What is the desTEAnation of Ceylon Tea?

Industry mulls over current issues and looks at strategies to shape the future

By Cheranka Mendis

While a cup of Ceylon Tea still commands attention from the world’s tea lovers, the industry is beginning to lose its shine with stagnant value addition, decreasing market share, and low investment in research and development and marketing promotion. Aiming for a tea hub concept in the future, the industry has much to deliberate on its way forward in the increasingly competitive global trade.

A weak cup of tea

While Sri Lanka has managed to hold fort as a premium brand, its competitive skills are no longer a match for the increasing competition, low cost production, changing consumer trends and brand promotion from other key tea producing countries such as China, India, and Kenya.

Although tea production grew at 3% globally (with fluctuations in between) over the past seven years, Sri Lanka grew at 1.2% in 2011 over 2010 and recorded a 0.3% drop in 2012. While concentrating on orthodox tea, the industry has had less focus on the CTC and green tea areas which are the current trends in the global market. Shares of Ceylon Tea in these areas are 2% and 5% respectively.

At an industry discussion titled the ‘MTI Tea Strategy Forum’ organised by MTI Consulting, Sri Lanka Tea Board Chairperson Janaki Kuruppu admitted that the country’s share of production in the world, from being among the 20% in the 1960s, has struggled to maintain a mere 9% since 1985.

Exports growth has also been fluctuating year on year with the Compound Annual Growth Rate (CAGR) for the past seven years amounting to 0.2% of world export growth. While the competition within the industry increases, our share in the pie is getting smaller and smaller.

“Sri Lanka’s tea exports earnings were Rs. 160 billion last year and we are estimating Rs. 380 billion this year,” Kuruppu said. “While this is a 9.5% increase in rupees, there is a slight drop in dollar terms as do the annual average Colombo auction prices.” Average auction prices in many of the auction centres are still fetching good prices while the Colombo auction still gets the highest tea prices in the world. “We are doing something right, we just need to protect it and sustain it.”

However, over the years, the country has managed to lose some of its key tea export markets such as the UK, Australia, USA and South Africa. Currently, the industry mainly exports to Russia, UAE, Iran, Syria and Turkey, narrowing exports to a few regions rather than going global. Approximately 80% of this share is in Russia and the CIS region, she said.

How to make it stronger?

To get out of the current pool of quicksand we seem to be stuck in, the country must continue and increase strategies for value addition on the teas exported, rather than selling them in bulk. “We are only exporting 40% as value added tea, either as Sri Lankan brands or as private labels, for multinational brands. We have been stagnant at this 40% to 42% during the past few years. If this is the way to make the industry more resilient, then you need to reconcile and assess how to do so. We need to change our strategies.” She noted that value added tea under Sri Lankan brands is currently amounts to 21% and 20%.

From the Government’s point of view, a strategic medium term plan has been set to correct the mistake. “We have set up some KPIs under agri facilities to improve earnings, yield and value addition.” The main issues the Government has identified are the cost of production, small holder sustainability, adulation and marketing.

While the cost of production is an issue faced by all countries, Sri Lanka’s costs are relatively higher than in other countries. To sustain the smallholders who make up 76% of production, the Government is suggesting closer business relationships between supply chains and an out grower model for regional plantation companies (RCPs) that have problems with productivity.

The Government will also introduce new standards for the local market, Kuruppu said, to counter the adulteration and quality issues. She also noted the importance of marketing, branding and promoting, and admitted that the country is falling back and needs to look into its high cost processes, changing consumers, slow innovation, lack of commercial marketing and lack of distribution networks. “We must invest in R&D, new products, regular marketing campaigns and new prospects. Ceylon Tea has a distinct taste, it is up to us to sustain it,” Kuruppu said.

Industry perspective – outside in

With its long existence, the industry is often looked at through tinted glasses and a lot of passion and as the saying goes, sometimes passion (or love) can make one blind. Has the industry been blind to its imminent challenges?

Observing from an unbiased outside-in perspective, MTI Consulting CEO Hilmy Cader noted that the danger signs are clear from the outside. Dividing the value chain into seven – grow, produce, trade (auction), product development, channel leading to retail point, retail, and consume, Cader noted that current market competition dictates the industry to look at the value chain, not from demand to supply, but from supply to demand.

