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| Chocolates off the line |
Chocolate as we know it is a
relatively new invention. In 1828, a Dutch chemist invented the cocoa press,
which allowed separating cocoa butter from the cocoa beans. It was not until
1847 that J. S. Fry & Sons, a British company made a chocolate bar
combining cocoa powder, cocoa powder, and sugar. It was even later when mass
production became possible with Lindt’s invention of the conching machine in
1879 (“Sweet History”). Processed chocolate caught on quickly. By a hundred
years ago, it was one of the most popular confectionary items, in spite of a
high price (“Chocolate”).
Chocolate has a
much longer history. For the first three and a half millennia it was consumed
as a food item, it was part of a drink mixed with water, vanilla, honey, and chili
peppers. It was a rare treat for the upper classes of various southern American
indigenous tribes such as the Olmec, Mayan, and Aztec tribes. This concoction
was imported to Europe with colonization. Along with gold, the Spanish brought
back chocolate, which remained an aristocratic treat (“Sweet History”).
Today, we can
enjoy Chocolate in many forms, and throughout the year. In the United States,
chocolate is an integral part of many holidays from Valentine’s Day to Easter
to Halloween. It is also a year round treat that can be picked up almost
anywhere in familiar forms for a low price. It is no longer just for the rich
of pre-Columbian South America or the royals of colonial Spain. Chocolate is
America’s treat. This paper will look at the current market for chocolate in
the United States using the five forces analysis as described by Michael Porter
and summarized in Besanko et al. in their 213 edition of “Economics of
Strategy” p. 258-256.
The current
market for chocolate is large. The average American is measured to consume
twelve pounds of chocolate annually (“Sweet History”). Globally, the chocolate
industry is expected to amount to $98.3 billion dollars in sales by 2016 (“How
Large”. The United States is the number one consumer of chocolate, consuming 764
tons of chocolate (“Cocanomics”). This consumption translates to over 18
billion dollars in sales in 2010 (“Sweet History”). A quick look at the math
shows that the American sweet tooth takes a large bite out of the global
chocolate consumption.
The market for
chocolate is divided by different segments. The divisions are by product, sales
category, and geography. The product segment looks at the type of chocolate.
There are different breakdowns for dark chocolate, milk chocolate, and white
chocolate. The sales division looks at how the chocolate is sold and breaks
down into category by premium chocolate, every day chocolate, and seasonal
varieties (“Global Chocolate Market”). For many of the segments, different
brands dominate. Whitman’s would be picked up more at Valentine’s Day while a
Snickers is something that is directed towards a more every day chocolate.
The supply chain
is long. The basis of chocolate is the cocoa bean. It is grown in equatorial
regions across the world. The means most of the chocolate is grown in Southeast
Asia or south America or Western Africa. The beans grow straight from the tree.
A single tree can only yield enough beans for half a kilogram of finished
chocolate per year. From growth, the bean is harvested, dried, taken to market,
packed, roasted, ground, and processed. It is then made into chocolate and
shaped into the form it will take for the consumer (“Cocanomics”). Other key
inputs include sugar and dairy, which can be obtained from domestic markets for
the American consumer.
The trade group
representing the chocolate manufactures is the National Confectioners
Association. They are bullish on the continued growth of the chocolate market
at a rate above the expansion of the national economy. They forecast growth
prospects at between three and four percent per annum for the next several
years. Categories seen leading this growth include both dark chocolate and
premium products (“Profile”). The growth prospects reflect the continued growth
of the national economy, but the specific segments of growth show that as a
nation we are tired of tightening our belts and are looking for specific ways
to treat ourselves. Finer chocolate is an affordable luxury for most people.
Approximately
400 companies make up the chocolate industry in the United States. These
companies manufacture ninety percent of the chocolate. These 400 companies
support almost 70,000 jobs in the direct manufacture of the chocolate, and it
is estimated twice as many more when the distribution and selling of the
chocolate is taken into consideration (“Economic Profile”). The majority of these
companies are rather small. Instead, the chocolate market is largely split
between global giants. The biggest share of the chocolate market in the U. S.
is enjoyed by Hershey, with 44.2% of sales. Mars is next with 29.5% of the
market. Nestle, Lindt, and Russell Stover each have about five percent each.
That leaves all other companies with just 11.6% of the market by sales (“Market
Share”). Assuming the smaller three hundred and ninety five companies split the
final 11.6% of the market equally, that gives the chocolate market a Herfindahl
index of .29. An index of .29 shows that the market for chocolate in the United
States is rather concentrated, to the point where it can be considered an
oligopoly
As
the leading firms in an oligopoly, the Hershey and Mars have considerable power
over the pricing and quantity of the chocolate they produce. There is some
overlap in the types of chocolates produced, but a key aspect of the chocolate
market is that there is strong brand loyalty. This brand loyalty has been built
up through years of advertising and concentration amongst the industry. This
differentiation means that the products of Hershey and Mars are not complete
substitutes, and that they have certain aspects of monopoly power within their
brands. There are plenty of substitute goods, so brand loyalty just means that
the demand curve for specific brands is more inelastic than the market as a
whole, giving the larger firms some pricing power. Even with this power, it is
seldom used. The price of all chocolates has risen inexorably over time with
inflation and it is often a spontaneous purchase, so it is in the best interest
of all companies to sacrifice unit profit over volume profit and to keep the
familiar brands an affordable commodity.
