A Short History of Costa Rica's Coffee Retention Program & the Beginning of a Specialty Coffee Market Strategy

I was part of the last contingent of staff at the United States Agency for International Development (USAID) Costa Rica as it was being closed in 1996. During the same period, USAID underwent a "Reduction in Force" (RIF), requiring some staff to be fired to reduce the agency's operating expenses. Except for top leadership, no one knew who would be terminated. I was 43 years old with a wife and two young children. Creating a new skill set I could carry into the private sector was on my mind when I enrolled in an executive MBA program at an affiliate of the University of Costa Rica. In my first class, Marketing 101, I chose to look at Costa Rica's coffee marketing strategy. My research took me into a theme that would be part of my life for years to come and would eventually result in a paper I wrote in 2000 regarding a strategy for how USAID could engage with the specialty coffee sector to increase the income of 25,000 small-scale coffee farmers worldwide.

The Reduction in Force (RIF), my enrollment in an MBA program in San Jose, Costa Rica, and the research I conducted on the global coffee sector led me to focus on coffee as a way to help small-scale farmers increase household income, reduce poverty, and promote national and regional stability. This paper was shared with the true pioneers of specialty coffee in Costa Rica and the world -- Steve Aronson of Cafe Britt; Jim Stewart, founder of Seattle's Best Coffee; Ted Lingle, Executive Director of the Specialty Coffee Association of America; and others. They led the way to the differentiated specialty coffee market that we have today.

In researching the coffee market, I discovered that the remnants of a coffee quota system originally established between Latin American producers and the United States were still in force for Costa Rica and other Latin American countries. In 1939, this quota system allocated coffee imports from Latin American countries to the U.S. market to provide economic support to those countries that had lost their European market due to the outbreak of World War ll. The quota system was extended through 1947 but was not renewed after that due to increased demand from Europe after the end of the war and a drop in production caused by a drought in Brazil. But in the early 1950s, increased prices caused by the Korean War and a freeze in Brazil resulted in market instability that provoked a meeting between the United States and some Latin American countries in 1954 to study how best to stabilize coffee prices on the world market. The result of these meetings was the signing of the first International Coffee Agreement in 1962 and the establishment of the International Coffee Organization (ICO) to monitor the implementation of the terms of the Agreement.

A significant function of the ICO was to assist in implementing a quota system to stabilize the world price of coffee. A price band was set in joint agreement among the member consuming countries and producing countries as a target range for coffee prices for a given period (usually set as annual targets). When coffee prices are under the target price, a retention scheme would be activated to decrease supply sufficiently and raise prices back to the target level. The sharper the initial decrease in coffee prices, the larger the percentage of coffee stock retained. Producing countries were allowed to sell overstocked coffee to non-member consuming countries under an arrangement that ensured that the highest quality coffee was sold to member countries.

A second agreement was negotiated in 1968 for another five years, and the system continued to control export quotas and stabilize world prices. However, in 1972, conflicts of interest arose, and growing dissension on quotas, selectivity, readjustment systems, and criticism that prices were kept down for the consuming countries caused the International Coffee Agreement to lapse in 1973. After the dissolution of the quota system, the ICO continued as a statistics-gathering organization. However, a price drop during 1973 and 1974 provided an incentive for producing countries to enter some market stabilizing arrangement again, while the 1976 "black freeze" in Brazil caused a dramatic increase in coffee prices (coffee prices went from US$0.50 to US$3.36 per pound) and encouraged consuming countries to again enter in a trading agreement. The result was the signing of a new deal in 1976 for six years. In 1983, the agreement was extended through 1991, but in 1989, the agreement's quota system lapsed.

In July 1993, coffee-producing countries began to band together to raise coffee prices. In September of that year, 28 countries representing nearly 90% of global coffee exports announced the formation of the Association of Coffee Producing Countries, with headquarters in Brazil. It included all major coffee-producing countries except Mexico, Guatemala, India, and Vietnam. The association agreed to hold back exportable production on a scale beginning at twenty percent when the 20-day moving-average ICO composite price for "Other Milds and Robustas" was below US$ 0.75 per pound.