Consumer comes first

From a market point of view, Sri Lanka has the conventional tea which competes in what can be considered a beverage/refreshment market and there is a larger wellness and lifestyles market in which brands such as Starbucks are competing in. Arguing that we are not in the tea business, as it is just a means to an end, Cader noted that there are five broader categories that need to be looked at. These are hot beverages, cold beverages, gifting, wellness and lifestyle.

In the hot beverage category, it was observed that coffee is consumed 1.8 times over that of tea, in terms of share of wallet. The challenge lies in transforming tea in to an ‘in thing’, tipping the mug of coffee over. However, this is a challenge that calls for a unified attack, as a single country or brand alone cannot fight it. On to the icier side of things, the numbers in beverages such as iced tea is increasing. USA is at a very advanced stage, with Southeast Asia catching up, although slower than the North American markets.

With some of the local brands doing exceptionally well in the wellness segment in countries such as Australia and New Zealand, to move tea beyond a beverage to a niche high value ingredient for wellness products, the country needs high strategic R&D investments in the area, he said. To compete in the lifestyle brand segment which has significant potential, in which the likes of Starbucks are operating, the country needs to invest in strong brands and franchise distribution.

MTI’s four R Global Tea Map

Sharing the findings of MTI when working with the Tea Board, Cader shared the four R Global Tea Map formed by his company. The four Rs stand for Regularised markets (Western Europe, Australia, New Zealand, Japan), Rough (essentially the Indian subcontinent, Indonesia, China), Ripe (Russia, CIS, Middle East) and Raw (Africa, Latin American market and the Far East).

With a 15% global market share, regularised markets pose a challenge in areas of product range and innovation. Sri Lanka’s share in this market is 16%. “We have certain brands like Dilmah that have done exceptionally well in Australia and New Zealand. To compete in this market, we must have very strong brands – front end strong brands or low cost supply.”

He noted that the country has progressively lost these markets, and to get back in, the cost of access is extremely high. “With the way our industry is fragmented, we do not have the critical mass to go in and negotiate at that level. Given the current product and approach, we can realistically look to about 1% of that 15%.” While Sri Lanka has been pushed out from this equation, countries such as Malawi, Tanzania and Argentina have gone in, supplying more than Sri Lanka.

While the rough markets take credit for 55% of global tea, the local share of exports to those markets is 2% or less. The key challenge lies in accessing these markets as the countries are big, with exceptionally low price points although there may be skimming opportunities for premium brands at the top but not for larger volumes. There are very strong localised brands in these markets and to enter these markets, a high distribution channel is needed. “Given the current product and approach that we have, realistically Sri Lanka can only access 0.5% of the market,” he said.

Where the strength lies for Sri Lanka is in the ripe market category. This segment holds 23% of the global share, yet 78% of Sri Lanka’s exports are to this segment. While this market gives preference to Ceylon Tea, Sri Lanka has managed to lose some ground here, like Egypt recently and Pakistan previously.

The country has strong relationships here and access to regional brands. The challenge is in the regional packing and the lower cost options, particularly Kenya. “Given the current approach of 23%, realistically we can only approach about 12%. Realistically, we are already 70% there. We are up against competition here.”

With 8% of the global share, the raw markets pose the challenge of widespread geography among many others. Sri Lanka’s share of exports to raw markets is approximately 4%. “The challenge here is that the markets are widely spread geographically and given the high cost of transportation and the fact that there are lots of tea producing countries in sub-Saharan Africa competing here, having profitable market entry is a challenge. Coffee culture is another challenge to compete with here. What we can approach with our current product approach is 0.75%,” Cader noted.

Building brands – the choices

In terms of branding there are five options to consider – build, buy, unify, supply, or interlink.

In building, the question is how to build brands and what to build. Do we have the critical mass to build all brands or look at particular brands and support them? The country should also look at buying, like Tetley in India.

“As a country, put a fund together, bring investors in and start acquiring smaller brands and start building a tea conglomerate,” Cader advised. “This may look too big to think about, but in our opinion, we are now at a stage where incrementalism has its limitations. We need to start thinking big and break out.”

The country should also consider taking the route New Zealand did with the dairy industry and unify to have corporative but a single brand. However, achieving consensus for this will be a huge challenge for Sri Lanka, he noted.

Looking at supply, Sri Lanka has two to choose from – ‘ohoma yang’ (just keep going) or more radical disruptive innovation. Or the country could take an interlinked approach and invest heavily in R&D, synergise with global brands and build high cost ingredients that will have many applications such as nutrition, cosmetics, wellness, therapy etc. “We need to break the mould.”

