a universal term which encompasses storage, insurance, loss etc.
For coffee, a typical contract is 37500 lbs, or one container of coffee. A savvy investor in coffee would be required to only put down a small deposit on the value of the contract, typically 5%. If the "C" is trading at $2.75, the value of the contract is $103,125.00 and 5% of that is $5156.25. If the price moves up 10%, then the contract is now worth $113,437.50 , a profit of $10,312.50 on a small investment of $5156.25. This example clearly demonstrates the power of leverage in commodity trading is an incredible draw for those with discretionary dollars to invest. Conversely, if the price drops, the investor will receive a "margin call" requesting more money to cover the daily losses if the value of the contract has dropped more than 50% of the initial investment.
There are many factors which indicate to me that the price is not about to drop in any significant way in the near term.
1. The American Dollar is weak and getting weaker. Printing money always results in inflation and a devalued currency, both working against a reduction in the price of coffee. The US is not likely to increase interest rates (raising the USD) which would stifle any recovery.
2. Supply is something that can take up to 3 years to address. Trees planted this year, won't produce anything this year or next and so we are stuck with the supply we have, or less if there is a natural weather event.
3. Emerging economies are doing quite well, and those that are disengaged from the American market are doing even better. Any growth in coffee consumption in those countries is not likely to wane, and put more pressure on the "C".
4. Commodities as a group of investments are doing remarkably well, and yielding excellent returns for investors, something that encourages new participants. The excellent liquidity in the "C" also benefits more participants as contracts trade at high volumes with many eager buyers and sellers. The ability to apply leverage when trading coffee makes it an attractive play when there is still room to move up.
5. Total coffee consumption is relatively inelastic to price spikes on a macro level. The real pain will be felt on a store level where individual customers will make rational choices based on price and quality. As the price at your favourite shop increases, customers will search for strategies to reduce the impact either by reducing their numbers of visits, or choosing a slightly cheaper option with more perceived value.
6. As I stated in a previous post, compared to a classic hedge like Gold, coffee has actually lost about 38% of it's value over the past 10 years leaving a lot of room to move up.
I hope this provides a little information for all to consider. Remember, there are many things in play in the coffee market which are driving prices higher. Here is an excellent source for further information on trading commodities
The extreme lows of the "C" experienced in the recent past caused an expansion of coffee consumption and the introduction into many new markets at very low costs. The low market price acted as a disincentive to growers to plant more crops and expand capacity. As consumption surpasses production, the price naturally rises. This is not a new story, but a fact of life when playing commodities.
There are many things that separately and concurrently effect price moves in the "C". Traditionally most feel that scarcity or supply concerns are the main market mover. If you listen to news reports or read blogs all the talk is about increased consumption in developing nations plus China, Russia and India. While this does have some impact, there are other things at play which are pushing coffee higher.
As the world struggles to exit from the great recession, every developed country has injected borrowed money into their economies to boost economic activity and employment. This, along with ridiculously low interest rates is the perceived magic bullet for most economies. The thing about super low interest rates is that anyone with money to invest is not looking to place it where they can expect 0.25% on bonds. The lack of interest in the American Bond market leads to the US dollar weakening...when no one wants to buy what you're selling you reduce the price.
The result of a lower USD is that all commodities get an instant bump every time the dollar drops because the commodities and the "C" are priced in USD. For fun just watch how the USD behaves against major currencies, and watch what happens to commodity prices on the same day.
Equity markets over the past decade have not performed in a rational way, with two extreme bubbles forming as a result of irrational exhuberance attached to tech companies in the 90's, and a housing bubble collapsing the market most recently. This has caused people with money to look for actual things to purchase, rather than stocks. Commodities are things that people don't need advanced degrees in math to figure out. They are things where prices behave in a rational way in reactions to real world inputs that you can read about and understand. When the weather in Brazil is bad, the price goes up. When there is trouble in the middle east oil supply chain, the price of oil increases. No accounting scandal is going to bring down the value of your investment in any commodity.
The thing with the "C" is almost no one actually takes delivery of coffee purchased on the market although the final settlement of the contract can result in delivery. The coffee is purchased as a contract with a set delivery date in the future. As the delivery date nears, it is normal for the purchaser to role the contract into a new one with the appropriate adjustments to the account made at the time of the rollover.
An individual can participate in the commodity market in one of several different ways including Non-discretionary account, a Managed Account or Commodity Pools. The important thing to understand is most participants have no intention of ever taking possession of coffee, they are simply trading futures in the hope of making profit.
FYI: There is another cost attached to commodity trading referred to as Contango. This is a universal term which encompasses storage, insurance, loss etc.
