There is a widespread belief that consumer coffee prices are high relative to bean prices and that lower consumer prices would lead to substantial increases in bean exports from Third-World countries. This issue is evaluated by analysing how retail prices, preferences and market power influence coffee demand in Sweden. A demand function is estimated for the period 1968–2002 and used, together with information on import prices of coffee beans, to simulate an oligopoly model. This approach gives estimates of the maximum average degree of market power and shows how coffee demand would react to reductions in marginal cost to its minimum level. The maximum level of market power is found to be low, but it generates large spreads between consumer and bean prices because the price elasticity has low absolute values. Moreover, the impact of a price decrease would be small because long-run coffee demand is dominated by changes in the population structure in combination with different preferences across age groups. Hence, a change to perfect competition would only have a negligible effect on bean imports.
It is a common opinion that oligopolistic market structures constitute a key problem for commodity-exporting, less-developed countries (Gibbon, 2005). This view gained ground after the collapse of coffee-bean prices in the late 1990s, when they returned to the 1960s level in nominal terms. Since a few multinational companies are active in most coffee markets, both as buyers of green coffee and suppliers of processed coffee, they are held responsible, directly or indirectly, for keeping bean prices down while maintaining high consumer prices.1 As a consequence, Third-World bean exports and bean prices are kept below the level that would prevail in a competitive market.
The issue of market power in commodity markets is analysed in some detail by Morisset, 1997 and Morisset, 1998. He looks at coffee markets, as well as several other markets, and finds symptoms of market power in all of them. For instance, in a sample of six industrialised countries, the average spread between consumer coffee prices and world bean prices increased on average by 186% from 1975 to 1994. This is attributed to asymmetric transmissions of world price changes to consumer prices. To evaluate the consequences of the increase in price spreads for developing countries’ export revenue, Morisset (1997) simulates the impact of a reduction in consumer prices to the minimum spread observed during the 1970–1994 period. It would have increased export earnings to the order of at least 20–60% annually from 1991 to 1994.
Talbot (1997) also addresses the issue of market power in coffee markets. He uses a different approach, global value chain analysis. He finds that the collapse of the International Coffee Agreement at the end of the 1980s led to an increase in market power and a massive shift of surplus from coffee producing countries to multinationals. According to Talbot, multinational companies exercise market power as buyers of green coffee by holding down prices and as sellers of processed coffee by inflating consumer prices. Global value chain analyses by Fitter and Kaplinsky, 2001 and Daviron and Ponte, 2005 obtain similar results.
Although multinational companies may have market power as buyers of green coffee, as Ponte (2002) argues, the large price spreads seem to occur between import prices and prices of processed coffee, not between farm gate and world market prices (see Daviron and Ponte, 2005, Chapter 6). Moreover, Krivonos (2004) shows that the transmission of price signals from world market prices to coffee growers works quite well after the implementation of coffee sector reforms in the late 1980s and early 1990s. Although these results do not preclude the existence of oligopsony power, they indicate we should search for market power in consumer markets.
There are probably less than 10 studies that directly attempt to test for market power in national consumer markets (see Gibbon, 2005). Most of these find that the degree of market power is small, although there is some evidence of oligopoly power, e.g. Bhuyan and Lopez (1997). There is, thus, conflicting evidence, and the question of why the difference between bean and consumer prices is perceived to be high is not answered.
The objective of this paper is to shed light on the presence of market power in the Swedish market for roasted and ground coffee, and evaluate potential losses for coffee growers. The Swedish market for roasted and ground coffee has a market structure that is typical for many European markets: in 2002, the four largest companies had a market share of 87% and two multinationals (Kraft Foods and Nestlé) had 57%.2 Moreover, roasted and ground coffee is relatively expensive in Sweden. It was 7% above the EU average in 2002 (European Commission, 2002a).
The analysis is carried out by first estimating demand for roasted and ground coffee during the time period 1968–2002. Then, the price elasticity estimates and import costs of green coffee beans are entered into a simple model of oligopolistic interaction to obtain values of the maximum average degree of market power. The cost of green coffee beans is used as the minimum value of marginal cost. This is because it is by far the most important input and there is a fixed relationship between roasted and green beans.3 Furthermore, there exists good data on import prices, which is not the case for other marginal cost components. In the final step, information concerning how the export of coffee beans to Sweden responds to price change is obtained by simulating a shift to perfect competition. In this model, perfect competition implies that consumer prices become equal to the price of imported beans.
