Why rising coffee prices may be a disaster for doughnuts

Doughnut lovers may enjoy some free sweet treats Friday, which is National Doughnut Day, but there may be a bitter aftertaste due to rising commodity prices.

"I have this every morning—if (the price) goes up I will cry," said Brittney Sanchez, a medical student from Queens, N.Y., whose typical order at Dunkin' Donuts is a hot chocolate, occasionally augmented by a doughnut.

"I think it's already ridiculous—$2.50 for a hot chocolate," she said.

Cronuts help celebrate National Doughnut Day.
Adam Jeffery | CNBC

But it may come to that. As the prices of milk and coffee rise, big-name brands are talking about when and how they might pass along those costs to consumers. Both Dunkin' Brands and Tim Hortons said during recent earnings conference calls that they have locked in coffee prices through 2014 but are figuring out what to do for 2015. Starbucks told analysts on its earnings call that it has locked in coffee futures for 40 percent of the next fiscal year, which ends in 2015.

But it's not as simple as just passing along higher costs to customers.

As a general rule, when you raise prices, "people buy less. That's just a fact of life," said Harry Balzer, vice president and chief industry analyst at NPD Group. "Having prices rising faster than your income, and that's the case here, that's the real issue."

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It also comes at a time when doughnuts are seeing a long-term decline in popularity.

"In 1989, 14.2 percent of all breakfasts included a doughnut and last year it was 9.1 percent. This is more about coffee than doughnuts," he said.

According to Balzer, 41 percent to 42 percent of all breakfasts include coffee.

Coffee futures have risen at a furious pace since a drought in Brazil and the spread of coffee rust, a fungus-generated disease damaging to coffee plants, lowered crop yields. Since a Nov. 6 low of $108.80, futures have spiked 54 percent.

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At the same time, milk futures are up 24.9 percent during the past year, and the price producers pay for raw milk jumped 30.7 percent. Considering that milk is a key ingredient in doughnut batter and many beverages these chains sell, it could easily provoke a disastrous price jump in both.

While Dunkin' Brands is discussing whether or not to gradually work in the 2015 coffee price hike into fourth quarter 2014 prices, Tim Hortons has said that it will pass the commodity spikes into the hands of its restaurant owners, allowing each one to decide if and how to pass costs on to consumers.

A price hike wouldn't affect Antonia Gomez's morning routine in Queens, N.Y. The singular nature of her habit, she said, is why she would be willing to cope with a rise in prices.

"I drink coffee only in the morning, not in the afternoon, because if I do I can't sleep at night."

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Making coffee at home isn't a solution. J.M. Smucker, the company behind both Folgers and the Dunkin' Donuts-branded coffee found in stores, raised its prices by an average of 9 percent this week. It was the first time it hiked its prices in three years.

Overall, coffee prices at the grocery store have risen for two consecutive months, according to the May consumer price index from the Bureau of Labor Statistics. But consumer prices for fresh sweet rolls, coffee cakes and doughnuts remain behind inflation and rising wages, and milk has gone up 5.6 percent during the year, according to the index.

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A price-conscious customer, Sentell McDonald from Harlem, N.Y., often gets doughnuts and coffee for breakfast across the city, but maintains an allotted budget. He said that a price hike would definitely make a difference in his routine.

"I don't spend too much, and I try to go to places that allow you a free coffee for every eight purchases, or something like that," McDonald said. "I probably would still buy it; I probably wouldn't buy it as much as I do, but I'd still get it. It's like gas, you have to have it. I probably would make more coffee at home though."

Bacon prices push higher
Bacon prices push higher

Companies such as Tim Hortons and Dunkin' Brands are being mindful that consumers may cut back, so they're improving quality and offering new menu items to keep customers returning. Both companies placed emphasis on their breakfast sandwich selections in recent earnings calls.

"It's not coffee and doughnuts anymore, it's coffee and sandwiches," Balzer said. "Forty-seven percent of all breakfasts include sandwiches now."

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But with doughnut innovations such as the cronut, the foie gras doughnut, alcohol-infused doughnuts and the relatively new Dunkin' Donuts glazed doughnut breakfast sandwich making many headlines in the past few years, don't count out the doughnut just yet.

This classic treat may endure even as demand declines and prices rise.

—By CNBC's Bo McMillan