For coffee, a typical contract is 37500 lbs, or one container of coffee. A savvy investor in coffee would be required to only put down a small deposit on the value of the contract, typically 5%. If the "C" is trading at $2.75, the value of the contract is $103,125.00 and 5% of that is $5156.25. If the price moves up 10%, then the contract is now worth $113,437.50 , a profit of $10,312.50 on a small investment of $5156.25. This example clearly demonstrates the power of leverage in commodity trading is an incredible draw for those with discretionary dollars to invest. Conversely, if the price drops, the investor will receive a "margin call" requesting more money to cover the daily losses if the value of the contract has dropped more than 50% of the initial investment.
There are many factors which indicate to me that the price is not about to drop in any significant way in the near term.
1. The American Dollar is weak and getting weaker. Printing money always results in inflation and a devalued currency, both working against a reduction in the price of coffee. The US is not likely to increase interest rates (raising the USD) which would stifle any recovery.
2. Supply is something that can take up to 3 years to address. Trees planted this year, won't produce anything this year or next and so we are stuck with the supply we have, or less if there is a natural weather event.
3. Emerging economies are doing quite well, and those that are disengaged from the American market are doing even better. Any growth in coffee consumption in those countries is not likely to wane, and put more pressure on the "C".
4. Commodities as a group of investments are doing remarkably well, and yielding excellent returns for investors, something that encourages new participants. The excellent liquidity in the "C" also benefits more participants as contracts trade at high volumes with many eager buyers and sellers. The ability to apply leverage when trading coffee makes it an attractive play when there is still room to move up.
5. Total coffee consumption is relatively inelastic to price spikes on a macro level. The real pain will be felt on a store level where individual customers will make rational choices based on price and quality. As the price at your favourite shop increases, customers will search for strategies to reduce the impact either by reducing their numbers of visits, or choosing a slightly cheaper option with more perceived value.
6. As I stated in a previous post, compared to a classic hedge like Gold, coffee has actually lost about 38% of it's value over the past 10 years leaving a lot of room to move up.
I hope this provides a little information for all to consider. Remember, there are many things in play in the coffee market which are driving prices higher. Here is an excellent source for further information on trading commodities
Tuesday, March 8, 2011
Raison D'etre
Raison d'etre is a french phrase which literally means "reason to be", or what do you want to be.
This is perhaps the most important question you can answer when deciding to start a coffee business. There are many different answers and motivations that all impact your decision making once your business is up and running. Admittedly I get focussed on financials, but I also run a business that roasts and serves Fair Trade Organic coffee, composts everything ourselves, sources our power from renewable resources, donates dollars and hours to many local charities and causes, and attempts to be responsible members of our community. I want to list some different motivations along with how that choice will impact your business going forward.
1. Passion: this term is perhaps the most overused word in coffee, which I typically reserve for teenaged girls dreaming of werewolves and vampires battling for their affection. For me passion implies a short attention span and a short career in coffee. Someone who describes themselves as passionate is likely looking to seek out the newest trends and adopt them quickly. This strategy will by necessity incur much higher training and capital costs and unless that is replaced with much higher sales, a lower profit margin. Try using LOVE instead of Passion. See how it fits? Love remains even when your business is a little saggy, needs improvement and even annoying. (Just ask a married person) You never give up on a love...ever! A company founded on a love of coffee in my mind is much more likely to endure the vagaries of the market, and will likely be seen by the owner as a long term life's work and not a passionate whim.
2. Sustainable: this term may be the second most overused word in coffee. It is usually applied to companies that are attempting to benefit community, farmers, employees, the environment and any other number of beneficiaries you can think of. As I mentioned in my prelude to this post, my company would probably fall quite easily into this category but with an important caveat...you can't be sustainable if your business is not financially sustainable. YOU CAN'T BE SUSTAINABLE IF YOU'RE NOT FINANCIALLY SUSTAINABLE! You can't help anyone if you're business is insolvent in a year.
3. Owning a coffee shop looks like fun!: Everyone who visits a cafe, (especially a great one) thinks they would love to own one just like it. There is something very appealing in picturing yourself in a pleasing, bustling environment, surrounded by intellectuals, students, film makers and musicians. The reality is that you don't get to choose your customers (my customers happen to fit the examples, good for me) they choose you. Cultivating a cafe culture requires countless hours of work, which is interrupted by plugged toilets, stock shortages, employee absenteeism, and lack lustre sales. If you think owning a coffee shop looks like fun and you have a passion for coffee, beware. Instead you'd be better off Loving coffee and thinking owning a coffee shop looks like a lot of work.
