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Coffee after Brexit

From the March 2019 issue.

Although there are still many questions, experts and coffee businesses alike say Brexit has big implications for the United Kingdom’s coffee industry.

Not too different than two years ago, when the United States found itself divided following presidential nominee Donald Trump’s election, today the United Kingdom finds itself at a crossroads, with the nation divided over its membership in the European Union.

In June 2016, 51.9 per cent of UK voters – in a record turnout – voted in favour of leaving the European Union, a 25-year partnership. So following invocation of Article 50 in March 2017, the United Kingdom had two years to create a plan and come to an agreement with the European Union for its departure on 29 March, 2019.

On 15 January, Prime Minister Theresa May’s proposal was rejected by a margin of 230 votes – the biggest defeat of government policy since the 1920s. Despite this, she survived a “no confidence” vote that was tabled by an opposing party the following day.

Although terms of the departure and their ultimate effects on businesses are still unknown (nothing had been finalised as of print), the United Kingdom’s looming departure of the European Union has many implications for the local coffee industry.

For two years in a row, Allegra World Coffee Portal’s annual Project Café UK report found local coffee operators both frustrated and concerned about Brexit’s effect on the industry and their businesses. In fact, 49 per cent of industry leaders surveyed for the 2019 report indicated that Brexit was negatively affecting their business, and 87 per cent believe Brexit has damaged the UK economy.

“Sustained uncertainty on the UK’s future relationship with the EU continued to frustrate the coffee shop industry in 2018. The political impasse over the past 18 months has contributed to growing anxiety on labour shortages, rising prices, investment and eroded consumer confidence,” the 2019 Project Café UK report says.

Among those leaders surveyed, Allegra CEO Jeffrey Young says there are questions around whether their growth would have been stronger if it wasn’t for the uncertainty of Brexit.

“Both branded chains and independents have all had tremendous growth, but that rate of growth has slowed radically,” he tells Global Coffee Report. “Until only a couple years ago, it was well over 10 per cent growth, but it’s down to 4 to 5 per cent growth predicted for the next few years.”

Currency concerns
Because coffee is traded as a commodity in the US dollar, currency always plays a role in the global coffee industry. But since Brexit entered the picture, the sterling pound has been weak and volatile.

“Following such a prolonged period of uncertainty through the negotiations, a problematic impact on UK coffee businesses has been the weakening of the pound, particularly at key points when Brexit talks have stumbled,” explains Chris Stemman, Executive Director of the British Coffee Association (BCA). “The weakening pound has added significant costs through foreign exchange to UK coffee companies in being able to trade, import, and sell coffee.”

Coffee imported into the United Kingdom, whether green, roasted, or ground, has become more expensive as financial uncertainty around Brexit has threatened currency values, says Jens Roehrich, Professor of Supply Chain Innovation at the University of Bath School of Management. UK coffee roasters and cafés have had to either absorb these cost increases or pass them onto consumers in the form of higher product prices.

Trade tribulations
Weak currency largely impacts trade, which is the Brexit topic with the largest implications on the UK coffee industry.

“Firms with international linkages on either the market or supply side need to be aware that Brexit may disrupt trading patterns not only between UK and EU countries, but also between UK and third countries,” Roehrich says.

The nation imports a significant percentage of its food supply from EU countries, and obviously all green coffee is imported into both the European Union and the United Kingdom. So even if a café sources its coffee from a UK roaster, for example, the beans are ultimately imported.

“Leaving the frictionless trade provided within the EU may result in the imposition of tariffs that could have a significant impact,” Roehrich explains. “Businesses importing goods from the EU should factor future applicable tariffs into their product costs now, and consider how this will affect them. The burden of increased tariffs and other costs could be pushed down onto producers and workers, [resulting in higher] purchase prices or lower wages.”

In the event of a “no deal” Brexit, UK trade would return to World Trade Organization (WTO) policies. Unless the United Kingdom eliminates tariffs for all WTO partner countries as part of a non-discrimination policy, tariffs on coffee imported from the EU would be set at 7.5 per cent for roasted and 9 per cent for instant, according to the BCA.

“Application of WTO rules and tariffs are particularly negative for the coffee industry,” Stemman tells GCR, “because even though the largest single category of UK imports is green coffee from the rest of the world, the supply chains that are in place mean that the imports of coffee and coffee products from the EU are of greater value than those from the rest of the world.”

On the opposite side of the trade debate is the idea that increased importing costs could encourage UK coffee companies to source more supplies locally and go direct to origin for their green coffee. These moves would support not only the local economy, but also the coffee farming communities that UK companies would engage with directly.

