Tuesday, April 14, 2009

Transparency Contract ©:
Mea$uring Your Relationships

(Originally Published in Roast Magazine September 2007)

Transparency = The full, accurate, and timely disclosure of information.

Contract = A binding agreement between two or more persons that is enforceable by law.

Relationship = A state of connectedness between people (especially an emotional connection).




Connections to people motivate our empathetic desires to take action on their behalf. Our sense of emotional connection causes us to write a Katrina check, drop a coin in the red bucket, or give our “to-go” box to the guy on the corner. These admirable actions crown humanity’s inherent emotional knowledge that we must care for one another.

In the sustainable coffee movement, we have cultivated the understanding of our relationships with people continents away, connected only by a green pebble path, and we have acted. We have grappled with our desires to help, and have lunged through the chaos with hundreds of programs and certifications.

Through time we have learned that the process is complicated. Relationships are just that, Relationships, not bound by rules but simply the interaction between unique individuals. Some relationships result in fruitful years of marriage, while others end sadly in bitter divorce. While a two person relationship can be difficult, a four party relationship is compounded with complications and fogginess. Add multiple language and cultural barriers, distinct currencies, various weight measurements and the chance of mirror understanding of the relationship is at the least problematic.

The Transparency Contract Concept:

The transparency contract was created to bring clarity to coffee chain relationships. In ten years of participation in sustainable coffee chains I’ve come to some key understandings that convince me we need to use a transparency contract platform in our sustainable coffee purchases:

1. Good friends do not always result in good business relationships.
2. Everyone does not have the same understanding of “sustainable” payments to coffee farmers.
3. No certification program exists that ensures the price the land holding farmer is paid.
4. Every “relationship” is distinct, with distinct needs by each party. In addition, each country and farmer has distinct costs of production.

Of course I am also writing with assumptions about you, the reader. I assume you are a specialty coffee roaster, able and willing to pay a minimum of $1.50 FOB (from port of origin) per pound. I also assume your providers understand their production costs, and they are willing and able to demonstrate their costs to you. It should also be noted that for the roaster’s sake the contract is put in terms of exportable pounds.

Within this transparent concept the essential seller is the farmer and the essential buyer is the roaster, placing the exporter and importer into service-oriented roles. Traditionally the exporter and importer retain both intellectual (producer information) and physical property rights to the coffee. This traditional model blockades the release of information and transparency in financial exchanges, because private knowledge is the primary security of the exporter and importer’s financial gain. The transparency contract attempts to give profit to the all parts of the chain for the transparency they provide, allowing us to keep our benefit focus on the farmer.

The transparency contract has two principle goals in mind:
1. Ensure the delivery of the farmer price
2. Motivate quality production

I believe these are two inherent goals of every specialty coffee roaster. The transparency contract is meant to be reviewed, negotiated, and signed prior to the harvest. In this way the farmer knows the potential earnings he has before him and is motivated by a firm offer to do the best job possible. To ensure the price delivered to the farmer is adequate it is calculated as the first line item in the contract, rather than starting at the roaster and just trying to find out how much gets back to the farmer.

For our industry to survive we must ensure that our producers are motivated to produce quality by the secure knowledge that premiums will reach them in direct correlation to the effort they put into their product. For this reason there is a tiered value structure that rewards increased quality. Simply put, higher prices motivate farmers to work harder.

Lastly this is meant to be a pre-harvest contract. Traditional contracts reference the NY”C” with differentials decided prior to harvest, but that has very little to do with the farmers’ actual costs of production, and gives zero confidence to the farmer as to what his end price will be months in the future. These contract prices are confirmed well after the coffee has been harvested, and usually after dry milling just before the coffee is placed on a ship. Some specialty coffee buyers are beginning to offer fixed prices well above and regardless of the “C”. These pre-harvest contracts have the power to bring security and motivation to our farmer partners.

