The Longread: Coffee trade in Yunnan - what's brewing South of the Clouds?

By in Features

This article is a pilot — the first in what will hopefully become a series of 'sector deep dive' articles about investment opportunities in Yunnan. We'll explore different industries, starting with the sector that produces our favorite morning brew: coffee. Article author Rachel Hemingway has been working internationally for 15 years focusing on the interactions between environmental policy, conservation and poverty alleviation. She is currently based in Kunming, where she studies Chinese..

The coffee market in China

For most investors, coffee would not necessarily be the first commodity that springs to mind. However, the domestic coffee market has grown explosively over the past twenty years, driven by the booming middle class and young consumers.

Current predictions indicate an 11% CAGR (Compound Annual Growth Rate) from 2019 2023 for instant coffee and coffee shops. Thousands of coffee shops tailored to the Chinese market are springing up in cities across the country, providing for a growing "café culture". The take-out market is also growing, driven by a desire for convenience and the growth of cheap rapid delivery services. So far, the emphasis in the market is less on coffee quality and more on the overall café "experience" but this is changing as Chinese consumers become more exposed to and attuned to high quality coffee — particularly in the large "Tier 1" cities such as Beijing, Shanghai and Guangzhou.

Instant coffee consumption in China is currently dominated by Nestlé and the Indonesian company Kopiko which mostly provides pre-sweetened "3 in 1" sachets rather than pure coffee. This preference for sweetened milky coffee is reflected in the types of coffee the coffee shop giants Starbucks and Café Bene provide. These are heavy on Frappuccino's, whipped creams and sweetened flavoured beverages rather than espressos.

These instant coffee and café business models are targeting very different markets within China with the coffee shops aiming to provide an "experience" for the upper income groups. Starbucks — which opened its first store in Kunming in 2011 — particularly has positioned itself as a luxury brand with the price of a drink running to around US$5 and has expanded rapidly, opening 3,500 stores across China by 2018, representing 60% of the coffee chain market share. However, Starbucks is seeing ever greater competition as more and more coffee businesses are entering the Chinese market; newly emerging retail outlets such as Luckin' Coffee are seeking to exploit the growth in consumer take out culture whilst small independent cafes are opening up across the country each with their own unique spin (think cat cafes and specialty roasters). There is plenty of demand to go around as coffee consumption is low compared to other countries (5 cups per capita per annum in China, 400 cups per capita per annum in the USA but is expected to grow rapidly.

The 2017 China Coffee Industry Report provides an excellent graphic overview of the import, export, production and consumption of coffee in China for recent years.

Coffee production in China

Not only is coffee consumption increasing rapidly in China but coffee production has also ramped up over the past twenty years to make China a serious contender in world supplies.

95% of all coffee grown in China comes from the mountainous Yunnan Province. Within Yunnan, the Pu'er area, more traditionally known for its tea production, is the main coffee growing region — producing roughly half of the province's output. Dehong, Baoshan and Lincang regions on the border with Myanmar account for the remainder.

Yunnan's climate, high altitudes and few pests — apart from the locusts which recently arrived — are ideal for coffee production. High yields are reported but these are currently based on significant inputs of fertilisers and pesticides and are unlikely to be sustainable in the long term.

Whilst coffee was originally introduced to China by missionaries, the coffee business didn't take off until a joint project between China, Nestlé and the United Nations Development Program (UNDP) to develop coffee as a cash crop spurred cultivation in the late 1980s. Coffee production has since grown rapidly to 110,000 tons as of 2018, 95% of which is Yunnan-grown arabica.

Coffee production in Yunnan was established on a commercial scale by Nestle in the 1980s and Nestle remains one of the major buyers, working directly with growers to provide continuous training and buying at the listed market price. Starbucks is another big player in Yunnan, bringing in international professionals to provide training, raise quality control processes and introduce new varieties of coffee.

