Argayoso, Melissa Tamara Aquino, Sarah Baguio, Jedidiah Bautista, Samantha Lau, Sydney The Coffee Industry of the

Philippines I. Scope and Limitation

EC111-I

This study will be focused on the Philippines' coffee industry, both from the point of view of its producers, the local farmers, and consumers. While the industry has grown from just instant, RTD, and the consumer good segment into being a large presence in the services sector with cafes, the paper will be mostly limited to the former. Particularly, this paper aims to view the coffee industry under the lens of economics and provide answers as to why something so highly demanded in the country has a supply that rarely fails to meet it. Following this, the group will provide recommendations from both the business and economic perspectives to bolster growth in the segment, which has been something the government has been desiring for a while now. II. Introduction As a commodity, coffee plays an important role in the world commodity with its position as the second most consumed beverage in the world after water. It is actually the second most traded commodity in the world after petroleum, and contributes to the economies of over 70 countries through its production and export. This also makes coffee the most valuable and widely traded tropical agricultural product. Internationally, the biggest coffee producer is Brazil, which provides for roughly 15% of the entire global coffee market. It is important to note that most major players in the coffee scene are developing countries, which Vietnam, Indonesia, Colombia, Ethiopia, India, and Mexico following Brazil. (NICCEP, 2012)

Figure 1. Largest Global Producers and Importers of Coffee

Source: Fairtrade Foundation. (2012) Fairtrade and Coffee: Commodity Briefing. The total size of the industry itself is worth over 100 billion dollars, putting it ahead of commodities like natural gas, gold, sugar, and corn. This translates to 500 billion cups of coffee a year and the livelihood of over 25 million people all over the world. (Goldschein, 2011). Exports alone amount to $23.5 billion (translated to 5.8 million tonnes) in 2011 to the GDP of developing countries. It is

important to note that the largest consumers and importers of coffee are traditional markets like Western Europe, Japan and the US, while the emerging markets of Eastern Europe and Asia are showing the most growth year on year amounting to roughly 46%. In relation to this, global consumption growth, which has grown by almost double in the past 40 years shows no signs of stopping, forecasted to reach 9.09 million tonnes by 2019 (Fairtrade Foundation, 2012). Two decades ago, the Philippines used to be among the developing countries that contributed a significant percentage to the global production of coffee. Unfortunately, today it produces less than 1% of the worlds total coffee exports. This is especially distressing as coffee production continues to fail to meet country demand. "Data shows that present consumption stands at 65,000 metric tons a year, while production only stands at 25,000". This implies almost P4 billion in imports that could be going into the hands of our local farmers (Keith, 2012). Realizing this lost opportunity, the country is taking measures to revive a redevelop its coffee industry through an allotment of P192 million for its Cacao Agribusiness Zone Development (Despuez, 2012), a Public Private Partnership (PPP) Program to learn from the best practices of Vietnam 2nd in world production (Cahiles-Magkilat, 2012), and partnerships with corporations like Nestle for them to buy more coffee berries from the Philippines and less from foreign sources (GMA News, 2011). The question of whether these are the best courses of action for the country still stands, and will hopefully be answered in the latter parts of the paper. A. Coffee Production in the Philippines The Philippines actually grows less than 2% of the worlds coffee production, which hardly maximizes the countrys potential in the industry as considering it geographically lies in the narrow coffee belt of the world, making it one of the few countries that can grow all kinds of coffee: Arabica, Excelsa, Liberica and Robusta. However, decades prior paint a different picture as the Philippines actually used to be a major producer and exporter of coffee products, peaking at 4 th worldwide in during the Spanish era. It was also a relatively major player in the 1980s, among the many developing countries in the coffee belt to produce for exports. However, the industry took a major dip in the 1990s where it no longer could compete globally with other coffee manufacturers (Austria, 2002). Figure 2. Relative comparative advantage of Philippine Coffee Production Industry to International Counterparts 1977-1999

Source: Austria, M. (2002) The Philippines in the Global Trading Environment: Looking Back and the Road Ahead. Currently the Philippines has a modest coffee industry that fails to maximize its potentials. Census data reveals that there are roughly 410,000 farms covering ~123,000 ha, of which all commercial varieties of coffee are grown: Robusta accounting for 70%, Arabica for 5-10%, and Excelsa and Liberica for 15-20%.

Unfortunately, this amount has not been growing along with the increasing global and local coffee demand (NICCEP, 2012) as production has even declined slightly from 2008 to 2009 in a downturn of 1.02%(Ang, 2000). Figure 3: Coffee Production in the Philippines (2007-2009)

Source: Ang, P. (2009) Philippine Coffee Annual. Declines in production are often attributed to the peace and order situation of Mindanao that grows approximately 60% of the countrys coffee beans, excessive weather conditions in the area caused by El Nino and El Nina phenomena. In addition to this, farmers also face the low-buying price of coffee in Caraga provinces as well as the continuous neglect of coffee farms in Cavite and Davao del Norte (COCAFM, 2000), which barely incentivizes them to continue coffee production. Figure 4: Share of Areas for Coffee Plantation in the Philippines

Source: COCAFM. (2011) The Coffee Industry, Congressional Oversight Committee on Agricultural and Fisheries Modernization. It doesnt help that coffee is a product whose price traditionally fluctuates from year on year according to weather conditions, disease and other factors. This price vulnerability makes those who depend on coffee as their livelihood especially vulnerable as it would become difficult for them to predict their incomes and budget for their household and business needs. This is especially true for the poor farmers of the Philippines, who have a hard time finding the incentive or the resources to invest in good maintenance and growth of their farms, especially when they end up struggling to make ends meet when the coffee market is down (Fairtrade Foundation, 2012). Below is the price fluctuations of the Robusta type of coffee, which is the majority of the Philippines production, and it can be observed that it went from as low as to 17 cents in 2001 a pound to as high as 120 cents in 2011.

