The Aroma of Fat Arabica Margins

The sweet smell of coffee’s success is a learning opportunity for diamonds. In Israel, a cup of cappuccino costs 10-15 shekels ($2.80-$4.20) depending on the café and its location. Since 2008, the price of coffee at cafés more than tripled compared to inflation. The price of a cup of coffee increased by 25% while inflation in the five-year period is about 8%, according to business information firm BDI.

A few weeks ago, a guy who specializes in low-cost retailing opened a takeaway café in Tel Aviv that sells everything – sandwiches, cakes and cappuccinos – for 5 shekels ($1.40). Costing half to a third of what a cup of coffee costs at most places, you may suspect that the coffee offered at this new place is low quality and therefore costs less to brew, however most people who have tried it said it was a very good cup of coffee.

What I found interesting in this story was not the retail battle, but the underlying economy of coffee, specifically the commodity prices. In 2008, the ICO Composite Price of coffee stood at 124.25 US cents per pound ($1.2425/lbs.). It increased by 86.1% to peak at $2.31 in April 2011 only to lose more than half its price in a tumble that has not ended yet. Despite the sharp rise, compared to 2008, the average price of the commodity is today 10% lower.

Why talk about coffee in the diamond world? Because there is so much to learn from it. For example, that there is a big disconnect between the cost of the raw material and the retail product, just as there is between rough diamonds and polished diamonds sold at a store.

The low-cost retailer showed that while his competitors are running in one direction – constantly increasing prices while offering differentiation in taste or setting – going in a different direction is also a viable option. In coffee, as in diamonds, sometimes volume is the name of the game, even if you offer high-quality product, service and setting.

More importantly, coffee companies are not worried that coffee beans are openly traded and that their selling price is publicly known. It does not prevent the price of a cup of coffee from increasing even though the price of coffee beans is declining. One of the reasons for that is that consumers standing in line at Starbucks don’t check the price per pound of Colombian Mild Arabica, Robusta or the ICO Composite Price.

After all, diamond traders resisting transparent prices are concerned that consumers will get hold of this information, which may harm profitability. Small neighborhood cafes and large retail coffee chains prove that consumers are willing to pay a range of prices almost regardless of the price of the underlying commodity. This is because retailers offer consumers a range of qualities, experiences, ambiances and competing services. The diamond jewelry business can, should and does do this, too. Transparent diamond prices won’t harm this. It will only make the trade more sophisticated.

Just to put this in context, the price of a single Nespresso capsule in the U.S. translates to about $54 per pound – compared with the ICO $1.1182 per pound in September. This is a wild 4,829% difference between the early-hand wholesale price of the raw material and the price of the finely tuned, high-end brew used at home by coffee connoisseurs. Further, at $0.60, the Nespresso capsule costs far less than a cup of coffee at any café.