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Coffee retail in America is undergoing a significant reconfiguration as a result of several seemingly contradictory trends.
For example, there will be several thousand fewer specialty coffee shops in 2010 ‑ yet thousands of new outlets with espresso machines will spend unprecedented sums advertising premium coffee.
Customer behavior continues its shift from indulgence to value as coffee drinkers forego $4 lattes ‑ yet consumption of foodservice coffee will increase and the amount of coffee prepared in-home will rise.
Total dollars spent on both grocery and foodservice coffee will increase.
To better understand these contradictions, Specialty Coffee Retailer sought the counsel of 25 industry leaders including association executives, suppliers, coffee growers, traders, buyers and, most important, retailers and retail roasters.
This series appears in print and online, where it will be updated throughout the year, permitting readers to comment and suggest constructive solutions to the many challenges faced by this industry in transition.
CHANGING RETAIL LANDSCAPE
The National Coffee Association’s annual survey on consumption found a reassuring 80 percent of coffee drinkers are doing nothing different despite the economic downturn. The remainder are visiting coffee shops less often, trading down, making more coffee at home, buying less-expensive brewed coffee and looking for sales.
Coffee remains an important part of their routine.
Independent shops report holding their own thanks to loyal customers who are cutting back but not going away.
“Our members are showing signs of strength, which leads us to be more optimistic than not,” says Specialty Coffee Association of America (SCAA) Executive Director Ric Rhinehart.
Respondents to the Association’s 2009 Retailer Survey report steady sales. “Nearly half reported increases, albeit more modest than in previous surveys,” says Rhinehart. “Respondents were generally optimistic about the future.”
Between 2000 and 2005 the number of coffee shops increased by 70 percent, reaching a count of 21,400 or roughly one coffeehouse for every 14,000 Americans, according to Mintel International, a market research firm based in Chicago.
“Every new opening increases demand by pulling in customers who pass by while going about their daily routines and this self-feeding cycle of growth has shown no signs of slowing or market saturation,” Mintel analyst Billy Hulkower observed in 2005.
He estimated saturation would occur at one shop in 10,000 residents, based on the fact that Seattle shops continued to thrive despite the nation’s highest concentration of shops per 100,000 residents. His prediction was realized in 2008 as the total number of shops neared 30,000.
Rhinehart estimates that there were 27,715 specialty coffee outlets at the beginning of 2008 with 47 percent operated by Seattle-based Starbucks® and other chains.
This represents a net gain of about 2,000 stores since the last survey, a total that includes the closing of 1,000 shops in the 4th quarter of 2008, he says.
“Based on what’s been reported thus far in 2009, we would expect to see another 2,000 drop in outlets this year,” says Rhinehart.
A correction was overdue, says Bob Phibbs, a consultant and former coffee chain marketing director known as the Retail Doctor. He estimates closures will reduce the all-time high by 20 percent, or 5,000 shops before the recession ends.
“As far as total employment, we only measured full-time equivalents, but 54 percent of respondents in our recent 2009 Retailer Survey employed one to five full-time workers,” says Rhinehart.
“What’s interesting is that 27 percent employed 6 to 10 workers compared with around 6 percent in the 2005 Gourmet Retailer/SCAA Specialty Coffee Survey. SCAA’s latest survey shows 20 percent of respondents had more than 10 employees compared with about 3.5 percent in previous studies,” says Rhinehart, who cautioned that the sample population was different between the two studies; the most recent study surveyed only current SCAA members.
MARKET OVERVIEW
No longer is America the country that simply drinks the most coffee – sales figures from 2008 reveal Americans are willing to pay for good coffee. Specialty coffee today accounts for $13.65 billion in sales, one-third of the nation’s $40 billion coffee industry.
Last year growth in value of coffee surpassed volume growth. This is largely because demand for premium coffee such as Fair Trade, single origin, organic and Rainforest Alliance has transformed the overall market.
Fair Trade coffee sales grew by 32 percent last year. Both Rainforest Certified and organic coffees had double-digit increases. Imports of all three will soon pass 100 million pounds, according to Daniele Giovannucci, one of the coffee world's leading consultants.
