Beyond Price: Building a Better Pre-Financing Model
Julia Baumgartner of Just Coffe and Irma Soccoro Olivas of La Fem picking coffee. photo by Michael Kienitz
By Matt Earley, Just Coffee
Our discussions about the recent high world coffee prices have raised questions about the “fair trade” model. With coffee prices well above $2 per pound and climbing, fair trade is in an awkward position. Fair trade marketing has focused on “paying a fair price,” which ironically was not really the case before prices rose and fair trade prices had to follow them. In this brave new fair trade world, certifiers, importers and roasters struggle to make a case that fair trade has any teeth to it.
As supplies shrink, prices rise and competition for good coffee increases, this discussion is not theoretical. Cooperatives face challenges collecting coffee from their members. In the past, enthusiastic farmers turned coffee into the co-op knowing that fair trade buyers would pay more than local buyers “coyotes.” As a result, farmers would tolerate the co-op’s partial (or zero) payment on delivery of the coffee and wait for full payment after buyers received the coffee in the United States or Europe. However, in these years of high prices, local buyers pay a price competitive with “fair trade” importers and roasters, and they pay cash on the barrelhead instead of the co-op's two or three payments.
This welcome development for cash-strapped farmers benefits them in the short-term but damages their cooperatives as they default on contracts with buyers, lose members and weaken as democratic forces in their communities.
Embracing the challenge, we’ve been discussing the situation with coffee farmers to find opportunities to deepen “fair trade.” With coyotes willing to match any price that we pay -- even up to $3 per pound, we no longer have the price advantage. Nor do we have the access of local buyers, who can communicate directly with producers on a daily basis. Furthermore, many coyotes do not care about sustainable growing practices or quality in general, leading farmers to potentially relax their emphasis in these areas. Despite these competitive disadvantages, many producers have told us that, if we could get more money into their hands sooner, we would have a better shot at getting their coffee.
The fair trade tenet of pre-financing comes into play here. In the past, the buyers’ commitments to “pre-finance” purchases with grower groups routinely were downplayed. Technically, the grower groups had to ask buyers for credit but didn’t demand advances because they feared alienating buyers who, at the time, paid significantly more for their coffee. Grower groups also often attempted to squeak by without pre-financing to avoid paying the interest on these transactions, which effectively reduced the already insufficient price received for their coffee.
As more “mission-based” fair traders entered the market and more growers requested credit, nonprofit lending organizations such as Root Capital formed to fill this much needed niche. Many growers and importers dedicated to fair trade wanted to provide pre-financing but lacked the necessary capital. Root Capital and similar organizations work with investors to provide financing for grower groups. They base their transactions on signed contracts with buyers, as well as on the grower cooperatives’ financial health. Grower co-ops receive up to 60% of the value of the contract after it is signed, which allows them to pay individual growers earlier so that they can invest in their crops, pay for the harvest and provide for their families.
A downside of this system, according to many growers, is that the farmer groups -- with occasional exceptions --pay the interest on these loans. Charging interest makes sense to cover costs of critical due diligence and processing transactions and to provide investors with a small return on their cash. That said, based on lengthy discussions with producer groups, the prevailing system seemed a little backwards to us at Just Coffee.
Let me explain.
In this market, being able to offer pre-financing helps Just Coffee obtain the coffee that we need to run our business. In order to secure the coffee, it is very helpful to prepay some of the contract. We generally do not have the cash flow to do this, so we have started working with the very excellent people at Madison's Working Capital for Community Needs (WCCN), a nonprofit that has been doing microcredit lending in Nicaragua for 20 years. They have recently expanded to work in other countries and are particularly interested in agricultural credit. WCCN is loaning Just Coffee $25,000 to finance our pre-purchase of La FEM's coffee in 2011.
This departs from the current model in a couple of important ways.
First, standard practice has been for the loan to go to the grower cooperative, which then repays the money to the lender after the buyer makes final payment for the harvest. Grower cooperatives also have been responsible for paying the interest on the loan. Our discussions with co-ops and among ourselves led us to consider ways to improve upon this model. If I go to the bank for a mortgage to purchase a house, the seller of the house does not pay the bank interest on the loan. I deal with the bank because I am buying the property and it will be to my benefit. In the same way, Just Coffee is able to secure our coffee by paying the growers a substantial amount of the purchase price before the shipment of coffee. This is our mortgage. It also allows Just Coffee to share the risk of a bad harvest or other unforeseen problem with the grower co-op that often shoulders much of that load.
The other departure from the standard pre-financing model is that in the past, as far as we could tell, nonprofits did not feel completely comfortable loaning money to a “for-profit” business to buy the goods that they need to do their business. It just did not seem to jibe with commonly held ideas of how differently organized entities work together in a “market relationship.” Luckily for us, WCCN is open to re-examining and improving the standard practices.
In a competitive coffee market, we need to strengthen relationships with our producer partners and to stress aspects of fair trade that are not pricing mechanisms. Sharing the risk of pre-financing allows us to do so. It also creates deeper relationships between our customer community and producer communities as, in this case, much of WCCN's funding comes from smaller private donors. We all have a deeper and more real investment in this model.
Fair trade needs to be re-created with a re-establishment of its initial principles. By focusing on something other than a good price, we can take some steps in that direction. When companies share more risk and involve others around them, a trading relationship can develop into a real partnership. Real “fair trade” requires that businesses look beyond habitually deflecting all risk from their organizations and onto producers and other actors in the chain. Sharing the risk is what we aim to do, and we are excited to be building a different pre-financing model with WCCN, La FEM and all of you.