Downstream, UK export business could strengthen as countries with stronger currencies look to the United Kingdom to leverage their buying power. This aligns positively with recent expansion in the UK re-export market. The nation’s coffee re-exports have grown at an average annual rate of 25 per cent in volume and 14 per cent in value, according to the CBI Ministry of Foreign Affairs. It mainly re-exports within the EU and to the United States.

Robin Abrams, Finance Director at UK trade and structured debt finance house Trade Finance Global (TFG), cautions against the net gain in that scenario. “It very much depends on what the input costs are and the source of supply,” he explains. If the UK supplier has inputs that are imported, which coffee businesses will, the higher costs from potential upstream tariffs could offset gains from greater export sales.

Some business owners are actually pushing for a “no deal” Brexit accompanied by a “free trade” agreement to remedy the issue of costly tariffs.

Though Abrams doesn’t promote one scenario over another, he again cautions: “The EU is one of the strongest trading blocks in the world, so coming out of that, you lose the established beneficial relations in trading with other jurisdictions. Plus, we’ve seen the time it takes to negotiate an exit, so actually negotiating a brand new trade agreement is not going to happen quickly.”

Investment instability
As the uncertainty surrounding Brexit affects UK trade with other countries, it also impacts UK investment by other countries. As of June 2018, 34 per cent of companies monitored in the EY Financial Services Brexit Tracker had “publicly confirmed, or stated their intentions, to move some of their operations and/or staff from the UK to Europe” in an effort to minimise tax issues and stock delays as a result of Brexit. These statements come from both massive multinationals and small enterprises.

“Political uncertainty stops investment, so stakeholders in the UK have been waiting to see what happens,” Abrams tells GCR. “A lot of companies held on for a long time, but they’re no longer willing to deal with the uncertainty and the potential risks. Slowly multinational companies are scaling back their investment in the UK and redeploying resources to protect themselves in case of a bad Brexit.”

Similarly, UK-based companies have delayed investment and related growth plans. With the general uncertainty around the economy and dampened consumer confidence, there is a lack of investment from UK coffee operators, Allegra’s Young says. “People are putting their business plans on hold because they don’t know what’s going to happen and, therefore, are not growing as rapidly as they would otherwise.”

There’s also been a slowdown in financing available to smaller businesses as lenders and insurers become more cautious, adds Abrams. “With smaller credit lines, businesses purchase and store lower volumes of stock from their supply chains, [potentially] reducing economic activity and leading to more supplier defaults.”

Labour laments
For some coffee companies, limited credit or stalled growth means hiring freezes or worse, labour cuts. A bigger impact on labour, though, is the high number of foreign workers in the United Kingdom.

“The UK economy relies heavily on inward migration of EU workers, and the current negotiating position suggests that free movement will end after Brexit,” BCA’s Stemman points out. “This will prove problematic for all industries, not least the coffee sector, making ‘business as usual’ significantly harder – or even damaging if companies can’t fill specific roles.”

As of September 2018, the number of EU nationals working in the United Kingdom had dropped nearly 6 per cent in 12 months, according to the Office for National Statistics (ONS) – representing the largest annual fall since 1997.

Whether non-UK nationals leave ahead of Brexit or are pushed out, coffee businesses are faced with diminishing staff and hiring pools. The flow-on effect is “higher wages, which will lead to higher costs for coffee businesses considering wages are such a significant part of operations”, Young explains. “The whole coffee industry is very predicated on the use of foreign labour. In London, for example, [up to] 90 per cent is foreign labour, and 50 per cent of those are from the EU. So how are you going to replace 50 per cent of your workforce?”

Only uncertainty is certain
Even though it’s early days, these concerns are already impacting growth in the UK coffee industry.

“This is probably the first time – even greater than the 2008-09 global crisis – that the industry seems to be slowing down faster than we imagined,” Young admits. “In my 20 years of analysing the UK market, this might be a time where the average middle-market consumer that has gotten used to a couple cappuccinos a week could end up cutting those out because coffee is a luxury and it gets expensive.”

Before they cut it out completely, experts estimate that UK coffee consumers will shift to drinking cheaper coffee at home, which could prove detrimental to UK coffee shops, such as the “big three”: Starbucks, Costa, and Caffé Nero.

While opposing sides see pros and cons to the various scenarios, the majority predicts two things: Brexit won’t likely get cancelled, and there won’t be a “no deal” Brexit.

Young estimates a 60 per cent chance that it’s pushed back by extension of Article 50, but “what won’t be pushed back is the feeling of malaise that huge swathes of the British population feel about their place in society and how they feel about isolation and nationalism”, he says. “This is all very doomsday, and it may not play out as badly as we expect, but there’s a huge amount of emotion around Brexit and a lot of misguided and irrational thinking at the moment.

“Fortunately the coffee industry has always been pretty buoyant and optimistic.”

For more information, visit www.tradefinanceglobal.com

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