How Climate Change Affects Starbucks
Starbucks is facing a massive issue: global warming is decimating the world’s supply of coffee beans. The farmers who supply Starbucks’ main input cost, the Arabica coffee bean, are facing plummeting crop yields from declining farming opportunities and deteriorating weather conditions. These supply issues stem from a combination of increased hurricanes, mudslides, erosion, pest infestations, and erratic rain patterns…all because of global warming. Not only does this affect the input costs of Starbucks’ coffee beans, but it also will likely lead to further supply constrictions as farmers become less incentivized to cultivate coffee in the future or switch to other crops.[ii]
According to a recent MIT research study, if global warming keeps up at the current pace, 80% of the Arabica coffee bean producing regions located in Central America and Brazil will no longer be fit to produce coffee beans by 2050. Given this effect, the international decline in the coffee supply would fall by a drastic 50%[iii], making Starbucks’ costs rise sharply as production drops. The company is extremely concerned, and their Sustainability Chief Jim Hanna attests: “if we sit by and wait until the impacts of climate change are so severe that is impacting our supply chain then that puts us at a greater risk. From a business perspective we really need to address this now, and to look five, ten, and twenty years down the road.” [iv]
How Starbucks is Fighting Back
Starbucks is seeking to mitigate these threats at the macro level by founding the Sustainable Coffee Challenge to push governments, businesses, and other companies to stimulate growth for sustainable coffee across the value chain. The project has been massively successful, and now includes “a diverse coalition of nearly 50 partners from across the coffee sector from retailers, traders, governments, donor agencies and other NGOs – united by a sense of urgency and shared commitment to ensuring the long-term viability of coffee.”[v]
At the micro level, Starbucks has partnered with Earthwatch to bring scientific research and sustainable farming practices to the farmers who supply their coffee beans. These efforts have been at the cutting edge of environmental science, successfully reducing the fertilizer usage levels and reducing acidity levels by increased use of limes (for savings of $243 per hectare equaling over $1,200 per farmer). These methods also increased coffee beans per branch from 25.1 to 33.4, a staggering 25% increase in yields.[vi] Starbucks has even taken their actions one step further, by working with farmers to counterbalance extreme temperature and limited water supply by using an adapted growing technique called “shade grown coffee.” This process utilizes a large canopy of trees which are “not only making their supply chains more resilient, but are curbing global warming by preserving tropical forests, which soak up carbon.”[vii] These actions are cementing Starbucks’ business viability long-term by ensuring that the Arabica coffee bean supply does not diminish rapidly around the globe, while effectively cutting COGs and positively impacting their bottom line.
Recommendations for the Future
Recently, Starbucks has performed admirably in hedging their costs, using one-year commodity hedging derivatives to lock in prices of coffee for next year. By pouring through research reports and looking at the most recent financial statements, one notices that Wall Street analysts have been impressed that management has been able to hedge their increasing commodity costs short term.[ix] However, the company will need to do much more in the future as climate change more drastically impacts the prices of coffee beans. By analyzing the prices of coffee futures longer term, management could actually realize a profit by using more advanced investment instruments. My suggestion is to hire a small team of exotic structured derivatives specialists. Looking at a current chart of the coffee futures market, these experts would identify the coffee market is in contango priced out till August of 2017. This means the index funds in this market have to pay a roll yield as they sell contracts before they expire at a lower price, and then buy a further out contract at a higher price. Devoting more resources and attention toward this will be imperative in the future, as coffee prices become more volatile and the coffee market becomes treacherous for the players trying to hedge out pricing on a yearly basis. A second step that Starbucks could take is commissioning an in-depth independent research study of where coffee prices will trade five years from now. This way instead of hedging out for just one years’ worth of supply, management could hedge out COGs using long term equity anticipation contracts (LEAP options). This would save them from paying higher option premiums for hedges. By doing this, Starbucks could effectively save itself millions of dollars in future costs, and make sure that coffee will still be helping people wake up in the morning for years to come.
[i] Kate Taylor, (2016), Starbucks Across America [ONLINE]. Available at: http://www.businessinsider.com/starbucks-are-running-out-of-coconut-milk-2016-7 [Accessed 2 November 2016].
[ii] Suzanne Goldenberg, “Starbucks Concerned World Coffee Supply Is Threatened by Climate Change,” The Guardian, October 14, 2011, accessed November 2, 2016, https://www.theguardian.com/business/2011/oct/13/starbucks-coffee-climate-change-threat.
[iii] “Coffee Shortage Predicted Due to Climate Change; Starbucks, Agriculture Industry Worried,” Nature World News, May 12, 2016, accessed November 2, 2016, http://www.natureworldnews.com/articles/22059/20160512/coffee-shortage-predicted-due-to-climate-change-worries-starbucks-and-the-agriculture-industry.htm.
[iv] Suzanne Goldenberg, “Starbucks Concerned World Coffee Supply Is Threatened by Climate Change,” The Guardian, October 14, 2011, accessed November 2, 2016, https://www.theguardian.com/business/2011/oct/13/starbucks-coffee-climate-change-threat.
[v] “Follow Starbucks’ 15 Year Journey to 100% Ethically Sourced Coffee,” Conservation International, 2016, accessed November 2, 2016, http://www.conservation.org/partners/Pages/starbucks.aspx.
[vi] “Earthwatch Case Study: Starbucks Helps Grow a Better Cup in Costa Rica,” EarthWatch Institute, 2016, accessed November 2, 2016, http://earthwatch.org/corporate-partnerships/corporate-partnership-case-studies/starbucks.
[vii] Lehner, Peter. “Major Businesses Prepare to Deal with Climate Change.” March 23, 2016. accessed November 2, 2016. https://www.nrdc.org/experts/peter-lehner/major-businesses-prepare-deal-climate-change.
[viii] Conservation International, (2016), Shade Grown Coffee [ONLINE]. Available at: https://coffeeruleseverythingaroundme.wordpress.com/portfolio/coffee-cravings-the-last-link-in-the-commodity-chain/ [Accessed 2 November 2016].
[ix] Bonnie Herzog, “Starbucks Corporation,” Wells Fargo Equity Research. accessed from Capital IQ, Inc., a division of Standard & Poor’s. April 21, 2016. accessed November 2, 2016.