Global Business Guide Indonesia

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Agriculture | Indonesia’s Coffee Industry Needs Growth Capital

Indonesia is the world’s third-largest coffee producer and exporter, after Brazil and Vietnam. Indonesia-based companies supply coffee across the entire quality range, from run-of-the-mill Robusta varieties to distinguished Arabica coffees and the renowned kopi luwak. National coffee output has grown over the past decades, albeit not in a linear fashion as harvests fluctuate strongly from one year to another depending on the weather. With per-capita coffee consumption on the rise both in Indonesia and the wider region, there is obvious room for further growth, but there is also an obvious need for investment. The capital required to take Indonesia’s coffee industry to the next level presents appealing prospects for investors, while the country’s burgeoning coffee culture also brings opportunities for foreign exporters.

Indonesia’s Coffee Industry Needs Growth Capital
At present, the principal destinations for Indonesian coffee are the US, Japan and Western Europe, but Indonesia is well placed to capitalise on the fast-rising demand in the ASEAN region and in China.
 

A coffee climate

Indonesia’s tropical climate produces almost ideal conditions for planting coffee. Cultivation dates back to colonial times and began in western regions of Java, but plantations soon spread to eastern Java and across the country. Today, most Indonesian coffee comes from Sumatra, but Sulawesi and Kalimantan, the Lesser Sunda Islands of Bali, Sumbawa and Flores as well as the country’s easternmost region of Papua all contribute to national output. Robusta coffee makes up more than three quarters of Indonesia’s produce; the remainder is of the milder Arabica type. The numerous coffee-growing regions in the country produce beans of distinct flavours and properties, and a number of highland Arabica coffees from Indonesia are recognised by aficionados the world over.

An export-led industry

Ever since the Dutch East India Company launched shipments from Batavia (Jakarta) to Europe in the early 18th century, coffee was an export commodity first and foremost. Indonesian planters compete with exporters from tropical Africa and Latin America for global market share, which renders the business vulnerable to world prices and currency fluctuation. The bulk of Indonesian coffee is shipped abroad, particularly in strong harvest years when output far exceeds national demand.

Indonesian coffee exports rose from 336,840 tonnes (or 5,614,000 60-KG bags) in crop year 2000/2001 to 656,400 tonnes (10,940,000 bags) in 2012/2013, according to data collated by the International Coffee Organization. Total production over the same period increased from 419,220 tonnes to 763,800 tonnes. At present, the principal destinations for Indonesian coffee are the US, Japan and Western Europe (particularly Germany), but Indonesia is well placed to capitalise on the fast-rising demand in the ASEAN region and in China.

Coffee production and exports, crop years 2008 to 2013

Coffee production and exports, corp year 2008 to 2013

Source: International Coffee Organization

Rising domestic demand

The home market will play an increasingly important role. Compared to citizens of Europe and the Americas, Indonesians are not coffee lovers – yet. Indonesian per-capita consumption of around 1.2 kg in 2012 pales against more than 4 kg in the US, around 7 kg in the world’s number one coffee producer Brazil and more than 10 kg in various European countries. But with Indonesian per-capita consumption having already doubled in just a few years, domestic demand looks to be on a fast growth trend. This puts the world’s fourth-most populous country on course to become a leading coffee market. Local demand is driven by the lifestyle changes that accompany urbanisation and economic development (See Teatime in Indonesia). Caffeine consumption tends to increase when a larger part of the labour force works in an office environment.

Instant coffee is particularly popular in Indonesia, where new 3-in-1 brands enter the market frequently. Instant coffees are also sold per cup at thousands of low-end cafes and corner shops, while consumers on higher incomes have taken a strong liking to coffee shops. As a result, foreign and local franchises are spreading across the country. Starbucks alone has announced plans to open some 100 new outlets in the country in three years. With awareness for healthy nutrition on the rise, much potential is seen in the market for coffee products that offer additional health benefits, such as coffees enhanced with ginseng or low-acid coffees that are milder on the stomach. Indonesians are also becoming more cautious of their generally high sugar intake, which is why coffee-and-creamer mixes may increase their market share at the expense of 3-in-1 products.

Farmers must up their game

With many of the large coffee estates replaced by palm oil and other agribusinesses (See An Overview of Indonesia’s Palm Oil Industry), smallholder farmers today contribute more than 90% to Indonesia’s national coffee output. Their plots often measure less than one hectare, which poses challenges for efficient cultivation and adds to a range of other issues that curtail the competitiveness of Indonesian farmers. According to a May 2013 report from the United States Department of Agriculture, ‘ongoing issues that limit production at the farm level include limited knowledge of best practices, widespread use of low quality and uncertified planting materials [and] an abundance of older, less productive trees.’ These factors, the USDA report says, ‘make Indonesian coffee production particularly prone to random changes and/or severe weather patterns.’

Merging plantations can bring down production costs by allowing for larger-scale farming and investment in modern harvesting techniques and equipment. This could help to lift per-hectare yields, which are very low in Indonesia compared to other coffee-producing countries. Producers would be advised, though, to retain such inherited production methods that enhance their marketing. This is something the Speciality Coffee Association of Indonesia is clearly aware of when it states that ‘traditional processing techniques add a layer of complexity not found in other specialty coffees.’ Certified organic production can also help growers achieve higher margins, particularly in the premium export segment. Keen to raise the quality bar and boost production of high-value Arabica beans, the government has launched measures aimed at supporting local farmers, including the distribution of seeds.

Downstream opportunities

Currently, most Indonesian coffee is exported as green beans to be processed abroad. With local consumption on the rise, the missing link opens up obvious opportunities downstream in the value chain, such as roasting, blending, packaging and marketing. Domestic processing companies require dependable supplies of consistent quality, which is why efforts to support farmers will yield benefits downstream as well. But just as the farmers; processing businesses need capital investment to upscale their production, increase their export earnings and fend off competition from re-imports of premium coffee.

Investment prospects

To take advantage of the current growth momentum, Indonesian coffee growers need to rejuvenate their ageing plantations with new trees, while processing companies must upgrade their facilities and exporters must enhance their marketing and packaging. The substantial capital investment that these measures require opens up opportunities for global coffee producers and supporting companies to enter the market. In many cases, joint ventures with local firms will be the path of least resistance. In addition, capital injections from private equity firms could become a game changer for many an Indonesian coffee producer as they seek to affirm their global presence and reinforce their foothold in the home market (See Private Equity in Indonesia: More Deals Await Those Who Dig Deeper).

Global Business Guide Indonesia - 2014

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Indonesia Agriculture Snapshot

Contribution to GDP: 13.88% (Q3 2015 including Fisheries & Livestock)
Number Employed in the Sector: 40.12 million (February 2015)
Main Products: Palm Oil, Palm Kernel, Rubber, Cocoa, Coffee, Tea, Tobacco, Rice, Sugarcane, Maize, Cassava, Tropical Fruits, Spices, Poultry, Fisheries.
Main Export Markets: China, USA, Japan, India, Singapore, Malaysia, Pakistan, South Korea, Italy, Netherlands, Bangladesh, Egypt.
Relevant Law: Presidential Regulation No. 39 of 2014 on the Negative Investment List imposes varying degrees of foreign ownership limitations in plantations depending on the crop type, and Government Regulation No. 98 of 2013 limits private plantations to 100,000 hectares.