Starbucks and Ai Ni execs at the Kunming press conference
Starbucks and Ai Ni execs at the Kunming press conference

Time and effort have paid off with Starbucks suppliers meeting world class specialty coffee standards enabling Starbucks to offer a "single origin Yunnan coffee". Starbucks also entered into a joint venture with Aini Coffee Farm in Yunnan to establish a mill in Yunnan capable of processing 20,000 tons of green coffee beans annually. Nestle and Starbucks both source their coffee supply from small farmers, farmers' cooperatives and small to medium domestic enterprises and have provided significant support and training in the region.

There are an estimated 200,000 coffee growing households in Yunnan, many based in Pu'er where tea and coffee are grown side by side. Until now most coffee grown in Yunnan remains of relatively low quality and is sold to make blends rather than speciality single origin. However, commodity grade coffee is subject to large price fluctuations on the world market which makes this a risky venture for farmers who may find themselves struggling to cover the costs of production. In light of this and the growth in domestic demand for quality coffee it is predicted that an increasing number of growers will seek to grow and process higher quality coffee that can be sold at specialty coffee prices. Also, as a result of declining tea prices, coffee is seen as an increasingly valuable crop and many farmers are switching to coffee in traditional tea growing areas.

Government support for coffee

Coffee production in China was initiated on a commercial scale by the government in the 1980s and continues to be supported by the Chinese government as a means through which to spur rural development. Most support comes through local government rather than national level efforts and there is currently no overarching national guiding framework.

Government support comes in a number of forms including establishing industry- specific bodies for research and marketing, sponsoring international events to bring specialists and local producers together or targeting specific firms for cooperation and support. The support tends to be fragmentary and is dominated by relationships between the government body and company in question. Local government bodies have been more active in providing tangible support to the coffee industry but the nature of support varies by region.

The Chinese government is keen to prevent price fluctuations affecting the coffee business in China. To help predict coffee prices a coffee price index was jointly published by the China Economic Information Service, Municipal Government of Pu'er as well as the Yunnan International Coffee Exchange Center in November 2018. This index helps industry investors analyse and predict price fluctuations in coffee and coffee types.

The Chongqing Coffee Exchange (CQCE) is another interesting development with a number of large investors setting up a trading platform for Chinese and Southeast Asian coffee. The trade volume of coffee hit 9.7 billion yuan (US$1.35 billion) in 2017 and CQCE has big plans, aiming to be the world's third largest coffee trading centre after London and New York. CQCE provides a variety of services for the coffee industry including warehousing, financing for members, sales guarantees, an online marketplace for coffee related equipment and translated international research reports on coffee trends and prices.

Yunnan provincial level support for coffee trade

Generally speaking, the Yunnan provincial government is active in encouraging investment through the development of an ASEAN-China Free Trade Area and a number of One Belt One Road (OBOR) projects linking Yunnan to neighboring countries. The China-South Asia Expo and the Kunming Import and Export Commodities Fair are both good opportunities to engage and connect with different industries as is the upcoming Yunnan Agricultural Expo.

Coffee is specifically included in the Provincial government's investment goals under both the key "Green Food" sector and the key "Plateau Agriculture" industrial area. As such coffee businesses can expect to encounter lower institutional barriers to entry in Yunnan Province as well as support in terms of tax breaks and low interest loans if the business is established in one of the newly opened Free Trade Zones (FTZs). See a video interview with Mark Respinger, an Australian businessmen who operates in the Yunnan coffee trade, about his experiences with the Kunming Free Trade Zone.

Online information in English is sketchy at best regarding these opportunities as they have only recently been developed, however the Yunnan Province International Trade Association has produced a guide in English and Chinese that helps to explain the FTZs and supported industrial sectors more thoroughly. To contact this organisation please add their WeChat account: china-ynftz.

The Yunnan Provincial government also established the Tea and Coffee Industry Bureau with a mission to promote Yunnan's coffee to wider range of markets and supported the development of the Yunnan Coffee Exchange (YCE) in 2014, to create new international markets and enhance the reputation of Chinese coffee. The International Yunnan Coffee Exchange is another venture heavily involved in many aspects of Yunnan Coffee. Hainan Province is the other coffee producing area in China and has also sought to promote coffee production through sponsoring an annual International Coffee Exposition where potential buyers, producers and traders can connect. The expo offers a useful first step into the world of coffee in China.