“If you add other forms of differentiation – including specialty or gourmet coffees of course – you have more than 60 percent of the U.S. market (by value) making the U.S. now primarily a market for differentiated coffees,” says Giovannucci.
The Philadelphia-based consultant says the sales growth rate for the specialty segment is four times that of traditional coffee with projections the category will top $18 billion by 2012. His latest North American Organic Coffee Survey of organic coffees shows that sales topped $1.3 billion, about 10 percent of specialty coffee sales. Last year Americans and Canadians imported 89 million pounds of organic coffee.
Americans drank 146 billion cups last year, consumed nine pounds of coffee annually and while three out of four cups are prepared at home, 87 percent of the dollars they spend are on foodservice coffee. Almost 20 percent of coffee drinkers prefer espresso drinks.
“This category of coffees has, quite surprisingly perhaps, actually thrived in these difficult times,” says Giovannucci, who annually surveys North American coffee importers. “My early calculations are that the certified sustainable coffees such as Fair Trade, Rainforest Alliance and Organic are doing quite well from late 2008 into early 2009,” says Giovannucci. "We seem to have extraordinary levels of customer loyalty to value-based purchasing. …. helping others has not gone out of style in the U.S. and Canada."
The SCAA survey of whole bean and ground coffee retailers found that 67 percent experienced sales gains in 2008. A similar percentage (62 percent) reported an increase in beverage sales. Only 12 percent experienced ground and whole bean sales declines. Independent coffee shops earned $12 billion in 2007. The average shop sold 230 cups a day.
Commodity coffee blends are also improving to satisfy customer preference and green coffee prices are rising, another good indicator.
Last year’s sale of Folgers Coffee Co. to J M Smucker Co. for $3 billion stimulated competition in this segment. In addition to Folgers, Procter & Gamble™ sold Millstone® and Dunkin’ Donuts® coffee brands in the deal making Smucker Co. the largest U.S. coffee manufacturer by sales. Look for a response from multinationals including Kraft, Unilever, Nestlé and ConAgra, the nation’s leading hot drink brands.
Looking ahead, much of the industry’s growth will remain in the specialty coffee segment. The shift to quality is quite apparent, but that does not signal comparable growth in retail beverage sales for independent shops.
DOUBLE DIGITS
The simple explanation for double-digit growth is complex. In Specialty Coffee Retailer's series of coffee shop profiles, great retailing is the common denominator.
Click here to read profiles from independent shop owners grossing 10 percent or greater sales over 2008.
Starbucks reported $150 million in quarterly earnings in September despite the fact revenue was down 3.7% to $2.42 billion. Earnings during the same period last year were a dismal $5.4 million. Savings of $580 million exceeded the company's target of $550 million. As soon as the company closed 800 U.S. locations it instituted a price hike of as much as 30 cents per drink along with significant hikes in more complex drinks. The move was succcessful and the introduction of Via, its instant coffee in September was well received. The innovative instant sells for $2.95 for a three pack. Sales at stores open a year declined 1 percent which is a significant improvement compared to the third quarter when same-store sales declined 5 percent. CEO Howard Schultz told analysts that in fiscal 2010, the company expects earnings per share to increase 15 percent to 20 percent, up from its previous forecast of an increase of 13 percent to 18 percent.
Peet's Coffee & Tea avoided deep price cuts and introduced up-scale offerings in its 200 company stores. The firm responded to market conditions with additonal training and service. Expansion proved critical as the Pacific-based firm began offering its packaged coffee on the East Coast. Sales of non-coffee products average $400,000 per year at a typical Peet's Coffee and earnings are up 25 percent in 2009. The new Godiva-flavored espresso drinks are selling well and grocery sales of top-quality coffees proved resilient. In 2008 Peet's earned 72 percent of its operating profit from bagged coffee sales in grocery stores, home delivery and its foodservice and office businesses. In November the firm bid $265 million to acquired Diedrich Coffee to gain entry into the single-serve market dominated by Green Mountain Roasters.
