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MARTA DOWEJKO GILBERT WONG THE LAO COFFEE INDUSTRY: IMPLEMENTING VERTICAL INTEGRATION FOR A SOCIAL CAUSE AT BOLAVEN FARMS Their hope is our joy. -Bolaven Farms about its resident farmers Founded in early 2007 by Sam Say, a Lao ref ugee who lived in Canada and Hong Kong, Bolaven Farms was a coffee business with a social purpose. With an office in Hong Kong and a farming facility in Laos, the venture’s mission was to provide high-quality coffee to the worldwide public while helping to alleviate poverty among coffee farmers. To achieve this lofty goal, Say developed a business model that involved a full integration of the coffee supply chain, from planting the coffee seed to selling the final branded product to wholesale and retail customers. The model hinged on Sa y’s ability to raise Lao coffee production to international standards, both in its quality and quantity. Once a stable supply of coffee was achieved, Say had to find customers who were willing to pay a premium price for the coffee he produced. To achieve this, Bolaven Farms trained its own cohort of local farmers in modern production techniques on its farm. The original idea was to provide farmers who graduated from the programme with a US$5,000 loan so they coul d set up their own farms and start supplying high-quality coffee to Say’s venture. However, it quickly became apparent that the farmers lacked the necessary skills to properly invest their loans. On the other side of the supply chain, Bolaven Farms began to test the market while its own farmers were setting up for production. Say ob tained high-quality coffee from a local cooperative run by a French non-governmental organization (“NGO”) and distributed it through his own channels. However, he had a hard time finding customers who were willing to pay a premium price for his coffee in the mature and highly competitive coffee market. Marta Dowejko prepared this case under the supeGilbert Wong for class discussion. This case is not intended to show effective or ineffective handling of decision or business processes. © 2011 by The Asia Case Research Centre, The UHong Kong. No part of this publication may be reproduced or transmitted in any form or by an—electronic, mechanical, photocopying, re cording, or otherwise (including the internet)—without the permission of The University of Hong Kong. Ref. 11/494C 1 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms Bolaven Farms expected its first coffee harvest by early 2011. Four years into operations, Say had personally invested US$4 million in the project. It was time to re-evaluate the business model and make the venture a success without compromising on its mission. The Worldwide Coffee Industry Worldwide Coffee Production and Consumption Coffee was one of the world’s most important tropical commodities, with 6.1 million tonnes being traded worldwide in 2008. Three main types of coffee were being traded: green, unroasted coffee beans; roasted coffee beans; and soluble coffee products. Green coffee accounted for more than 80% of the worldwide coffee trade, in terms of value and volume. 1 Two principal varieties of coffee beans, Arabica and Robusta, made up the majority of trade. The International Coffee Organization valued the 2007 coffee export market at US$12.7 billion, with an annual growth rate of 17%. Between 70 and 75% of the coffee produced each year was intended for export. The retail value of the coffee traded was estimated at US$32.1 billion in 2009, up 6% compared to 2007 and 42% compared to 2004. 3The largest coffee producers, Brazil, Vietnam and Columbia, accounted respectively for 31%, 14% and 9% of 4 the world’s green coffee production in 2009. 5 Coffee consumption had been growing at an annual rate of 2.4% since 2000. In 2007, Europe was the largest consumer of coffee, accounting for 31% of worldwide consumption, followed 6 by the United States with the consumption of 16% of the world’s coffee, and Brazil with the consumption of 13% of the world’s coffee. 7 Coffee prices were notoriously volatile, which had a very strong impact on the economy of 8 coffee-producing countries and the living standards of coffee farmers. For the farmers, the lower income from crops meant limited access to education, housing, food and medical services. The Traditional Supply Chain The coffee industry’s traditional supply chain involved four main phases of production, according to the stages of processing the coff ee bean: farming, trading, roasting and distribution [see Exhibit 1]. Coffee Farming The coffee plant, a tropical and subtropical shrub, yielded the best results in humid and warm conditions. If well maintained, each coffee plan t could provide up to two harvests per year, 9 with the first crop harvested four years after planting the shrub. 1For details, see the Tropical Commodity Coalition website: http://www.teacoffeecocoa.org. 2 3International Coffee Organization, http://www.ico.org (accessed 30 March 2010). Euromonitor International, http://www.euromonitor.com (accessed 30 March 2010). 4International Coffee Organization, http://www.ico.org (accessed 30 March 2010). 5Pay, E. (2009) “The Market for Organic and Fair-trade Coffee”, Food and Agriculture Organization of the United Nations, http://www.fao.orgccessed 30 March 2010). 