In
theory, entry into the chocolate market should be easy. All a potential entrant
needs is the know-how to put the constituent parts together and then a place to
sell the final products. This is true for very small producers. They can fill a
specific niche as a specialty maker, but their own market will be
geographically limited as well as limited by the expectations of the potential
consumers in the geographic area served. How many consumers will pay more for a
chocolate product when there is a much lower price substitute available almost
anywhere? To go with the supposed ease, few high governmental hurdles exist to hinder
entry.
In
fact, the barriers to entry are fairly high, since the market is dominated by
so few firms. These larger firms have the knowledge and the scale to operate at
lower costs than most new potential market entrants do. The price the consumers
pay has not been artificially inflated, so if a new firm wants to enter the
market, they have to achieve similar cost structures as the incumbent firms or
forego the profits the larger companies make. Further, as spoken earlier, many
consumers are brand loyal. Favorite chocolate brands are developed as a
preference at a young age and that is hard to shake. The big companies foster
this brand allegiance. Hershey, for one, tries to keep itself in consumer minds
as an honest and trustworthy brand (“Brand Equity”). They have even gone so far
to try to associate their brand with fun by building a theme park in its
hometown of Hershey, Pennsylvania. The strong brand awareness creating high
barriers to entry is seen even with the bigger companies. Often if they want to
introduce a new product, it does not hang by itself but is tied to an existing
brand. A new candy-coated malt ball product is does not have its own name, but
instead it is reintroduction of Crispy M&Ms.
Further
barriers to entry are the scale at which the big companies operate. To have
almost half of the chocolate industry entails a lot of knowledge in the
manufacture and marketing of chocolates. It also means a lot of experience with
the supply chain, which as we have seen goes all the way back to the growth of
the original tree in Africa, South America, or Southeast Asia and into the
tummies of satisfied Americans from Bangor to San Diego.
When Americans
want to treat themselves, they have other options than chocolate. There are
various substitutes, from crunchy chips, to salty peanuts, to savory beef
jerky. The availability of these substitutes is what keeps the lid on some of
the pricing power. The chocolate industry is considered a subset of the
confectionary industry, which includes many of the possible substitutes for chocolate.
In spite of the many available substitutes, for the confectionary industry as a
whole, chocolate accounted for over sixty percent of the entire industry. The
industry itself has grown at a rate comparable to the growth rate of chocolate
sales, meaning that the overall share of chocolate as a percentage of the
industry has remained stable (“Confectionary Industry”). The continuing growth
of the industry as a whole and for the chocolate segment in isolation bode well
for industry, as being an affordable treat; it is also shown to be rather
recession proof. People will continue to buy chocolate because chocolate is
pleasing to the American palate in a way that those other substitutes are
lacking.
Sugar and dairy
are huge inputs into the chocolate industry as raw materials, but the one thing
that makes chocolate chocolate is the cocoa bean. Once that is harvested,
refined, and pressed, then the end user can enjoy a chocolate bar or a bonbon. That
cocoa bean is also the source of much worry. Though the bean originated in
South America, as of 2014 47% of U. S. cocoa imports came from the Cote
d’Ivoire (“Economic Profile”). This is narrow neck for the supply chain. If any
geopolitical issues arose in that country, there would be a price pressure on
the raw materials that are needed to make chocolate. Ultimately, even if the
prices doubled from that one supplier, there are other countries that fill the
gap. There is also the fact that the raw materials cost for the cocoa is only a
small fraction of the ultimate price the end consumer pays. It is estimated
that only eight cents of every dollar stay with the immediate producers of the
cocoa bean (“Cocanomics”).
A
larger worry would be if something happened on a global level that harmed the
supplies from all cocoa growing nations. That would mean there would be fewer
beans to meet the supply and no substitutes for them. Unfortunately, that has
happened. Weather issues from drought and a fungal disease known as frosty pod
have put significant price pressure on the chocolate industry globally. This
supply shock has seen the larger companies approach different changes. Some
companies have raised prices at the retail level, while others are
reformulating their products in the hope that the public will accept less
chocolate and more nuts and nougat in the mix (“Cocoa Crunch”)
A
final consideration for supply issues is in the use of sugar. The American
government has long protected domestic sugar growers, limiting import of sugar
from abroad where foreign growers can refine sugar at lower cost. This means
that any chocolate made in America will have a higher cost because of higher
cost American sugar (“Confectionary Industry”). This increased cost of sugar is
an issue that is faced by many of the substitutes for chocolate, so it is not a
pressing concern for the chocolate industry as they try to maintain their
advantage over the other segments. The pressure on the cocoa bean is real and
is a potential game changer. If the supply of cocoa beans dries up, the cost of
chocolate will take it from an affordable luxury to a product to be enjoyed in
limited amounts at special occasions or just a thing rich people consume.