Tim Chapdelaine of Volcafe Sepcialty Coffee, an importer using the Transparency Contract, summarizes the importance: “The most important piece for all parties is definition of responsibilities. It is crucial that expectations are defined clearly and are laid out in the contract. The transparency contract is a means to achieve clarity of expectations. The responsibilities, the costs for them and the margins for effort are clearly laid out.”


The Parties:

In the coffee trade chain there are four essential players: roaster, importer, exporter and farmer. In traditional coffee business these four participants in the chain are separate entities with very specific roles and very private information. In some cases the farmer is also the exporter. In a cooperative scenario the farmer can also be an owner in the export company (the cooperative) but the roles remain distinct. The farmer is not just an owner in the cooperative, but also legally sells his product to the coop, and as such is the first vendor in the chain.

I recognize that there is no “one size” fits all contract. In some scenarios the farmers deliver cherry, others dry parchment, others wet parchment and yet others dry cherry. However, I do feel this model can be used in most contexts and can be easily modified to suit each unique situation. For certain, some scenarios need additional players in the chain (such as local collectors), yet most of the world operates with these four primary participants.

The Measurement:

In order to keep the prices simple the measurements are in US $ per exportable pound. Obviously this contract can be translated into the currency of a given country and the weight measurement that is most relevant. I do suggest that US $ be used since that is the currency of the international sale to North American roasters. Naming the measurement as exportable pounds is vital since this is the international exchange unit (sale between exporter and importer), as well as the importer to roaster sales unit.

The Farmer:

The first and most important price to determine is the price the farmer will receive. We start here, rather than ending here. In typical coffee trade the farmer receives whatever is left at the end of the chain, after all the costs and profits of the importer and exporter have been deducted. Assuming that one of our primary goals is to reward the farmer for quality production, we include the negotiated farmer price first.

For purposes of illustration, I have used a dry parchment contract. This means the farmer sells to the exporter his dry parchment, a common practice in most of Latin America. The standard of physical quality is listed to be 70 percent yield. This means for every 100 pounds of dry parchment sold to the exporter there should be 70 pounds of exportable coffee with a maximum of 5 SCAA defects (after dry milling: hulling and selection).

This yield can be calculated at the moment the farmer delivers the parchment to the exporter through a simple sampling of the coffee. The “specialty” vs. “off” grades weight distribution could then be calculated in order to pay the respected prices for the coffees. In most relationships the farmer is paid a premium entry price above the local market at the moment of parchment delivery. Once the coffee is prepared for shipment, and given final sensorial and physical grading approval, the actual mill results are used for final payment calculation to the farmer. In this way the actual export numbers are subject to the contract auditing, not projected calculations.

The third note clearly states that the agreed upon price(s) should be paid the farmer with signed receipts. In most coffee producing countries this is a legal requirement, though in reality very few farmers issue or are given receipts for their coffee sales, even within many cooperatives. This formality is a vital step in ensuring and auditing the realization of our intentions to pay the farmers specific premiums. The receipts must be open for the roasters to view, and when visiting the farmers one could simply ask them “can I see your receipt from last year?” This requirement elevates the farmers’ power for reclamation to the project, and allows them to be the on-the-ground enforcement police. Of course this assumes that as part of the project the roaster will be traveling to origin and conversing with the farmers. While fax and emails might allow for some secretarial knowledge level of verification, it is still only as good as phone dating without a personal visit to verify.

The forth note in this section can be uncomfortable for some business folks. It allows flexibility in the quantity based on the performance of the coffees on the cupping table. Volumes are not pre-determined, because the quality has not been produced yet. This is where trust in the relationships needs to be established in order to have a fruitful business transaction. The farmer, exporter and importer have to trust that the roaster will sincerely grade the coffees with sound judgment and without prejudice. In order to balance this out many exporters cup the coffees prior to sending samples to the roaster. This checks and balance system is ideal, but is not available in most cases not currently available due to lack of resources and/or a lack of cupping expertise at origin.

Cost of production for farmers is one of the most difficult calculations to make. This ranges wildly between each country, region and even farmer. That said, I do believe that ensuring $1.40+ per pound farm gate price to the farmer is a healthy place to start. This would most likely translate into a $2.00+ price for delivery to the roaster.