4. I want to teach people about great coffee: There are some incredibly knowledgeable folks out there who have a ridiculous amount of information bidding it's time inside their cranium, looking for an excuse to make an appearance. Giving, well meaning, awesome teachers, terrible business people. Unless your business IS teaching people about coffee in a classroom/lab area, this is a bad reason to start a coffee business. Here's a little anecdote to show you the pitfalls of taking on the role of single handedly changing your local market. Several years ago my company was supplying a local health food store with organic coffee. We tried to introduce CO2 Organic Decaf because I thought it tasted better than Swiss Water. The owner (not the brightest bulb) couldn't get it through his head that CO2 wasn't a chemical, but a gas that we expired about once every 10 seconds. Every time we delivered the CO2 Decaf, I would have the same conversation and he'd be grumpy. Then I came up with the perfect solution...I started selling him the Swiss Water that I thought didn't taste as good, and he was happy. There is an old saying in coffee that goes like this: Q How should I drink my coffee? A The way you like it. Guiding customers to make the better choice is a great strategy, telling them how to drink it is a terrible one.
5. I'm a great barista and I want to run my own shop: I happen to think all committed baristas should own their own shops. As a barista, you should be fully acquainted with the less than glamourous side of espresso, if not the paperwork side. You are one of the main reasons I'm taking the time to write this blog. While your skills behind the cash register and espresso machine may be impeccable, the money is made in the back office. Leverage your skills by attracting other quality baristas, and step back to learn the business side of cafes. Know your break even...cold. You should be able to recite your daily, weekly and monthly break evens, and massage your costs to yield desired results once your are familiar with your expected revenues. For goodness sake, take time to read my pointers on negotiating a lease, and managing your capital costs before you even consider writing a business plan. Remember Love, hard work, good intentions, community, education and skills all factor into a successful start up cafe.
This is perhaps the most important question you can answer when deciding to start a coffee business. There are many different answers and motivations that all impact your decision making once your business is up and running. Admittedly I get focussed on financials, but I also run a business that roasts and serves Fair Trade Organic coffee, composts everything ourselves, sources our power from renewable resources, donates dollars and hours to many local charities and causes, and attempts to be responsible members of our community. I want to list some different motivations along with how that choice will impact your business going forward.
1. Passion: this term is perhaps the most overused word in coffee, which I typically reserve for teenaged girls dreaming of werewolves and vampires battling for their affection. For me passion implies a short attention span and a short career in coffee. Someone who describes themselves as passionate is likely looking to seek out the newest trends and adopt them quickly. This strategy will by necessity incur much higher training and capital costs and unless that is replaced with much higher sales, a lower profit margin. Try using LOVE instead of Passion. See how it fits? Love remains even when your business is a little saggy, needs improvement and even annoying. (Just ask a married person) You never give up on a love...ever! A company founded on a love of coffee in my mind is much more likely to endure the vagaries of the market, and will likely be seen by the owner as a long term life's work and not a passionate whim.
2. Sustainable: this term may be the second most overused word in coffee. It is usually applied to companies that are attempting to benefit community, farmers, employees, the environment and any other number of beneficiaries you can think of. As I mentioned in my prelude to this post, my company would probably fall quite easily into this category but with an important caveat...you can't be sustainable if your business is not financially sustainable. YOU CAN'T BE SUSTAINABLE IF YOU'RE NOT FINANCIALLY SUSTAINABLE! You can't help anyone if you're business is insolvent in a year.
3. Owning a coffee shop looks like fun!: Everyone who visits a cafe, (especially a great one) thinks they would love to own one just like it. There is something very appealing in picturing yourself in a pleasing, bustling environment, surrounded by intellectuals, students, film makers and musicians. The reality is that you don't get to choose your customers (my customers happen to fit the examples, good for me) they choose you. Cultivating a cafe culture requires countless hours of work, which is interrupted by plugged toilets, stock shortages, employee absenteeism, and lack lustre sales. If you think owning a coffee shop looks like fun and you have a passion for coffee, beware. Instead you'd be better off Loving coffee and thinking owning a coffee shop looks like a lot of work.