6 The International Coffee Organization calculates the consumption level as disappearance of coffee in an importing country by 7 deducting the re-export from imports and adjusting it by the official inventory levels. International Coffee Organization, http://www.ico.org (accessed 30 March 2010). 8Pay, E. (2009) “The Market for Organic and Fair-trade Coffee”, Food and Agriculture Organization of the United Nations, http://www.fao.orgccessed 30 March 2010). 9Interview with Sam Say, founder of Bolaven Farms, December 2009. 2 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms Ripe coffee cherries were harvested manually and processed on the farm before being sent for further processing or exports. The primary processing included extracting coffee beans from the cherry, drying and fermenting. There was a general misconception among the public that all you needed to get a good cup of coffee was to plant high-quality shrubs. However, the processing was equally important. After the ri pe cherries were harvested, the processing needed to follow without delay, as oxygen would start to attack sugars in the cherry and begin the fermentation process. The control over the length and conditions of the fermentation process would determine the potential quality of the coffee. There were two principal methods of processing, wet and dry. In the wet method, the cherries were fermented, washed, dried and peeled. In th e dry method, also referred to as the “natural method”, the cherries were dried and peeled. Th e end products of both methods were green coffee beans. These could be traded as green coff ee, further roasted, or processed into soluble coffee. Coffee Trading Green coffee was made available to buyers eith er directly from farms or via the trading markets based in Europe and the United States. Most buyers were looking for uniform and consistent quality of green coffee. The vendors were expected to provide information on the country of origin and type of coffee, whethe r it underwent wet or dry processing, and the 10 official grade standard of the coffee beans. 11 The farmers earned only between 2.5 and 6.5% of the final retail value of the coffee. The largest share of profits from the coffee exports went to the intermediaries and large roasters. Coffee Roasting The coffee traders and exporters were responsible for ensuring the quality control of the green coffee before proceeding with its sorting accord ing to grade. The grading was helpful in establishing the final use for the coffee batch, i.e., whether it was for whole roasted beans, ground coffee, instant coffee or coffee capsules. At this stage, the coffee was cleaned and checked for any defects before being sold to roasters or brokers. 12 Roasters, in turn, were responsible for creating coffee blends and roasting and grinding sorted and graded coffee beans. The roasting profiles of green beans were used to determine the end- product type. The profiles consisted of the co ffee's origin, grade, variety and primary processing method. Six main coffee roasters serve d the worldwide retail markets, buying up to 45% of the green coffee imports worldwide and holding 45% of the branded coffee market share: Philip Morris/Kraft, Tchibo, J.M. Sm ucker Company, Starbucks, Sara Lee/Douwe Egberts and Nestlé. Roasters were the main source of innovation in the market, developing new products and blends and creating coffee brands for the end consumer. Innovation in product development and marketing added value to the final product, which allowed roasters to set high prices. Consequently, roasters earn ed the highest profit margins in the coffee supply chain. 10 For details, see the Tropical Commodity Coalition website: http://www.teacoffeecocoa.org. 11Gresser, C. and Tickell, S. (2002) “Mugged: Poverty in Your Coffee Cup”, Oxfam, http://www.oxfamamerica.org (accessed 30 March 2010). 12For details, see the Tropical Commodity Coalition website: http://www.teacoffeecocoa.org. 13Ibid. 3 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms Coffee Distribution The most common distribution channels for coffee products in the United States and Europe were through supermarkets and traditional retail chains, speci alty stores, and cafes. The price of the coffee varied to a great extent between different outlets. The lowest priced coffee was offered by supermarkets and retail chains, wh ile cafes charged the highest prices for a 0.25 kilogram bag of coffee. 14 Certified Coffees Certified coffee was defined as coffee produced with respect for the three pillars of sustainable development: economic development for farmers, environmental conservation and social improvements. It was certified by independent third parties. 15 Four main certification systems were offered for coffee: Rainforest Alliance, Fairtrade Labeling Organization, UTZ Certified and Organic. 16 Two main types of certified coffee were rec ognized worldwide: organic and fair trade. Organic coffee was produced using processes th at adhered to organic farming standards. Organic coffee agriculture relied on ecological processes adapted to lo cal conditions, rather than on the use of synthetic fertilizers, antib iotics or genetically modified organisms. However, it was estimated that in 2007 around 25% of organic coffee produced worldwide did not bear any certification and was sold as a conventional coffee. 