Figure 5. Price Fluctuations of Robusta Coffee (1989-2011)

Source: Fairtrade Foundation. (2012) Fairtrade and Coffee: Commodity Briefing. In recent years however, government has been very adamant to boost up coffee production. In particular, they are looking at new areas to put farms and increase capacity, especially in the Visayas which is yet to grow coffee. They are particularly looking at Negros Occidental; they also want to increase the area of coffee production in Davao, especially in the areas of Mt. Apo and Mt. Matutum, and the Cordilleras Ifugao and Mountain Province. This is looking to add roughly 7,000 metric tons of coffee per year in two years (De la Fuente, 2012). B. Coffee Demand in the Philippines The demand for coffee has been increasing across the years. In 2011, volume sales increased by 7% and is projected to have a 5% CAGR in the coming years (Euromonitor, 2012). The graph below details the industrys historic retail value growth (2007 to 2012) and its expected future growth (2013 to 2017).

Retail Value RSP - Ps bn

60 40 20 0 18.9 21.4 24.3 27.2 30.2 31.5 34.8 38.3 41.9 45.7 49.5

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Source: Euromonitor

Furthermore, according to the Philippine Coffee Board Inc., PCBI, demand rose from 75,000 tons in 2010 to 100,000 metric tons in 2012 (Olchondra, 2012). The increasing popularity and consumption of coffee can be attributed to the wide range of its captive market segments. In fact, coffee is considered to be a staple to a Filipino household (Ang, 2009). It is usually served to accompany breakfast,

may it be pan de sal or rice meals. The average Filipino consumer an average of 2 cups of coffee per day (Avillanosa, 2012). The lower to middle income consumers hugely account for coffee demand in the country. Their main considerations aside from taste are convenience and value for money (Euromonitor, 2011). As such, most of the coffee companies continue to innovate and introduce new variants, such as pre-mixed, instant coffee (eg 3-in-1, 4-in-1, 5-in-1) and single-serve packaging, to encourage consumption from this segment. This market positioning strategy is motivated by the fact that classes C, D (average Filipino or masa) and E comprise 9%, 60% and 30% of the population, respectively (NSCB and SWS data, James 2012). Capturing these segments can certainly increase a companys market share. However, companies should be willing to set modest prices as they are catering to buyers who are very price conscious and sensitive. On the opposite end, there is also a market that prioritizes premium quality coffee variants over price. Although it is a rather niche market, high-income and some middle-income consumers are willing to pay extra for a better coffee experience (Euromonitor, 2012). They prefer fresh coffee and more sophisticated flavors that are available only in chained supermarkets, hypermarkets or specialty stores, typically found in the countrys key cities (eg Manila). Demand for fresh coffee is not so high, accounting for only 10% of total volume sales. It did, however, record a 4% increase in volume sales in 2011, slightly lower than instant coffees 7% rise. Aside from the socioeconomic profile of coffee drinkers, the market expanded to include younger consumers as well. The age bracket for Filipino coffee drinkers go as young as 15 years old to as old as 65 years old (Avillanosa, 2012). In fact, in 2008 the 15-24 age group took up a 26% share in the countrys total coffee consumption (Research and Markets, 2008). According to Andrew Ward, Nescafs worldwide account director, Coffee is now th beverage of choice amongst young people.. (PhilStar.com, 2001) III. Industry Environment A. Major Players & Competition The chart below shows the major competitors in the industry. Nestl Philippines, Inc. for the past years has dominated the coffee industry. In 2011, it accounts for 88.6% of value shares with its Nescaf brands. The second major player lags very far behind with a 3.7% market share. Universal Robina Corp. has two brands, namely Great Taste (3.6%) and Blend 45 (0.1%). It is then followed by Mayora Indahs Kopiko (2.2%), San Miguel Super Coffee Mix Co. (1.9%), and Krafts Foods Phils, Inc. with its brand, Maxwell House (1.8%). The other players in the industry account for the remaining 1.7% market share.

