Coffee and tea are becoming more sophisticated as suppliers drive premiumisation, but commodity pressures threaten to make brands even more expensive, says Nick Hughes

The good times have been rolling for fresh coffee suppliers ever since the likes of Starbucks and Costa showed the public there was more to coffee than granules and hot water. It's even been stealing consumers away from tea.

As the trend for frothy lattes and wake-me-up espressos percolated down to the retail aisles, demand for fresh coffee soared. Not even recession could grind down sales, with value up more than 6% last year. But the party may be about to come to an abrupt end. The retail price of fresh coffee looks set to rocket in the months ahead as a perfect storm of growing global demand, concerns over crop shortages in key producing regions, and speculators working their alchemy in the futures markets send commodity prices into orbit.

The saving grace for fresh coffee is that it's not alone. While the high-quality arabica bean preferred by fresh coffee roasters is under pressure, so too is the robusta favoured by instant coffee manufacturers, denying consumers the option of trading down. Arabica has risen 35% over the year and robusta hit a high of more than $1,800 a tonne on the London futures exchange in July, driven by fears of adverse weather affecting key producer Vietnam. Although the price has softened slightly, it remains well above the $1,400 of September 2009.

All this means the retail price of coffee is set to spike in coming months as suppliers look to protect their margins. "We haven't moved prices, but as input costs continue to rise there's an inevitability of price inflation coming through," says Paul Rodin, head of supply chain and procurement at Cafédirect.

If price forces consumers to lose their taste for coffee they'll find cold comfort in tea, which has suffered from similar pressures over the past year.

A handful of US coffee suppliers have already pushed through price increases. Kraft Foods put up its Maxwell House brand by 11% in August following the lead of JM Smucker Co, one of the US's biggest roasters, which raised prices by 9%. To date, UK suppliers have resisted the same urge, but unless the market price softens significantly and quickly, retail price hikes are almost inevitable.

"If prices stay at current levels it's definitely going to impact on our cost base," says Kevin Sinfield, Taylors of Harrogate coffee brand manager. "Increases in demand are at the higher end of the market, which is where Taylors as a brand is purchasing, so for better-quality arabica coffees we're having to pay much higher prices."

The impact of poor harvests in Colombia and a low-yielding year in Brazil have led to a market imbalance. The 2009/10 crop season is now under way in all exporting countries and production is expected to be down 5% on last season, according to Mintec. It is hoped next year's Brazilian season, which has only just begun, will yield more to help redress the balance. But it's still early days and fears are mounting that the La Niña weather phenomenon could lead to frosts that would significantly damage the crop.

Equally damaging is speculation by fund managers buying up futures contracts both for arabica and robusta. "While fund managers are continuing to use coffee in that way, it's going to maintain prices at that high level," says Sinfield.

Exchange rates are also a headache for UK-based manufacturers who have to buy coffee in dollars. "The poor value of sterling is adding to the inflationary pressure," says Rodin. "Many companies will buy forward for a period to take some of the unpredictability of currency fluctuations out of the equation, but eventually stock will run out and you have to buy at the market rate."

Meanwhile, burgeoning consumer demand for more sophisticated blends a trend repeated throughout the developed world is reflected in market value growth. Roast and ground coffee sales have grown 15.9% in value and 5.4% in volume [Kantar 52w/e 13 June] compared with 4.4% and 3.5% respectively for instant. The roast and ground segment is dominated by own label, which accounts for about a third of total sales and has grown 16.6% to £57.2m in the past year [SymphonyIRI 52w/e 17 July].

The most stellar growth is coming from the leading brand Taylors of Harrogate whose sales jumped 42.8% on the back of new listings and NPD to £17.8m [SymphonyIRI]. Taylors relaunched its ground coffee range in 2008, bringing the various sub-brands together under the Taylors brand and improving the pack design, a move Sinfield believes was directly responsible for Taylors winning new listings in Morrisons, Asda and Tesco.

The Lifestyle range has increased to 10 over the past year as the launch of Cafe Brazilia earlier this year was followed by the introduction of After Dark in August.

"Coffee consumption has grown on the high street over recent years where consumers tend to favour espresso-based drinks," says Sinfield. "We've seen a trend in the past two to three years towards darker roasted coffees."

The desire to recreate out-of-home coffee shop experiences in the home is reflected in the growth of coffee pods, sales of which, according to Fine Foods International, are up 10.5% in the past year and are now worth £40m.

Lavazza launched four limited-edition brightly coloured versions of its A Modo Mio pod coffee machines earlier this year and is launching a machine called the Piccina in time for Christmas (rsp: £99). "The capsule market is going from strength to strength," says David Rogers, Lavazza sales and marketing director in-home. "More and more consumers are adapting to this technology and the availability of capsules is growing."

