Frank Dennis is president and CEO of Ten Peaks Coffee Co. Inc. (TSX: TPK), the new incarnation of Swiss Water Decaffeinated Coffee Income Fund, which early this year converted to a public corporation to adapt to new tax laws.
The Burnaby-based company uses its proprietary, chemical-free Swiss Water Process to decaffeinate coffee. It ranked No. 91 this year on Business in Vancouver’s list of the top 100 public companies. Dennis told BIV about how the company is navigating soaring coffee prices, a high Canadian dollar, new competition and the recession – while exploring new opportunities in the decaffeinated coffee space.
Think about the total coffee market in the form of a pyramid with four boxes: super premium, premium, mainstream and value. Mainstream and value have actually been in decline kind of over the longer term. Premium – Starbucks [Nasdaq: SBUX], Second Cup [TSX:SCU], Seattle’s Best – and the super premium, which is sometimes called the third-wave specialty coffee, is absolutely growing. Also at that top of the marketplace is where all the single-serve K-cups sit. I would say there’s absolutely room within specialty coffee for continued growth, both in terms of storefront as well as in grocery, just because there are still people that consume coffee that can move up market.
Preparation methods right now are really driving interest if not growth. For example, the idea of pour overs: a ceramic cone, just like your gold cone filter from the 1980s, that sits on top of an empty mug and you literally put a paper filter in the cone, put coffee in and pour hot water over it.
If you go up and down the West Coast of the U.S. and here, pour overs are absolutely all the rage. From a retail coffee shop point of view, you can capitalize on it. Also these methods are coming back in home again, too.
Decaf is growing at the top of the marketplace and it’s declining at the bottom of the marketplace. Decaf, from a large mainstream commercial point of view, has been in decline primarily due to quality over the past 10 years. A lot of roasters, especially mainstream roasters, will use cheaper coffee in their decaffeinated blends because there’s a process cost and they want to make up for that margin by using cheaper coffee, while the results are that the consumer walks away from the category, which is a shame.
We’re seeing a lot of trends toward healthier foods and healthier lifestyles. Is that driving a trend toward decaf?
You know, I really thought so; 10 years ago, I would have said absolutely. The fact is that caffeine is not bad for you. It just isn’t. People might decide to have varying levels of caffeine throughout the day. So that’s really where our space comes in, to provide great-quality coffee. You can get the category to grow by focusing on quality, by giving the consumer alternatives, variety, interest – because they’ll respond.
Where we fit in is primarily in the premium end of the marketplace. What’s driven our space is a very well-entrenched consumer trend surrounding better-for-you food products. And if an organization cares, if a brand cares, if a roasting outlet cares about what they serve their consumer and they know how to market behind it – which isn’t hard, but it’s part of the story – they’ll choose chemical-free decaffeination.
And that’s really what we focus on: providing roasters, of course, the product but also the idea of how to market that to consumers. Last year we spent almost $500,000 in consumer research, just because we’re repositioning the business. By doing that we’ve found some unique areas of opportunity within the decaffeination space that are leading us down to some new opportunities. I can’t say what those are but it is very interesting.
If I think back over the past 18 months when coffee was sitting at $1.40 as measured on the New York C Exchange, it’s now trading at $2.75. So it’s absolutely skyrocketed, not unlike cotton, not unlike sugar, not unlike copper. It is certainly causing a lot of angst in terms of working capital, in terms of being able to manage doubling the cost of your inventory, increasing the cost to hold inventory.
Certainly, we are seeing pressure in the broader marketplace in terms of people reducing their inventories, people maybe paying slower, people maybe exiting the category from a roasting point of view. Some are pricing for the end consumer well and that’s critical. Others, maybe new to coffee in the past 10 years, have never seen a run up on the C like this.
The last time it really happened like this was in 1997 and if you weren’t around then, you price too slow, your margins collapse, all of a sudden you can’t pay your end suppliers and you run into some difficulties.
For our business specifically, we have been focused on ensuring that our entire value proposition is as refined as it possibly can be. Going through a recession and also for us specifically dealing with increased competition from Mexico, from Germany, we need to ensure that our value proposition is absolutely spot on and so that means significantly improving our quality through capital projects.
We’ve put productivity initiatives into our facility here to help deal with some of the squeeze in margins that we’ve had over time and we’ve changed our overall pricing strategy to improve competitiveness in the marketplace, and that’s what’s been yielding results through 2010.
Eighty per cent of what we price is in U.S. dollars, 80% of our margin is made in U.S. dollars and that needs to be converted into Canadian dollars. Talk about a challenge, absolutely.
We’re at, in our estimation, kind of a new level: parity dollar is where we’re going to be and that’s the basis on which we need to go forward and compete and that’s why quality initiatives are so critical. Why? Because you don’t want to be losing customers, you want to be gaining customers, and you’re not going to gain them simply by pricing; you’re going to gain them by an appropriate value offering.
I really think that the third-wave element of the marketplace is re-energizing coffee in a way that is unexpected, almost as unexpected as what Starbucks did 20 years ago. A private equity group bought one of the leaders in third-wave new coffee [recently] called Stumptown [Coffee Roasters]. That’s the first time that I’ve seen private equity interest in this particular space and it’s simply because there is growth in this area. I also think that single serve is still going to be a very critical trend at the mainstream or the commercial end, which would be in the form of K-cups. At the more specialty end of the marketplace, this idea of single serve for everybody in terms of pour overs is a very unique trend. I think that that will drive consumption, it’ll drive interest, it’ll drive variety, it’ll drive quality.
What are some of Ten Peaks’ top goals for 2011?
We are focused on broadening out or diversifying our entire operation. Decaffeination will always be the core of our business; however upstream into warehousing and logistics is clearly an opportunity for us. It is something that is already core to our business yet we are not operating in that space. Logistics, warehousing, brokerage – while not particularly sexy – is core to providing great service, so we’ll be building upstream into that space. As well, downstream, closer to the consumer, there are opportunities for our business.