microeconomics Final

Running head: THE HERSHEY COMPANY 1

The Hershey Company

Student Name

Southern New Hampshire University

ECO 201

March 16, 2016

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The Hershey Company

Did you know that the number one flavor in confectionery treats among Americans is chocolate?

And the demand for chocolate in the global market is expected to have an “annual growth rate

approaching 3 percent. Demand in Asia is a major source in the growth of sales, and is expected

to rise to a 20 percent share in the global market by 2016” (Bradford, n.d.). As a consultant for

one of the “top ten global confectionery companies” (The Chocolate Industry, 2015) in the

industry, it’s essential that the core microeconomic principles be examined to ensure the firm’s

sustainability and future growth in the market. As the demand for chocolate grows, so does the

demand for cocoa, the key ingredient needed to make chocolate. The cocoa farming industry is

struggling to keep up with the rising demand primarily due to the lack of resources and monetary

earnings by “small-scale family farmers who grow 90% of the world’s cocoa” (Goodyear, n.d.).

As a result, many farmers are leaving the industry for higher-paying work. This is a pressing

issue for the chocolate industry, as there is high probability that the company will not be able to

sustain future growth in the market if the key ingredient is no longer available. Hershey will need

to support and invest in the cocoa farming industry if they want to continue in the chocolate

confectionery market.

History

The founder of the Hershey Chocolate Company, Milton S. Hershey, faced several

challenges prior to becoming one of the most successful entrepreneurs around the world. He was

born in Derry Township, Pennsylvania. As a teenager with no formal education, he chose to

enter a four-year apprenticeship program with a candy maker located in Lancaster, Pennsylvania.

In 1876, after completing the apprenticeship program, he opened his own candy business that in

the end failed after six years of hard work. He went on to pursue work with a confectioner in

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Denver and learned the trade of making caramels using fresh milk (Hershey's History, n.d.). He

then moved to New York to open his second candy business, which also failed. Still determined

to make a go of the caramel business, he moved back to Lancaster, where he first learned the art

of making candy, and in the end he finally found his niche to succeed. In 1893, while attending

an exposition in Chicago, he became intrigued by the technique used to make chocolate and

purchased some German machinery so he could start producing “chocolate coatings for his

caramels” (Hershey's History, n.d.).

In recognizing the high demand for just chocolate, he started the Hershey Chocolate

Company and eventually sold the caramel business so he could devote all his time to making

chocolate. As his empire grew, so did his generosity of giving back to the community by

providing “employee housing, schools, parks, recreational facilities, and a trolley system”

(Hershey's History, n.d.). He and his wife gave the majority of their fortune—including

ownership of his enterprise businesses—to the Hershey Trust that is held for the Hershey

Industrial School for orphans. In 1945, after his passing, “the company, town and institutions that

bear his name were well positioned to grow” (Hershey's History, n.d.). And today, the “Hershey

Chocolate Company has evolved into The Hershey Company” (Hershey's History, n.d.), which

offers a large selection of products and notable attractions.

Current Goods and Services

The company manufactures more than 80 brands of products, with known classics such

as Hershey Kisses, Reese’s, Almond Joy, Kit Kat, Mounds, York, and many more. They also

produce non-chocolate candy, gum, mints, baking goods, pantry goods, drink mixes, dessert

toppings, and snacks. In addition, they make products to meet the dietary needs of consumers

who are gluten-free, kosher, or sugar-free (Our Brands, n.d.).

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Areas of Operation

The company’s manufacturing plants are located in Pennsylvania, Illinois, Virginia, and

Guadalajara, Mexico, with each location designed to produce specific brands. They have a global

presence with their international retail stores located in Canada, Mexico, Brazil, China, Japan,

Korea, and India, as well as their U.S. retail stores located in Times Square, New York, and

Chicago (Hershey's Manufacturing, n.d.). But the largest operating facility and famous tourist

attraction, Hershey’s Chocolate World, is located right in the heart of Hershey, PA (Hershey's

Chocolate World, n.d.).