Nescafé is launching a new addition to its successful Nestlé Dolce Gusto family of machines this month. The Piccolo has a 15-bar pressure pump, which Nescafé says allows it to consistently deliver on its 'coffee shop at home' promise.

Evidence suggests younger consumers, who have grown up around a coffee shop culture, are driving the move to fresh coffee and a recent YouGov poll found a definite generational divide exists in consumption. Over a three-day period in March, 83% of over-55s had drunk a cup of instant coffee, while just 67% of 18 to 24-year-olds had done likewise.

Not that instant coffee makers have given up trying to woo younger consumers. Starbucks recently launched an instant coffee of its own to attract them to the category. Starbucks Via (see box p49) landed in its UK outlets in March. Starbucks, which continued the roll out through multiples in July, invited consumers to tell the difference between Via and its fresh filter coffee. If other coffee chains take a leaf out of Starbucks' book, it could prompt a change in young people's drinking habits.

"It is possible moves by coffee house chains into instant might see a slight rebalance in favour of instant at home," says James McCoy, research director for YouGov SixthSense.

Even without the younger generation on side, instant coffee still accounts for 80% of coffee sales. Nescafé remains the giant of the instant coffee category, with sales almost three times in excess of its closest rival. However, Nescafé's growth was slower than that of the overall instant coffee market, up 2.6% to £347.9m and 0.2% in volume growth. This time last year, the big news in coffee was Nestlé's £43m investment in its Coffee at its Brightest campaign, taking coffee out of the kitchen and back to its origins of the forests of Brazil.

The campaign runs for 16 months and is much broader than the £10.1m spend registered by Billetts (see box above), encompassing extensive in-store activation and marketing, as well as the above the line advertising.

In the context of an increase in ad spend and promotional activity (Nescafé accounts for a third of all promotional activity in the hot beverages category in the past year), Nescafé instant sales look disappointing, but Nestlé trade communications manager Graham Walker insists Coffee at its Brightest is a "long-term campaign" that will take time to bear real fruit. "We've not been doing it for 12 months yet. It's part of a long-term commitment we have for the category and for the brand," he says.

Nescafé hopes the launch of its new 3in1 coffee this month [see box p49] will bring more young consumers into the instant coffee category. It also plans to change the lid on its Green Blend mix from black to green to ensure greater standout on shelf. Since its launch in September last year, Nescafé Green Blend, which contains polyphenol antioxidants that help to protect the body's cells from day-to-day damage, has achieved household penetration of 550,000, according to Nestlé.

In May, the brand launched a TV campaign for its more premium freeze-dried Gold Blend, which saw the debut of the new Nescafé Gold Blend couple, who are due to return for a second instalment this month.

The ads are a bid to tap into the growing popularity of freeze-dried coffee, sales of which overtook instant coffee granules in both value and volume for the first time last year.

The trend towards freeze-dried is "partially driven by the promotional offers on branded freeze-dried products that have reduced the price differential against granules", according to Austin Sugarman, MD of Fine Foods International.

Kenco shook up the freeze-dried market last year with the launch of its Eco Refill packs, which Smart says continue to be well received by consumers, with household penetration reaching 11% in the past year. Kenco's instant coffee portfolio, which also includes Kenco Smooth Roast, Kenco Pure and Kenco Cassio, strongly outperformed the market, with sales up 8% in value to £117.4m and 11% in volume [SymphonyIRI].

Kraft's other key coffee brand Carte Noire, and Sara Lee's Douwe Egberts, also delivered strong value and volume growth. Tough times for tea

While the coffee sector has seen impressive growth, tea has been having a more difficult time. Severe droughts in Kenya and India created a deficit in tea supply that raised worldwide prices to a historical high late last year. When prices fed through to retail, PG Tips was 28.2% higher in February year-on-year [The Grocer 33], while Tetley was 6.5% more expensive. This goes a long way to explaining why value sales of standard tea have risen 7.7% to £520.4m in the past year, even though volumes are down 1.45%, consistent with a long-term decline [Kantar].

There seems little sign of respite for tea suppliers, who continue to battle against price volatility and unfavourable exchange rates. "If you go back to 2006, we were paying about $1.50 in Mombasa [the main African tea auction house]. Today we're buying through the same auction at about $3/kg so there's been huge inflation over time and last year in particular," says Yorkshire Tea brand manager James Prentice.

The outlook for world tea output had looked more promising, with expected higher crop yields in both Kenya and Sri Lanka causing prices to fall in the first half of 2010. But in August, Mombasa lost a ship carrying five million kgs of tea, which led to the price spiking again. What's more, the recent floods in Pakistan and northern India have caused prices in Calcutta to increase, as concern rises about India's tea-producing prospects and the likelihood of extra demands being put upon it to make up any shortfall in its neighbour's teagrowing areas.

