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.

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.

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.

Manual Brew Costing Part II

I've felt the need to dig a little deeper into Manual Brew Costing since it is a relatively new revenue stream for many coffee shops, and very different metrics apply to determining it's profitability. I really appreciated the comments, and hope to provide some more info for discussion. So here goes my second instalment in a complete workup of Manual Brewing.

My first assumption is that Batch Brewing and Manual Brewing are perfect substitutes from the consumers perspective. That means that a customer would be equally happy ordering a manual brew coffee and a batch brewed coffee in most circumstances.
Second, I am assuming that most customers are accustomed to ordering their coffee as a batch brew, and therefore it is the default order for most customers. Because it is the default, most customers are acquainted with "normal" wait times when ordering a batch brew, and are familiar with normal pricing associated with it. This is important because if Batch Brewing is the default, the exogenous inputs of "Wait time" and "Price" affect only Manual Brewing.

Using these assumptions I have come up with the following equation to represent the consumers demand for Batch Brewed and Manual Brewed Coffee:

Demand for Coffee = Brewed Coffee + (Manual Brewed Coffee/Wait Time and Price)

In this equation, the + sign indicates that both are substitutes for each other and combined demand equals total demand for coffee. (I understand that in parts of Europe the Americano factors strongly, but I'll examine that at a later date.)

It has been pointed out to me that Intelligentsia is successfully using all manual brewing and achieving a high profit through efficiency by brewing approximately 4 brews in 6 minutes negating my 7.5 minute assumption. I spent some time thinking about this, and of course came to the conclusion that efficiency is best met when output is maximized, ie a busy shop like Intelligentsia. So the question is how can a smaller operation achieve the same efficiency? I think the equation provides some revealing info.
If Brewed and Manual are perfect substitutes, then eliminating one simply means more volume of the other. If a shop eliminates Batch Brewed (like Intelli) the full volume shifts to Manual Brewed where there is the possibility of achieving efficiency though volume. Further, because there is no Batch Brewed Coffee, the expectations for speed and pricing may be altered negating the drag on demand by the denominator in the equation. (Assuming there isn't a super fast direct competitor next door tempting impatient customers away) In the equation, the default was Batch Brewed, and the drag was placed on Manual because it introduced unfamiliar inputs of extra time and elevated price. However, eliminate Batch, and the default changes to Manual. I expect that there would need to be a transition period where staff would build skill levels and determine best sequencing, as well as a period of preparing customers for a change. I still have serious reservations about whether cost effective manual brewing is possible in most situations, but am intrigued.
I'm sure Intelligentsia went through this exercise, but thinking through it step by step helped me realize that perhaps in the right circumstance, labour can be applied efficiently in Manual Brewing. I will sit on this for a few days and expand on it by costing a manual brew only shop with quicker brew times and maybe an equation that capture the Supply side of the transaction.
Please share your comments, they help me work through things I hadn't thought of and bring different perspectives to an important subject.