July 30, 2018

Examining coffee production costs across Latin America

A coffee at your local café might cost US $4.00, but this doesn’t tell you how much green coffee is required to buy and produce the crop. However, today’s third wave of consumers demand fairer prices for better-quality coffee. However, without knowing how much farmers spend to produce it, and how that varies across countries and production methods, it’s hard to know what “sustainable prices” really are. Consequently, you should know what coffee production costs across Latin America.

To illustrate this reality, Caravela Coffee, as part of its PECA or “coffee grower education” program, has recently published a report on the cost of production in six Latin American countries: Ecuador, Colombia, El Salvador, Guatemala, Nicaragua, and Peru. However, find out exactly how much coffee really costs, I spoke to Luis Guillermo Cortes, the PECA Program Director.

Lee este artículo en español Esto es lo Que Cuesta Producir Café en Latinoamérica

coffee plantation

Credit: Sunghee Tark

Understanding coffee production costs

As Caravela Coffee’s report states, “the sustainability of the coffee industry starts by understanding costs of production and the variables that affect it.” Until we know this, sustainability is impossible.

For example, Luis tells me that “the majority of coffee producers are not aware of how much it costs exactly to produce a kilogram of coffee.” Consequently, this can leave them unable to effectively budget and allocate resources throughout the year, putting them in a vulnerable position.

To illustrate this, Caravela Coffee aims to build on this report by creating an app that will help farmers track their coffee production costs. But until then, at least we now know how much, on average, it costs to produce coffee in six countries – and what some of the biggest expenses are.

cost of production

Credit: Caravela Coffee

How much does this data tell us?

To organize the data into a usable tool, Caravela Coffee made three assumptions concerning coffee production.

  1. Firstly, the size of the farm will be three hectares with between 4,500 plants (Ecuador) and 5,500 plants per hectare (Colombia). Luis tells me it’s because “three hectares is what a family needs to survive; with one hectare of land, a family cannot survive.” It’s worth nothing that costs per hectare (or pound) will decrease as farm size increases.
  2. Secondly, each farm will produce 25–30 bags of parchment coffee per hectare.
  3. Thirdly, each producer will have 15% of their planted hectares under renovation each year.

Analysing coffee production costs

From here, Caravela Coffee calculated costs at a national level. Consequently, different farm structures and production methods mean that the costs cannot be completely accurate for every farm (this is where the app will help). Yet Luis says, “This study made the key assumptions in order to calculate what would be ideal to invest in a farm of a given size, so as to derive the best output.”

Additionally, some things will affect the model and may fluctuate over time. Luis says, “The fluctuation of the exchange rate affects the producers when the payment per pound is made in dollars – which is what happens. In Colombia, one dollar used to be 3,000 pesos but has gone down to 2,800 pesos. So, the money that the producer gets is affected.”

Other domestic changes also have impact. Luis says, “In El Salvador, the minimum salary at country and the city level are the same. The situation for the producer has changed.”

Caravela Coffee’s data is a useful starting point. However, it’s important that it’s updated and that every producer, trader, roaster, and more is aware of the impact of local changes.

Unripe coffee

Unripe coffee cherries on the branch.

Results: How costs vary across countries

Here’s how costs vary across six countries for three hectares.

 ColombiaEcuadorNicaraguaPeruGuatemalaEl Salvador
Administration5,5377,3182,9434,7216,3405,316
Harvest5,6906,7503,8705,7695,0684,875
Labor 9501,6831,3161,2922,118265
Supplies2,5943,3062,4522,4432,7553,363
Infrastructure7786682,186332783979
Renovation195188215279336704
TOTAL15,74419,91312,98114,83717,40015,503

Ecuador has the highest production costs and Nicaragua the lowest. Combined labor costs explains much of the variation. El Salvador spends the least on labor but the most for renovation. Nicaragua has the lowest costs overall but allocates more for infrastructure – something that evident when we look at cost distribution by percentage. This is because infrastructure includes the drying facilities and they have pay by the pound for a mill to dry coffee.

Cost Distribution

 ColombiaEcuadorNicaraguaPeruGuatemalaEl Salvador
Administration35%37%23%32%36%34%
Harvest36%34%30%39%29%31%
Labor 6%8%10%9%12%2%
Supplies16%17%19%16%16%22%
Infrastructure5%3%17%2%5%6%
Renovation1%1%2%2%2%5%
TOTAL100%100%100%100%100%100%

Luis says that specialty coffee will typically cost more as pickers are paid more for selective picking, and more is invested in wet milling and drying.

Costs (USD/lb)

 ColombiaEcuadorNicaraguaPeruGuatemalaEl Salvador
Administration0.420.700.240.410.510.44
Harvest0.430.650.310.500.410.40
Labor 0.070.160.110.110.170.02
Supplies0.200.320.200.210.220.28
Infrastructure0.060.060.180.030.060.08
Renovation0.010.020.020.020.030.06
TOTAL1.191.911.051.281.401.28

As we can see, there is a difference in production costs between geographically close countries.

A country-by-country guide to production costs

Above all, the data points to the need to treat each country individually as costs and sustainable prices differ from country to country.

Colombia: Around one-third of costs go on administration, and another third goes on harvest-time labor, meaning that labor shortages or changes to workers’ rights could have a significant impact here. Renovation costs are slightly lower than average.

Ecuador: Administration is Ecuador’s biggest cost, in a country where the cost of production is already high. (At US $1.91/lb, it is significantly higher than the international market price for commodity coffee of US 110.72¢, as of the 16th of July 2018.)

