by Nicholas Deaton, Anish Kumar, Nicholas Quigley, Cornell Tech MBA '18 (5/14/18)
Juan Valdez Cafe can trace its roots back to December 12, 2002, when the Federación Nacional de Cafeteros de Colombia (Fedecafé) established the brand through Procafecol S.A. Its eponymous first storefront opened at Bogota’s El Dorado International Airport. Today, Procafecol continues its original mission to expand the reach of premium Colombian coffee around the world. Juan Valdez Cafe is the product of the joint efforts of over 500,000 coffee growers and producers, most of which are family operated farms, and its fictional namesake has become a highly successful advertising icon. Formed as a non-profit co-operative in 1927, Fedecafé acted as a unifying force among small scale producers combining their supplier power to: “protect the industry, study its problems, and further its own interests.” In [JW1] addition, Fedecafé acted as a quality assurance agent, ensuring the high quality of its Colombian coffee exports throughout the globe.
Juan Valdez Cafe established itself during conditions that were ripe for the creation and expansion of coffee houses. In the early 2000s, coffee bean prices were low and brand name coffee houses like Starbucks and Costa Coffee began proliferating in North America and Europe. Furthermore, Fedecafé authorized Juan Valdez as the only brand to officially sell Colombian coffee. Given its high pedigree, this authorization granted the company an early customer base and market defensibility. In 2004, Juan Valdez began to expand internationally, first to the U.S. and then throughout Europe, South and Latin America, and Asia, specifically targeting large population centers like New York City, Madrid, and Mexico City. Juan Valdez currently has over 300 locations and employs over 5,000 people in a joint owned-store and franchise model.
As Procafecol’s expanded itsJuan Valdez Cafe locations, they also broadened their product line to include a native e-commerce platform selling Colombian coffee beans, candies, and accessories. This expansion was not without high costs: the company only had one profitable year between its creation in 2002 and 2012. However, subsequent years saw trending profitability due to improved cost management and revenues that soared 19% year over year in 2016.
Procafecol continues to enter new markets with recent additions in the Middle East and East Asia. Their strategy relies on several main tenets: premium products, great customer service, and unique experiences provided by their Colombia-centric stores and ingredients. As Procafecol continues to grow, it will face strong competition from major international brands such as Starbucks, Peet’s Coffee, Costa Coffee, and Tim Horton’s. Further threats arise due to the unpredictable trend of customer tastes as well as the frequent fluctuations in coffee bean prices.
From a macroeconomic perspective, the country of Colombia is quickly growing into a role as a leading economy in South America. Gross domestic product (GDP) has grown steadily on an annual basis, and is tied closely to the price of oil and mining commodities, which are two of Colombia’s largest industries. Safety in Colombia dramatically improved since the passage of Plan Colombia—a year 2000 U.S. foreign aid initiative that sought to address the Colombian drug cartels and insurgent groups. Since 2002, kidnappings have decreased by 90% and homicides have decreased by 50%. By many accounts, Plan Colombia was a success and led the Colombian congress to ratify a peace agreement with the Revolutionary Armed Forces of Colombia (FARC) in 2017. The agreement stipulates that the FARC should demilitarize and integrate into society, and established a system of alternative justice for crimes committed. While more than a quarter of the population remains beneath the poverty level, Colombia has peaceful elections, strong civil liberties, and established democratic institutions.
Coffee has been a Colombian crop staple for decades. There are more than 500,000 coffee growers in the country who unite in the Colombian Coffee Growers Federation (Fedecafé), which exclusively supplies beans to Juan Valdez. Coffee production in Colombia is the third highest in the world at greater than 11 million bags, behind only Brazil and Vietnam, according to the International Coffee Association. Colombian coffee exports represent an economic value of $1.7 billion. However, production was devastated twice in the last decade. Both Colombia and other countries in the region had breakouts in 2008-09 and 2011-12 of the fungus Hemileia vastatrix, also known as coffee leaf rust, which ruins crops and significantly decreased production levels across the region. In general, Colombia’s diverse geography supports arable land that is favorable to several coffee flavors. The profile of Colombian coffee is usually a strong aroma, full body, and high acidity level.
Procafecol spent decades building its coffee brand through a variety of marketing channels. From sponsoring the U.S. Open to ad segments with heads of state, Juan Valdez spent years building positive brand equity with a wide reach. Its iconic logo of a coffee farmer with a donkey distinguished the company as a premium coffee brand among competitors that lacked any brand recognition. Physical coffee retailers leveraged the brand as a stamp showing that the product they sold was premium Colombian Coffee. For example if Folgers were selling coffee, it would have the Juan Valdez symbol alongside of it, setting it apart from other brands in a supermarket.