17 Fair-trade coffee was purchased directly from th e farmers at a higher rate than conventional coffee. The growers were offered a minimum price for their certified coffee, and a premium was added for farmers implementing organic fa rming techniques. Within the fair-trade scheme, coffee farmers received US$1.30 per pou nd of natural, conventional Arabica coffee compared to the worldwide average growers’ price of US$1.07 per pound in 2008 [see 18 Exhibit 2]. In 2008, 52% of certified fair-trade coffee sold worldwide received the organic certification as well. 19 The certified coffees had a small market share in coffee imports worldwide, accounting for less than 1% of the coffee imports to Europ ean countries, the Unite d States and Japan in 2008. This market share varied considerably from country to country, with market shares of 21 5% in Germany, 25% in the Netherlands and below 1% in Italy. However, the import volume of organic coffee to these countries grew by 564% from 2004 to 2008, with an 22 average yearly growth of 90%. 14Ibid. 15 Tropical Commodity Coalition for Sustainable Tea Coffee Cocoa (2009) “Coffee barometer 2009”, http://www.teacoffeecocoa.orgccessed 3 May 2010). 16Giovannucci, D., Liu, P., and Byers, A. (2008) “Adding Value: Certified Coffee Trade in North America”, in P. Liu (ed.) Value Adding Standards in the North American Food Market – Trade Opportunities in Certified Products for Developing Countries, Food and Agriculture Organization of the United Nations: Rome, pp. 33-–49. 17Pay, E. (2009) “The Market for Organic and Fair-trade Coffee”, Food and Agriculture Organization of the United Nations, 18http://www.fao.orgaccessed 30 March 2010). International Coffee Organization, http://www.ico.org (accessed 30 March 2010). 19Pay, E. (2009) “The Market for Organic and Fair-trade Coffee”, Food and Agriculture Organization of the United Nations, http://www.fao.orgaccessed 30 March 2010). 20The European countries include Austria, Belgium, Denmark, Finland, France, Germany, Norway, Switzerland, Ireland, Italy, 21Luxembourg, Netherlands, Poland, Portugal, Slovenia, Spain, Sweden and United Kingdom. Tropical Commodity Coalition for Sustainable Tea Coffee Cocoa (2009), “Coffee barometer 2009”, http://www.teacoffeecocoa.orgccessed 3 May 2010). 22International Coffee Organization, http://www.ico.org (accessed 30 March 2010). 4 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms Agribusiness Conditions in Laos People in Laos According to the United Nations (“UN”), 76. 8% of the Lao population lived under the poverty line of US$2 per day in 2007. 23The literacy rate for the adult population was at 73% in 2008. Roughly 40% of primary school stud ents continued their education in secondary schools. In 2008, Laotians had on average less than nine years of education, and very few 25 graduated from vocational schools and universities. The combined primary, secondary and tertiary education gross enrolm ent ratio in 2007 was 59.6%. 26The adult life of Lao citizens 27 started at age 15, and individuals attaining this age were expected to work full time. According to UN statistics for the years 2000–2008, over 75% of the economically active 28 population worked in agriculture. Low Productivity in Agriculture The World Bank estimated that the GDP per capit a (in current US$) in Laos in 2008 was US$858. Agribusiness in Laos, representing one third of the country’s GDP and covering 29 8.5% of the country’s land area, mainly relied on traditional farming techniques. Poor levels of general education and a subsequently lim ited access to knowledge hindered the farmers’ understanding of advanced farming technologi es and contributed to a reliance on local seed varieties and a scarce use of soil fertilizers or pesticides. The lack of advisory services on farming, management and hygiene issues also contributed to the inferior quality and yield of farmers’ harvests. Consequently, the local cr ops were often substa ndard and very much dependent on the weather conditions and seasonal infestations. Legal Constraints for Agribusiness A 1997 Laotian law allowed for the transfer of la nd inheritance in terms of land use but did not envisage the transfer of the title to the land. 30In addition, in many areas the land was treated as community property and was distributed by the state accordi ng to local needs, in small parcels of land defined by state guidelin es. This impeded the use of land by a large number of farmers who were unabl e to acquire larger plots of land or unwilling to invest in land that was not theirs. In addition, business registration and licensi ng procedures provided limited legal options and were discretionary and lengthy, taking as long as 195 days in 2005 and up to 100 days in 31 2008. Taxes were applied by provincial governments on an arbitrary basis and were required to be settled in advance. 32A similar non-transparency policy was applied to exportation regulations due to government officials’ l ack of understanding of international trade procedures. 23UNICEF, http://www.unicef.org (accessed 27 April 2010). 24 25Ibid. United Nations Statistics Division, http://unstats.un.org (accessed 27 April 2010). 