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Cost Pass-Through in the

Economic
Research
Service
U.S. Coffee Industry
Economic
Research
Report Ephraim Leibtag, Alice Nakamura,
Number 38 Emi Nakamura, and Dawit Zerom
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Cost pass-through in the U.S. coffee industry.

(Economic research report ; no. 38)
1. Coffee trade—United States—Costs.
2. Coffee—Prices—United States.
I. Leibtag, Ephraim.
II. United States. Dept. of Agriculture. Economic Research Service.
III. Title.
HD9199.U62

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 A Report from the Economic Research Service
United States
Department www.ers.usda.gov
of Agriculture

Economic
Research
Report
Number 38
Cost Pass-Through in the
March 2007
U.S. Coffee Industry
Ephraim Leibtag, Alice Nakamura,
Emi Nakamura, and Dawit Zerom

Abstract
A rich data set of coffee prices and costs was used to determine to what extent changes
in commodity costs affect manufacturer and retail prices. On average, a 10-cent increase
in the cost of a pound of green coffee beans in a given quarter results in a 2-cent
increase in manufacturer and retail prices in that quarter. If a cost change persists for
several quarters, it will be incorporated into manufacturer prices approximately cent-for-
cent with the commodity-cost change. Given the substantial fixed costs and markups
involved in coffee manufacturing, this translates into about a 3-percent change in retail
prices for a 10-percent change in commodity prices. We do not find robust evidence that
coffee prices respond more to increases than to decreases in costs.

Keywords: cost pass-through, retail prices, manufacturer prices, commodity costs, coffee.

About the Authors

Ephraim Leibtag is an economist with the Economic Research Service. Co-authors
Alice Nakamura, Emi Nakamura, and Dawit Zerom worked on this project through a
co-operative agreement with Harvard University and a data-sharing agreement with the
University of Alberta, Canada. A. Nakamura is the Winspear Professor of Business at
the University of Alberta, E. Nakamura is a doctoral candidate in the Department of
Economics at Harvard University, and D. Zerom is an assistant professor in the Depart-
ment of Finance and Management Science at the University of Alberta.
Contents
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .iii

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

The Coffee Value Chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

Data Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

How Important Is the Coffee Bean in Determining Costs? . . . . . . . . . . . . .7

Differences in Prices Across Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

Responding to Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10

Asymmetric Cost Adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

Pricing Strategy Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

Price Change Announcements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16
Pass-Through From Manufacturer to Retail Prices . . . . . . . . . . . . . . . .19

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

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Cost Pass-Through in the U.S. Coffee Industry / ERR-38
Economic Research Service/USDA
Summary
A perennial issue in economics is the effect of changes in commodity prices
on manufacturer and retail food prices. The traditional explanation is that
the extent to which cost increases are “passed through” in a vertically organ-
ized production process depends on the market power of producers at each
stage of production as well as the value added by each producer in the
production process. The U.S. coffee industry is an excellent venue to study
the issue of cost pass-through, since green coffee beans are important
components of the marginal costs in this industry and are publicly traded
commodities.

What Is the Issue?

This report uses unique data from the U.S. coffee industry to estimate how
changes in commodity costs affect retail coffee prices. The results are rele-
vant beyond the coffee industry, providing insight into how changes in
commodity costs pass through to consumer and producer prices in other
industries, too. “Cost pass-through” is a central issue in international
economics since it determines how an economy responds to exchange rate
adjustments as well as to changes in the prices of other imported commodi-
ties, such as oil.

What Did the Study Find?

Average manufacturer coffee prices dropped from 23 cents in 1997 to 17
cents per ounce in 2002. That drop corresponded with a fall in the coffee-
bean share of the manufacturer price from 48 percent to 24 percent, while
labor and other material costs rose from 15 percent to 32 percent.

The authors found that, on average, a 10-cent increase in green-coffee-bean

prices per pound yields a 2-cent increase in both manufacturer and retail
prices in the current quarter. If a cost change persists, it will be incorporated
into manufacturer and retail prices approximately cent-for-cent with the
commodity cost change. In addition, cross-sectional differences in prices are
substantially larger at the retail than the wholesale level.

Since manufacturer prices adjust approximately one-for-one with

commodity prices (rather than proportionally), the ratio between manufac-
turer prices and commodity costs rises as commodity costs rise. We do not
find robust evidence that coffee prices respond more to increases than to
decreases in costs.

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Economic Research Service/USDA
How Was the Study Conducted?
An unusually rich collection of data on the ground-coffee industry was used
to analyze the issue of cost pass-through. The data set included market-level
average retail prices collected by Nielsen ScanTrack, market-level manufac-
turer prices collected by PromoData, and panel data collected by Nielsen
Homescan to calculate the share of coffee by brand for each income level.
Regression analysis was used to estimate the impact of changes in
commodity prices on retail and manufacturer prices. These regressions are
carried out for both absolute levels and in percentage terms. In addition,
instrumental variable and fixed-effect methods were used to look at the
manufacturer-retail price relationship and to analyze whether prices respond
asymmetrically to cost increases and decreases.

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Cost Pass-Through in the U.S. Coffee Industry / ERR-38
Economic Research Service/USDA