Supply and Demand

With the demand for chocolate rising and its growing popularity in the international

markets, it’s important that we analyze and understand the supply and demand trends to

determine how Hershey can best align its firm’s product to sustain future growth in the

confectionery market. In addition, we need to evaluate pricing along with revenue growth to

understand the impact it will have on consumer responsiveness by utilizing the price of elasticity

of demand as our guide. As noted in my initial introduction, the demand for chocolate in the

global market is expected to have an annual rate increase of about 3 percent, with Asia being the

major source in the growth of sales and “expected to rise to a 20 percent share in the global

market by 2016” (Bradford, n.d.).

As illustrated in the graph below, Hershey has shown tremendous growth in sales over

the last 5 years and has received much of its growth from “a nearly 10% price increase that was

phased in over the last couple of years” (Wismer, 2013).

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Figure 1. Hershey’s Revenue and Cost of Goods Sold (COGS incl. D&A) data for the past 5

years. Adapted from HSY Annual Income Statement - Hershey Co. annual financials (n.d.)

The company also had a strong, aggressive business strategy that included special promotions,

brand extensions, new products, and acquisitions of candy makers that offered diversity in

product textures and unique flavors. With a solid rank in the U.S. market, the company is now

positioned to expand its operation into key international markets to improve global sales

(Wismer, 2013).

In 2013, the company expanded into China and acquired 80% of renowned candy maker

Shanghai Golden Monkey. The established company is recognized in its home market with

supported net sales growth in the double digits, making it the ideal partnership for Hershey to

expand its footprint and gain access to an emerging demographic market (De La Merced, 2013).

The acquisition resulted in a good deal, with Hershey growing its sales to $7.4 billion in 2014

and China being responsible for 4.5 percent of those earnings. According to Reuters (2015), “the

chocolate consumption growth in the emerging markets closely tracks GDP growth, suggesting

China’s increasing urban population would drive chocolate consumption.” Based on these facts,

the demand for chocolate by the urban population in China is expected to grow to $4.3 billion by

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2019. That would be almost a 60 percent increase from the $2.7 billion sales in 2014 (Reuters,

2015).

As the popularity of chocolate grows, so does the increased demand for cocoa, which is

the main ingredient needed to make chocolate. There are many factors that influence the price of

cocoa, with the most serious being lack of resources and monetary earnings by the “small-scale

family farmers who grow 90% of the world’s cocoa” (Goodyear, n.d.). This has resulted in low

production, with many farmers leaving the industry due to low wages and poverty in their

community. “Demand for cocoa is predicted to rise by 30% by 2020 but without . . . investing in

small-scale farmers, the industry will struggle to provide sufficient supply” (Goodyear, n.d.).

Price Elasticity of Demand

A shortage in the supply of cocoa would have a significant impact on the confectionery

market and its input costs, leading to a major shift in retail pricing for chocolate. As a result, and

with few alternatives, consumers craving the taste of chocolate will not be able to replace the

desirable treat with another confectionery product, making the demand for chocolate inelastic.

But if a particular brand of chocolate goes up in price, then the consumer could substitute their

choice by switching to another brand, such as milk chocolate instead of dark chocolate, making

the demand for the brand of product elastic. “The biggest fear surrounding the chocolate industry

right now is that the supply situation leads to further retail price increases which create

conditions where chocolate is seen as a luxury item” (Maduri, 2014). When a product is viewed

as a necessity, such as gas, milk, or bread, the quantity demanded will not change in response to

price fluctuations. But when a product is seen as a luxury, the price change will influence the

quantity demanded, as consumers with less disposable income will do away with the purchase

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altogether. The possible thought behind this fear is that chocolate, once viewed as an affordable

treat, could now be considered too expensive by the average consumer (Maduri, 2014).

Since 2012, chocolate retail prices have increased by 60%, prompting Hershey to

implement a pricing strategy focused on consumer responsiveness (Maduri, 2014). To diminish

the shock of rising retail prices, Hershey gradually increased the costs on its retail products by

adding a certain percent over time in order to avoid interruptions with consumer demand. Thanks

to this strategy, consumers continued to buy their brands instead of avoiding the purchase

altogether, leading to increased sales and revenue growth over the last couple of years (Maduri,

2014). As an example, in 2012, the company “increased its prices on products by 6% on average,

which resulted in a 2% increase in sales volume, a 140 basis point increase in gross margins, and

a 14% year-over-year increase in EPS” (Asad, 2014). In recognizing the impact that the supply

cost of cocoa would have on its input costs, Hershey was able to sell its products with less price

elasticity by gradually increasing the costs of its retail products by a certain percent over time,

making the consumer view the product as still affordable. This approach had a positive impact on

sales and company margins.