26United Nations Development Programme (2009) “Human Development Reports”, http://hdr.undp.org (accessed 3 May 2010). 27Interview with Sam Say, founder of Bolaven Farms, December 2009. 28Food and Agriculture Organization Statistics Division of the United Nations, http://faostat.fao.org (accessed 27 April 2010). 29 30United Nations Statistics Division, http://unstats.un.org (accessed 27 April 2010). Zola A. (2009) “Scoping Study on Cross-border Agribusiness in Lao PDR: Focus on Champasak Province”, Trade Development Facility of World Bank, http://www.worldbank.orgssed 30 March 2010). 31World Bank, http://data.un.org (accessed 27 April 2010). 32Zola A. (2009) “Scoping Study on Cross-border Agribusiness in Lao PDR: Focus on Champasak Province”, Trade Development Facility of World Bank, http://www.worldbank.orgssed 30 March 2010). 5 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms The Coffee Industry in Laos In 2008, Laos produced 31,125 tonnes of green coffee, accounting for less than 0.5% of worldwide production, with an average yield of 538 kilograms per hectare [see Exhibit 3]. In comparison, Vietnam’s average yield in the same period was 1,989 kilograms per hectare and Brazil’s was 1,260 kilograms per hectare: 33 Most of the local [Lao] farmers are “ natural farmers”. They leave the coffee trees as is, with no intervention, and harvest beans at the end. Surprisingly, they get the harvest, but it is not enough in terms of quantity and quality to move them away from poverty. Within their method, on average, a hectare of land produces up to 500 kilos of green be ans, before roasting. It is much less after roasting. And their beans are small er, so the price is even cheaper than for big beans. The lack of proven farming skills has kept Lao farming community in poverty. - Sam Say, Founder of Bolaven Farms Bolaven Farms Bolaven Farms desires to act justly, show kindness, love, and walk humbly alongside the farming poor. By managing the entire supply chain of fine Bolaven coffees from farm-to-table, we commit to poverty eradication. - Sam Say, Founder of Bolaven Farms The Beginning In 2006, Say was on one of many trips to his homeland, Laos. He felt a deep need to come back to the country from which he had to flee a long time ago. Coming a long way from being a refugee in a UN camp at the Lao border, he had become a successful steel trader from Hong Kong, and all he wanted was to forget the tr aumatic events of his adolescence. Yet, after learning about the deeply rooted social and economical problems of Laos, he had developed a strong need to contribute to the improvement of his compatriots’ living conditions: Before I had no interest in Laos because I had too many bad memories related to the war, being a refugee, and my family’s financial losses. I put Laos in the freezer. It was natural fo r me to try to forget these painful memories. In 2006, I felt the urge of going to Laos more often and ask myself why I was there, because I had no love for these people. I now believe my God has given me the capacity to love Lao people and to become an advocate for the economic justice. - Sam Say, Founder of Bolaven Farms During his visits to Laos, Say learned about the many challenges that local coffee farmers faced. They lacked basic farming knowledge, and their crops were insufficient to feed and support entire families. They also lacked access to markets and were often not able to sell their produce outside of their provinces. Their development prospects were also very limited, as local banks would not lend money to farmers, most of whom did not even have bank accounts. Say grew convinced that the only way to help local farmers was not through providing financial or material support, but through building an infrastructure for them to learn how to farm and how to monetize the fru its of their labour. In his mind, linking the 33 Food and Agriculture Organization Statistics Division of the United Nations, http://faostat.fao.org (accessed 27 April 2010). 6 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms entire coffee supply and distribution chain, from planting the seed to pouring the last drop from the coffee pot, was a way to give farm ers more exposure and better development prospects. The idea of Bolaven Farms was born with the main purpose of alleviating coffee farmers’ poverty in rural Laos, specifically by: • providing farmers with access to coffee cons umption markets and ensuring higher profit margins for their produce • improving the quality of Lao coffee by dissemi nating practical and affordable organic farming systems free of charge • ensuring farmers’ growth prospects by provi ding them with land and the know-how to develop their own operations • educating young agri-managers by providing them with hands-on experience. To realize his vision, Say teamed up with expe rienced people willing to contribute their time and energy to developing a business model and farming processes for Bolaven Farms. He found support among his friends, who advised him on managerial issues and helped to develop the business model and marketing strategy for Bolaven Farms. Portia Tam, a graphic designer; Becky Leung, a brand manager; D oug Miller, a public relations consultant; and Dennis Ng, an IT specialist, were the core te am of Say’s