Company Value Shares (2011)

2.2% 1.9% 3.7% 1.8% 1.7% Nestl Philippines, Inc. (Nescaf & Nescaf Taster's Choice) Universal Robina Corp. (Great Taste & Blend 45) Mayora Indah Tbk PT (Kopiko) San Miguel Super Coffee Mix Co. (San Mig Coffee & San Miguel) Kraft Foods Phils. Inc (Maxwell House)

88.6%

Source: Euromonitor Comparing the brand volume shares across the years, the top two brands, Nescaf and Great Taste, have lost 2.1% and 2.5% of its shares, respectively. Kopiko and San Mig Coffee, on the other hand, have gradually increased its product following by 5.3% and 0.6%, respectively. However, it is worth noting that although Nescafs volume shares declined, it still continued to register an increase in value shares from 86.7% in 2007 to 88.5% in 2011. This is because (1) Nescafs instant coffee is still priced slightly higher than of other brands and, (2) Nescaf has a lot of product variants differentiated that cater to several market segments, including the high-income buyers. Nescaf. As already mentioned, this brand clearly dominates the market with 88.6% of the market share. Nestl has been around since 1895, and Nescaf was first introduced in 1938. The brands long history and stretched presence in the industry is a superior advantage. In the Philippines, coffee is almost always associated with Nescaf. They continue to nurture brand equity and brand loyalty through aggressive advertising. Among all the players, Nestl allocates the biggest budget for marketing and invests and capitalizes on almost all channels. It has placements on traditional avenues such as television, radio and print media (Avillanosa, 2012). It also explores non-traditional marketing as well, such as the use of social media (Facebook, viral Youtube videos) and interactive marketing (Bayani, 2012). In fact, Nestl Philippines Inc. won the ARAW Advertiser of the Year Award in 2011the most prestigious award in the Philippine advertising industry (Nestle.com.ph, 2011). Also, Nescafs digital campaigns were so effective that a double digit growth in sales was recorded in 2012 (PANA, 2012). Its Facebook fan page currently tops all brand pages in the country with over 2.2 million fans. Aside from an extensive advertising, Nescaf has a lot of variants as well. This is aligned with its strategy to cater as many market segments. As phrased in their Facebook page, No matter who you are, or what taste you prefer, Nescafe has a coffee specially roasted for you. Product differentiation is in terms of flavors, packaging and price points offered. It is summarized in the table below. Nestl also leverages on a comprehensive distribution network in supermarkets, groceries, convenience stores and even in neighborhood, sari-sari stores. Nescaf occupies the largest shelf-space in supermarkets.
Type of Consumer Middle to Lower Class Middle to High Class Product Flavor Pre-mixed coffee (3-in-1) - classic, original, strong n rich, decaf, brown n creamy, creamy latte, chocolate, etc. Premium Coffee Gold Dolce Gusto Italian coffee flavors (peach, vanilla latte macchiato, grande intenso, mocha, etc.) Packaging Single-serve sachets Single-serve sticks Doy Packs Doy Packs Boxes (with single serve sachets)

Health Conscious Younger Market

Body Partner (Protect, Fit, Relax, Lingzhi) Decaf, 3in1 Decaf, 3in1 sugar free Mocha, Latte

Jars Doy Packs Single-serve sachets Ready-to-Drink Cans

Nestls Research and Development arm is another key competitive advantage of the firm. The 29 research development and technology facilities it has worldwide are all aimed towards providing and assuring its consumer base with high quality and safe food solutions. This focus on bulding consumer trust strengthens brand loyalty for Nescaf (Nestle.com.ph). Great Taste is the secoond largest coffee brand in the country. It is locally owned by John Gokungweis Universal Robina Corporation. Its first product offering was the Blend 45, that would be known as the Pinoy coffee. It gained so much popularity that it even became the largest -selling brand in the market, even surpassing the sales of Nescaf (URC.com.ph). However, market shares began to decline as URC continued to expand its product lines to include chips, chocolates, poultry, other drinks, etc. Although Blend 45 still exists today, URCs main coffee brand is Great Taste. It has a 3.6% market share in 2011. This has declined from the 5.9% share it had in 2007. This is partly due to URCs current focues on strengthening the position of C2, given the thriving market of ready-to-drink teas. Similar to Nestls strategy, URC offers a variety of Great Taste products to capture different market segments. These include 3-in-1 instant flavored mixes (sachets), Great taste Granules (doy packs), Great Taste Premium (doy packs) and Great Taste Decaf (doy packs). URC also offers a ready-to-drink variant, Coffee Twist, to compete with Nescaf. Great Taste 3-in-1 White coffee was a very successful product innovation in 2011. Its milder and creamier taste suited Filipino taste, and has acquired good reviews (Euromonitor.com). Kopiko is the coffee brand of Mayorah Indah TBK Pt., an Indonesian company. It is very wellestablished that it imports to over 50 countries, including New Zealand, UK, Canada, Japan, etc (Mayora, 2012). It appointed Tridharma Marketing Corporation (TMC) to be the exclusive national distributor in the Philippines in 2005 (TriDharma). Kopikos market share has greatly improved from 1.10% inn 2007, to 6.4% in 2011. This growing popularity is attributed to the distinct taste of its instant coffee products. It was the first to introduce the Brown Coffee variant that makes use of brown sugar instead of white. This makes the coffee creamier with a caramel flavoring. Among its other variants are: Kopiko Astig and Kopiko Kopiccino (Mayora, 2012). Because of the success of this product, Nescaf and Great Taste have introduced their own version of brown coffee (Euromonitor, 2012). Although they have available largersized doy packs, its main size variant is the single-serve sachet. It targets middle and lower income consumers. San Mig Coffee is San Miguel Corporations main coffee brand. Its market share gr ew from 1.2% in 2007 to 1.7% in 2011 (Euromonitor, 2012). Like Kopiko, it strategically priced its products lower than Nescaf, effectively capturing a part of this price sensitive market. It mainly operates in the middle to low income consumers. As such, its main product form would be the pre-mixed (3-in-1) packed in single-serve sachets. In 2008, its most successful product offering was the San Mig Coffee Sugar Free mix, which was initially introduced in 2005 (San Miguel Corp). This variant is mainly differentiated by having no cholesterol and 50% less calories. This rides on the health and wellness trend. Now, it even offers a pro-fiber variant, as well. Like Nescaf, San Mig Coffee utilizes an exhaustive distribution network as well, like supermarkets, groceries, convenience stores, sari-sari stores and market stalls. Currently, it has 16 product variants: super packs (super, brown, white, chococino), 3-in-1 regular coffee

