The State of Speciality Coffee – Part 3: Implications and Predictions

A Market Correction

What I believe we are heading towards is, simply, a situation where we have more cafes than we have customers for them. This leads to a pretty obvious conclusion: a substantial number of cafes are going to close.

They are going to close at a variety of points in the business cycle. Some will hit a break in their lease and decide enough is enough. Selling a lease will, for some, yield better profits than the previous years of trade. For others the business may simply fail. Experience tells us that many Businesses aren’t very good at closing and tend to hit a wall of either cashflow failure or they simply exhaust the patience of creditors. These businesses are the biggest concern as their failure passes something back down the supply chain: debt.

Cafes have come and gone for decades, until recently it was normal for most people to be dismissive of them as high risk businesses (like restaurants) with very high rates of failure. That tone has changed in the past decade. What we’re likely to see is quite a large number of cafes close in a relatively short time frame. This will pass back a wave of debt onto roasters. Those roasters who’ve chosen to lower prices, and offer longer credit terms, will be hit with those debts and will likely suffer cashflow issues. In particular younger companies that have had less time to build cash reserves, or businesses where cash has regularly been pulled from the business. As such I would expect to see some Coffee roasting companies fail.

It is not unlikely that a green coffee importing business or two be damaged or taken out if a few of their roaster customers happen to fail.

I think it will be a difficult time, but the upside is that it will damped the rate of new openings and we’re likely to see the Market stabilise at a more sustainable size. I doubt it will be as positive an environment for growth on the other side, but it will also be less fragile.

We’re already beginning to see this. Talking with various people in Korea, I was told that the most common business closure in Seoul is now a coffee shop – this a city that had an unprecedented explosion in coffee. A city with 800 coffee roasting companies, and over 2,000 cafes.

To be clear: I don’t think everyone will fail. I don’t think the majority of businesses will fail. I do believe a substantial correction will occur in the next three to five years in a variety of markets around the world.

One other sector is also in a difficult position here: equipment suppliers. Certain manufacturers produce machines that are both popular in speciality coffee, and also able to retain their value when sold second hand. A higher level of failure in speciality will be particularly bad news for equipment manufacturers as the growth in the second hand market will doubtless impact new equipment sales. I know some of them are already aware of this and beginning to strategise.

Consolidation

Consolidation is a word on everyone’s lips at the moment, primarily due to the aggressive movement of JAB Holdings in the coffee sector, and also off the back of Blue Bottle’s funding and growth model. I think we’re likely to see plenty more in the future. I believe a few different factors will drive this:

Looking at other industries that have gone through consolidation, I believe the primary driver is the desire for scale to achieve sufficient profitability. In a competitive market prices and margins are driven down, and one solution to grow net profit is to acquire larger scale through inorganic growth. Companies successful in the market early, and companies compelling enough to acquire funding to do so, will use capital to acquire other businesses that either fit well due to commonalities – i.e. a roaster buying other roasters, and sharing green coffee resources between all of them – or acquiring complimentary business such as a chain of cafes acquiring a bakery. One might consider Starbucks as an example of this kind of behaviour.

The increased number of businesses suffering from the market correction also presents an increased number of relatively cheap acquisitions. This itself will spur some level of opportunistic consolidation.

None of this seems particular surprising when looking at other industries that have historically gone through a boom and bust cycle, and seen the consolidation that went with it. (Beer would be a good example, and not unlikely to happen again in that industry in the near future). I don’t think this HBR article is completely accurate in describing this phenomenon, but I think plenty applies.

Is it all just doom and gloom?

I started out with the results of a survey that show immense levels of positivity in speciality coffee about the future of the industry. My goal was to share my reasoning behind my caution, and concern about our shared future. I’m interested in speciality coffee being both successful and sustainable and I believe we’re not considering the implications of our growth.

Around the world coffee suppliers regularly meet with people opening cafes for all the wrong reason. They hate their office job (while it may pay well, they feel their soul is being crushed), and they’ve always loved cafes. They have no experience in running a business and no experience in coffee.

To date, as an industry, we’ve sold the idea that if they just serve good coffee then all will be well. If they buy the right machine, buy the right coffee from the right roaster who buys from the right farmer, then success is assured. We know this isn’t true, and we really need to stop pretending it is.

For the short term gain of a sale a level of instability and fragility is introduced into our marketplace. I believe we need to consider our long term actions more carefully.

Should I Start a Coffee Business?

I gave a talk similar to this in Prague earlier in the year, and someone asked this in the Q&A. It’s a fair question – am I trying to discourage people from opening new businesses, do I think there are no opportunities left?

The answer is not simple, but I would say “Yes, you should open a coffee business.” It comes with a few caveats…

It is a crowded and competitive market. Do not enter if you do not believe you have something notably different or better. Make sure that you have a good understanding of the existing financial model of the category you are entering and have a good idea as to how you’ll compete.

Have something to say. People will always respond to individuals and businesses with vision, with personality and authenticity. I don’t think anyone in this industry believes we can have too many businesses like that.

I’ve shared my thoughts here because I think it is important we talk about the challenges we face openly. My mind is not fixed, I’m open to other people’s thoughts and ideas, criticisms or suggestions. I hope to start a continued conversation online and in person.