RECESSION
The long, dark night brought by recession has fundamentally altered consumer behavior. Coffee and value-focused fast food such as McDonald's has proven resilient, but foodservice remains vulnerable. The National Restaurant Association reports that foodservice revenues have shrunk 30 months in a row.
Fifty-seven percent of restaurants reported a same-store sales decline in January from a year ago — worse than the 49 percent in December, according to the National Restaurant Association.. Expensive bistros suffered the biggest losses but family- and casual-dining places report their customers order more takeout, visit less frequently and cook at home. Chains that have introduced small plates under $6 have drawn additional sales and that practice is likely to spread. Restaurant traffic is the $75 billion casual-dining businessis not expected to grow until the second half of next year according to NPD Group, a market research firm.
The Associated Press reported that the economy grew at a 3.5 percent annual pace in the July-September quarter ending a record four straight quarters of decline and providing the strongest signal yet that the recession is over. Consumer spending, which accounts for 70 percent of the nation's Gross Domestic Product (GDP) grew at 3.4 percent for the quarter reflecting economic expansion.
But signs that the worst is behind us are deceptive. Economists declared the recession's end on technical measures this summer after an upturn in several key measures such as stock market benchmarks and rising housing sales.
While the Dow Jones Industrial Average has topped 10,500, returning to pre-recession levels, there are still key components of the economy, such as the availability of small-business financing, that continue to falter. In September consumers were boyant. In October consumer confidence declined and then experienced an uptick during the holidays. Spending rose 3.6 percent from Nov. 1 through Dec. 24 compared with the same period last year, according to MasterCard Advisors' SpendingPulse, which estimates all forms of payment including cash. Adjusted for an extra shopping day between Thanksgiving and Christmas, the number was closer to a 1 percent rise. That was still better than the flat sales analysts had predicted, according to Associate Press reports.
Unemployment
Joblessness remains the biggest impediment to a retail recovery.
The United States lost only 11,000 jobs in November when unemployment dropped from October's high of 10.2 to 10 percent. Yet November was the 23rd consecutive month of job losses. October marked the first double-digit unemployment average since 1983. There are now 15.4 million people out of work. The post-World War II unemployment high was 10.8 percent set in December 1982.
An interactive map published by Slate of employment gains or losses by county tells the story of how job losses first struck in the most vulnerable regions and then spread rapidly to the rest of the country.
Unemployment was 4.9 percent as recently as January 2008. Since then a record 5.9 million have been out of work at least six months. When you add laid-off workers who are no longer seeking jobs and those forced to settle for part-time work, the unemployment rate rises to 17.5 percent, the highest since 1994. The average duration of unemployment grew by about two weeks, to 28.5 weeks in November -- the highest on record.The proportion of the unemployed who have been out of work for over 26 weeks, at 35.6 percent, is the highest since World War II.
Most economists say it could take at least until 2015 for the unemployment rate to drop down to a historically more normal 5.5 percent. All this would come after a decade that created relatively few jobs: a net total of just 464,000. By contrast, 21.7 million new jobs were generated between 1989 and 1999, according to Associated Press reports.
The recession has eliminated a net total of 7.3 million jobs since 2007 including 3 million since the stimulus package was approved. The Wall Street Journal reported "that long-term revisions based on other sources of data will likely show the recession has actually wiped away more than eight million jobs."
Click to see a Wall Street Journal graphic depicting unemployment figures since 1948.
As reported in the Wall Street Journal, the International Monetary Fund's World Economic Outlook predicts U.S. unemployment will average 10.1 percent in 2010. The jobless rate won't hit 5 percent until 2014, according to IMF.
Productivity, the amount of output per hour worked, jumped 9.5 percent in the third quarter, according to the Labor Department. That's the sharpest increase in six years, and it enables companies to produce more without hiring extra workers.
The $787 billion stimulus package passed in February is intended to "save or create" 3.5 million jobs by the end of 2010. The White House predicts less than 10 percent of the employment impact from the stimulus will take place during 2009. In October the Administration claimed the stimulus was responsible for 660,000 new or saved jobs.