Buyers have a
lot of power in the chocolate market. The end consumer is the one that will
eventually take all of the output from the firms, but there is a key mediator
between the consumer and the companies manufacturing the chocolate. That
mediator is the retail stores that the majority of the chocolate sold has at
appear. Mass-market stores such as Target and Walmart are the largest sellers
of chocolate, followed by drug stores and supermarkets, with convenience stores
in fourth place (“Sales by Distribution Channel”). This means that there is a
finite amount of space that all chocolate or confectionaries can take up on the
shelves. Given a finite space, the power of the branding is crucial. Stores
want to stock the familiar brand that will move product, not to try out
something new that may or may not sell. It also gives the firms selling the
goods power. If they want to pay a particular price for the wholesale box of cholates,
they can ask it. If they are a large enough customer of the chocolate
companies, they will get that price and thus be able to sell their good for
less or capture more of the profit. An example is Walmart. If your product is
not on the shelf at Walmart, then in many areas it is just not for sale at all.
Walmart prices many of their candy bars at just a dollar. Who is taking the
haircut there, Walmart or Hershey?
Further
pressure from buyers might be seen in two different areas. First of all, even
though it might be easy to be flippant about the prospects of industry growth,
saying, “As long as people are gaining money, they will continue to buy
chocolate. You can’t cure a sweet tooth,” there are some potential pressures
that the end consumer might take. The first potential pressure on the makers of
chocolate by the buyers of chocolate is that there is question over how their
chocolate is grown. The West African nations that grow the cocoa are poor and
poorly governed, so it should be no surprise that there have been allegations
of human rights abuses including reports of child trafficking and slavery on
the cocoa plantations (“Chocolate”). Fair Trade chocolates have filled a niche
at a higher price point than the large companies trying to alleviate the fact
that the grower of the cocoa received a small amount of the ultimate dollar
spent – and even that amount is shrinking (“Cocanomics”). Ultimately, for the
good of the industry, the players will want to ensure that the raw materials
are sourced from reliable vendors, but in the short term, it has proven that
few of the ultimate customers are looking too hard at where their chocolate
comes from.
The
second demand pressure from the end users may come from a growing health
consciousness about the food consumed. Most chocolate is high in diary, fat,
and carbohydrates from the added sugar. Of the twenty-four pounds of
confectionaries Americans eat, a lot of that weight sticks to the bones.
Accepting the fact that some Americans are becoming more health conscious,
chocolate companies are filling the gap to create a healthier chocolate.
Varieties of chocolate have been released with less gluten or less sugar or
less fat (“Healthier Chocolates”). Ultimately, chocolate is not a staple of the
diet, instead it is a limited treat portion. Americans as a whole seem to not
want much of the healthier chocolate offerings for now, relegating the healthier
choices to a small niche of the chocolate industry as a whole.
The
economy as a whole looks to be in full recovery mode. Jobs have been added at a
fairly brisk pace, the unemployment rate is going down, and the stock markets
have been reaching new highs lately. The recovery has also trickled down to the
consumer level. The chart in figure one shows the real percent change in
consumer expenditures. The drawback during the crisis is evident, but looking
at the last few years, not only has spending by consumers been growing, the
general trend for growth is positive, meaning consumers are finally starting to
feel comfortable spending money again, almost a decade after the peak of the
housing bubble. This bodes well for industries that are highly reliant on
consumer spending such as the chocolate industry. Barring any unforeseen
shocks, the industry anticipated rate of growth of between three to four
percent seems within reach as long as no consumer preferences change.
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| Figure 1 |
The main firms
within the industry are in a good position for further success. They have the
use of the learning curve and have long ago achieved economies of scale so that
they have lower costs than potential rivals have and have built strong brands
that will be hard to compete with. These large firms should maintain a
steady-as-she-goes outlook, not diluting their brands but also on the lookout
for new opportunities. The lesser firms should continue finding the places
where the larger firms are not, filling in the spaces for specialty chocolatiers
and fair trade and health conscious fare. They may not be able to challenge the
giants, but they could find a profitable living in these areas.
Overall, the
prospects for the continued success and growth of the chocolate look good. The
consumer base is built in and enjoys the products. There are few negative
externalities built into the consumption of chocolate, in that it may be
unhealthy for the consumer and unhealthy in a different way for the producers
of the raw material. The supply of cocoa is the only real unknown in the health
of the industry. Chocolate is competitively priced with regards to its
potential substitutes, but a supply shock to the cocoa plant may see some
switching. The demand for chocolate is inelastic, but only to a point. It is
now widely enjoyed and pricing pressure might limit it to a special occasion
consumer item. The market continues to grow as a whole even though there are
barriers to new entrants.
Doing
the research for this paper has been instructive on the varieties of chocolate
and the various substitutes that exist. A surprise was how much of the general
snack and treat market was occupied by chocolate. A further learning experience
was in finding out about the concentration of the chocolate market between just
two big players, while the rest of the firms struggled for the crumbs and other
market niches abandoned by the big players.
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