mixes (original, mild, strong, extra strong), 3-in-1 sugar-free coffee mixes (original, mild, strong, extra strong), pro-health coffee (pro-fiber coffeemix with inulin fiber, pro-slim coffeemix with L-carnatine) and 100% premium instant coffee (San Miguel Purefoods). Maxwell House is a coffee brand from Tennessee. It is sold globally in markets such as Canada, China, France, Germany, Ireland, the Middle East, Poland, Russia, Taiwan, UK and the US. It was brought into the Philippines on April 2002, to be sold in ready-to-drink sachet mixes. The available variants include regular, sugar-free and rich (Mondelez International, 2012). It is manufactured by Kraft Foods, Inc. But after the the companys split in 2012, Maxwell House now falls under Mondelez International (Egan, 2012). Its market share declined from 3.1% in 2007 to 1.8% in 2011 (Euromonitor, 2012). Higher income and health conscious consumers are its main target. Here is a table summarizing the prices of the 5 brands. This is based on Rustans prices:
Nescaf Original 3-in-1 Great Taste 3-in-1 Kopiko Brown 3-in-1 San Mig Coffee 3-in-1 Maxwell House price/sachet 4.65 6.00 5.75 3.75 5.08 g/sachet 14 20 25 14 9 cost/gram 0.33 0.30 0.23 0.27 0.56

B. Trends Health and Wellness Trend. This can be an opportunity for firms. They can market and develop healthier variants (eg. Decaf and sugar-free). On the other hand, this trend coupled with the inceasing education of consumers regarding the bad effects of coffee consumption, could be a threat to the coffee industry (Euromonitor, 2012). These negative effects usually manifest much later in life, such as coffee dependency, increased heart rate and blood pressure, etc (Harvard Health Publications, 2004). Thus, more of the health conscious consumers would prefer to switch from coffee to tea, which is increasingly gaining popularity as a healthy beverage. Convenience. Due to the fast paced lifestyle of Filipinos, especially those who live in urban areas, more and more Filipinos are looking for products that require a limited preparation time. This explains the growing demand for instant pre-mixed coffee served in single-serve sachets.. The growth of the BPO industry in the Philippines means that there are more middle-aged buyers with higher disposable income (Euromonitor, 2012). This will positevly affect the coffee industry, especially for specialist coffee shops, given that the nature of their work, that consists of long working hours and graveyard shifts. Breaks in coffee shops becomes a part of their lifestyle. Potential of younger, more adventurous demographics. As previously mentioned, coffee has gradually become the choice beverage for younger individuals. This is a huge potential for specialty coffee shops, like Starbucks and Coffee Bean & Tea Leaf, as this market segment usually value ambiance and flavor variety over price, as coffee shops become a venue for study and socialization. This market also has an increasing appreciation for more sophisticated flavors, which can stimulate demand fro fresh coffee (Euromonitor, 2012). There are around 650 specialty coffee shops in the country (2011). The increasing number of supermarkets and malls, are seen to postively influence higher demand. Currently, supermarkets are the largest retail distributor for fresh and instant coffee, 57% of volume sales (Euromonitor, 2012). Malls, on the other hand, provide a perfect avenue for specialty coffee shops to open.

C. Economic drivers The economic drivers of the coffee industry in the Philippines are all about the opportunity that the increased demand poses for the growth of the local industry in the country. The increase in demand for coffee can be seen both within the country as well as in the countries surrounding the Philippines. This development offers incentive to those countries with a strong coffee industry. Realizing this, the local government has taken steps to revitalize the local coffee industry in order to take advantage of the present opportunities. Demand for coffee abroad has increased, most especially in China, which provides the most relevant opportunity there is to the Philippines in terms of its coffee export industry. By 2020, it is expected that each citizen in the mainland are expected to consume a cup of coffee a day or sipping $50 billion-worth of coffee. (Ordinario, 2012) On the other hand, local increase in demand is fuelled by two factors. First, there has currently been tremendous growth in the business process outsourcing (BPO) industry in the Philippines, which has led to the increase in the consumption of coffee due to the nature of the business (graveyard shifts, long hours, etc.). (France-Presse, 2010) Second, the local increase in demand is due to the various trends discussed in the previous section and is and will be bolstered by the significant increase in the per capita income in the country in the past years as well as in the near future. This is mainly caused by the increased government spending on infrastructure and social services to help those who live along and below the poverty line in the country. The foreseen increase in per capita income is also due to the fact that, of our total gross domestic product, the outstanding debt of the Philippine government is now only at 50 percent as opposed to a previous 84 percent. (Remo, 2012) D. Government - import/taxes, legislation Given the huge potential that comes with the production of coffee within a country, like how it helps the economy of Brazil in the present, which is the biggest producer of coffee worldwide, the government has become very much involved in the activities surrounding coffee production in the Philippines. In the country, there are two ways by which the government asserts its role in the coffee industry in the Philippines. First, it regulates trade through timely directives and republic acts that aim to improve the health of the local industry. The second way by which the government exerts its power in the industry is through development programs that are enacted to stimulate the expansion of the local coffee industry, which can be seen much especially in the past few years. During the 1880s, the Philippines was one of the top coffee producers in the world which began when the Spanish brought the beans with them into the new colonial world, as Agence France-Presse remembers in an article for ABS-CBN News. She mentions that the Philippines is now determined to once again regain our position as a prime producer of coffee. (France-Presse 2010) As of 2010, the Philippines only produced coffee that constitutes less then one percent of total global production. (Global Agricultural Information Network, 2010) Clearly, if the country wants to regain its position, it has a lot of work to do.