4. I want to teach people about great coffee: There are some incredibly knowledgeable folks out there who have a ridiculous amount of information bidding it's time inside their cranium, looking for an excuse to make an appearance. Giving, well meaning, awesome teachers, terrible business people. Unless your business IS teaching people about coffee in a classroom/lab area, this is a bad reason to start a coffee business. Here's a little anecdote to show you the pitfalls of taking on the role of single handedly changing your local market. Several years ago my company was supplying a local health food store with organic coffee. We tried to introduce CO2 Organic Decaf because I thought it tasted better than Swiss Water. The owner (not the brightest bulb) couldn't get it through his head that CO2 wasn't a chemical, but a gas that we expired about once every 10 seconds. Every time we delivered the CO2 Decaf, I would have the same conversation and he'd be grumpy. Then I came up with the perfect solution...I started selling him the Swiss Water that I thought didn't taste as good, and he was happy. There is an old saying in coffee that goes like this: Q How should I drink my coffee? A The way you like it. Guiding customers to make the better choice is a great strategy, telling them how to drink it is a terrible one.
5. I'm a great barista and I want to run my own shop: I happen to think all committed baristas should own their own shops. As a barista, you should be fully acquainted with the less than glamourous side of espresso, if not the paperwork side. You are one of the main reasons I'm taking the time to write this blog. While your skills behind the cash register and espresso machine may be impeccable, the money is made in the back office. Leverage your skills by attracting other quality baristas, and step back to learn the business side of cafes. Know your break even...cold. You should be able to recite your daily, weekly and monthly break evens, and massage your costs to yield desired results once your are familiar with your expected revenues. For goodness sake, take time to read my pointers on negotiating a lease, and managing your capital costs before you even consider writing a business plan. Remember Love, hard work, good intentions, community, education and skills all factor into a successful start up cafe.
Monday, March 7, 2011
Coffee Pricing Part II
I wanted to add an interesting update to provide some context for the current coffee market price.
In my last post I indicated that the differentiation between the coffee price valued in USD, and that of Canadian and Euro was the effect that a weak American dollar had on the market. Certainly there has been an increase in the "C", but at least 30% of that can be attributed to the fact that the "C" is valued in USD.
As an interesting bit of information, I've figured out the Price of Coffee in Gold for each of the time periods, to determine how coffee has performed against the standard measure of hedged value versus world currencies.
In 2001, one ounce of gold equalled 376.53 lbs of coffee.
In 2005, one ounce of gold equalled 365.60 lbs of coffee.
In 2010, one ounce of gold equalled 496.24 lbs of coffee.
Today, one ounce of gold equals 518.10 lbs of coffee.
From 2001 to present, the price of coffee stated in terms of gold has fallen 38%. Even at the extreme low price of 2001, coffee was worth more in real value, than it is today at relatively high priced "C".
This is relevant because Gold is perceived to be the measure of secure wealth in the world. Currencies pre-1971 were backed up by vaults filled with the stuff as security against the value of the dollar. The US no longer holds near enough gold to guarantee it's currency value, and instead issues promises to pay. Recent events has made those promises increasingly suspect, which makes gold more valuable versus a declining USD. Pricing coffee versus Gold clearly shows us that although the price is relatively high versus USD, against a standard measure of value like gold, it has actually lost value in the past 10 years, even when comparing a $0.71 market of 2001 to today's $2.76.
In my last post I indicated that the differentiation between the coffee price valued in USD, and that of Canadian and Euro was the effect that a weak American dollar had on the market. Certainly there has been an increase in the "C", but at least 30% of that can be attributed to the fact that the "C" is valued in USD.
As an interesting bit of information, I've figured out the Price of Coffee in Gold for each of the time periods, to determine how coffee has performed against the standard measure of hedged value versus world currencies.
In 2001, one ounce of gold equalled 376.53 lbs of coffee.
In 2005, one ounce of gold equalled 365.60 lbs of coffee.
In 2010, one ounce of gold equalled 496.24 lbs of coffee.
Today, one ounce of gold equals 518.10 lbs of coffee.
From 2001 to present, the price of coffee stated in terms of gold has fallen 38%. Even at the extreme low price of 2001, coffee was worth more in real value, than it is today at relatively high priced "C".
This is relevant because Gold is perceived to be the measure of secure wealth in the world. Currencies pre-1971 were backed up by vaults filled with the stuff as security against the value of the dollar. The US no longer holds near enough gold to guarantee it's currency value, and instead issues promises to pay. Recent events has made those promises increasingly suspect, which makes gold more valuable versus a declining USD. Pricing coffee versus Gold clearly shows us that although the price is relatively high versus USD, against a standard measure of value like gold, it has actually lost value in the past 10 years, even when comparing a $0.71 market of 2001 to today's $2.76.
Thursday, March 3, 2011
Coffee "UN" Common
This is a little off my normal topics of finance and costing but no less relevant to my target reader. My target reader is a barista who wants to own their own shop one day, a family run shop trying to get better, the great majority of shops who serve great coffee every day but lack some technical knowledge, advice and resources to get them there.