Income Shrinking
Household income, adjusted for inflation, has shrunk in the past decade.
Median household income, adjusted for inflation, fell to $50,303 in 2008, according to the U.S. Census. That gauge combines wages and salaries, investment income and government benefit payments like Social Security. It's down 4 percent from a peak of $52,587 in 1999, when incomes were bolstered by stock gains from the dot-com boom.
Commercial Credit Crisis
Tightening credit for small business causes a disproportionate effect on the economy, because these smaller firms account for about 60 percent of the nation's jobs. Statistics compiled by the U.S. Small Business Administration show that firms employing fewer than 500 created nearly two-thirds of all new jobs in the past 15 years. These businesses tend to rely on credit cards and home equity lines to maintain their cash flow.
"Now that mortgage market has collapsed and credit line limits are being slashed and rates raised to 30 percent neither of these options are viable," Nobel Economist Joseph Stiglitz told Newsweek.
Even though interest rates remain as low as the easiest years of easy money the cash supply isn't flowing, he said. "Bank loans have fallen off 17 percent since last year."
The November bankruptcy of CIT, for example, placed in jeopardy financing for many Dunkin' Donuts franchise holders. CIT was the chain's preferred lender for 50 years and has provided $400 million in financing. Private-sector job losses fell to 84,000 in December, marking the ninth consecutive monthly decline, according to ADP’s National Employment Report, based on data from the Roseland-based payroll processing company. In November, companies shed a total of 145,000 employees, according to the report. The December decline was the smallest since March 2008, according to ADP.
Employment at service-providing companies with less than 50 workers increased by 11,000 during December, the first increase since March 2008.
The report found companies with fewer than 50 workers shed 25,000 jobs
Click to see ADP employment statistics at firms employing 50 or fewer workers.
Commercial real estate prices have fallen 41 percent since October 2007, according to Moody's Investors Services. Office vacancies, meanwhile, have risen 17 percent since the third quarter to a five-year high. This spells further trouble for banks which hold about half of the $3.5 trillion in loans secured by U.S. commercial real estate. Researchers estimate banks already have lost as much as $110 billion on commercial real estate and construction loans.
In June the FDIC identified 416 banks at risk of failure. So far 174 lenders have failed and the pace is expected to pick up in 2010. In December, more than 349,000 households, or one in 366 homes, were hit with a foreclosure-related notice. That represents a 14 percent spike from November and a 15 percent jump from December 2008, according to Associated Press reports. There were 2.8 million foreclosures last year, a number expected to peak at 3.5 million. In December banks repossessed 92,000 homes, up 19 percent compared to November.
Click to view a Wall Street Journal graphic of bank and savings and loan failures.
Consumer Confidence
This is a consumer-led recession and retailers can see from the purchasing behavior of their customers that workers remain fearful for their jobs.
Consumer Confidence Index to 52.9 in December, up from a revised 50.6 the month before, according to the Conference Board. While far below a 90 reading that would signify a solid economy, consumers' outlook on jobs over the next six months reached its highest level in two years.
There is some evidence employers view 2010 as a time to rebuild staff. One-fifth of employers plan to add full-time, permanent employees next year, up from 14 percent in 2009, according to CareerBuilder.com, an online jobs site that surveyed more than 2,700 hiring managers and human resource professionals. The survey was conducted online for CareerBuilder.com by Harris Interactive from November 5 to November 23.
Just 9 percent said they plan to cut head count in 2010, down from 16 percent in 2009, according to the nationwide survey.
A survey by Sun Life Financial Inc. in October showed 77 percent of adults between 18 and 66 say they're cutting spending. Nearly eight in ten of those cutting back say they are spending less on entertainment and eating out, and more than half have put off a home improvement project or buying a car, according to an Associated Press report.