venture. They were all highly motivated volunteers who shared Say’s concerns about Lao poverty issues and were willing to give their time to Bolaven Farms on weekends or during holidays. Through his connections, Say recruited Gilbert Suico, an agriculturalist from the Philippines. Suico’s NGO, Asian Rural Life Development Foundation (“ARLDF”), was already actively contributing to the development of farming techniques in the Philippines and supporting local communities in improving their social conditions. The ARLDF was a perfect match to Say’s vision of reviving coffee farming in Laos, so Suic o decided to take this opportunity to share his agribusiness knowledge outside of the Philippines. He committed to Say’s cause for 10 years, starting in 2007. In 2006, the founding team travelled to La os to negotiate a land lease with the local government. They got access to government offici als though Lao contacts. They were aware that the negotiations might be lengthy and diffi cult. After all, their main preconception was that there was rampant corruption in Laos, but the Bolaven Farms team was not willing to compromise on its values. Full of hope, they presented themselves as a small business from Hong Kong, willing to share openly and freely its knowledge on farming and resources with others. A few months later, the government granted them a lease of 67 hectares in the Bolaven Plateau, an ideal place to grow high-quality coffee. With land to farm, Bolaven Farms was offici ally launched in April 2007 as a Hong Kong- based limited company with a 100% subsidiary in Laos. The Bolaven Farms vision was “to invest and empower the farming poor to break the cycle of poverty and build a stronger nation”. Its mission statement was, “Growing the finest coffee is our passion. Restoring land ownership to the joy of the farming poor is our desire.” Bolaven Farms’ Approach Say’s path through life was not easy. A UN refugee in 1977, he was sent with his family to Calgary, Canada, as a part of the UN programme of refugee relocation. Before leaving Laos, his family was entrepreneurial and prosperous, but the revolution took away all the fruits of their hard work. His father, a proud owner of a brick-making company, taught him a sense of righteousness in doing business. Equipped with strong personal values, people-oriented and with an eager personality, Say built his career as a steel trader in Hong Kong. His success in 7 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms trading helped him put aside enough money to launch Bolaven Farms with no bank loan. He decided that US$4 million was more than enough to launch operations and put his ambitious business model in place. This sum was intended to sustain operations for the first four years or until the first coffee harvest. After that, he expected his business model to be operational, the supply chain to be linked, and the venture to break even. Once earned back, 80% of the future profit would be reinvested in the community development. Say thought that entering the coffee industry would not pose any major problems for a person with his experience. With a professional background in steel trading and almost 20 years of a successful career in commodities, he was convinced that trading yet another commodity, such as coffee, would not raise any unexpected challenges. At the initial stage of development, the venture was supposed to be run mainly with the help of Hong Kong-based volunteers who were willing to invest their time in working for a social cause. Say, an experienced networker, was c ounting on his interpersonal skills in securing eager cooperation to develop marketing and ope rations, and on the appealing mission of his business to generate sales and external support. Soon, several other volunteers joined Say, Suico, and Say’s brother, Thomas, an experienced business manager, on their quest of rebuilding the reputation of Lao coffee. Business with a Cause Bolaven Farms had two main lines of business: (1) coffee farming and distribution, and (2) farmer education and management training for young Laotians. The coffee-farming system was implemented in 2007 in cooperation with Suico, a founding member of the ARLDF. He provided the farm with his expertise in organic farming techniques. Of the 67 hectares that Bolaven Fa rms leased in the Bolaven Plateau, 40 hectares were allocated for a coffee pl antation and the remaining 27 hectares were reserved for housing, animal stock and other plantations. The farm replicated the ARLDF’s farming system and integrated legumes as a source of nutrient-rich vermicompost (worm-produced compost) for the coffee plants. Livestock was inte grated into the system to provide the farm with an additional income and a source of provisions for the farmers. The main reason for founding a farm was to u se it as a demonstration and training centre for Lao farmers and future agri-managers. In th e first round, Bolaven Farms invited a group of 130 farmers, together with thei r families, to come and live at the farm for two years. The package for each family included three meals a day, on-site housing, a wage for the adults for the work they provided, basic schooling for the children below age 14 and a 30% reimbursement of medical bills. The initial two-year learning period