For those of you who aren't aware, an association has been launched at the TED Conference in Palm Springs California where the self appointed "creme de la creme" of coffee invite each other to share a space and inform the attendees on how coffee should be experienced. Admittedly I have not witnessed this personally so judging the relative importance of what they are sharing is a mystery, but I believe it is safe to say it is less an educational exercise and more a self promotional one. *I'm sure there'll be a slick black and white video released soon that will shed more light for those of us not attending, so keep an eye out for it!
The reason this is relevant to my target reader is I want to warn you of the pitfalls of believing this is how you build a successful business and make money in coffee. Certainly there is an imperative to constantly draw attention to yourself when you compete for customers in London, Los Angeles or New York City, but not so much in middle America or Canada. Thinking that being part of a self congratulatory "security council" with a veto on who is relevant and who is dismissed will lead to distraction and ruin.
The blurring of lines between some SCAA/Barista Guild executives and the relentless self promotion is becoming hard to ignore, neither of which serve the community as a whole but alienate the supportive base of both organizations. Maybe an unintentional consequence, but a real sentiment felt by thousands of companies who are getting the message "you're not important", but renew anyway.
The main point I want to get across is that it's ok to be a great operator in rural Maine, middle Kansas or Winnepeg Manitoba. The value of what you are bringing to the Specialty Coffee Industry is relevant to all the companies like you, and you are managing to do it without alienating and diminishing your peers. Good on you!
For those of you who aren't aware, an association has been launched at the TED Conference in Palm Springs California where the self appointed "creme de la creme" of coffee invite each other to share a space and inform the attendees on how coffee should be experienced. Admittedly I have not witnessed this personally so judging the relative importance of what they are sharing is a mystery, but I believe it is safe to say it is less an educational exercise and more a self promotional one. *I'm sure there'll be a slick black and white video released soon that will shed more light for those of us not attending, so keep an eye out for it!
The reason this is relevant to my target reader is I want to warn you of the pitfalls of believing this is how you build a successful business and make money in coffee. Certainly there is an imperative to constantly draw attention to yourself when you compete for customers in London, Los Angeles or New York City, but not so much in middle America or Canada. Thinking that being part of a self congratulatory "security council" with a veto on who is relevant and who is dismissed will lead to distraction and ruin.
The blurring of lines between some SCAA/Barista Guild executives and the relentless self promotion is becoming hard to ignore, neither of which serve the community as a whole but alienate the supportive base of both organizations. Maybe an unintentional consequence, but a real sentiment felt by thousands of companies who are getting the message "you're not important", but renew anyway.
The main point I want to get across is that it's ok to be a great operator in rural Maine, middle Kansas or Winnepeg Manitoba. The value of what you are bringing to the Specialty Coffee Industry is relevant to all the companies like you, and you are managing to do it without alienating and diminishing your peers. Good on you!
Monday, February 28, 2011
Coffee Prices From a Different Perspective
This is a subject I have been interested in for a long time but lacked a forum to develop any ideas. I have been curious about the spasms in the Commodity price for coffee and how currency fluctuations effect both the producers and the consumers. Recently anyone in the coffee business can't ignore the heights that the "C" has climbed, closing today at $2.7170. The thing that started me thinking recently is the fact that economics in the world have changed and drastic measures are currently being taken to get a handle on the catastrophic events caused by the Sub Prime mortgage market and access to easy credit. The American Federal Reserve reaction to the events was to increase money supply through stimulus initiative which both increases economic activity and reduces the value of the American Dollar. Any American who has travelled extensively in the past decade or so has seen their spending power erode when they convert their greenbacks to local currencies. Here in Canada very recently we were accustomed to receiving $0.65 US for every Canadian Dollar we exchanged. At today's market close I would receive $1.03 US for every Canadian Dollar I exchange. When I examined the relationship of the Euro to the USD I found a similar relationship.
I began to think that although there has been an increase in the "C", that a decent portion of that increase was actually a weakening of the USD. Think of it this way, if I am purchasing coffee with money that is worth less, the price of the coffee must increase. I decided to create a chart to visually represent the relationship of the American, Canadian and Euro to the "C" price for the years 2001, 2005, 2010 and Present.
Graphically the important thing to notice is how the pitch of each graph differs. Notice the strength of the USD in relation to the other currencies in 2001, and how it's value relative to the others has reduced. Looking at the Canadian and Euro lines, both follow a similar trajectory which probably follows the actual increase in the commodity price. When we look at the USD line, it clearly has a greater pitch than either the CDN or Euro. In fact, that increased pitch begins as early as 2001 for both comparisons. If we were to extend the lines out a year, the price gets increasingly steep for Americans, and less so for the rest of the world. I did take some time to examine the British Pound, but the Pound is a mess largely due to the same factors which are affecting the USD. I know there are some Aussies and Kiwis out there reading so when I get some time I'll poke into those currencies as well and maybe throw gold into the mix.