Cost of Production

If supply costs increase, so will the cost to manufacture products, which changes the

company’s profit margins if costs are not adjusted according to product demand and projected

sales. The price of cocoa, the key ingredient needed to make chocolate, has climbed “more than

45% since early 2013” (Ferdman, 2014). Hershey’s pricing strategy is not designed to pass

fluctuating supply costs onto the consumer: The company factors “the volatility into their

pricing, assuming that pinched profits today will be followed by swollen profits tomorrow”

(Ferdman, 2014). The root cause behind the rising cost of cocoa is that farmers are not able to

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keep up with the demands from the emerging global market as the popularity and consumption

of chocolate grow. In 2014, Hershey had to “[raise] the price of its chocolate to compensate for

the abnormally high cocoa prices. . . . The price increase . . . amounted to roughly eight percent”

(Ferdman, 2014). The decision was based on the increased cost of production and the influence it

would have on the company’s margins, which were already down from the previous year’s

quarterly earnings of 46.1% to that year’s earnings of 43.8% (Gasparro & McCarthy, 2014).

The company’s fixed costs, such as advertising, insurance, and property taxes, do not

change with the level of output. But the variable costs needed to make chocolate, such as

commodities, will fluctuate based on production activity. When the output activity is high,

supply spending increases, and when the output activity is low, supply spending decreases. When

the company foresees a decline in sales, the production schedule is adjusted to reduce output,

which decreases the company’s variable costs. The devised plan is meant to maximize profits,

and when the company does not adhere to this arrangement, the added costs impact profit

margins. This level of error was one of the factors in why the company’s margins dropped from

the previous year’s earnings. The company did not “adjust its production schedule as quickly as

they should have in light of how sales were changing” (Gasparro & McCarthy, 2014).

Overall Market

The confectionery market consists of about 150 U.S. candy makers with “Mars and

Hershey [controlling] around 75 percent of the national chocolate market, and 60 percent of the

US candy market overall” (Kahn, 2013). As illustrated in the graph below, Hershey is shown as

the top leader, with 44.2% of the U.S. market share.

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Figure 2. U.S. Chocolate Market Share, 2014. Adapted from U.S. market share of chocolate

companies, 2014 (n.d.)

In the global market, Hershey is one of the top ten leaders, with continuing efforts to expand into

the emerging global market to support consumer demand and improve international sales.

Figure 3. Top Ten Global Confectionery Companies. The symbol * includes the production of

non-confectionery goods. Adapted from The Chocolate Industry (2015)

In the 1960s, when consumers wanted to purchase chocolate, they would head down to

their local candy maker. The owners had such passion for making chocolate that they would

spend long hours coming up with unique, original recipes specific to their shop. As the market

grew, so did the pressure to compete against the big players. The neighborhood candy makers

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slowly found themselves being bought out by these big companies. In 1963, Hershey purchased

Reese’s and then Almond Joy. Nestle jumped on board and bought Goobers and Baby Ruth. The

local shops that resisted the takeover were now struggling to stay afloat (Kahn, 2013). In the

1970s, a popular candy named Heath Bar caught Hershey’s interest, and when the company

offered to buy them, Health declined. Hershey ended up buying the “original recipe from another

company and introduced the Skor Bar to compete head-on” (Kahn, 2013). As a result, Health

sales plunged, and in the end, Hershey bought the company. It was through strategic planning

and financial leverage that the big players were able to consolidate the market by bringing the

number of candy makers down to around 150 producers (Kahn, 2013). Now, with only a few

companies dominating the market and little motive to create new products, the confectionery

industry is viewed as an oligopoly market structure.

