In this article, local supply chain consultants from West Monroe Partners discuss how brewers handle the volatility of hop prices as demand and supply costs continue to grow.
The beers once villainized by Keystone’s “Bitter Beer Face” campaign are now some of the most popular styles in America. This evolution of consumers’ taste buds hasn’t been without its challenges for craft brewers.
Hop prices have doubled over the last five years due to increased demand and increased supply costs related to land and labor. Among other factors, land values associated with expansion in hop growing regions have climbed, labor rates have increased due to competition with apple farmers, and the short picking and drying window for hops restricts the farmers’ ability to cost-effectively increase yields. So what have your favorite brewers done to meet this challenge? The answer lies in hedging.
The market for hops, unlike the more established markets for commodities like wheat and corn, is relatively new and as such presents unique challenges to breweries. Brewers have two basic options for procuring hops: buying hops as needed on the open market, known as the spot market, or signing long-term, fixed price contracts with suppliers, known as hedging. Hedging is a long-standing strategy that companies relying heavily on commoditized inputs have used to insulate themselves from price increases.
Though it’s common for small breweries to buy on the spot market, it should be avoided because prices are regularly high, price spikes in the volatile spot market can suddenly drive prices even higher, and some hop varieties can be difficult to source on shorter lead times. Instead, brewers pursue hedging strategies by signing contracts directly with hop farmers or with brokers.
Some midsize and large brewers have taken a different approach and signed contracts directly with hop farmers. Most smaller brewers won’t have the buying power to make the arrangement beneficial for the farmers. This approach cuts out the middleman and has the bonus of strengthening supplier relations; however, it comes with the risk of product availability and the additional coordination for the brewer of inspection, oil/acid analysis, pelletizing, packaging, and storage.
Brewers often buy whole cone hops direct from hop farmers at the end of the growing season for immediate use in limited wet hop harvest beers, which mitigates the costs of pelletizing, packaging, and storage.
Hop brokers engage brewers in long-term (one to five year) contracts to buy a fixed quantity of hops. Like in other commodities markets, brokers serve as a middleman between farmers and brewers—often processing raw hops (pelletizing and packaging) for farmers and storing frozen hops for brewers. Selling to many breweries, brokers have the purchasing power to negotiate prices low enough to pass savings to brewers while still supporting their own business. Contracting arrangements with brokers have become more common for breweries of all sizes to combat rising prices.
Hedging is a beneficial strategy if utilized effectively, but alone it won’t protect brewers from a consistent rise in hop prices. To maintain margins and avoid passing along price hikes to consumers, brewers should pursue additional avenues to control hop costs.
- Purchasing Collectives – As opposed to utilizing a broker to consolidate demand, brewers can form a purchasing collective to increase buying power through the overall volume of commodities that they are purchasing, which ultimately serves to put downward pressure on supplier pricing. This approach is most effective when purchasing common hop varieties (e.g., chinook, cascade, and centennial), as opposed to less common varieties used for specialty brews.
- Substituting Varieties – Hop prices fluctuate by variety, which allows brewers the option to substitute more expensive varieties for less expensive varieties. This strategy can be most easily executed for bittering hops but can be more difficult with aromatic hops due to the importance and uniqueness of the flavor profile.
- Increasing Efficiency – Brewers can also increase efficiencies of hops used in each batch by using hop extract rather than full cone or pelletized hops for bittering. Hop extract dissolves evenly during the brewing process, decreasing volume losses that result from filtering. This approach can be controversial as some view hop extract as less pure. Additionally, new technologies in the brewhouse are allowing for higher product yields.
- Vertical integration – The boldest approach to cost control would be buying or green fielding (literally) a hop farm. This would give brewers complete control over the varieties produced and would insulate the brewer from spiking or gradually rising hop prices. Elk Mountain Farms in Idaho is owned by AB-InBev and primarily grows hops for the brewing giant’s brand Goose Island. For most breweries, purchasing a hop farm on the level of Elk Mountain isn’t financially feasible. Additionally, farming is a far leap from the core competency of most brewers, and thus has a steep learning curve.
Though high profile in terms of raw materials, controlling the cost of hops is only one battle in the war against cost increases for brewers. To be prepared to scale as the craft beer industry is expected, brewers need to have comprehensive approaches to all areas of cost control—especially for the highest cost areas like packaging and logistics, both of which typically make up a larger percentage of brewers’ costs than hops. As consumers, the hope is that brewers fight to cut costs in the other input areas while maintaining a focus on quality in their hops. Realistically, brewers positioning themselves for long-term success need to be considering both.
Craft brewers face unique challenges, and have successfully navigated unsteady terrain for the last 30+ years. This isn’t likely to change, though the obstacles will be different. Luckily, the industry has faithful customers who will be there to support it one pint at a time.
For more information on how brewers can mitigate risks of hop prices and scale to meet growing demand, please contact Tom Racciatti at [email protected]