An October phone survey by GfK researchers for Move.com revealed 45 percent of Americans worry that they, or someone they know, will face foreclosure in 2010. A third of those with a mortgage already have contacted their lender this year seeking to reduce payments.In November the Wall Street Journal reported that 10.7 million households owed more on their mortgage that their property was worth in the third quarter. Among this group, which totals 23 percent of all morgage olders, 5.3 million have mortgages that are 20 percent higher than the value of their home.
First American CoreLogic of Santa Ana, Calif. conducted the survey which noted that 520,000 of the borrowers have received a default notice.
Another factor impacing consumer confidence is wage gains that stalled over the summer. Average hourly earnings were $18.67 in September, weekly wages fell $1.54 to $616.11. No wonder retailers reported a tough summer.
"The bad news for retailers is that 60 percent said they will spend less on holiday shopping," according to the Associated Press which notes economists expect holiday sales to be at best flat from a year ago, which saw the biggest declines since at least 1967 when the Commerce Department started collecting holiday sales data. Still, this is the holiday season and the consumer sentiment index, tracked monthly by Reuters/University of Michigan which stood at 69.4 in October is expected to rise in the early part of November. Consumer sentiment was 73.5 in September. A holiday poll of consumers by consulting firm Deloitte LLP says 74 percent intend to buy items on sale and 54 percent intend to use more coupons.
The drop highlights a disconnect from the views on Wall Street and Main Street where there's still a lot of concern, explains Daniel Penrod, Senior Industry Analyst, California Credit Union League, Ontario, Calif. "We've seen savings increase significantly while the lending and borrowing side has not increased. That indicates that the consumer still has a kind of bunker mentality. This does not bode well heading into the holiday season. The likelihood is this will dampen expected holiday sales."
Click here to review latest measure of consumer confidence.
Credit Card Crisis: Credit card delinquencies soared to a record 6.60 percent this spring. U.S. consumers ended March with $939.6 billion of revolving credit outstanding, a rough approximation of credit card debt, according to Federal Reserve data. Revolving credit, which is primarily credit-card borrowing, declined to $14.8 billion in October to $2.46 trillion, the eightth consecutive month. The decline has been the longest streak on record, according to Bloomberg.com.
Nonrevolving credit, such as loans for autos, vacations and education, declined at an 11.7 percent annual rate. According to the American Bankruptcy Institute, public bankruptcy filings in October rose 28 percent from the October 2008 figure.
Although households are shedding debt, they are not doing so quickly. Consumers’ debt exceeded their after-tax “disposable” income by 28 percent in the first quarter, according to Scott Hoyt, senior director of consumer economics at Moody’s Economy.com. This debt-to-disposable income ratio peaked in the first quarter of 2008, when debt exceeded income by 33 percent.
Forecast: The recession began in December 2007 but the economy actually grew for the first six months of 2008. Third-quarter GDP had slipped only .5 percent before a wrenching 6.3 plunge in the fourth quarter of 2008.
The 1 percent rate of decline in the April-June quarter of 2009 followed decreases of 6.4 percent in the first quarter and 5.4 percent in the final three months of 2008, the sharpest back-to-back declines in a half-century. The four straight quarterly declines in GDP, which measures the country’s total output of goods and services, mark the first time that has occurred on government records that date to 1947. Recovery began in the second quarter of 2009 and GDP was 3.5 percent in the third quarter, signalling a technical end to the recession.
Estimates are varied but economists predict less robust growth in the early part of 2010 due to continued unemployment with modest 2.4-percent growth in 2011. Doug Roberts, chief investment strategist for Channel Capital Research told the Wall Street Journal, "Right now, if the consumer at these levels feels there's a prospect of being unemployed, he's going to pull back. This is a consumer-led recession, and despite the government’s best efforts, they can't get them to spend."
A return to prosperity remains in the distance. Even after growth returns, market researchers say that consumer behavior has undergone a permanent change. Credit-card hubris is past. Frugality is the new reality with consumers both young and old returning to basics like home-brewed coffee and health-conscious and sustainable innovations that emphasize value.
-- Updated Jan 23, 2009
TEN 2010 TRENDS
Insight: State of the Industry
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