Prefecture level government support

Pu'er Prefecture restructured government departments to actively incorporate the coffee business and include coffee in its 12th and 13th five year plans (2010-2020). This support provided significant funding from various sectors (financial, agricultural, forestry, poverty alleviation and resettlement activities) for developing coffee farms without a specific focus on companies.

In contrast the Dehong and Lincang regions of Yunnan have focused a lot more on building up large single-owner farms (Hogood in Dehong and Linfeng in Lincang) rather than for the industry as a whole. These companies are regarded as "Dragon Head Enterprises" (DHEs) important for national economy and as a result are provided with tax breaks, advantageous policy arrangements and low or zero interest loans.

Yunnan's coffee challenges

Regardless of the rapid rise in coffee production in Yunnan over the past twenty years there are some issues that still need to be overcome, as well as environmental challenges that will only become more severe in the coming years if trends continue. These issues are not all unique to Yunnan, problems stemming from price fluctuations in commodity grade coffee, labor shortages, climate change, pests and lack of market awareness are universal for coffee producers. However, the Yunnan Development and Reform Commission Development Plan for the Coffee Industry of Yunnan Province (2010 – 2020) notes the following issues that are and will continue to cause problems for the industry without attention:

• Water availability and sustainability

• Lack of domestic coffee brands and up to date knowledge on the coffee industry amongst producers

• Lack of local government support and a unified management system;

• Poor infrastructure which limits the overall production capacity;

• Small, scattered and inferior processing machinery (often used and outdated) which weakens the competitiveness of the final product;

• Lack of acknowledging market risks and effective precautionary measures to deal with price fluctuations

Industry insiders have noted that Yunnan arabica can be inconsistent in quality as a result of non-standardised washing and quality control processes. This issue is one that is steadily declining as more training and investment are provided to growers and processors in the area.

Environmental Sustainability

Coffee is mostly grown in south western Yunnan near the Myanmar border at elevations from around 900 to 1600m; generally around 1100 to 1200 m. Hundreds of thousands of small farmers grow conventional non-shade coffee alongside or for large state-run or privately-owned plantations.

Shade grown coffee protects the environment which the coffee needs to grow but is rarely seen as the initial investors supported intensively farmed sun grown varieties. These yield more and faster but require significantly more chemical inputs such as pesticides and fertilizers as well as more forest clearance which affect profitability in the long term through declining soil fertility and erosion. Organic coffee production in China is currently pretty much unknown, environmental sustainability is often discussed at national levels in China but local practices tend to lag quite a bit behind.

Unfortunately, coffee production in Yunnan is already both suffering from and exacerbating environmental problems such as unpredictable rainfall, deforestation and drought. Yields have fallen after severe cold snaps which kill the berries as well as periods of drought as coffee is a water-intensive crop.

On a positive note, Yunnan Provincial government recognizes these issues and is actively starting to promote and encourage organic coffee production. This aim also ties in with a recognition that Chinese coffee has a reputational problem as low quality. The goal in Yunnan is to simultaneously boost quality, brand awareness and sustainability of production in order to build a long lasting and successful model of production rather than suffer rapid soil erosion and infertility as has been seen in Vietnam. Rainforest Alliance certification is coming into Yunnan as well as support from governments to switch to shade grown and organic coffee in line with support for the "Yunnan Green Food" brand.

Xishuangbanna and Pu'er local governments are also actively seeking to avert future sustainability issues through encouraging intercropping and shade grown coffee varieties. In 2012 these local governments distributed free shade-tree seedlings to all coffee growers under their jurisdiction to promote more shade- grown coffee and environmental benefits.

Overall it is safe to say that the coming years will likely see a change in the focus of Yunnan's coffee production. This will involve a shift from intensively farmed low quality commodity coffee to more environmentally sustainable and potentially higher quality beans. However, without sustained attention on coffee processing training for local producers the quality of the bean is not guaranteed.