Green Coffee Imports (1,000 60kg Bags)

2500 2000 1500

1000
500 0 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011

Green Coffee Imports (1,000 60kg Bags)

(Data sourced from www.indexmundi.com) As can be seen in the chart above, there has been a dramatic spike in the increase of coffee imports beginning in the year 1995. The behavior of imports illustrated above is an effect of government policies enacted to protect and foster the growth of the Philippine coffee industry. The Philippine government first started to assert itself in the local coffee industry back in 1960 when it released Republic Act 2712 - An Act to Prohibit the Importation of Coffee, which was lifted in 1996 when it released Republic Act 8178 - An Act Replacing Quntitative Import Restrictions on Agricultural Products, Except Rice, with Tariffs, Creating the Agricutural Competitiveness Enhancement Fund, and for Other Purposes. These two republic acts, as illustrated in the chart above, dramatically affected coffee trade in the country. From 1960 - 1996, there was really almost no importation of coffee products at all. This was done in order to stimulate local production of coffee in the country. However, the government decided to change its approach to redulating the coffee industry in the country and decided to remove the ban of coffee imports and replace it with a tiered tarriff system. Within the quota, the tarriffs would decline to 45% in 2000 from 50% in 1996. Outside the quota, it would decline from 100% to 60%. This seems to be in response to the increasing local demand for coffee, which could not be addressed by local production. President Aquino mentioned in an interview that, currently, Nestle, which is the biggest player in the local coffee industry, sources 80% of its coffee from outside the country. (Aquino Commits, 2012) In the country alone, there is a demand of up to 120,000 tonnes annually, while local production has been pegged at only around 25,000 tonnes per year. (Olchondra, 2012) The government relies on the Bureau of Import Services when it comes to the implementation of these directives. In its effort to regain self-sufficiency and once again become a net exporter of coffee in the future, the government has also place institutions and programs in order to foster the local industry. As a part of the International Coffee Organization (ICO), an institution whose member countries collaborate to tackle issues regarding the world coffee industry, the Philippine government has put up the International Coffee Organization Certifying Agency (ICOCA) in order to provide service and support to the local coffee export industry in an attempt to revive local production. Given the huge amount of coffee imported into the country, it certainly will be a big boost to the economy for us to first be self-sufficient. Towards this goal, President Aquino has included the planting of coffee in his National Greening Program, which he started in 2011. The program is essentially a big reforestation program that aims to grow 1.5 billion

trees in 1.5 million hectares nationwide within the time period of 2011 to 2016. (National Greening Program, 2013) With a big effort at planting a huge amount of coffee comes government support in the form of the National Convergence Initiative, a collaboration between the Department of Agriculture, Department of Agrarian Reform, and the Department of Environment and Natural Resources. The initiative aims to pool the resources and strengths of the three government arms in order to foster sustainable rural development of the Philippines countryside. The initiative was started in 1999 and, unfortunately, has yielded lackluster benefits for two reasons. The fragmented delivery of services to the countryside and the fact that the beneficiaries of the program, farmers, fisherfold, and indigenous groups, remained underdeveloped. Seeing this, President Aquino revamped the program to create that aims to fill the gaps of the previous program and go for incremental but sustainable and holistic development that aims to integrate the people with the development of their local economies. (Enhanced DA-DAR-DENR Convergence, 2013) IV. Coffee Economics Supply and Demand There is a growing demand for coffee in the Philippines, specifically for coffee mixes (Euromonitor International 2012). Despite the inflation rates during the year 2011, all the more did the players in the industry try to innovate with their coffee mixes, offering 3-in-1, 4-in-1 and even 5-in-1 blends. Also, industry players like Kopiko and San Mig Coffee have started to focus on lower-priced brands, tapping the more price-conscious low-income segment of consumers, and in turn boosting their consumption (Euromonitor International 2012). We see here how the demand for coffee has been stimulated precisely by the introduction and innovation of coffee variants. And more particularly, it were those coffee mixes which contained brown sugar (instead of the usual white) which saw an increase in demand from the low-income segment (Euromonitor International 2012). On the one hand, these innovations include and encourage more people to participate in the demand for coffee, even in the face of higher than expected inflation. Also, even with the increase of 4% on the unit price of coffee, an inflation rate of 5% in 2011, and an increase in input prices of sugar, the major players have still handed down these costs increments to consumers at the lowest possible price as to not hurt demand (Euromonitor International 2012). So on the other hand, you also have the conscious effort of the manufacturers to let the shocks of inflation be absorbed gently by the consumers. But in the face of growing demand, and also an increased production of coffee, supply has not been able to keep up with this growth. Because of the more strenuous and prolonged working hours, coffee has become almost a necessary commodity to the daily life of the Filipino. The demand for coffee beans in general is still continuing to grow, and it is mostly local. As you can see, we are really a nation of coffee drinkers, and there are now more people working almost 24/7 who end up drinking coffee, says Ms. Pacita U. Juan, Philippine Coffee Board Chairman (de la Fuente 2012). She also stated that this demand for coffee is increasing in proportion to the growing population, more than production (Keith 2012). And so apart from the coffee mixes, a bulk of this demand is also attributed to the local cafs that integrate Arabica and Robusta varieties to their beverages.

