COVID-19 Could Not Stop the Premiumization of Coffee | 25, Issue 14
Last year was a year for many companies to scrap their well thought out and detailed strategic plans for the year and to try to be as nimble as possible responding to an unprecedented crisis.
Rabobank’s JIM WATSON, STACIE WAN, SUDIP SINHA, and GUILHERME MORYA share an overview of COVID-19’s impact on the global coffee market.
Globally, the coffee market has held up quite well. The supply may have been creaky, but held strong in the end and consumers quickly found alternate paths to their favorite cup of coffee. Our baseline belief is that core consumer desires are not changing due to COVID-19; consumers who want a single origin coffee with a truly unique taste profile will continue to want the same coffee. The changes instead are about where (and how) the consumer buys the coffee and where they consume it. In the US, consumers in 2020 often brought their specialty coffee home with them, which marks a notable change from behavior during the 2008–09 recession. This change was aided by specialty coffee companies moving aggressively into takeaway and e-commerce to find the consumer where they are. We saw significant investment in building out those new routes to the consumer.
In fact, while there was a slowdown in out-and-out coffee mergers and acquisitions in 2020, there has still been plenty of investment within the industry. Interestingly, the investments have been largely in categories that were growing strongly pre-pandemic, like Ready to Drink (RTD) coffee, tech-enabled coffee platforms, subscriptions, etc. We have not seen money invested in distressed assets generally (to buy out companies struggling to survive for example), as the most common investor view is that companies really struggling through COVID-19 are struggling for a reason. Though perhaps this will change in 2021.
The coffee trends and investment story matches one of the broader takeaways from across the consumer processed goods world: that COVID-19 is often simply accelerating the trends that are already in place. When looking at how the specialty coffee market has been impacted by COVID-19 outside of the US, we find this often to be the case. To the extent that a lockdown is a lockdown is a lockdown, many of the same impacts by channel have been felt around the world. Equally, where specialty coffee had already been growing, it continues to grow and attract new investment.
In looking at a number of different markets around the world, we want to highlight some of the changes we see. Many of these pertain to a premiumization of coffee—whether or not they fall into a strict definition of specialty—but all come back to the idea of upgrading both the coffee and the coffee experience.
China: Increased Demand for Domestic Brands
In China, 2020 continued the multi-year trend of large international coffee players making significant investments to build out scale and also to upgrade the consumer experience. The most recent example is from McDonald’s, where McCafé upgraded to higher-quality coffee beans and launched a new brand logo and packaging, intending to refresh McCafé in consumers’ minds. Most importantly, McCafé will open up omnichannel from online to offline which means consumers can place orders anytime, anywhere, in the form of self-pickup or delivery through McDonald’s counters, self-service ordering machines, and digital platforms such as applets, public numbers, and apps. The focus on the digital side of coffee investment as a way to push premiumization was a fully global trend in 2020. On the same day that McCafé announced its accelerated investment plan, Starbucks Coffee Innovation Park (CIP in Kunshan officially broke ground with a total investment of approximately US$130 million, which is the largest manufacturing investment outside of the US and its first in Asia. The new CIP will directly source, process, roast, package, and distribute coffee from origins in China and around the world. Once in operation, Starbucks will integrate the advantages/resources of Yunnan’s production into CIP, to create a complete closed loop system from cultivation, roasting and processing, logistics, and distribution to in-store services and retail products. The advantage and competitiveness of Starbucks’ vertically integrated supply chain is a response to (and attempt to differentiate within) the increasingly competitive coffee market in China.
Until recently, affluent Chinese consumers had been gravitating towards foreign beverage brands, which were seen as status symbols; in contrast, consumers tended to view local brands as inferior and lacking prestige. More recently, however, the situation has changed dramatically. An increasing number of domestic brands are breaking away from old strategies—no longer focused on producing low-priced products, they are striving to upgrade the quality, performance, and value of their offerings. This is also driven by the proposed “dual circulation” strategy for the next phase of economic development, in which China will rely mainly on “domestic circulation,” an internal cycle of production, distribution, and consumption.
We certainly see an example of this in the coffee market with Saturnbird coffee. Saturnbird launched a new twist on an established concept and adopted a new production method to make a cold brew instant coffee, targeting the younger generations who have shown a preference for novel products characterized by an eye-catching appearance, convenience, and higher quality. We’ve also seen international companies move to form more partnerships or joint ventures with local companies, an efficient option for foreign brands to conduct their localization strategy and deepen their presence in the Chinese market. Since its entry into China in 2017, Peet’s Coffee has established a joint venture, Peet's Coffee China, with Hillhouse Capital. In the past three years, they jointly opened 13 coffee chains in Shanghai and Hangzhou and will expand into Beijing next year.