Coffee Processing in China

Coffee processing is where a lot of variation in end-product quality can emerge. High quality processing needs training and is labour, time and input intensive. Training programs are available in Yunnan but without sponsorship most of the small family businesses growing and processing coffee can't access them. Coffee processing also produces not-insignificant amounts of polluted water, processors need to be aware of and treat this so as not to pollute the local groundwater and soil.

The big international players; Nestle and Starbucks, as well as smaller companies such as Yunnan Coffee Traders and Yunnique have all invested heavily in training programs for their suppliers in Yunnan. Government initiatives such as The Yunnan Coffee Exchange and joint ventures have set-up training centers and supported a new processing manual from the Coffee Quality Institute. For those with the means to attend Torch Coffee provides hands-on training in Yunnan Province for a number of levels and types of people involved in the coffee business through its training program.

Despite these efforts there remains a gap between local producer's knowledge and the skills and equipment that are needed to process the coffee berries to a high standard. Continued investment from local government and trading companies entering the market will hopefully help to bridge this gap in the coming years.

Following local processing the beans are roasted, only a small portion of this currently happens in Yunnan, beans are often exported or sent off to the large commercial roasters providing beans for instant coffee. Starbucks has recently announced plansto build a second commercial scale roastery in China and Luckin' Coffee is building a large scale plant in partnership with Louis Dreyfus in Xiamen.

Smaller roasteries are growing in number, sourcing mostly speciality beans in smaller quantities. Seesaw coffee, a small roastery in Shanghai has recently been recognised as one of the global top ten roasteries for quality, Seesaw is also the biggest domestic buyer of Yunnan-Grown speciality coffee beans.

Starting a Coffee Trading Business in China

Coffee is definitely attracting a lot of attention in China, growing, processing, roasting, trading and consumption trends are all following a sustained increase. For those seeking to invest in this area there are big opportunities for growth as long as the business model is right.

Assuming you don't plan to acquire land rights and start growing coffee in competition with local farmers in Yunnan the most appropriate model for foreigners to engage in the coffee industry is as a trader or a coffee shop owner. For more detailed and general guidance on how to open a business in China you can visit Invest In Yunnan's How to Guide. However, in a recent interview David Faber, owner of local coffee trading company Yunnique, noted that for any type of business you want to start in China it is highly recommended you work with a Chinese company or individual who understands the processes and regulations involved.

Whilst the paperwork and procedures can be complicated he noted that the government has made huge strides in simplifying everything over the past few years and the investment environment is better than it has ever been.

China Briefing also provides useful guidance for investors interested in the beverage industry in China. Specific to coffee, China Briefing also offered guidance in 2013 that covered the steps for setting up a coffee trading company. You can find more detailed and up to date guidance on setting up the necessary legal structures here.

Useful websites

1421 Consulting. This company specialises in Chinese business and investments, the website provides useful in-depth articles on regulations as well as business culture and business experiences. They also provide guidance and a comprehensive range of service for investors and businesses.

China Briefing. This website provides an excellent source of information about laws, regulations and doing business in China. They also provide guidance and a comprehensive range of service for investors and businesses.

China Pilot Free Trade Area (Chinese only)

Chongqing Coffee Exchange. Website offering industry information in English and Chinese.

Coffee Info China (Chinese only)

Finder. This site provides guidance on how to get started in the import-export business with China

FDI China. A company dedicated to supporting overseas investors establish and run businesses in China.

MSIDistributors. A company that can help with the import and export process with China

Path to China. This company provides a comprehensive range of business services for companies looking to establish a legal entity in China. The website also offers clear guidance on the steps to take to get started.

Sapore Di Cina. This website is a comprehensive guide to living, travelling and working in China with excellent visa advice.

Yunnan Coffee (Chinese only)

Yunnan Department of Commerce (Chinese only)

Yunnan Local Government (Chinese only)

Yunnan Provincial Investment Bureau (English and Chinese)

Yunnan Coffee Traders. WFOE based in Yunnan growing, processing and trading coffee.

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Great general article on the current state of this industry in Yunnan. Thank you.

Great article, thank you!

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