was necessary to start the farm and make it grow. In May 2009, five fa milies graduated from the programme, and there were another 72 adults and 29 children gaining organic farming skills. The business plan envisaged six-month training for the subsequent farmers, with a training capacity of 30 families per year. It cost approximately US$1,000 per year to train of a single farmer. A second group of Lao citizens receiving an edu cation at the farm consisted of management trainees. According to Say, the most qualif ied Lao university graduates brought into the programme were at best on the same level as Hong Kong’s secondary-education graduates. The hands-on learning opportunities provided by the farm were therefore very helpful in developing and educating the local community. In the initial group, there were eight trainees enrolled for a three-year training course. In 2009, the group was further extended to 14 trainees. They took care of different segments of the farm, such as coffee-farming management, wet-mill processing, livestock ma nagement, fertilizer production and building 8 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms maintenance. The training of a single manage ment trainee cost US$2,400 per year and the programme was taking up to 50% of the farm manager’s time. In late 2009, there were 150 people involved in the farm’s operations. These included 18 full- time staff members in Laos, working directly fro m the farm under Suico’s direct supervision. At that time, only one person in the manageme nt team was a full-time employee. In early 2010, the organizational structure of Bolaven Fa rms grew further, and there were seven full- time employees to support the venture’s operations [see Exhibit 8]. A Future for Farmers Once farmers graduated from the programme, they needed an assurance of employment and additional land to cultivate. In late 2009, ther e were already five fa milies who had graduated from the programme and who required further assistance with acquiring land for farming. At that time, Bolaven Farms considered two solutions. The original idea was to give a loan of US$5,00 0 to each of its graduates to establish their own three-hectare farms. However, according to the management trainees, this was not a very good solution. They feared that Bolaven Farms w ould never retrieve the money it invested in farmers who were uneducated in business. Inst ead, they opted for contract farming, where Bolaven Farms would own the la nd and hire farmers to each maintain and manage three hectares of land: one for coffee farming, one for housing and livestock, and one for an alternative crop to counterbalance the risk from coffee. The initial income from each three- hectare farm would cover its establishment cost s. Once the cost was recouped, 60% of the farm’s output would belong to the farmers. This meant that to implement the training pr ogramme, Bolaven Farms needed to acquire 90 hectares of land per year to accommodate all graduating families. This required not only an advanced level of cooperation with local author ities, but also further financing to purchase new land. To this end, in early 2010 Say began talks with Lao and Hong Kong banks and searched for individual investors. His idea was to find 30 of his friends who were willing to invest US$20,000 each with 5% return and who would be fine if the money was never returned to them. Linking the Supply Chain The principal idea behind the business was to re model the traditional supply chain for coffee products [see Exhibits 1 and 4 ]. Bolaven Farms intended to remove at least four intermediaries from the chain and to increase the profit margins paid to farmers [see Exhibits 5 and 6 ]. By doing this, the farm took the responsibility for selling the green and roasted coffee to wholesalers and retail customers alike. As the first coffee harvest was expected in early 2011, Bolaven Farms temporarily engaged in reselling coffee from other suppliers to sustain its operations. Its first cooperation project was initiated in 2008 with the Bolaven Plateau Coffee Producers Group Association (“AGPC”) 34, a cooperative of coffee producers founded by the French government and consisting of 53 villages and 700 coffee-growing families. Th e contact with the cooperative had been established through the personal ties of Say’s brother, Thomas. Under the agreement, Bolaven Farms was to purchase AGPC’s crops and initiate bu siness contacts with distributors in order for AGPC to build its own brand. The coopera tive followed internal protocols of coffee producing and post-harvest treatment to ensure the quality and organic certification of the 34 The acronym “AGPC” comes from the French name of the organization, Association des Groupements de Producteurs de Café du Plateaux des Bolovens. 