The analysis only gives rough estimates of average levels of market power and their impact on consumption and imports, and it would have been preferable to use detailed firm-level data that allow modelling dynamic firm interaction, but these are not available. Nonetheless, the approach is robust and transparent, compared to estimating a structural oligopoly model for a market over a 35-year period when there is a paucity of data on costs.4
Our main findings are that in the long run coffee consumption per adult is dominated by population dynamics in combination with differences in preferences across generations, and the absolute values of the price elasticity are small (on average 0.19). As a result, sharp reductions in price only generate small increases in demand and, consequently, in the import of coffee beans. Moreover, the measure of market power, the maximum elasticity adjusted Lerner index, was found to only be about 0.10 for the period 1985–2002. This result is less than half of what Cournot competition predicts and very far from unity, which would indicate prefect collusion. However, because of low price elasticity, the low degree of market power generates a substantial spread between consumer and bean prices. Another finding is that the average value of the elasticity adjusted Lerner index is higher during the period 1985–2002 than before. As Talbot (1997) claims, this could be due to increased market power following the breakdown of the International Coffee Agreement. In absolute terms, the increase in market power is small, from about 0.05 in the early 1970s to 0.1. But without checking for other components of marginal cost, we cannot say what caused the change.
The rest of the paper is organised as follows: Section 2 gives a brief description of the Swedish coffee market, while Section 3 outlines the theoretical framework. Section 4 presents the econometric approach used to model coffee demand, and Section 5 describes the data. Section 6 reports the results from the econometric analysis, and Section 7 interprets the findings using the oligopoly model. Finally, section 8 summarises and draws some conclusions.
The objective of this paper was to evaluate the role of market power and prices in determining
the demand for roasted coffee in Sweden. This is of interest because it can shed
light on the functioning of consumer coffee markets and the determinants of the demand
for coffee beans supplied by Third-World countries.
Demand for roasted coffee was estimated using market data from Sweden for the period
1968–2002. In the long run, demand is mainly determined by population dynamics in combination
with differences in preferences across generations; those born before the 1960s
consume more coffee than younger generations. This result is in accordance with industry
wisdom. Consumer prices also influence demand, but they only explain deviations from
the long-run trend. Moreover, price elasticity is low, on average 0.19 in absolute terms.
As a result, even large price reductions generate small increases in demand for roasted coffee
and, consequently, for imports of coffee beans.
To illustrate the response of coffee consumption to a consumer price decline, the impact
of a price reduction to the level of the import price of green beans, including import and
value added tax, was calculated for the period 1990–2002. Bean imports would have been
about 8% higher, even though the price declined by over 50%. This finding differs from
those of Morisset (1997), which indicate a substantial increase in export earnings, albeit
in a very different model. The reason is probably that Morisset’s model does not include
the dynamics of coffee demand adequately.
The maximum elasticity adjusted Lerner index was found to only be about 0.10 for the
period 1985–2002, where zero is perfect competition and one is monopoly or a perfect cartel.
This points to the presence of some market power, but it is small and well below what
is predicted by Cournot competition. The analysis does not show where this market power
comes from, since market data is used and coffee is treated as a homogenous good. However,
roasters are likely to have some market power because of branding and advertising
and some roasters might be able to exercise regional market power. Moreover, it is possible
that retailers also have some market power, although margins for coffee are considered
to be low in general. Detailed micro data are needed in order to analyse these issues.
Unfortunately, they are not available.
Although there is a low degree of market power, a substantial spread between consumer
and bean prices is generated when it interacts with the low price elasticity. This is evident
when comparing periods before and after 1985. The measure of market power increased
from approximately 0.05 to 0.1. Although this was a small increase in absolute terms, it
nevertheless led to a substantial rise in the spread between consumer and import prices
(roughly from 25% to 50%). We cannot say whether this change was due to increases in
other costs without controlling for all components of marginal cost. Nonetheless, it was
in line with Talbot (1997) and others who claim that there was an increase in market power
following the breakdown of the International Coffee Agreement.
The results of this study were obtained from one national coffee market, and they might
not be relevant for other markets. Nevertheless, most industrialised countries have a market
structure similar to the Swedish one: some of the largest multinationals are present in
almost all consumer markets and the concentration of the four largest firms is usually very high (see Clarke et al., 2002; Sutton, 1991). Moreover, price elasticity is generally low, and,
at least in North European markets, per-capita consumption is stagnant or declining
(Durevall, 2003).
Finally, it is possible that large roasters and traders have market power as buyers in the
market for green coffee, as argued by Oxfam (2002) and Ponte (2002). We have not analyzed
this issue. However, if they influence bean prices, increased competition is likely to
have a beneficial effect on export revenue of coffee producing countries, particularly since
consumer price elasticity is low.