Touching on the subject of value addition, Cader noted that the current debate on whether we should import or not is suboptimal. “I think that you need to step back, broaden it and use the framework, and look.”

He added that value addition will depend on what branding route the country will take and that the industry must consider its socio economy with some 400,000 smallholders dependant on the sector.

“In today’s cluttered global media environment, will an eight to nine million dollar campaign around the world put sufficient pressure on the consumer so that it trickles down to the retailer and the chain? Or do we pick a few Sri Lankan brands and throw the challenge at them and say, ‘We will invest so much, match the investment with this amount of money and we will support you.’ Another point to ponder is what investments we have made in this brand name ‘Ceylon.’”

Retail issues

Retail can be broken down into modern trade, supermarket general trade and out-of-home consumption. There is a power shift to retailers even in emerging markets. In Sri Lanka’s strong markets – CIS, Russia, and the Middle East, a lot of trade has been in general sales and wholesale. The trend towards supermarkets is now increasing and the ‘posher’ the market gets, the more Sri Lanka seems to lose.

Out-of-home consumption is also growing significantly and there are lots of organised chains coming up for this purpose. A strategic choice the industry should make is whether Sri Lankan brands should enter retail chains or if this should be invested in Ceylon Tea. The channel from auction to retail chain should also be considered as many multinationals, buying houses and local buyers are coming in.

Sri Lanka is said to have had 883 people buying at the auction last year even though not everyone is active. 77% of them buy less than 100 kilograms a week which is partly the issue as the industry is very fragmented, therefore lacking critical mass. However the number of buyers has increased by 32% between 2009 and 2011.

“The strength here is the very strong relationship we have with customers. The challenge here is the lack of brand control. Does the tea industry have the sufficient motivation to grow and multi-nationalise? Does the current set of people in the industry have sufficient motivation to really take those quantum leaps? Do we need a new set of entrepreneurs to come in and take us to the next level?” he questioned.

The talent in the industry is family-centric – the industry has an aging senior management and faces challenges in succession planning.

Development issues

Two major components of growing tea are labour and fertiliser. The latter can range to 12-18% of total annual cost of which 90% is imported. Transportation makes up about 8-9% of the total cost. With energy and machinery all currently imported, except for labour, when moving towards tea bags, importation costs are likely to rise.

“Whether we are actually adding as much significant value as we think is the question.” Overall, across the industry, R&D investment is very low and the entire TRI budget is approximately Rs. 325 million. “To seriously to compete in the global market, particularly in areas such as iced tea etc. we really need to up our investment in R&D,” he said.

Trade, producer and grower concerns

The current process of auctions has been proven as quite a successful outlet. However, in a recent study, some of the concerns that cropped up were time taken, major concerns on governance, HR, discipline and the complexity of transactions. Brokers have provided a lifeline to tea factory owners, not only providing the brokering function but the funding, advisory, logistics, and sales part of it as well.

The fragmented tea industry in Sri Lanka today houses over 700 factories whereas Kenya has 108. Economies of scale clearly come into play here. “Kenya has higher volumes with lesser factories. Here, there is very limited investment in R&D as well as production efficiencies and because of this there is unhealthy competition for tea leaves.”

Cader also noted that 72% of tea comes from smallholders. “There are 4,000 smallholders, and 1.2 billion dependants. Approximately 84% of smallholders have less than half an acre. When taking the entire revenue and the per capita average, they earn about Rs. 250,000 per year. The revenue of regional plantation companies is between US$ 1.5-2.5 billion.”

The three key challenges faced here is the increasing labour cost and competing against countries that have much lower labour costs. When assessing the top 10 tea producers in the world, barring Turkey and Argentina, their cost bases are 20-30% lower than Sri Lanka. The industry also faces competition with the plantation industry which is very old, posing challenges in terms of productivity along with issues in areas of continuity of labour, job stigmatisation, next generation getting into planting, and the jobs being at the lower end of society.

“Do we grow tea or are there other options?” Cader questioned. “Do we do essences, extracts of tea and go into other choices or do we grow less tea and get higher returns? Or, do we find some way of driving consolidation while maintaining their livelihood of the smallholders? Could we be small and big at the same time?”

Pix by Sameera Wijesinghe