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The Great Coffee Conundrum

I freely admit that I'm addicted to coffee. Nothing short of a blizzard or pneumonia will stop me from venturing out of my house and making the ritualistic trek to my local Starbucks (NASDAQ: SBUX  ) to grab my daily cup of coffee. You can consider part of my addiction based on my surroundings -- I do live in the Seattle suburbs -- but the love of coffee is also engrained in American culture.

Source: McKay Savage, Flickr.

Roughly 100 million adults in the U.S. drink coffee daily, with a whopping $18 billion being spent on specialty coffee each year. Coffee is a gigantic business, from the containers and instant coffee we buy in grocery stores to the specialty coffee we order at small and large coffee houses.

But coffee is at an interesting crossroads for the American consumer. Less than three years ago, coffee prices soared past $3.00 per pound and pushed up prices quicker than you could blink. Green coffee beans, those used to make the brews of coffee we find in Starbucks and our local coffee shops, had been under pressure because of supply concerns in South America at the time, and skittish investors rallied prices past the $3-per-pound mark.

Times have changed, though, and since then coffee prices per pound have been ground down to nearly a four-year low, touching as low $1.16 last week. Although the immediate impact on paper would be one of jubilation in that lower coffee prices should translate into lower prices for consumers and potentially lower costs for businesses, this isn't the case.

We've seen some partial victories for consumers in the grocery aisle, with J.M. Smucker (NYSE: SJM  ) , the producer of Folgers, the top-selling coffee in the U.S., reducing its prices in accord with falling coffee costs on more than one occasion. The good news here is it means cheaper prices for the consumers without Smucker's having to sacrifice its margins because its costs have also fallen. Over the long run, this could be a positive for its Folgers brand, as lower prices could be looked upon favorably by consumers and actually cause its market share among store-brand coffee to increase.

The great coffee conundrum
However, if you move beyond the supermarket scene, you'll find a completely different picture. Despite a rapid descent in coffee prices as supply fears abated and crop yields have improved, consumers aren't seeing those savings passed along to them by large coffee chains such as Starbucks and Dunkin' Brands' (NASDAQ: DNKN  ) Dunkin' Donuts, or even Keurig brewer and K-cup provider Green Mountain Coffee Roasters (UNKNOWN: GMCR.DL  ) .

The reason we've seen this bifurcation is simple: These three behemoths can purchase large enough quantities of green coffee, which locks in the lowest possible price. Local shops don't have the same luxury when it comes to buying capacity, which means they're still paying well over the market rate in many cases for green coffee. With most large-chain coffee houses and wholesale brewers like Green Mountain having no incentive to compete against locally owned coffee shops, they can simply keep their price on par with local shop prices and reap the benefits of a growing margin as coffee prices continue to fall.

While this completely stinks for the American consumer, it's fantastic news if you're a shareholder in Starbucks, Dunkin' Brands, or Green Mountain Coffee Roasters, because all three are going to continue to benefit if green coffee prices continue to march lower.

We have reached what I think is the great coffee conundrum: How do consumers reap the benefits of lower coffee prices if supply is essentially no longer relevant with the bulk of the buying in the hands of a few large coffee houses?

If you have the answer to that question, I'd love to hear it in the comments section below.

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Comments from our Foolish Readers

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  • Report this Comment On June 24, 2013, at 9:37 AM, eBips wrote:

    The coffee conundrum can only be broken open by the consumer shifting business to smaller coffee shops, Mickey D's or another beverage until the big guys are forced to react by reflecting the lower cost of beans in their per cup prices. For the month of July make Mickey D's your choice for morning coffee.

  • Report this Comment On June 24, 2013, at 9:58 AM, swagv wrote:

    Easy: the massive coffee suppliers have to satisfy a large amount of customers at a time and ensure supply chains are large and broad enough to service millions of customers. That requirement in itself locks them out of dealing with smaller producers who are capable of making a much more distinguished product.

    There are only so many rows of grapes to make a fine estate Burgundy, but Yellow Tail cab can be produced from wide swaths of grape fields all over Australia.

    So there's no conundrum here. If you like the mass market stuff and it suits your tastes, go to the big boys. But if you have specific tastes are like things with more precise pedigree, you deal with the independents and back it up with a willingness to pay for better coffee. This is now different now than it was 5 years ago.

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