In the past decade, though, smaller brands have begun to encroach on leading brands’ market share with their agile, responsive, and innovative go-to-market strategies. Several small brands emerged and successfully created new beverage segments or occasions (e.g., kombucha, RTD cold brew coffee) and continue to do so (e.g., RTD cocktails, hard seltzer). Aside from a solid understanding of consumer needs, their innovative route-to-market approach building on communication and distribution was critical to their success. All these growth drivers, featuring smaller and more localized offerings, are very well suited to support specialty coffee growth.
South East Asia: Diverse Development
Beyond China, COVID-19 underlined both the challenges and opportunities for coffee in South East Asia. In Indonesia, specialty cafés struggled to innovate their way out of the pandemic’s disruption. Meanwhile, Vietnam’s café market remained abuzz with several entrants in 2020.
Ông Bầu entered the Vietnamese café market with an ambitious target of 10,000 stores (!). Although COVID-19 delayed the planned launch in the first quarter of 2020, by the end of June, Cà Phê Ông Bầu coffee chain had 100 stores across 16 cities. In September, Vinamilk announced plans to launch Hi-Café, expanding its 400+ existing dairy outlets into full-fledged coffee shops. There were other entrants, too—PAN Group acquired Shin Coffee, Nestlé launched Nescafé Hub—underlining the growing interest in the affordable coffee segment. In the premium segment, amidst established players, Highland Coffee, Starbucks, Trung Nguyen, and Legend, The Coffee Shop showed robust performance.
In Indonesia, the latest funding round of Kopi Kenangan (US$109 million), led by Sequoia, underlined some interesting points. First, coffee—especially prepared coffee—retains favor with investors. Kopi Kenangan has done remarkably well for a three-year-old business, taking just under two percent of the Indonesian coffee market, underpinning investor interest. Second, the seamless transition of digital and physical infrastructure (online to offline) is crucial for building and retaining customers. During the pandemic, Kopi Kenangan showed agility to pivot its business model from an offline experiential to a tech-enabled delivery model, which was rewarded by investors pouring money into the business.
The rush to develop and invest in such a diverse set of coffee shops across South East Asia despite the massive challenges of 2020 shows how exciting the sector is. Kopi Kenangan’s significant foreign investment indicates that more modern, premium, digitally capable coffee shops are something we can look forward to in the future.
Brazil: Global Players Drive Growth
Across the globe in Brazil, the story of coffee premiumization is just as strong. In Rabobank’s numbers through September of 2020, premium coffee sales in the country increased almost 100 percent, while roast and ground was slightly negative and instant coffee grew roughly 10 percent. This is part of a longer standing trend in Brazil, but was clearly not interrupted by COVID-19 in any way. Similarly, the coffee pod segment grew 50 percent, as Brazil continues to be one of the biggest growth markets in single serve coffee.
A lot of this growth is being driven by investments from the global coffee giants. Jacob Douwe Egberts, for example, has launched a new line of premium coffee under its Café Pilão brand to better compete in the growing premium segments, which have a nice mix of international and local brands. Nestlé is equally investing in the premium end of its portfolio.
And to show just how global all these trends are, 3corações created its own e-commerce platform. While the company already had an e-commerce channel, it is now working to internalize its operation, expanding its margins. The resulting platform will support business-to-business and business-to-consumer approaches, taking advantage of its 28 distribution centers in-country to focus on coffee pod machines, coffee pods, and specialty coffee.
Coffee subscriptions grew in double-digits last year, though in Brazil there is probably more room for specialty coffee to grow through the coffee shop side in the near term. Coffee & Joy, a specialty coffee shop company founded in 2016, has taken advantage of the situation. In 2019, it grew 10 percent per month, seeing its numbers double during the pandemic.
While overall 2020 was obviously very difficult for the coffee shop sector, all the underlying drivers for growth and investment capital are still in place for future growth. The Mais1 café chain was started in 2019 and, using a franchise model, managed to open 27 stores in 2020. The stores are on-trend, focusing on a small footprint with a “to-go” approach and small stores (12–20 square meters). More interestingly, it has already negotiated the opening of 123 new stores in 2021.
During the early part of the pandemic, the thought of coffee premiumization booming might have seemed rather unlikely. But a K-shaped recovery (divergence where the wealthy benefit from a much stronger and more rapid recovery than the rest of the economy) across a number of markets, capital looking for new growth opportunities, and strong premiumization trends already in place have created a vibrant high-end of the market. Beyond basic premiumization, an increasing focus on local options and the ability of e-commerce and subscriptions will act as a strong tailwind for years to come, driving the growth of smaller specialty brands. ◇
JIM WATSON (New York, US), STACIE WAN (Shanghai, China), SUDIP SINHA (Singapore, Malaysia), and GUILHERME MORYA (São Paulo, Brazil) are Beverage Research Analysts at Rabobank, a global food and agriculture financing and sustainability-oriented bank.
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