Important Additional Note: I spent a few minutes looking at what the "C" would look like if the USD had maintained the relative price levels versus both the Canadian Dollar and the Euro circa 2001 to see what the "C" price would look like today.
If the Canadian dollar was still worth .65 USD, then the "C" would be priced at $1.7585 USD today.
If the Euro was still worth 1.05842 of a USD, then the "C" would be priced at $1.86 USD.
These numbers would indicate that the difference between $2.7170 and $1.86-$1.75 USD is the impact the depreciation of the American Dollar has had on the "C" or between $0.85-$0.97 USD.
I began to think that although there has been an increase in the "C", that a decent portion of that increase was actually a weakening of the USD. Think of it this way, if I am purchasing coffee with money that is worth less, the price of the coffee must increase. I decided to create a chart to visually represent the relationship of the American, Canadian and Euro to the "C" price for the years 2001, 2005, 2010 and Present.
Graphically the important thing to notice is how the pitch of each graph differs. Notice the strength of the USD in relation to the other currencies in 2001, and how it's value relative to the others has reduced. Looking at the Canadian and Euro lines, both follow a similar trajectory which probably follows the actual increase in the commodity price. When we look at the USD line, it clearly has a greater pitch than either the CDN or Euro. In fact, that increased pitch begins as early as 2001 for both comparisons. If we were to extend the lines out a year, the price gets increasingly steep for Americans, and less so for the rest of the world. I did take some time to examine the British Pound, but the Pound is a mess largely due to the same factors which are affecting the USD. I know there are some Aussies and Kiwis out there reading so when I get some time I'll poke into those currencies as well and maybe throw gold into the mix.
Important Additional Note: I spent a few minutes looking at what the "C" would look like if the USD had maintained the relative price levels versus both the Canadian Dollar and the Euro circa 2001 to see what the "C" price would look like today.
If the Canadian dollar was still worth .65 USD, then the "C" would be priced at $1.7585 USD today.
If the Euro was still worth 1.05842 of a USD, then the "C" would be priced at $1.86 USD.
These numbers would indicate that the difference between $2.7170 and $1.86-$1.75 USD is the impact the depreciation of the American Dollar has had on the "C" or between $0.85-$0.97 USD.
Sunday, February 27, 2011
Negotiating a Lease Part 3
I wanted to continue to post on topics which will materially benefit potential cafe owners and especially baristas hoping to own their first shop. I can't think of any topic which is more important to the success of a coffee shop than negotiating your lease. I have already posted a couple of times with some helpful hints, but believe the spreadsheet I have created will greatly benefit coffee shop owners and arm them with the same tools landlords have in their arsenal.
Basically the spreadsheet measures the landlords costs and income related to the lease, and the tenants potential costs related to the lease. When a tenant enters asking price and other inputs they should be able to determine how much room the landlord has to negotiate which ultimately benefits the tenant (good guys). There are some terms which I should explain in more detail.
NPV is short form for Net Present Value. Net Present Value is the total value of the lease added, then each year multiplied by a factor related to the expected rate of inflation. This factor is available from a Net Present Value table similar to the one following.
The reason NPV is useful is it represents a value today to the tenant and conversely the landlord. On the landlord's side we would make the factor the expected rate of inflation plus the desired return. The difference between the tenants and landlords NPV is the negotiating room.
If you would like a copy of the spreadsheet, please let me know through the comments and I'll email it to you. In the interim I'll try to figure out how to make it available for download. Try entering numbers from listings of commercial space from online listings in your area and get a feel for the numbers landlords use to skew deals in their favour. I have made the calculations assuming a constant rate of inflation of 4% which may need to be adjusted over time. The key of this whole exercise is to realize that the landlords have these tools and they understand them fully in order to determine how to make you pay as much as possible. Get tough, learn everything you can about how your landlord thinks, and save yourself tens of thousands of dollars. Commercial Real Estate agents are reluctant to share these numbers with you since effectively their compensation is based on getting you to pay as much as possible as well, but ask your agent to prepare a similar breakdown for you. Let me know whether this is useful or not.
Good luck.
Basically the spreadsheet measures the landlords costs and income related to the lease, and the tenants potential costs related to the lease. When a tenant enters asking price and other inputs they should be able to determine how much room the landlord has to negotiate which ultimately benefits the tenant (good guys). There are some terms which I should explain in more detail.