The Exporter:

In most cases farmers depend upon an exporter (cooperative or private) to take care of dry milling and export of their coffees. In many cases there are one or two other internal country trading partners. In the example at hand the exporter is in charge of handling and processing the coffee from the determined farmer and retaining lot identities. This includes administrating the sample preparations and sending them to the roaster. Once the samples have been graded by the roaster, and results returned to the exporter, the blending and dry milling takes place. Dry milling includes hulling the parchment coffee and passing it through the selection process (screen size, density, color monitoring and/or hand selection).

The exporter’s expertise in dry milling is equaled by their ability to get a container of coffee legally out of their country and on the correct ship. In some cases, as in the example, the exporter can put the small amount of coffee with a container sized load already programmed for export to the importer.

The primary gross costs an exporter has beyond purchasing parchment coffee are: the milling and transport, exporting documentations, and certification costs. Beyond that the exporter needs to have a gross profit for their business, which is listed as a separate line item. Separation of gross costs from gross profit is vital in any transparent negotiation.

In our example we also have included a 5 cent social benefit fund. Most private exporters are enthusiastic about administrating donations proposed by roasters, and can even offer counter donations for projects. These projects can be tailored to specifically meet the needs of the producing farmers in the contract and are many times initially used to assist in quality improvement investments, such as improved wet mills. Cooperative exporters usually have a social program in place for their members and the premium can easily be incorporated into that program.

In my experience most exporters (cooperative or private) are willing to give extra care to specialty coffee for a gross profit between 8-15 cents per lb. Traditional mills and exporters operate with gross profit margins as little as 1-2 cents per lb. This has created volume focused systems which are tripped up by the needs of specialty coffee buyers. For example it typically takes at least 3-5 times more milling time to prepare a container of specialty coffee (5 defects or less) vs. a container sold to the NY “C”. As you can see in our example we pay more for the higher quality coffee which demands even greater attention to detail. We must generously provide incentives for our exporters and mills beyond just actual costs added.

The Importer:

Importers play a vital role in our industry. They make the legal international purchase, must have enormous sums of capital on hand to cover the purchase, and have very low profit margins. Their primary costs are Freight, Distribution, and Financing. And as always no one works for free, so the importer is also rewarded for their essential contribution.

The importer’s Gross Profit margins are very negotiable. Obviously the higher the volume one purchases the lower the importer is willing to do the services for per pound. Most importers are willing to charge between 10 to 20 cents per pound gross profit on container size specialty coffee shipments. Note: that is their gross profit margin; financing and freight/storage are separate line items which can vary drastically based upon the origin & destination. Most importers are willing to share their import and distribution costs freely. The example at hand shows the shipping cost from Callao, Peru (principle Peruvian port) delivered and distributed through an Oakland, California warehouse.

The Roaster’s Role in Relationship:

The Roaster is the player within the chain who has the most power to demand that a transparent system be usedIn the end you, the roasterroasters, have the greatest power in the chain to demand that a Transparency Contract is implemented. This does not diminish the importance of having quality partnerships with your importer, exporter and farmers. Yet roasters must recognize they are the deciding clientThe fact of the matter is that Roasters are THE deciding client in the chain of custody with the greates with the option to purchase coffees that subscribe to a particular program, as well as the deciding link whom can who have the opportunity to shape the public's perception of sustainable coffee.

The sustainability efforts of our industry need to surpass our marketing claims and apply real $ terms to the relationships. The question, “How much does the farmer get paid?” sounds so simple to answer; yet sadly most roasters and importers who are selling coffee labeled as ‘sustainable’ cannot answer this question with certainty. This hollowness in our industry needs to catch up with our activism and marketing, and only roasters have the power to ensure that happens.

In the end I believe this is what the charity in our hearts greatest desire is wants the most: to claim we are assisting farmers and to be able to be absolutely certain that is the case. Without a signed contract certainty is next to impossible.

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