9 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms final product. The role of Bolaven Farms wa s to ensure the high quality of the roasting process and the worldwide product distribution. The solution was temporary, and its objective was to ensure the sustainability of Bolaven Fa rms’ operations until its first harvest was ready for sale. In the first year of cooperation, Bolaven Farms purchased 140 tonnes of green coffee from AGPC at US$2,400 per tonne, which was 35% above the regular coffee price, with the intention of selling it in the US market. Say spent the entire year travelling throughout the United States and meeting with people who might be interested in buying his high-quality stock, but with little luck. The US buyers were not interested in buying an expensive product from an unknown producer, and Say was not willing to lower the price. After all, he said, the higher price was intended to provide an incentive to farmers to invest more time and effort in farming a high-grade coffee. Say strongly believed in another sales lead, Hong Kong’s five-star hotels. Say believed that their cooperation would give the hotels positive media exposure. However, he quickly learned that most of the hotels were providing their coffee free of charge at breakfast, so the fair-trade organic coffee would seriously increase their costs. These hotels simply did not have room in their budgets to buy coffee that was more expe nsive. As people were not complaining about the quality of the hotel coffee, or worse, were not even drinking it once it was served, the hotels did not see a reason for changing their coff ee supplier. This market proved to be more difficult to enter than Bolaven Farms had initially anticipated. After two years in the market, Bolaven Farms had learned some hard lessons. Its first sales were far below expectations [see Exhibit 7 ]. The coffee market was a mature one, with powerful coffee roasters taking up a large pr oportion of the market share. Most coffee contracts were set up for two years or more, and people were reluctant to change their coffee suppliers or to pay a higher price. Bolaven Farms decided to play on the main advantage of its coffee compared to its competitors: its social dimension. If You Cannot Push, Then Pull With the market saturated with many experien ced suppliers, Bolaven Farms decided to take another approach to building its market share. It continued to send brochures and letters to prospective clients, but this time its objective was to become a voice fo r the social cause and to raise awareness about the origin and qualit y of the coffee being served. The corporate social responsibility of companies distributing coffee became the main issue. It was thought that positive media exposure rela ted to their work with Bolaven Farms could generate more customers for cooperating companies. Bolaven Farms set up a website in 2008 and a Facebook page with a related cause in early 2009. 3The first article about Bolaven Farms, inspired by Say’s close friend, Drew Spike, appeared in the South China Morning Post, the largest Asian English-language newspaper, in June 2009. When the South China Morning Post article was published, the chief editor did not limit himself to interviewing Say and writing the story up . He had spent four days at the farm with a photographer and invested his time in understanding the Bolaven Farms concept. Eventually, this journalist became a good friend and a strong supporter of the cause. He continued to educate the general public about the importance of organically grown coffee and introduced new people to Bolaven Farms’ managers. 35 A cause is a Facebook-based campaign for collective action. The purpose of a cause could be to increase awareness over an issue or to raise money to support related actions. 10 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms As a result of these introductions, Bolaven Fa rms collaborated with Impact Asia, a public relations firm from Hong Kong. Impact Asia’s CEO, moved by the idea behind the venture, offered pro bono help in de veloping a professional public re lations strategy for Bolaven Farms. Bolaven Farms did not have to wait long for its first sales results either. After the publication of the first article, Say’s phone rang with good news. One of the largest catering companies servicing large banks and corporations, Sodexo, expressed an interest in distributing Bolaven Farms coffee in the Hong Kong market. At that time, Say was pitching directly to one of its customers. The article triggered a response to an e-mail sent earlier to Sodexo headquarters with an offer of cooperation. In a very shor t time, Sodexo’s corporate social responsibility vice president, residing in Singapore, connected Say with the Hong Kong branch involved in developing Sodexo’s new private label. Say could not ask for more. Sodexo was looking to increase its coffee sales by setting up its own brand and all it was missing in the plan was a coffee supplier. It was looking for a supplier that would have exte nsive knowledge about and full control over the quality and origin of the final product. They were a perfect match. The initial agreement was to distribute 10 tonnes of Bolaven Farms’ roasted coffee per year in automated coffee distributors, pantries and corporate cafeterias. In addition, Sodexo pl edged to provide help in raising awareness about the social cause behind the Bolaven Farm s coffee. The first Sodexo client to switch entirely to Bolaven Farms coffee was the 10-floor and 3,200-employee Hong Kong headquarters of one of the major international investment banks. Beyond the Start-up Four years into operations and the company had already invested US$4 million in the project. With this money, it had purchased land, applied for