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Adjusting Coffee Prices To Reflect Higher Costs Is Necessary For Survival

by Kevin Daw
Posted On: 5/25/2011

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The coffee market has remained very bullish, closing at $2.97 at this writing in early May. This puts the market $1.60 higher than it was a year ago. When you take into account the shrinkage caused by roasting, we are looking at roasted coffee costs to operators almost $2 a pound higher, should this bull market remain firm, going forward.

Roasters have slowly raised prices, as they "average up" inventory costs incrementally, using a mix of existing inventory with incoming coffees purchased at ever-increasing costs. For this reason, the current coffee market price has not yet been reflected fully on your invoices.

If you were fortunate enough to have locked in pricing contractually, congratulations. It will still be important for you to consider when and by how much you will need to increase your pricing to your clients, going forward.

One of the most stressful and fear-inducing activities an office coffee operator faces is the need to raise prices. Visions of legions of clients abandoning ship for cheaper offers cause many operators to delay, or even to try to absorb, higher costs for as long as possible. Though this is an easy road to travel, it never ends well, usually wreaking havoc on income statements, balance sheets and creditworthiness.

When our OCS operations were confronted with the need to increase client pricing, my father, Stuart Daw, always used to say, "I've never known an operator who fared worse after raising prices."

He once gave me an example to illustrate his point, comparing two OCS companies. It went something like this:

Two companies of equal size face a $5 increase per case. Operator A keeps prices the same on his 100 accounts, which use an average three cases per month. So those three cases per location x $5 a case = $1,500 in monthly absorbed costs.

Operator B raises prices $7 a case, and loses 5% of his 100 clients. Five clients lost x three cases at $15 gross profit per case = $225 in monthly GP loss. But he keeps 95 clients x three cases x $2 in extra GP = $570 in new GP: $570 - $225 = a $345 increase in gross profits.

Although operator B lost 5% of his or her account base, the company actually improved its situation. The improvement is even greater when you consider that those that dropped the service were price-driven buyers who were likely to leave whenever they got a better offer -- and they may well have been greater-than-average credit risks to boot.

Even if operator B only raised the price by the amount of the actual increase in cost ($5) and lost 5% of the account base, he or she is still better off, because operator A is "eating" $5 a case (or $1,500 in GP) while operator B only lost $225 in GP. These examples demonstrate that you would need to lose a big portion of your base to be worse off for having raised your prices. I have not reflected the loss of allied -product GP, but I have not reflected the expenses saved by servicing a smaller client base either. I'd say these are a wash.

So, now that we know we need to raise prices, the question remains: how much and when? My dad had another great saying: "You take dollars to the bank, not percentages."

As long as you are profitable at your current GP dollar rate, you can feel comfortable in raising prices equal to your product cost increases, right? Well sort of. What is often overlooked is cashflow. If your receivables are running at 45 to 50 days and suppliers hold you to a strict 30-day policy, you are playing banker on 15 to 20 days of inventory that has increased in cost significantly. If pallets of coffee on your warehouse floor used to represent little piles of money, they now represent mountains!

In one of the greatest debates my father ever engaged in, he was pitted against "consumer advocates" who were calling for a coffee boycott during the wild price increases attributed to the "black frost" in Brazil during the 1970s.

In his patient attempt to explain the need for sizable price increases to deal with the replacement cost of inventory, he posed the question:

"If you bought coffee at $1, sold it for $2 and then rebought coffee at $3, did you make a dollar or lose a dollar?"

The advocates were completely taken aback and sat twisting this question in their minds for a few seconds until Stuart explained that you made a dollar in gross profit but lost a dollar in cashflow, and you still have to pay taxes on the money earned!
This point was lost on the consumerists as they interrupted with "yeah, buts."

However, the message was and is clear: Prices must be increased as quickly as possible to keep a positive cashflow. Your bank balance suddenly winds up on your warehouse floor, and trying to lean on your roaster for extra credit may prove difficult -- roasters are experiencing the exact same issue!

Price increases are a bitter pill to swallow, but I've found if you wash them down with a nice blend of quick reaction and positive returns, the aftertaste is not nearly as harsh.

KEVIN DAW is president of Heritage Coffee Co. (London, ON, Canada), a leading private-label roaster serving the breaktime management industries in North America. He is in charge of coffee buying for Heritage. A 30-year veteran of the workplace service business, Daw has served as a commission coffee service salesman, a principal of a vending operation and president of a bottled water company. Since 1990, he has concentrated on coffee roasting. Active in industry affairs, Daw is a Specialty Coffee Association of America Certified Brewing Technician, a member of the National Beverage and Products Association Hall of Fame, a recipient of the National Automatic Merchandising Association Supplier of the Year Award and a NAMA Coffee Ser­vice Committee member.