In 2011, coffee production was 88,526.09 MT, a huge dip from the 94,536.01 MT of 2010 (de la Fuente 2012). The 88,526.09 MT consists mostly of the production of 62,978.41 MT of Coffee Robusta (a 7% decrease from the prior years 67,933.06 MT) and 19,002.27 MT of Coffee Arabica (as compared to the prior years 19,420.53 MT) (de la Fuente 2012). These production figures fall short from the local demand of 75,000 to 120,000 MT of coffee annually, leaving the Philippines a supply gap of 31,473.91 MT (de la Fuente 2012) for the year 2011. Over the past 10 years, coffee production only held an average of 25,000 MT (Olchondra 2012). Currently, the Philippines is importing P9.5-billion for coffee, because of the supply gaps that it has to fill (Olchondra 2012). V. Market Structure The market sturcture of the coffee industry is two prongit is a combination of monopolistic competition and oligopoly. On the one hand, Nestl holds a staggering amount of 87% of the share of the market, consistent throughout the years, garnering an almost monopolistic status (Euromonitor International 2012). But on the other hand, despite its dominance in the market, it does not have full contol over prices, as the other players are also able to set prices for themselves because of the different market segments they cater to, as well as the variety that the innovations are allowing the industry players to differentiate on, and therefore, set their own prices. It is under monopolistic competition because you have other industry players, with roughly the same size (except Nestl) who are competing based on a differentiation of products. But at the same time, it can also be under an oligopoly, because of the dominance of Nestl and the good prospects of growth (although currently small now) for the other market players such as Universal Robina Corp, Mayora Indah Tbk PT, and San Miguel Super Coffee. Monopolistic Competition The characteristics of a monopolistic competition that the Philippine coffee industry encompasses are the following: 1) the existence of a large number of firms, 2) differentiated products, 3) some influence over the price, and 4) non-price competition. As we have seen earlier, there is a great demand for coffee in the Philippines, and the market for it is huge. Hence, we could conclude that the industry consists of many buyers, a characteristic of a monopolistic competition. Also, the industry has a large number of firms, and if we inspect the coffee scene further, there are a significant number of industry players that are of more or less equal size. Taking aside the size of Nestl, the other playersUniversal Robina Corp., Mayora Indah Tbk PT, San Miguel Super Coffee Mix Co. and Kraft Food Phils Inc.all hold a share of market that is below 4%. These other players are still able to significantly able to gain a share of the market and remain competitive because of the markets size and the leeway for product differentiation afforded by innovating on coffee mixes. Let us then elaborate on product differentiation. There are three kinds of product differentiation that the coffee industry is engaged in. First is physical product differentiation, where we find the different competitors set themselves apart through the size of their packets, their packaging design, their color themes, and most importantly, the tweaking of blends, although the main takeaway from their products are the samewhich is to satisfy the caffeine fix of the consumers. For instance, other manufacturers tried to tap the health conscious segment, creating blends such as Boncaf Decaffeinated, Maxwell House 3-in-1 Sugar Free and Illy Espresso Decaffeinated (Euromonitor International 2012). Firms have been

trying to consistently widen their lines of instant specialty coffee, to cater to the different taste buds of customers, who are looking for a variety of coffee blends ( Euromonitor International 2012). So instead of just having just around three blends, firms are now offering blends for every Filipino. Next, is marketing differentiation. This is where firms differentiate based on distinct packaging and promotional strategies. That is to say, it is in branding and brand building that most of these firms use to convey a sense of uniqueness, and it is where they try to set their brand apart from the other. For instance, Nescaf has long owned the color red for all of its brands, while San Miguel is able to capitalize on the quality and consistency that have been proven by its other products. Also, Nescafs tagline of Para Kanino Ka Gumigising? has greatly distinguished it from the rest. It also separates itself by creating online contests and even sponsoring music festivals. This is exactly why the coffee industry is characterized by non-price competition, because it wins customers over not through price, but through advertisement costs. The last kind of product differentiation is human capital differentiation, wherein the firm differentiates through the skills and the level of training of its employees. This is particularly clear for Nestl wherein it stresses to create quality relationships especially with their coffee farmers, different from the supplier relationships of other industry players. The industry players also have some influence in price. Despite the dominance of Nestls market share, we should not be fooled that it operates almost like a monopoly. On the contrary, despite its size, Nestl does not have complete control, or even dominant control on the prices released in the market. Our industry leader, Nescaf, does not fix price. Other industry players, although small, are still able to haggle for prices. This is due to the slight differences of their product offerings, as seen in the slight difference of mixes and branding. And it is this dynamic that makes the coffee industry on the one hand, under monopolistic competition, because in a monopolistic competition, firms cannot fix price, but can influence price. Most of the firms still do competitive pricing, because the prices of the different firms are close to each other; but they still differ by small amounts, accounted for by product differentiation.