Prentice says Yorkshire tea will do everything it can "to ensure the consumer doesn't feel the full impact" of higher input costs. He concedes, however, that market realities and pressures from retail buyers may make further price rises inevitable.

Price increases may have benefited value sales of standard tea, but they've done few favours to volumes, which have been in decline for some years. Simon Attfield, customer marketing controller for Tetley brand owner Tata Global Beverages, believes consumers "eased off" buying tea as price increases went through.

A change in the promotional mix also had a knock-on effect on volume sold. During what Unilever senior category manager for tea, Adrian Adams, describes as the "promotional excesses" of the previous two years, consumers stocked up their cupboards with bogofs and 3-for-2s, resulting in them not having to repurchase to the same degree at the start of this year. Promotions still "have their place", according to Attfield, but while activity in recent years has focused on shifting volumes, in the past year the focus has been on giving consumers a better price to alleviate the impact of price hikes.

"The two-fors and three-fors are not really what people are buying into," says Typhoo marketing manager Chris Hall. "A third off the standard price is where the deals are happening as people focus more on controlling the total cost of their grocery bill."

Creating promotions that encourage consumption, rather than stockpiling, is one of two key targets that Adams believes tea manufacturers must achieve to grow volumes. The other is better innovation "be it health, convenience, taste or modernity. For too long there's been an acceptance of consistent decline".

Yorkshire Tea, the undoubted star of standard tea with 23.7% value growth [IRI w/e 17 July], ticked the taste box in October last year with the launch of Season's Pick a range of seasonally grown teas comprising Assam Gold, Rwanda Gold and Kenya Gold that are only available when the tea is at its highest quality.

"Seasonality in terms of produce is something UK consumers are familiar with through fruit and veg but not so much in tea so we thought we'd buy into these fantastic periods of the season when the tea is at its best," says Prentice.

The key to Yorkshire Tea's growth, he says, is the expansion of its national footprint through advertising, particularly focused on the south-east.

Other, more mature brands are looking to grow through diversifying into faster-growing sectors, popular with younger consumers. Tetley recently refreshed the brand in an attempt to unite its range after research flagged up low levels of awareness among its loyal consumers of the wide range of teas available.

Much of the 12.2% growth in green tea volumes, Attfield believes, is thanks to Tetley's decision to advertise its green tea on television "to make people more aware and get them trying more of these teas". He sees plenty more growth potential in green tea, which ticks the consumer trend for healthy products.

One of the biggest campaigns in tea in the past year has been Unilever's £2m spend on its new Lipton fruit and herbal infusions brand, sales of which soared more than 300% to £1.7m in the past year, making it responsible for over half the growth in fruit and herbal teas (see box, right). "The level of repeat purchases we're seeing is really strong," says Adams.

Not all small brands have enjoyed the success of Lipton. Clipper fruit and herbal teas fell 28.7% in volume. Its standard Organic tea also fared poorly, with volumes down 8.8% over the year. Joe Hale, client director at Dragon Rouge, describes organic as "a tax too far for many" and suggests its premium price has turned off shoppers.

Hot chocolate and Horlicks
Organic may be a step too far, but Fairtrade is a different story. Cadbury is extending its Fairtrade commitment, following its decision last year to achieve certification for its Dairy Milk range. Its Dairy Milk hot chocolate will carry the Fairtrade logo for the first time this month and Cadbury is supporting it with a £1.5m ad campaign.

The hot chocolate category as a whole saw value sales rise 4.3% to £88.5m, although volume growth was just 0.1%. The malted drinks category, on the other hand, delivered strong value and volume growth of over 5%, disproving the theory that it's a drink for old people. These brands are working hard to shake off the old consumer image, says Sugarman.

Horlicks cites the success of its Made for Evenings campaign as key to driving 6.3% growth in the brand's sales, with most incremental sales from new shoppers, says Sandi Boyden, senior brand manager for Horlicks. "The campaign helped re-establish the relevance of Horlicks by reminding consumers of the role it plays in their lives," Boyden says.

Horlicks isn't the only hot drinks brands with chocolate variants keeping an anxious eye on the commodity price of cocoa, which is about 30% higher than last year, helped along by speculators such as 'Mr Choc finger', the chocolate financier Anthony Ward who took 148,000 tonnes of cocoa off the market earlier this year, betting on or perhaps hoping to engineer a price rise.

The volatility in the commodities market, above all other issues, will dominate the thoughts of every hot beverage supplier as they enter the final quarter of 2010... and a nice hot cuppa will be the very last thing they want to take their minds off their worries.

Focus On Hot Beverages