Fedecafé, supported by the Colombian government, intended to build a pan-national brand to bolster local growers and increase their ability to sell their product in the international market. With an eye on expansion, senior leadership decided to enter the food and beverage market through a line of brick and mortar stores. Juan Valdez Cafe has the majority of its brick and mortar locations in Latin America with an increasing footprint of stores outside this region. The premise was to leverage the decades of legacy brand equity in a retail store setting, taking advantage of the significantly higher margins inherent to in-store sales. Even so, the coffee house market was very crowded with large brands such as Starbucks and smaller mom and pop stores. Individually owned stores set themselves apart with unique, community ambience.
Meanwhile, Starbucks offers a combination of top quality and variety as well as a consistent brand of high customer service, trendiness, and professionalism. Furthermore, Starbucks provides the customer with the option to buy a variety of beans such as Ethiopian and Java blends. Each geographic-based coffee has a distinct taste and acidity that attract different type of consumers. By limiting itself to Colombian beans, Juan Valdez hamstrings its business by offering a limited flavor profile. It appears Procafecol identified this weakness and attempts to compensate by setting its price points slightly below competitors like Starbucks. For example, a single espresso is priced approximately 17% lower than Starbucks.
Juan Valdez’ Cornell connection should not be overlooked. When Hernan Mendez was choosing a business school for his MBA, he could have gone anywhere. He was accepted to many top schools including Wharton, but chose Cornell’s SC Johnson College of Business because it offered him ample opportunity to enjoy the great outdoors in Ithaca, New York. Mendez received his MBA in 1983 and took the helm of Juan Valdez as CEO in 2010 as the company languished in year-over-year losses. Juan Valdez began rapidly opening cafes beginning in 2002, and by 2010 had accrued heavy debt from the expansion, along with a long list of failing cafes. Mendez cut the company’s losses, and pioneered a strategic move into franchised stores, which the previous leadership had resisted. Within four years, the company turned around and underwent a cultural and strategic renaissance under Hernan Mendez’s leadership.
Procafecol’s largest risk is macro-economic, in terms of the Colombian economy’s health. Two aspects of Procafecol’s business model create this dynamic: its supply chain concentration, which obtains 100% of its coffee from Colombia and has most of its brick and mortar stores located within Colombia and its environs. Currently 76% of Juan Valdez cafés are located in Colombia at a moment of economic uncertainty. Efforts to diversify the retail base outside of Latin America were met with mixed success. Currently, the Colombian economy is highly connected to oil production, which experts believe will run out within five years. Furthermore, oil accounts for about one-fifth of total government revenue. Combined with immigration pressures from Venezuela due to its collapsing economy, Colombia sits in a precarious position. Standard and Poor's rates Colombia at BBB- on downgrade watch, one notch above junk status, an economic indicator that reduces Colombia’s ability to borrow. Higher borrowing costs on the international market can limit Colombia’s growth especially with the lack of oil revenue in its coffers.
Moreover, climate change and its impact on the coffee harvest pose another significant risk. Although Colombia has some of the most famous coffees in the world, the coffee plant is not indigenous to the country. Spells of higher than average temperatures—a welcoming environment to pests—have severely impacted crop yields. Heavy rains and other shifting weather patterns have also made a major impact. At a micro level, coffee farmers have trouble consistently predicting a harvest’s success. The cost of a pound of Colombian coffee in the U.S. can increase significantly in a year with low yields, for instance. Large brands such as Maxwell, Yuban and Folgers increase prices as a result. Juan Valdez Cafes suffer from lower margins during low crop yields because the storefronts are under pressure to keep prices steady in order to be competitive with non-Colombian coffee houses. To make matters worse, Arabica coffee beans, which Colombia grows almost exclusively, are especially sensitive to changes in climate.
The initial purpose of forming Juan Valdez 60 years ago was to create a stronger position to negotiate pricing with coffee roasters and, in turn, retailers. Historically, any downward price movement in the coffee commodity hit growers the hardest—the coffee roasters and retailers were left relatively unscathed. Juan Valdez aimed to mitigate that risk by uniting coffee growers under a single entity. The Juan Valdez brand has been successful for decades, but we believe that the current attempt to vertically integrate into the saturated coffee house segment with Juan Valdez Cafes is a foolhardy move. While Procafecol has succeeded in the Latin America region, the entrance of Starbucks and other multinational brands with their own coffee houses competing for regional consumers spells trouble for Juan Valdez. Furthermore, operating a brick and mortar store requires a distinct skill set from certifying coffee beans, advising growing techniques, and giving tools to local Colombian coffee growers. Due to these factors, we believe that Procafecol should continue to invest in its coffee growers and ensure these producers have the best possible resources to grow great coffee. Despite recent success, vertically integrating into the retail segment seems to cloud that vision by offering no significant increase in bargaining power for coffee growers nor any significant long term sustainable profits. Instead, they should look for an opportunity to offload their coffee house operations to a major player and double down on their main focus—growing great Colombian Coffee.
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[JW1]Please check page number in citation. 5793?