- Starbucks cut coffee hedging from $1B in 2019 to $200M amid a 70% price surge this year
- By relying on price-to-be-fixed contracts, Starbucks is shifting risk to an uncertain future
- Starbucks and many small to mid-sized roasters are betting on future price drops but risk hefty costs if prices remain high
Starbucks, the world’s largest café chain and a buyer of 3% of the world’s coffee, has taken a risky gamble in its approach to coffee purchasing.
By cutting its hedging programme from $1 billion in fixed-price coffee contracts in 2019 to just under $200 million at the end of its fiscal year in September, it has drastically reduced its reliance on tools designed to cushion against market volatility.
This decision comes at a precarious time. Arabica futures have surged to over $3 per pound – with prices rising by over 70% in the past year alone – while Robusta bean futures in London jumped 7.7% to $5,507 a tonne, all largely driven by climate-induced supply shocks in top producers like Brazil and Vietnam.
By reducing its hedging commitments, Starbucks is saving on the escalating costs of collateral required for fixed-price contracts. However, the company is now more exposed to market fluctuations, potentially forcing it to absorb rising costs or pass them on to consumers.
Starbucks’ current strategy relies on “price-to-be-fixed” contracts, which defer price-setting to a later date. While this approach may allow flexibility, it also pushes the risk into an uncertain future.
Hedging requires hefty upfront collateral, which has grown as coffee prices climbed. By stepping back, Starbucks may avoid these costs but risks facing higher spot prices for coffee should market conditions worsen.
The strategy also raises the stakes for Starbucks’ pricing power: Will it pass on costs to consumers, who are already paying premium prices for their morning brew? Or will it use its scale to negotiate harder with suppliers, squeezing margins further down the chain?
The coffee industry at large is experiencing a reckoning and impacts are being felt across the board.
“Smaller exporters, importers and cooperatives are definitely being affected, especially those who use short futures to hedge physical coffee inventory,” says Ryan Delany, Founder and Chief Analyst at Coffee Trading Academy, LLC. “Even larger exporters are being affected.”
“We’ve heard rumours of companies in serious financial trouble, seen some headlines of companies going bankrupt, and of larger companies buying out financially troubled companies. This happens periodically when prices rally to extreme levels like this.”
The mechanics of coffee contracts & supply chain dynamics
To understand the significance of Starbucks’ move, it’s crucial to examine the mechanics of coffee contracts and market-based instruments for agricultural price risk management.
Broadly, buyers like Starbucks have two main options: fixed-price contracts and price-to-be-fixed (PTBF) contracts.
Fixed-price contracts provide predictability by locking in a set price for a specific quantity of coffee, but they require hedging through derivatives to stabilise costs. These contracts are expensive to maintain in a rising price environment, as escalating coffee prices push up margin requirements for futures contracts used in hedging.
In contrast, PTBF contracts allow Starbucks to agree on a quantity and quality of coffee while deferring the final price to a later date. This approach reduces immediate financial obligations but exposes the company to future price volatility.
Starbucks’ shrinking hedge book suggests it is relying more heavily on PTBF contracts, effectively betting on price declines or its ability to manage volatility without traditional safety nets. Despite these risks, Starbucks maintains that its approach is part of a broader effort to remain agile in a dynamic market.
“We keep a healthy and ample green coffee inventory that outpaces other roasters,” Starbucks said, according to the Financial Times.
The company highlights its robust inventory of green coffee as a buffer against spot market volatility. As of September 2023, Starbucks’ combined inventory of unroasted and roasted coffee beans was valued at $920 million, according to its annual report, the lowest fiscal year-end figure since 2021.
Overall, the recent coffee market rally has created a stark divide between farmers benefiting in the short term from high prices and exporters struggling with the financial strain of short futures positions, highlighting vulnerabilities across the supply chain.
“Over the last 3 years, farmers have gotten excellent prices, even more so in the last few weeks, so if they were delaying the price fixing of their coffee this would mostly have benefited them,” says Ryan.
“For exporters, market rallies present significant challenges, as they hold short futures and must cover margin calls when prices surge. Smaller exporters, with limited access to credit, often feel the financial strain first, but even multinationals face their own constraints, as their credit capacity is not infinite.
Both are vulnerable in extreme conditions, potentially leading to forced hedge lifting, financial distress, or even bankruptcy. But this has nothing to do with the hedging strategies of roasters. The exporter will be short futures regardless of whether their customers (roasters) are buying PTBF or flat price.”
Despite its scale, Starbucks is not immune to the pressures facing exporters and suppliers. Multinational suppliers also face credit limitations, and in extreme market conditions, both small and large players risk being forced to lift hedges or declare bankruptcy.
Starbucks’ reduced hedging strategy reflects broader trends in the coffee industry. Many roasters and traders have scaled back their purchase contracts, influenced by tightening credit conditions and unpredictable supply chains. This has left smaller suppliers particularly vulnerable, as PTBF contracts delay price setting and payments, adding to their financial instability.
For Starbucks, the strategic gamble of reducing hedging aligns with a broader emphasis on operational agility. However, this approach comes with its own set of risks, particularly as global coffee production remains in flux due to erratic weather patterns and supply challenges.
Implications for Starbucks and the coffee industry
Starbucks’ hedging reduction is a high-stakes bet that underscores shifting priorities within the company and the broader coffee sector.
By reducing hedging, Starbucks is banking on stable or declining coffee prices in the near future. However, with ongoing weather disruptions in major coffee-producing countries, this bet may not pay off.
Rising prices could erode profit margins, forcing Starbucks to pass costs onto consumers. This would challenge its premium brand positioning, particularly in markets where affordability is key.
Tension is at an all-time high as the iconic chain navigates these tensions amid broader efforts to revitalise its brand and keep up with competition. New CEO Brian Niccol has emphasised a return to the company’s roots as a community-focused coffee house.
“At Starbucks, coffee comes first,” he said in a recent video message that sounded more like an attempt to reassure investors rather than an authentic moment of reconnection with its customers.
The decision to scale back hedging raises questions about how the company will balance its alleged commitment to quality and sustainability with the financial realities of a volatile market.
Starbucks’ reduced hedging strategy contrasts with competitors like Nestlé, which likely maintain more robust hedging practices. Competitors with stable cost structures may gain an edge, allowing them to offer consistent pricing to consumers during market volatility.
This could intensify competition, especially in cost-sensitive markets such as China, where Starbucks faces declining sales and growing competition from local chains like Luckin Coffee – competition that will now extend to the US where Luckin is setting up operations.
Starbucks’ decision to drastically cut its coffee price hedging is a calculated risk and a move that aligns with a broader trend of prioritising operational flexibility.
However, it also exposes the company to significant financial and reputational risks. As for many in the coffee industry choosing to defer price fixing in the hope of future price declines, this strategy carries significant consequences if prices continue to soar.
Whether Starbucks’ strategy proves successful will depend on the trajectory of coffee prices in the coming year. For now, the company’s actions signal a shift in how risk is distributed within the coffee industry.
Coffee Intelligence
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