Direct Sourcing: Dealing with the Details

by

Logistics are critical but not a core element that interferes with direct trade agreements, so long as transactions are transparent.

By Dan Bolton

Performing uncanny logistical feats is just part of the job for global coffee traders.

Coping with port peculiarities and warehouse options, Byzantine export regulations, and shipping company (Hanjin) bankruptcies are everyday challenges compounded, on occasion, by violent regime change, political unrest, and massive volcanic eruptions.

Zephyr Coffee Merchants in Connecticut, a subsidiary of the Louis Dreyfus Company, prides itself in sourcing specialty and sustainable coffee from anywhere in the world, but general manager Michael Lutz is equally adept at seeing that these coffees reach roasters unscathed.

Coffee roasters with direct trade relations could hire logistics specialists with a mastery of grains—but Lutz says that coffee merchants like Zephyr offer superior service, both in logistics support and financing prior to delivery to the roaster as well as managing the idiosyncratic risks involved in the transaction.

It’s baked into the business, explains Lutz. Zephyr annually oversees the safe transit of countless bags of coffee. Monitoring port and coffee warehouse conditions, knowing which shipping lines excel in transport, and consolidating container handling are essential skills honed over years.

ALSO: 'Direct' Defined

Direct trade is often thought of as eliminating middlemen but handling the transit logistics for specialty roasters à la carte is a service in demand.

“During the past five years direct trade has become more common as consumers become more sustainability-conscious and a new generation of roasters market their relationships at origin, a trend many in the industry have started calling 4th wave coffee,” Lutz explains. Following the lead of successful direct traders like Intelligentsia, Stumptown, and Counter Culture Coffee enables roasters to influence and personally vouch for coffee quality. But once they discover a gem in the rough, most roasters simply cannot bear the full cost of transportation, financing, and logistics on lots of a few dozen bags, said Lutz.

“They realize that while finding great local producers and coffee is part of what they want their brand to represent, logistics can be a costly distraction,” he said. If transparency is assured and the coffee arrives in good condition, paying a coffee merchant to handle the logistics and warehouse the coffee for a fixed, transparent fee is buying peace of mind, he said.

Lutz prefers to sell roasters lots from Zephyr’s extensive offer list but for quantities as small as 100 60-kilo bags, Zephyr will deal with the details of direct trade.

What could possibly go wrong?

Roasters who source direct pride themselves in identifying a quality partner. At origin, the two parties are on their best behavior. Buyers see for themselves tidy farms, well-maintained processing equipment, and reassuring labor, sanitation, and environmental practices. Growers appreciate the recognition and financial incentives as they lock in the deal. All that is left is to load and ship the coffee. What could go wrong?

Consider Nicaragua.

Transportation is paralyzed. The economy is at a standstill. An entire harvest is going nowhere.

Escalating violence and political unrest in Nicaragua crested early this spring at the peak of coffee export season. Supplies still cannot safely reach the docks and buyers are wary of visiting farms. Thousands of students protesting the administration policies of President Daniel Ortega took to the streets in confrontations that led to loss of life.

The violence forced the Alliance for Coffee Excellence, sponsors of the Nicaragua Cup of Excellence which was judged in April in Matagalpa, to ship winning coffees to the US prior to the auction date.

“Merchants who deal on a daily basis with Nicaraguan shippers will have a better handle on the situation, when and where coffee stops flowing and what ports are still open,” said Lutz.

Burundi is more typical. “Burundi is a difficult origin to get right. Upstream stewardship has improved significantly, but transport, storage, and government auctions all conspire to obscure traceability and limit greater development,” according to Lutz.

“The recent opening of individual washing stations to independent marketing has provided an opportunity to source higher quality pieces and to prepare more consistent lots,” according to Lutz.

“I remember situations where we had to send our own staff from Nairobi to ensure that the coffee loaded were the right lots,” he said.

 Andi Trindle Mersch, director of coffee at Philz Coffee and a former coffee trader with Atlantic Specialty Coffee in Oakland, says she is “a big believer in the value added by importers. In addition to logistics expertise and economy of scale advantages, importers expertly and efficiently navigate customs and understand changing government requirements, according to Trindle Mersch. Especially now with the FSMA (Food Safety Modernization Act) rolling out in phases and undergoing version changes, she suggests most buyers in the US at least need to rely on importers and exporters to understand and educate around these requirements.

Green coffee contract

Traders rely on industry protocols established in the 1920s to resolve disputes whenever the coffee ordered differs significantly from the coffee that arrives in port. Standards and simple solutions like discounting for observable defects and subtracting the weight of stones and debris from the price paid to resolve most disputes. The focus is on visuals. Arbitration panels meet periodically to consider more thorny questions and insurance settlements resolve the rest.

Disputes involving specialty coffee are more challenging. When a trader accepts responsibility for transporting coffee from origin to roaster, the most important consideration is taste. The first cup quality test dates to the early 1900s when green coffee broker Clarence E. Bickford at Hills Bros. insisted on blind tastings. The company was an early adopter, reasoning that when it paid a premium it should be based on characteristics evident to consumers.

The most recent considerations include sustainability, which brings into the assessment of quality attributes such as environmental and labor practices.

While the Green Coffee Association (GCA) conventional contract terms are used as a basis for transactions in mainstream physicals and futures markets, they differ from several “alternative” contracts that exist to promote specific sustainability systems. These certifications are devised by non-governmental organizations and third-party certifiers including UTZ | Rainforest Alliance, Fair Trade (FLO), and by private companies like Starbucks’ (coffee and farmer equity preferred supplier program) C.A.F.E.practices.

During her many years as a trader, Trindle Mersch advocated for a multi-party contract designed to protect merchants like Atlantic and Zephyr.

“It is the importer that usually pays the producer or exporter for the coffee. Importers may pay out $100,000 or more per container,  including high priced green coffee and service fees,” she explains.

“If the roaster doesn’t like the quality, precisely who is accountable?” she asks. “Even if the roaster is ethical and the two sides work it out, at a minimum the importer is on the hook for the entire time it takes to settle the dispute,” she said.

The worst case is when the buyer refuses to accept the shipment. The trader is then stuck in the middle and must find a buyer. “I’ve seen that occur and it is very dangerous business,” she said.

Multi-party transactions involving direct sourcing are not covered in the green coffee contract, said Trindle Mersch.

To address that concern the Specialty Coffee Association in 2012 formed a committee that worked with its attorney Marshall Fuss to draft model amendments to the green coffee contract. The following year the committee was expanded to include representatives of the National Coffee Association and GCA.

The goal was to create an alternative contract with standard clauses addressing terms and conditions unique to multi-party transactions, said Trindle Mersch. The committee exchanged drafts and met through 2015 “before it fizzled out,” she said.

The work remains important, she says.

“Honestly, I’m still quite passionate about it. If anyone is ready to pick up the baton I’m still at the ready to run,” said Trindle Mersch.

“Offering direct trade services is an opportunity to stay relevant with a new generation of roasters,” said Lutz. “Zephyr has publicly committed with Conservation International to grow our direct trade business to 10% of our total volume,” he said.

“Contract language that enables all parties to better understand the obligations will facilitate direct trade. In this ever-changing environment, it is crucial to ensure that we “future proof” any standardized agreement to help entrepreneurs and innovators apply new technologies to our industry. Self-fulfilling contacts as well as e-commerce trading platforms come to mind, but also social/impact financiers like Root Capital will benefit,” said Lutz.