?Members exporting less than 400,000 bags annually would be exempt from retention, and no decision was made on whether to include instant coffee in the scheme. After averaging nearly US$0.54 for 1992, the indicator price had risen, with the scheme's implementation, to over US$0.71 in mid-December 1993. Coffee prices shot upward in 1994 because Association of Coffee Producing Countries members announced they would continue withholding coffee from the market. Also, a freeze occurred in Brazil, reducing the estimates for its crop.

The retention operation was barely underway when it was suspended after prices moved above US$ 0.85 per pound. Prices took off when a survey estimated that the freeze, followed uncharacteristically by drought, would cut the 1995-96 Brazilian crop short by 9 million to 13 million bags from its 29 million-bag potential (a 12% to 15% reduction in world supply). Prices of green coffee, which had averaged about US$ 0.62 per pound in 1993, went as high as US$ 2.75 on the futures market in September 1994 but fell as low as US$ 1.45 in early December. Retail prices of roasted coffee in the U.S. averaged U.S. $2.47 per pound in 1993, reaching a plateau just below US$ 4.50 in August-November 1994. In 1995, increased production by non-members of the Association of Coffee Producing Countries and reported cheating by some member nations resulted in a decrease in coffee prices below the US$ 0.85-floor price established in 1994.

In response to this price drop, Brazil, Colombia, Costa Rica, El Salvador, Honduras, and Nicaragua signed an agreement on July 10, 1995, to institute a coffee retention plan again. The Santa Fe de Bogota Agreement called for limiting world coffee exports to 15 million bags in the following quarters (July/September 1995 through April/June 1996). This represented a 30% contraction in world production, slated to be achieved by a quota system limiting exports imposed on each signatory. The agreement also provided that the retention of coffee required to meet these levels would be subject to audit verification and that efforts would be made to include other members of the Association of Coffee Producing Countries in the retention plan to ensure that the 15 million per quarter limit on exports worldwide was met. Brazil reconfirmed its commitment to abide by the required retention levels. Brazil also committed itself to effectively managing coffee stocks under government control under the retention scheme.

In analyzing coffee prices, export versus retail, I realized that the retail market would retain the benefit from decreases in export coffee prices. The graph above shows that while the export price of coffee decreased by 47 percent, the retail price declined by only 2 percent during the same period. With a differentiated product linked to small-scale coffee producers, this type of market relationship would be replaced with a need by retailers to maintain their unique coffees through more equitable green coffee prices. The dream was to move beyond bulk contract coffee to a coffee product that provided great taste, a connection with a specific production zone, and the feeling of a relationship with the small-scale producers who made it possible.

My analysis of the market and the coffee retention agreement led me to believe that Costa Rica's best way forward was to break free of the coffee retention program and pursue a specialty coffee segment in the U.S., European, and Japanese markets. The internet was beginning to open the way to relationship marketing in an unheard-of capacity. My conclusion in the analysis was that Costa Rica's future in the international coffee trade depended on the development of a strategic partnership between private and public interests to 1) produce a high-quality coffee, 2) promote Costa Rica coffee as a specialty coffee identified by region and cupping characteristics, and 3) support the development of innovative marketing channels. I stated that continued participation in coffee retention plans could slow movement toward these objectives. The focus needed to be on market segmentation targeting the specialty coffee sector and product differentiation by finding ways to market the unique characteristics of Costa Rican coffee based on production systems, quality, sustainability, and equity.

This work led to my developing a strategy for USAID in 1999 that shaped the Agency's approach to the coffee sector over the last twenty years. See https://www.maxey.info/global-coffee-strategy.

This paper provided the impetus for executing a Memorandum of Understanding between USAID and the Specialty Coffee Association of America in 2000. See https://www.maxey.info/global-coffee-strategy. A copy of the MOU is here.