It’s not easy for small candy makers to enter the marketplace, mainly because they lack

the funds and leverage needed to promote their products on store shelves. Also, they are not in

the financial position to offer discounts or deals, which is often expected by the retail chains

(Kahn, 2013). Hershey is the dominant player in the U.S. market and is working towards gaining

more market share in the international arena. The company is now opening a new facility in

Malaysia, one of the fastest-growing regions for its products, and they invested $250 million

USD, representing the “single largest investment in Asia during the company’s 18-years history

in the region” (“Hershey Building,” 2013). The new facility location was deliberately chosen to

provide “easy distribution access to more than 25 markets across Asia” (“Hershey Building,”

2013). To keep up with consumer demand, the company will utilize proprietary equipment and

systems designed specifically for their production needs. The company’s strategic plan for global

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market success is to “produce high-quality products tailored to local taste preferences and to

meet rapidly growing demand” (“Hershey Building,” 2013).

Recommendation

As Hershey continues to execute its business plan to increase its global market share,

there’s growing concern about whether the cocoa farmers will be able to sustain enough supply

to meet the company’s needs. Without cocoa, the company will not be able to manufacture

chocolate, as there is no other ingredient that can be used to manufacture the product. The

majority of the world’s cocoa is supplied by small-scale family farmers who use “out-dated

farming methods and lack resources to invest in fertilisers or in replacing ageing trees past their

peak productivity” (Goodyear, n.d.). With low wages and inadequate funding for their crops, the

farming community is living in poverty. As a result, the farmers are starting to leave the industry,

and future generations have no incentive to take over the cocoa farms, so they are moving into

jobs in higher-paying industries. Many manufacturing companies are realizing the urgency that

“no cocoa farmers = no chocolate bars” (Goodyear, n.d.).

The recommendation would be for Hershey to support and invest in Fair Trade certified

cocoa organizations, which encourage long-term business relationships with cocoa farmers by

ensuring higher wages and proper resources to produce long-term quality products. By aligning

with and buying its supplies from Fair Trade certified farmers, the company would be

strengthening its business relationships and investing in the most crucial ingredient for the

company’s products: cocoa. Without this ingredient, the company would no longer have a

functioning chocolate confectionery business. The resources and funding would go towards

“investing in replacing old cocoa trees to increase productivity, or investments in better facilities

for crop collection, storage, transport, or processing. . . . business or organisational development,

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or to support improvements in production and processing” (Goodyear, n.d.). The investment

would sustain future growth of cocoa farmers and supply the essential ingredient needed to make

chocolate.

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References

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from http://www.fool.com/investing/general/2014/06/26/hershey-is-moving-to-secure-its-

future.aspx

Bradford, C. (n.d.). How large is the chocolate industry? Chron.com. Retrieved from

http://smallbusiness.chron.com/large-chocolate-industry-55639.html

China chocolate market seen growing to $4.3 bln by 2019 – Hershey. (2015, February 18).

Reuters. Retrieved from http://www.reuters.com/article/2015/02/18/hershey-china-chocolate-

idUSL1N0VS2MZ20150218

The chocolate industry. (2015, January 23). International Cocoa Organization. Retrieved from

http://www.icco.org/about-cocoa/chocolate-industry.html

De La Merced, M. J. (2013, December 19). Hershey goes to China for its biggest-ever deal. The

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china-for-biggest-ever-deal/

Ferdman, R. (2014, July 18). Your chocolate addiction is only going to get more (and more, and

more) expensive. The Washington Post. Retrieved from

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is-only-going-to-get-more-and-more-and-more-expensive/

Gasparro, A., & McCarthy, E. (2014, October 29). Hershey margins hurt by higher costs. The

Wall Street Journal. Retrieved from http://www.wsj.com/articles/hershey-sales-rise-5-8-

1414582768

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Goodyear, D. (n.d.). The future of chocolate: Why cocoa production is at risk. The Guardian.

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zone/chocolate-cocoa-production-risk

Hershey building state-of-the-art confectionery plant in Malaysia to serve Asia region. (2013,

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state-of-the-art-confectionery-pl/

Hershey's Chocolate World. (n.d.). The Hershey Company. Retrieved from

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Kahn, L. (2013, November 1). Why so little candy variety? Blame the chocolate oligopoly.

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the-chocolate-oligopoly/

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www.thehersheycompany.com/brands.aspx

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in-the-us/

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Day? Forbes. Retrieved from

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stocks-on-earth-this-valentines-day/