Short Term and Long Term Graphs for Monopolistic Competition (Source: EconomicsOnline UK)

Oligopoly After having discussed monopolistic competition, there are still some characteristics of the coffee industry of the Philippines that belong under an oligopoly: 1) relatively constant prices, 2) high barriers to entry, 3) high advertising and selling costs. The most important characteristic that the coffee industry has under oligopoly is its high barriers to entry. Barriers to entry generally mean the high start-up costs and other hindrances that prevent new players from entering the industry. These include things such as high plant and factory investment, R&D costs, established brand capital etc. For instance, players in the coffee industry have already invested high amounts of capital and already gained considerable economies of scale throughout the years. Nestl currently is the largest buyer of coffee in the Philippines, purchasing 80% of the Philippines entire coffee production (The Manila Times 2012). Such a dominant players have huge haggling power over its suppliers, and in fact, farmers are trapped in the low prices that Nestl and Universal Robina Corp. dictate (Alave 2012). Other players, like San Miguel Corporation, even have to tie up with international firms (because the supply of coffee here in the Philippines is dominated by Nestl and URC) hence going into a joint venture with the Singaporean Company, Super Coffee Mix Manufacturing (Euromonitor 2012). For instance, Nestl has just opened its newly completed Nestl Lipa Integrated Commercial Center in Batangas, a five-hectare, P25 million facility that serves as a one-stop shop for coffee farmers (The Manila Times 2012). In fact, it even has plans of expanding its instant coffee -making facilities, investing some $160 million (Banal 2012). Even if acquiring the beans is not that difficult (as some independent coffee sellers are able to do this as well), having the factories and facilities to process the coffee in massive quantities requires a huge amount of capital. Also, as said earlier, it is important in this industry to innovate to differentiate and offer a wider array of coffee mixes to choose from. Thus, along with the high capital investment, industry players also need a strong research and development arm, which taps into the market preferences and uses these to come up with new products. For instance, Nescafs success is attributed mostly to its new line of Italian coffee flavors ( Euromonitor International 2012). Kopiko on the other hand captures the taste buds of middle to lower-income consumers, with their Kopiko Brown (coffee, brown sugar and cream) served in one package, and it is this innovation that allowed Mayorah Indah to garner the fastest off-trade value sales growth of 26% in coffee in 2011 (Euromonitor International 2012). Brand equity can also be considered as an obstacle. Nescaf has in fact established itself as synonymous with coffee and coffee mixes in the Philippines. And this is important to note, especially in an industry wherein customers identify themselves with the brand. This is again connected to the high advertising and selling costs, because the different industry players go for aggressive advertising as a way to differentiate themselves from other brands. Distribution chains are also considered to be barriers to entry, because getting a product into these network means having to go through FDA approvals and accreditation, before it is allowed to go into the major retail channels such as supermarkets. For instance, parameters for instant coffee include moisture content, caffeine content, ash content, and pH level (FDA 1985).

Also, in the competition in the coffee industry, prices are kept relatively constant. If there are increases in price, it will be just a small amount, and usually because of some extra quality feature. Firms in the industry dont battle it out with price, but with features. For instance, we mentioned a while ago the success of Mayorah Indahs Kopiko Brown. Other insant major coffee brands, namely Nescaf and Great Taste soon followed suit with this trend, trying to copy in their own way the success of Kopiko by introducing brown coffee variants (Euromonitor 2012). Among the two market structures, it seems to be that although it has many facets of a monopolistic competition, there are hints that the industry has been slowly been tending towards an oligopoly. This is because of the good outlooks for growth or URC, San Miguel and Mayorah Indah, already threatening the long-standing dominance of Nestl. For instance, Kopikos brand volume shares have grown from 1.10% to 6.40% from 2007 to 2011 (Euromonitor 2012). Also, consumers are slowly starting to explore and embrace the different brands.

(Source:EconomicsOnline UK) VI. Conclusions and Recommendations From the economic perspective, the coffee industry in the Philippines was initially a form of monopolistic competition wherein the industry was dominated by a particularly strong player: Nestle through its coffee brand, Nescafe co-existing with other minor players. However, recent events indicate the rise of competition from companies such as San Miguel which have started increasing its market share of the industry thus changing the field into an oligopolistic competition wherein Nestle dominates the market but whose prices still affected by the growing competition which primarily composed of major players. Minor players still play a role in the industry but are not influential enough to affect market prices. Knowing the economic structure of the coffee industry and the nature of oligopolistic competition, is it even recommended for a minor player to stay or enter into the business? In order to understand the coffee industry further, the application of Porters five forces may be necessary to gain better insights into the industry. Porters five forces is a framework commonly used for business analysis of an industry in order to determine its attractiveness. Porters five forces highlights the importance of

these five factors: 1) Threat of new competition; 2) Threat of substitute products; 3) Bargaining power of customers (buyers); 4) Bargaining power of suppliers and 5) Intensity of competitive rivalry. A. Porters Five Forces
Threat of New Entrants: Low Oligopolistic structure prevents minor players from gaining large market shares. Large players already have economies of scale and there are high capital requirement to enter the industry. Entry cost is high. There is high product differentiation. There is low switching cost for buyers since stiff competition means competitive prices but effect is mitigated by brand loyalty and strong marketing campaigns.