certifications, and trained 250 farmers and 7 management trainees. However, it was still e ducating the public and finding international customers willing to pay premium prices for the coffee. Say had to admit to himself that, contrary to his initial understanding of the ma rket, producing organic coffee was actually the easiest part of his business. Selling coffee and providing development prospects to graduating framers were more difficult than he expect ed. He considered his business successful in fulfilling social objectives, but he was also well aware of the weakness of its business component. The original plan was to increase the busin ess production capacity by granting loans to farmers while expanding the sales network worl dwide. In reality, Bolaven Farms had to reconsider the loans to farmers, as they turned out to be impractical and created difficulties in building its sales. Both ends of the supply chain needed further refinement and investment. With the first coffee crop becoming available in early 2011, Say had to face the reality that the business model that he had been implementin g for the past four years might not be the most effective one for a business start-up. The vision of his business might have been very inspiring to many people, but in reality, it w as difficult to find followers for his noble cause on the demand end of the value chain. Say had to admit to himself that, contrary to his initial evaluation, building his business and a coffee brand from scratch was no easy task. It was time to re-evaluate the business model and make the venture a success without compromising on its mission. 11 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms Online Resources 1. Bolaven Farms website: http://www.bolavenfarms.com. 2. Bolaven Farms Facebook page: http://www.facebook.com/pages/Bolaven- Farms/52597831587. 3. BBC World, Earth Report: Gambling on Laos, aired on 2 July 2010. The excerpt is available here: http://www.youtube.com/watch?v=6PrGOZOmR-w. 12 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms EXHIBIT 1: THE TRADITIONAL COFFEE SUPPLY CHAIN Individual farmers Cooperatives Coffee cherry Curing plants Association of farmers Traders Exporters Green coffee Roasters Retailers Catering Consumers Roasted or soluble coffee 13 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms EXHIBIT 2: FAIR-TRADE COFFEE PRICES IN 2008 F AI-TRADE FAIR- FAIR-TRADE VARIETY Q UALITY P ROCESSING MINIMUM TRADE PRICE PRICE PREMIUM A RABICAC ONVENTIONAL W ET 1.25 0.10 1.35 DRY 1.20 0.10 1.30 ORGANIC W ET 1.45 0.10 1.55 DRY 1.40 0.10 1.50 R OBUSTA C ONVENTIONAL W ET 1.05 0.10 1.15 DRY 1.01 0.10 1.11 ORGANIC W ET 1.25 0.10 1.35 DRY 1.21 0.10 1.31 NON -AIR-TRADEA RABICA 1.07 NON-FAIRTRADE ROBUSTA 0.72 FLO Fairtrade Minimum Price and Fairtrade Premium for coffee, per pound (FOB, in US$) compared to the average price paid to growers in 2008. Sources: Fairtrade minimum prices and premiums, http://www.fairtrade.net/list.html?&no_cache=1(accessed 10 May 2010); International Coffee Organization, http://www.ico.org (accessed 30 March 2010). 14 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms EXHIBIT 3: COUNTRY-LEVEL PRODUCTIVITY IN COFFEE FARMING The comparison of coffee yield in kg/Ha in Brazil, Laos, Vietnam and worldwide. Source: Food and Agriculture Organization Statistics Division of the United Nations, http://faostat.fao.org (accessed 3 May 2010). 15 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms EXHIBIT 4: BOLAVEN FARMS’ SUPPLY CHAIN Graduating farmers Cooperative Current farming apprentices Coffee cherry Bolaven Farms Green coffee Roasters Consumers Retailers Catering Roasted or soluble coffee 16 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms EXHIBIT 5: BOLAVEN FARMS’ GROSS MARGINS FOR 2009 GROSS MARGIN C OFFEE TYPE (IN%) NOTE PREMIUM GREENS 40–66 E XPECTED R EGULAR GREENS 10–20 B EFORE SALES COMMISSION B EFORE SALES PREMIUM ROASTS (RETAI) 85 COMMISSION B EFORE SALES REGULAR ROASTS (RETAI) 75 COMMISSION PREMIUM ROASTS 70 B EFORE SALES (WHOLESALE) COMMISSION REGULAR ROASTS B EFORE SALES 60 (WHOLESALE) COMMISSION EXHIBIT 6: BOLAVEN FARMS’ SALES COMMISSIONS FOR 2009 T YPE OF ORDER S ALES COMMISSION IN %) RETAIL 0 W HOLESALE 12 H IGH VOLUME WHOLESALE UP TO30 EXHIBIT 7: BOLAVEN FARMS’ COSTS AND REVENUES FOR 2007–2010 OPERATING COST YEAR (INUS$) REVENUE (INUS$) 2007 1,000,000 0 2008 1,000,000 0 2009 1,000,000 38,460 2010ESTIMATE) 230,770 192,310 17 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms EXHIBIT 8: ORGANIZATIONAL CHART FOR BOLAVEN FARMS AS OF JANUARY 2010 Sam Say Founder and CEO Laos Hong Kong Branch HQ Chapman Lee Somsay Boaukhasith General Manager Commercial Director Gilbert Suico Leo Nevado Management English Teacher Trainees Pat Chan Head Agriculturalist and Translator Administration Farm Staff Dennis Ng Operations Director Resident Farmers Charles Schmitt Corporate Relations Bikash Pun Local Logistics Volunteers 18 This case is for use in the HSBC Business Case Competition 2013 only. 11/494C The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms EXHIBIT 9: THE EVOLUTION OF THE COMPOSITION OF SOCIAL NETWORK TIES FOR BOLAVEN FARMS FROM 2007 TO 2010 19 This case is for use in the HSBC Business Case Competition 2013 only.
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