NPV is short form for Net Present Value. Net Present Value is the total value of the lease added, then each year multiplied by a factor related to the expected rate of inflation. This factor is available from a Net Present Value table similar to the one following.
The reason NPV is useful is it represents a value today to the tenant and conversely the landlord. On the landlord's side we would make the factor the expected rate of inflation plus the desired return. The difference between the tenants and landlords NPV is the negotiating room.
If you would like a copy of the spreadsheet, please let me know through the comments and I'll email it to you. In the interim I'll try to figure out how to make it available for download. Try entering numbers from listings of commercial space from online listings in your area and get a feel for the numbers landlords use to skew deals in their favour. I have made the calculations assuming a constant rate of inflation of 4% which may need to be adjusted over time. The key of this whole exercise is to realize that the landlords have these tools and they understand them fully in order to determine how to make you pay as much as possible. Get tough, learn everything you can about how your landlord thinks, and save yourself tens of thousands of dollars. Commercial Real Estate agents are reluctant to share these numbers with you since effectively their compensation is based on getting you to pay as much as possible as well, but ask your agent to prepare a similar breakdown for you. Let me know whether this is useful or not.
Good luck.
Friday, February 25, 2011
Manual Brew Costing Part III
Hello again and welcome to my third in what may end up being a long series on manual brew costing. Think of it in the same way you do when one variable in espresso changes, there's several solutions which all work, but one perfect solution which takes several attempts to reach.
From my last post "Manual Brew Costing Part II" I came to the conclusion that Batch Brewing and Manual Brewing are perfect substitutes, ie a normal customer would be just as happy if he received one instead of the other at the same price and time. We can argue all day whether one tastes better than the other, but for the sake of progress, I'm assuming a customer would choose a Manual Brew over Batch Brewing if:
1. They had more time to spend
2. They were willing to pay more for their coffee
3. They were convinced the cost of 1 and 2 was worth it in the cup.
So I will repeat the equation I formed to describe this transaction:
Demand for Coffee = Batch Brewed + Manual Brewed/Higher Price and Wait Time
The denominator of Higher Price and Wait Time reduces the number of Manual Brewed Coffees sold and does not affect Batch Brewed Coffee.
I next concluded because they are perfect substitutes, there exists the possibility of eliminating one and shifting all volume to Manual in order to attempt to achieve labour efficiency. The new equation would look something like this:
Demand for Coffee = Manual Brewed/Price + Wait Time
This is effectively the same sort of equation which would describe any transaction. You could substitute any good into it and it would describe most pretty well. The reality is any espresso bar has many imperfect substitutes in the form of tea, espresso, juice, hot chocolate, cappuccino etc, which all serve to tempt the customer away from Manual Brewing with various degrees of effectiveness. I claimed that eliminating Batch Brewing in my last post could potentially eliminate the drag Price and Wait Time had on the demand, but there are other choices which also serve to tempt the customer. For this reason, the denominator must remain as a drag on Manual Brew Sales.
All coffee shops operate in highly competitive environments, so much so that we often look for any competitive advantage available in order to differentiate ourselves from our nearest competitors. The reality is that coffee is (wait for it) not a necessity, but a luxury good. Stop cringing, I drink way more coffee than most, but it isn't water, diapers or medication.
The degree with which demand fluctuates with price is determined by the Price Elasticity of Demand which is defined by the following equation:
Price Elasticity of Demand = Percentage Change in Quantity Demanded/ Percentage Change in Price
Including this into our Demand equation it becomes:
Demand for Coffee = Manual Brewed Coffee/Wait Time + Batch Brewed Coffee + Price Elasticity of Demand
Since most coffee shops operate in highly competitive environments, one where customers are very aware of your prices and your competitors, we can deduce that the elasticity is relatively high for coffee on an individual level. A high elasticity means in practical terms, that if you raise your prices 10%, you will experience a greater than 10% drop in quantity of sales. If you lower your price by 10%, you will experience a greater than 10% increase in quantity of sales. There does exist factors which can buffer the effects, such as customer brand loyalty, relatively cheap purchase, increased perceived value derived from marketing efforts, captive customers related to store location etc, but generally this relationship of price to volume is pretty sound. Anyone who would argue that the elasticity of demand is neutral is effectively claiming that they can raise their pricing while remaining galvanized against a negative customer reaction, which if it were true, we'd be witnessing $10 cups of coffee on every corner.
I do want to point out that on a macro or market level, demand is relatively inelastic, meaning increases in prices don't appear to negatively effect the whole coffee market. We are currently testing C market prices not seen in over a decade and demand has not waned, perhaps because of the elastic nature of micro choices keeps the prices competitive for the individual.
