Direct Trade Sourcing Strategies for Specialty Coffee

Authors: 
Scott Webster, Arizona State University
Burak  Kazaz,  Syracuse University
Shahryar Gheibi, Siena College



Journal:

Manufacturing & Service Operations Management

Summary:

We develop a model that determines optimal sourcing, pricing and production decisions for specialty coffee roasters that rely on "direct trade" in sourcing premium coffee.

Research Questions:

We provide insights into managing a specialty-coffee supply chain by investigating the following research questions:
1.      How should a specialty roaster set Direct Trade contract acreage for a single-origin label coffee?
2.      After the single-origin harvest yield and market uncertainties are revealed, how should a specialty roaster allocate the harvested beans among single-origin label and blend labels, and determine the selling price of single-origin label coffee?

What We Know:

Coffee is one of the most popular beverages worldwide. While coffee consumption is expected to continue to experience steady growth, consumers seem to increasingly demand high-quality coffees around the world. Some coffee roasters have targeted the specialty coffee market and are reshaping the coffee industry. Pioneer roasters in the specialty coffee industry include Counter Culture, Intelligentsia, and Stumptown. These roasters, which are referred to as the Big Three, were early drivers of initiatives aimed at enhancing the quality of the produced coffee and they often rely on "direct trade" sourcing of premium coffee beans. The specialty coffee bean market is significant, estimated at 50% of the global value of traded coffee. Interest in the segment is reflected in the recent acquisitions of Intelligentsia and Stumptown by Peet’s Coffee at high prices.

Novel Findings:

We identify several new insights: (1) Two factors determine which strategy is optimal:  the mean price of the inferior product (blend label) and the marginal cost of the superior product (single-origin label). (2) The weighted average price of an agricultural product is decreasing in negative yield-price correlation. We coin this as “farmer’s curse,” which carries lessons for direct trade sourcing (e.g., advocating against paying the grower at post-harvest market prices). (3) We find evidence of a virtuous feedback loop wherein the grower-roaster relationship becomes stronger over time. Our findings also point to a simple signal that policymakers may use to identify coffee-growing locales where targeted interventions can improve grower welfare.

Implications for Practice:

A roaster has the option to allocate some of the single-origin beans for sale under a blend label, known as downward substitution. We identify three distinct optimal sourcing strategies: specialized (no downward substitution), diversified (consistent downward substitution), and mixed (between these extremes) and show that they are robust under different definitions of yield and demand.

Implications for Policy:

We find evidence of a virtuous feedback loop wherein the grower-roaster relationship becomes stronger over time. Our findings also point to a simple signal that policymakers may use to identify coffee-growing locales where targeted interventions can improve grower welfare.

Implications for Society:

With better sourcing strategies, roasters can source premium coffee beans and offer them to consumers at reasonable prices.

Implications for Research:

Our research will inspire scholars to employ similar methods in examining sourcing strategies in other agricultural goods that have commodity price information.

Full Citation:

Webster, S., B. Kazaz, Gheibi, S. Direct trade sourcing strategies for specialty coffee. Forthcoming in Manufacturing & Service Operations Management.

Abstract:

Problem definition: Leading specialty coffee roasters rely on direct trade (DT) to source premium coffee beans. We examine a roaster who sells two basic types of roasts: (1) a single-origin roast is sourced from a specific locale, (2) a blend roast uses a mix of beans from sources that vary over the course of a year. The price of blend roasts is lower than single-origin roasts and appeals to a larger market. We study how characteristics of the operating and market environment affect the optimal sourcing strategy for single-origin beans. 

Methodology/results: We develop a two-stage stochastic program with recourse that reflects these characteristics. A roaster has the option to allocate some of the single-origin beans for sale under a blend label, known as downward substitution. We identify three distinct optimal sourcing strategies: specialized (no downward substitution), diversified (consistent downward substitution), and mixed (between these extremes) and show that they are robust under different definitions of yield and demand. 

Managerial implications: We identify four main insights: (1) Two factors determine which strategy is optimal: the mean price of the inferior product (blend label) and the marginal cost of the superior product (single-origin label). (2) When compared with the newsvendor model, we find distinct structural differences across strategies. For example, while the effects of increasing uncertainty on optimal quantity align with the newsvendor model under a mixed strategy, the effects are distinctly different under specialized and diversified strategies (e.g., monotonic decreasing behavior for specialized, no change in quantity under diversified). (3) The weighted average price of an agricultural product is decreasing in negative yield-price correlation. We coin this as “farmer’s curse,” which carries lessons for direct trade sourcing (e.g., advocating against paying the grower at post-harvest market prices). (4) We find evidence of a virtuous feedback loop wherein the grower-roaster relationship becomes stronger over time. Our findings also point to a simple signal that policymakers may use to identify coffee-growing locales where targeted interventions can improve grower welfare.

Web URL for the Article:

 https://bkazaz.expressions.syr.edu/wp-content/uploads/2024/05/GKW2-rev3-v12-4d.pdf