Determinants of Supplier Power: Low Supplier concentration is low Availability of substitute input is high due to foreign competition Supplier input is important to firms but easily sourced Suppliers product differentiation is low

Rivalry amongst Existing Firms: High 5 main players in the industry competing on the basis of price and brand loyalty.

Determinants of Buyer Power: High High product differentiation Low switching cost for the buyer Multiple product sources available Product is a luxury item High volume of consumption

Most main competition are large companies that are rivals in size.
The industry growth rate is around 3.1% Buyers have high switching costs due to similarity in pricing.

Threat of Substitute Products: High Substitute products include: tea, soda, energy drinks. Relative price is mostly similar or sometimes cheaper than coffee. Relative quality of substitute also has grades similar to coffee.

Thus in effect, Porters five forces attempt to explain that the coffee industry is currently unattractive for the minor player to enter into due to the oligopolistic nature of the industry wherein strong players dominate and control the industry through dictation of prices and economies of scale. At the same time, buyer power is high hence consolidating market share poses a challenge for the minor player who is without the resources of the major players thus unable to compete in mainstream marketing which requires large investments. This in the end entails that if no major change is attempted by either the minor players, local suppliers or the government then the current situation in the coffee industry will remain at status quo due to the overall unattractiveness of the coffee industry to entering and staying players. There are two methods in confronting this challenge of overcoming the status quo. First is an attempt of product differentiation wherein the minor player has the opportunity of aiming at a niche market instead of the market segments widely targeted by dominant players. In the coffee industry, there are new emerging markets such as the specialty coffee market and the sustainable coffee market with niche markets such as organic, shade grown and fair trade coffee. A fair example of a potential niche market in the Philippines is the Cordillera fair trade coffee which reflects the consumer trend of increasing health-consciousness as well as concern as to the origin of their food. While initially positioned for the high-end market, fair trade coffee has started to penetrate the low-end market segment as well as the health-consciousness trend spreads.(NICCEP, 2010) Second is to establish macroeconomic as well as microeconomics policies that aim to address the issue of oligopoly in the coffee industry through the creation of tariffs, taxes, subsidies and so on for the macroeconomic side and an exploration of alternatives for the microeconomic side such as micro financing and the creation of cooperatives that could capitalize on the funds gained from micro financing. Utilizing the information revealed by Porter's five forces, the group has realized that one of the main reasons why major companies still hold dominant market shares is due to the financial resources available to them. Given that mainstream marketing has been one of the main distribution channels in the coffee industry, minor players have little chance of penetrating the coffee market. There are four ways in which the Philippine government could establish a macroeconomic intervention. Firstly, any intervention made by the government will have to aim at strengthening the local suppliers through increasing the financial capabilities of minor players in the local scene given that many factors that determine local pricing are in the hands of major players. Secondly, It is also important for the government to stimulate local coffee production in the country given that the country is currently experiencing high coffee imports to counter the low local production of coffee by giving more incentives to local farmers such as financial grants for coffee seedlings or for equipment that will enable farmers to increase their yield or to sell for a higher prices, for example roasted coffee sells at a premium compared to green coffee beans.(Alave, 2012) Thirdly, on the international front, the government should start increasing tariffs in order to inhibit foreign competition such as Vietnam or Taiwan from entering the Philippine coffee market. Finally, the government could also aim at reducing local demand for coffee by establishing higher taxes for coffee products given that these would have a stronger effect on consumer surplus due to high demand or by introducing a price floor for coffee higher than current market prices which will still largely impact on consumer surplus. On the microeconomic side, there is a variety of alternatives available to both minor players as well as local suppliers to ensure financial stability in the face of dominant players which dictate the

market price. For the minor players and local suppliers, profit maximization and cost minimization through economies of scope and scale can increase profit without restoring to drastic measures. Given that local production is low, reducing fixed costs may help local farmers achieve lower average costs through equilibrium. Finally on the business side, the minor players alternatively can prioritize niche marketing over mainstream marketing which will allow them to avoid direct competition with the major players in the industry as well as profit from an untapped market. As mentioned before, a potential niche market in the Philippines is the Cordillera fair trade coffee; another possible niche market would be the Civet coffee. (NICCEP, 2010) In terms of increasing financial capabilities, government as well as non-government aid can boost finances through grants and partnerships which can go a long way in mitigating high entry costs incurred by participating in the industry. An option for private aid is also possible through micro financing which is available to companies as well as cooperatives on the part of local farmers. For the local suppliers, same alternatives apply, differentiated products through different types of coffee beans grown and application for financial aid in order to address expenses such as equipment, transportation and etc. In conclusion, while the Philippine coffee industry is currently oligopolistic with the right government interventions as well as the use of proper economic and business strategies by both minor players and suppliers, it is possible to overturn the current economic structure. This would entail effort from both fronts as players and suppliers have to assert themselves in the local scene against dominant players which seek to manipulate market prices and in the international scene where foreign competitors are more capable of supplying demand for coffee. Hence while the industry is currently seen as unattractive, there is still hope of becoming profitable in the future.

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