Finally, if we can agree that coffee is a highly competitive product, and possesses a high elasticity of demand, then the rise in pricing will negatively effect sales volumes at a greater percentage rate than the price increase itself. Further, since Manual Brewing will always incur higher portion costs than Batch brewing, the price should always be higher than Batch Brewed. If the price is higher and the wait time is longer, then the volume will always be less than Batch Brewed even if we completely eliminate Batch Brewed coffee as an option. Instead customers will either seek out alternatives within your shop, or go elsewhere. If the volume is less than Batch Brewed Coffee, then the possibility of achieving labour efficiency is hobbled and Manual Brewing becomes a drag on profitability.
From my last post "Manual Brew Costing Part II" I came to the conclusion that Batch Brewing and Manual Brewing are perfect substitutes, ie a normal customer would be just as happy if he received one instead of the other at the same price and time. We can argue all day whether one tastes better than the other, but for the sake of progress, I'm assuming a customer would choose a Manual Brew over Batch Brewing if:
1. They had more time to spend
2. They were willing to pay more for their coffee
3. They were convinced the cost of 1 and 2 was worth it in the cup.
So I will repeat the equation I formed to describe this transaction:
Demand for Coffee = Batch Brewed + Manual Brewed/Higher Price and Wait Time
The denominator of Higher Price and Wait Time reduces the number of Manual Brewed Coffees sold and does not affect Batch Brewed Coffee.
I next concluded because they are perfect substitutes, there exists the possibility of eliminating one and shifting all volume to Manual in order to attempt to achieve labour efficiency. The new equation would look something like this:
Demand for Coffee = Manual Brewed/Price + Wait Time
This is effectively the same sort of equation which would describe any transaction. You could substitute any good into it and it would describe most pretty well. The reality is any espresso bar has many imperfect substitutes in the form of tea, espresso, juice, hot chocolate, cappuccino etc, which all serve to tempt the customer away from Manual Brewing with various degrees of effectiveness. I claimed that eliminating Batch Brewing in my last post could potentially eliminate the drag Price and Wait Time had on the demand, but there are other choices which also serve to tempt the customer. For this reason, the denominator must remain as a drag on Manual Brew Sales.
All coffee shops operate in highly competitive environments, so much so that we often look for any competitive advantage available in order to differentiate ourselves from our nearest competitors. The reality is that coffee is (wait for it) not a necessity, but a luxury good. Stop cringing, I drink way more coffee than most, but it isn't water, diapers or medication.
The degree with which demand fluctuates with price is determined by the Price Elasticity of Demand which is defined by the following equation:
Price Elasticity of Demand = Percentage Change in Quantity Demanded/ Percentage Change in Price
Including this into our Demand equation it becomes:
Demand for Coffee = Manual Brewed Coffee/Wait Time + Batch Brewed Coffee + Price Elasticity of Demand
Since most coffee shops operate in highly competitive environments, one where customers are very aware of your prices and your competitors, we can deduce that the elasticity is relatively high for coffee on an individual level. A high elasticity means in practical terms, that if you raise your prices 10%, you will experience a greater than 10% drop in quantity of sales. If you lower your price by 10%, you will experience a greater than 10% increase in quantity of sales. There does exist factors which can buffer the effects, such as customer brand loyalty, relatively cheap purchase, increased perceived value derived from marketing efforts, captive customers related to store location etc, but generally this relationship of price to volume is pretty sound. Anyone who would argue that the elasticity of demand is neutral is effectively claiming that they can raise their pricing while remaining galvanized against a negative customer reaction, which if it were true, we'd be witnessing $10 cups of coffee on every corner.
I do want to point out that on a macro or market level, demand is relatively inelastic, meaning increases in prices don't appear to negatively effect the whole coffee market. We are currently testing C market prices not seen in over a decade and demand has not waned, perhaps because of the elastic nature of micro choices keeps the prices competitive for the individual.
Finally, if we can agree that coffee is a highly competitive product, and possesses a high elasticity of demand, then the rise in pricing will negatively effect sales volumes at a greater percentage rate than the price increase itself. Further, since Manual Brewing will always incur higher portion costs than Batch brewing, the price should always be higher than Batch Brewed. If the price is higher and the wait time is longer, then the volume will always be less than Batch Brewed even if we completely eliminate Batch Brewed coffee as an option. Instead customers will either seek out alternatives within your shop, or go elsewhere. If the volume is less than Batch Brewed Coffee, then the possibility of achieving labour efficiency is hobbled and Manual Brewing becomes a drag on profitability.
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