Why You're Going to Pay More for Coffee

Starbucks announced a price increase on some of its drinks, highlighting that coffee beans are just one of the many costs the company pays.

Andrew Marder
Andrew Marder
Jun 22, 2013 at 11:21AM
Consumer Goods

"That and a nickel will get you a cup of coffee" now only makes sense if the "that" is a two-dollar bill. Starting later next week, Starbucks (NASDAQ:SBUX) customers are going to need to add in yet another dime to that proverbial equation. The company announced that, on the same day it updates its menus with new calorie counts, it's going to update the prices of a few drinks, too.

While many headlines are focusing on the fact that coffee bean prices are down, that overlooks the fact that coffee costs make up a relatively small amount of what Starbucks puts into a cup. A spokesperson said beans account for just 10% of your overall coffee cost. So why the increase, and can consumers expect more of these increases from other companies?

What's in that cup?
If you buy a regular coffee, you cover three costs -- beans, water, and time. Most customers buying regular coffee shouldn't see increases, and those who do will see a small $0.10 increase in the cost of a cup. In other drinks, the contents get much more complex, and the costs get higher.

Milk is one of the main ingredients in a functioning coffee shop. As McDonald's (NYSE:MCD) and others get in on the act, more and more customers are exposed to non-standard coffee -- milk-based drinks, for the most part. With milk running at a healthy $3.40 per gallon, coffee companies are spending a huge amount on dairy. On top of that, milk prices may see increases over the coming years, as legislation comes to the table that would help farmers charge more for milk in the future.

The rising cost of milk, more so than coffee, would severely affect the margins of coffee retailers. McDonald's has already suffered from declining margins for the past three quarters, and a hit to the higher-margin coffee business would cause serious pain.

Prices on the rise
That's why it's likely we'll be seeing price increases all over the place in the coming years. As milk prices increase, and coffee continues to climb, everyone is going to feel the pinch. Although coffee itself doesn't make up much of Starbucks' cost, it does play a role.

Right now, major coffee-growing regions are experiencing new bouts of disease, such as leaf rust. The disease covers plants in an orange powder and kills off plants at an alarming rate -- and it's now spreading in Central America.

And if disease doesn't kill off your supplier, a shifting climate might. Increasing temperatures are pushing coffee growers higher up into the mountains to escape the heat, which can have a detrimental effect on coffee production. The problem is that there's a limited amount of space up in those hills, and at some point, we run out.

With all the forces pushing coffee prices up -- roasting and shipping are the other major coffee production costs, and they both rely on fossil fuels -- you can bet your bottom dollar that your morning cup is going to go up in price, too.

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While many brands, including Starbucks and Dunkin Brands' (NASDAQ:DNKN) Dunkin' Donuts line, dropped their bagged coffee prices earlier this year, I wouldn't be surprised to see those climb back in a year's time. Dunkin' may have the longest to hold out, as its adjusted operating margin has crept up, hitting 43% last quarter. That may buy it some time, but in the end, we're going to be paying more no matter where we get that cup.