Nicaragua: One of the few countries where coffee production costs less than the international market rate (barely), administration is less expensive but infrastructure costs more. Supplies make up a larger percentage of the budget but, in real terms, are relatively inexpensive.

Peru: Harvest-time labor is this country’s biggest expense; out of all the countries surveyed, only Ecuador spends more on it in real terms. However, at 40%, no other country dedicates such a large percentage of their budget to it.

Guatemala: Another relatively expensive country, Guatemala’s harvest-time labor makes up a lower percentage of their outgoings. However, the amount in real terms isn’t particularly low, compared to its neighbors.

El Salvador: A relatively cheap country in which to produce coffee, El Salvador still invests significant money in administration. Harvest-time labor costs are low, however, while renovation is relatively high.

Ripe-red coffee

Credit: Sunghee Tark

Breaking down coffee production costs

But it’s not just enough to understand how much everything costs. Specifically, we need to understand why and how this affects quality, profitability, and sustainability.

Luis says, “In coffee, more than 70% of the total production cost goes towards labor costs.” Roughly 28% of this is administrative labor costs. Therefore, labor costs are linked to the profitability of a Latin American coffee farm. However, this factor is often outside of producers’ control.

He adds, “In Ecuador, labor is a lot more expensive than in Nicaragua due to the lower minimum wage in Nicaragua.” And in Colombia? “The cost of labor is high due to the higher cost of legal fees and insurance…In the past five years or so, the labor cost has increased quite a lot.”

This is because younger generations are generally less interested in working on farms, instead seeking more profitable work in the city. Additionally, this has helped fuel a labor shortage and driven up costs.

Graph of Cost Structure

Credit: Caravela Coffee

Renovation & Fertilization

Labor makes up almost 70% of total costs. As a result producers are left with just 30% of their budget to do everything else on the farm. Luis says that this “is split among other expenses, such as the fertilizers, costs of combating plant disease, utility costs, transportation, etc.”

But this can have a troubling knock-on effect. As a result, Luis explains, “This means that if the price of coffee goes down, the producers will stop fertilizing.” With such a small amount of their budget dedicated to it, there is little flexibility for cutting costs. However, they cannot prioritize fertilizer over the wages they have to pay seasonal workers or, say, providing food for their own family.

“This imposes a great risk for the following year,” Luis stresses. Additionally, reduced fertilization will reduce productivity, which will mean less money earned. As a result this will mean even less money for fertilizer.

Breakdown of cost structure

Credit: Caravela Coffee

How this impacts producers

Luis tells me that, once producers know their costs, they can estimate their profit and cost margin using this equation:

Profit Margin = Sales Revenue – Costs of Production   X 100 

            Costs of Production

(This is also explained in more detail in a Caravela Coffee blog post, while in another blog the company gives advice for tracking and recording these costs.)

The price of coffee fluctuates over time. As a result of this it’s hard to calculate the exact profit margin for each country. However, on June 11th, 2018, the international market price (the C price) closed at US 117.10¢ per pound.

Firstly, in Ecuador, the cost of production is US $1.91/lb, a farmer paid the C price would make a loss of -38.7%. Secondly, Nicaragua has a slightly lower production cost of US $1.05/lb, leading to a profit margin of 11.4%. Thirdly, Peru would have a profit margin of -8.6%. Finally comes Guatemala with -16.4%, Colombia with -1.7%, and El Salvador with -8.6%.

In other words, most countries cannot profit when only paid the market price. And Luis is of the opinion that farms require a minimum of a 30% profit margin to survive and pay for basic things such as education, food, and healthcare.

When Caravela Coffee compared the market price to the costs of production in 2017, they noticed a serious deficit for both one- and three-hectare farms. The market price is lower than what it costs to produce coffee in nearly all of these six countries, threatening the sustainability of the industry.

international coffee price

Credit: Caravela Coffee

What does this data mean for you?

Thanks to the app, producers can record your costs more easily. Specifically, Luis says that this was designed to help you manage your farm in terms of budgeting and resource allocation. As you’re paid just one to three times a year, you know how critical this is for ensuring a successful harvest the following year.

What’s more, it will help you evaluate your farm’s performance. In turn, you can allocate resources to the most profitable areas, resulting in increased productivity and profitability overall.

Lastly, the study gives insights into how much you should be selling your coffee for in order to operate sustainably.

wet mill

Sunghee Tark

How roasters, producers, & consumers are impacted

Luis says: “Finally we have an idea of what it costs for a producer to produce coffee per three hectares. The industry can decide, then, how much we can pay for it.”

He recommends that if “it costs US $15,000 on a three-hectare coffee farm… producers must receive at least US $20,000 for the coffee they produce in order to sustain them and their family.” This is for commodity coffee. On the whole, specialty coffee will cost more.

Additionally, Luis highlights that buyers must understand the importance of having the right resources at the right time. Consequently, resources can be your last priority when funds are low.

In fact, he says that if the producer doesn’t control diseases or pests at the beginning of the production their crops will be affected for rest of the period.

However, he adds that “the market can investigate and consider how they can promote resources for the producers to invest more in their farms.” In turn, this will lead to increased productivity, which benefits the entire industry.

chemex

For example, Luis says: “If you ask any farmer in Latin America if they are saving up for retirement, no one will say yes. However, the money made from coffee isn’t enough for them. This cost needs to be added to total production costs so that people can prepare.”

As a result, Luis believes that “the change toward a sustainable chain within the industry starts with cafes. So there’s an inequity. However, where does the largest portion of the money generated from coffee get retained? In spite of everything, never comes back to the producers.”

All quotes translated from Spanish by the author.

Please note: This article has been sponsored by Caravela Coffee.  

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