to "The Ultimate Professor" Only

Running header: CHOCOLATE MARKET ANALYSIS 1

CHOCOLATE MARKET ANALYSIS 15

The Hershey Company

Student name

Southern New Hampshire University

ECO-201

March 16, 2015

The Hershey Company

Did you know 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 with Asia being the major source in growth 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 firms 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 worlds 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

As 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. And 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 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 with 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 that are gluten-free, kosher and sugar-free (Our Brands, n.d.).

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 is located right in the heart of Hershey, PA. Also known as “Hershey’s Chocolate World” (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 growth sales, and is 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 contributes much of its growth from “a nearly 10% price increase that was phased in over the last couple of years” (Wismer, 2013).

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.). Retrieved from http://www.marketwatch.com/investing/stock/hsy/financials

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 (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 rising demand for chocolate by the urban population in China is expected to grow to $4.3 billion by 2019. That would be almost a sixty percent increase from the $2.7 billion sales in 2014 (Reuters, 2015).

As the popularity for the taste 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 worlds 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. The “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 for chocolate will not be able to replace the desirable treat for 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 it that the supply situation leads to further retail price increases which creates conditions where chocolate is seen as a luxury” (Maduri, 2014). When a product is viewed as a necessity such as; gas, milk, or bread - the quantity demanded would not change in response to price fluctuations. But when a product is seen as a luxury, the price change would influence the quantity demanded as consumers with less disposable income would do away with the purchase all together. 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. By incorporating 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 the supply cost of cocoa would have on their input costs, Hershey was able to sell their products with less price elasticity by gradually increasing the costs by a certain percent over time to its retail products making the consumer view the demand for the product 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. 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 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 keep up with the demands from the emerging global market as the popularity and consumption for chocolate grows. In 2014, Hershey had to “raise the price of its chocolate to compensate for the abnormally high cocoa prices, which 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 this 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 such as commodities needed to make chocolate 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 on 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% of the national chocolate market, and 60% 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.

Figure 2. U.S. Chocolate Market Share, 2014. Adapted from U.S. market share of chocolate companies, 2014 | Statistic. (n.d.). Retrieved from http://www.statista.com/statistics/238794/market-share-of-the-leading-chocolate-companies-in-the-us/

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, January 23). Retrieved from http://www.icco.org/about-cocoa/chocolate-industry.html

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 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 slowly found themselves being bought out by these big companies. In 1963, Hershey purchased Reese’s and then bought Almond Joy. Nestle jumped on board and bought Goobers and Bath Ruth. For the local shops that resisted the takeover, they 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 area” (DailyFinance, 2013). The new facility location was deliberately chosen to provide “easy distribution access to more than 25 markets across Asia” (DailyFinance, 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 market success is to “produce high-quality products tailored to local taste preferences and to meet rapidly growing demand” (DailyFinance, 2013).

Recommendation

As Hershey continues to execute its business plan to increase its global market share, there’s growing concern on 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 fertilizers 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 onto higher paying industry jobs. 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 Fairtrade 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 and buying their supplies from Fairtrade certified farmers, the company would be strengthening their business relationship 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, investing in better facilities for crop collection, storage, transport, and processing - business or organization development, and 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.

References

Bradford, C. (n.d.). How Large Is the Chocolate Industry? | Chron.com. Retrieved from http://smallbusiness.chron.com/large-chocolate-industry-55639.html

The Chocolate Industry. (2015, January 23). Retrieved from http://www.icco.org/about-cocoa/chocolate-industry.html

Hershey's History. (n.d.). Retrieved from www.thehersheycompany.com/about-hershey/our-story/hersheys-history.aspx

Our Brands. (n.d.). Retrieved from www.thehersheycompany.com/brands.aspx

Hershey's Manufacturing. (n.d.). Retrieved from www.thehersheycompany.com/about-hershey/manufacturing-network.aspx

Hershey's Chocolate World. (n.d.). Retrieved from www.hersheys.com/visit-us/hersheys-chocolate-world.aspx

HSY Annual Income Statement - Hershey Co. Annual Financials. (n.d.). Retrieved from http://www.marketwatch.com/investing/stock/hsy/financials

Wismer, D. (2013, February 12). Hershey's: 'One Of The Sweetest Stocks On Earth' This Valentine's Day? - Forbes. Retrieved from http://www.forbes.com/sites/davidwismer/2013/02/12/hersheys-hsy-one-of-the-sweetest-stocks-on-earth-this-valentines-day/

De la Merced, M. J. (2013, December 19). Log In - The New York Times. Retrieved from http://dealbook.nytimes.com/2013/12/19/hershey-goes-to-china-for-biggest-ever-deal/

China chocolate market seen growing to $4.3 bln by 2019 -Hershey| Reuters. (2015, February 18). Retrieved from http://www.reuters.com/article/2015/02/18/hershey-china-chocolate-idUSL1N0VS2MZ20150218

Goodyear, D. (n.d.). The future of chocolate: why cocoa production is at risk | Sustainable Business - Fairtrade partner zone | The Guardian. Retrieved from http://www.theguardian.com/sustainable-business/fairtrade-partner-zone/chocolate-cocoa-production-risk

Maduri, F. J. (2014, November 21). Why chocolate prices will continue to rise - UPI.com. Retrieved from http://www.upi.com/Top_News/Analysis/Outside-View/2014/11/21/Cocoa-crunch-The-worldwide-chocolate-shortage/3631416423327/

Asad, F. (2014, June 26). Hershey Is Moving to Secure Its Future. Retrieved from http://www.fool.com/investing/general/2014/06/26/hershey-is-moving-to-secure-its-future.aspx

Gasparro, A., & McCarthy, E. (2014, October 29). Hershey Margins Hurt by Higher Costs - WSJ. Retrieved from http://www.wsj.com/articles/hershey-sales-rise-5-8-1414582768

Ferdman, R. (2014, July 18). Your chocolate addiction is only going to get more (and more, and more) expensive - The Washington Post. Retrieved from http://www.washingtonpost.com/blogs/wonkblog/wp/2014/07/18/your-chocolate-addiction-is-only-going-to-get-more-and-more-and-more-expensive/

Kahn, L. (2013, November 1). Why So Little Candy Variety? Blame the Chocolate Oligopoly | TIME.com. Retrieved from http://ideas.time.com/2013/11/01/why-so-little-candy-variety-blame-the-chocolate-oligopoly/

U.S. market share of chocolate companies, 2014 | Statistic. (n.d.). Retrieved from http://www.statista.com/statistics/238794/market-share-of-the-leading-chocolate-companies-in-the-us/

Hershey Building State-of-the-Art Confectionery Plant in Malaysia to Serve Asia Region - DailyFinance. (2013, October 3). Retrieved from http://www.dailyfinance.com/2013/10/03/hershey-building-state-of-the-art-confectionery-pl/