Demand - Challenging Assumptions in Coffee – Part 1
- Ryan Delany
- Mar 4
- 5 min read
One widely held assumption I have heard for years is that global coffee demand is fairly stable.
There is a reason that it is generally agreed upon, it is born out in both the data and the theory. The theory states that coffee demand is “inelastic” which in economic terms means that the consumption of coffee is not very responsive to price. The annual consumption data also shows that this is true. The common wisdom in coffee S&D was to assume 2% annual increase in consumption year over year, and that has proven to be a valuable heuristic for many years.
However, this common wisdom has been thrown for a loop multiple times in the last 5 years and in this article, we are going to challenge and re-examine what demand look like in the coffee market. In the ensuing paragraphs we will look at the previous paradigm of a 2% increase in consumption per year, we will look at how this broke down in 2020 and how this old model will change in today’s high price environment.
Old Paradigm – Usually 2% Growth
In looking at the old paradigm, lets start with the theory.
The previous conventional wisdom was that coffee is a material good with inelastic demand. This means that demand is resistant to price moves. If prices are high we demand the same amount of coffee as when prices are low.
Petroleum is an example of a product that is considered to have inelastic demand. Many people drive their car to and from work every day (and kids ride the bus to and from school), so they aren’t easily able to adjust the amount of petroleum that they consume based on price.
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Coffee would be similar to petroleum because caffeine is an addictive drug. The fact that coffee is addictive means that humans are going to be resistant to changing consumption patterns. The data appears to bear this out. As humans become adults, we tend to consume 220-250 mg/day and that stays fairly constant from age 18-64.
Given this consistency in per capita consumption patterns, then logically it follows that the main variables to watch for coffee consumption are population growth, and the rate of adoption (i.e. rate of acquiring new coffee drinkers). Global population growth is around 1% per year but this rate has been declining for decades. As populations become richer, they tend to have less children and the world has been getting richer at an exponential rate.
Anecdotally, coffee consumption also seems to be tied to GDP per capita. Certainly, this is true of both alcohol and soda consumption (on the alcohol chart, this becomes even more true if you exclude the Muslim countries in the bottom right. These are wealthy countries that don’t consume alcohol for cultural reasons).
Source: data from World Bank, chart modified for clarity from Our World in Data
So to sum this section up, we have two paradigms that together seem to add up to 2% annual growth in coffee consumption.
1) developed countries have steady population and saturated consumption
2) developing countries have increasing population and increasing consumption.
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In terms of the microeconomic model for demand, inelastic demand looks like the red line in the chart below. This means that individuals making purchasing decisions do not significantly reduce the quantity consumed based on increases in the price of coffee.
This model seems to contradict the data from the gdp correlation. However, what it actually represents is the consumption patterns of the developed country—the stable consumption in paradigm 1 above. As countries become richer and more developed, they include more industrialized global products (perhaps not incidentally, coffee’s rise in popularity coincided with other “sober” activities like the industrial revolution, the enlightenment and the rise of factories, restaurants and coffee shops). Once added to an industrialized economy, coffee becomes inelastic, just like petroleum driving to work.
What is more elastic is the consumption in developing nations, where coffee starts as a luxury good, but gradually becomes a staple as the countries industrialize.
The net effect of these dynamics, population and gdp growth in developing economies and stable consumption in developed economies, manifested as (on average) 2% consumption growth per year.
Where this Breaks Down
This model took a major hit during Covid. The Covid crushed demand from two different directions: lockdowns and recession.
China experienced both lockdowns and recession and you can see how the annual growth previously enjoyed took a sharp turn in 2020, and continued to be volatile over the next few years.
The global recession caused by covid, impacted coffee consumption in developing nations where coffee was viewed as a luxury and demand was more elastic.
In the more economically developed nations, the recession would likely have had less impact on the consumption of coffee, but the lockdowns had a major impact. Not only could you no longer go to a cafe or a restaurant, but major communal events that served coffee (weddings, conventions, church services, parties) were now on hold and to make matters worse, the office culture was completely up-ended.
“’We’re seeing demand increase across all of our products, with particular strength in single-serve coffee, water, carbonated soft drinks and juice, so we are prioritizing manufacturing capacity devoted to those products,' Keurig Dr. Pepper’s spokesperson shared.
Similarly, J.M. Smucker’s non-Dunkin’ single-serve ground coffee brands such as Folgers, Kava, Café Bustelo, Café Pilon and Medagilia D’oro saw a collective sales increase of 31 percent.”
An old cliche in the coffee industry is that one of the largest consumers of coffee is the “kitchen sink”, meaning that when we brew coffee for multiple people but only drink half of it, half of the coffee is thrown away. When communal workplaces, locations and events are shuttered, then coffee is no longer brewed in large batches.
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Even within the home, coffee consumption became more efficient with sales of single-serving pods (which had already been increasing for a decade) soaring.
To make matters worse, the logistical bottlenecks caused by the covid disruptions led to roasters and importers turning inwards towards stocks rather than outwards to origins to meet consumption needs. Global destination stock levels began to decline, a trend that would continue.
As stocks declined, the market soon had to deal with a new issue, the Brazilian frost of 2021, this sent brazilian differential prices to the roof and expectations for future supply to the basement. This double whammy instigated the market inversion in the futures market.
This is because Certified coffees are often used as a Brazil replacement and so savvy roasters turned this relatively cheap coffee to augment their needs for brazilian naturals. The low certified inventory and reduced expectations for a Brazilian coffee inverted the futures market.
With the futures market inverted, it became very expensive to carry coffee. (if you are unfamiliar with this dynamic, its a complex and unintuitive topic, but suffice it to say that when a market is inverted hedgers of physical coffee essentially pay a penalty every month that their coffee is hedged. you can read more about it here and here). Since holding coffee was now expensive, roasters and importers shifted to a “just-in-time" model of supply, and reduced inventory levels further.
So to summaryize section 2, during covid demand was hit hard by 1) lockdowns in destination markets, 2) recession + lockdowns in developing markets, 3) inventory reductions.
If you notice, one thing that all 3 of these have in common is that they are all temporary, mostly to do with covid, so in theory, they will all be short-lived. Right? ... Right?!
To be continued: Next Article “The New Paradigm”
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