Economic, social, ethical, and environmental sustainability

¶ … Chocolate Value Chain

Analyzing the Chocolate Industry Value Chain

The chocolate industry value chain is one of the most global in scope, encompassing the growing and harvesting of cocoa beans throughout Africa, Asia, South and North America, with processing centers in over 100 different countries of the world (Delfosse, 2009). To the extent that industry's value chain is tightly synchronized across all suppliers and there is a minimum acceptable level of quality, the entire industry can continue growth. It appears from the results this industry has been able to accomplish in terms of growth over the last twenty four months that the industry appears to be recession-resistant (Delfosse, 2009). According to DataMonitor global market research estimates, the global chocolate industry grew at an annualized compound annual growth rate of .5%, achieving $102.4 billion in sales in 2008 from 2006. The global industry is expected to increase its rate of growth however, increasing to a 2.3% compound annual growth rate, achieving $114.6B in sales by 2014. This is attributable to the greater involvement of nations whose economies rely on chocolate as a significant proportion of their Gross Domestic Product (GDP), the continued maturing of trading exchanges throughout the European Union (EU), and the development of supply-side procurement and trading exchanges that are creating buyer groups for more leverage with suppliers. All of these factors are contributing to the supply chains and distribution channels of the industry, transforming the value chain in the process, becoming significant more efficient and focused on cost reduction and quality improvement.

Introduction

In evaluating the value chain for chocolate, the economic, ethical, social and sustainability aspects of the industry need to be taken into account from the perspective of their contributions and detractions of the overall efficiency of the industry's functioning. Beginning with the economic factors, the role of suppliers and the supply chain of this industry is marked by a high level of commoditization and segmentation of quality levels of suppliers across 3rd world and developed nations. As the a result of this high level of supplier consolidation due to market makers including Cadbury, Mars, Ferrero, and Nestle, in addition to smaller regional brands exerting significant price pressure on growers, the buyer-supplier relationship throughout this industry's value chain favors the market makers. This is also being exacerbated by the fact that private label mass merchandisers including Carrefour, Tesco, WalMart and others are creating their own brands to save on costs and more fully control their distribution channels as well. Due to market makers and mass merchandisers having such a significant advantage in the context of this industry's value chain, substitute products are plentiful and often the strategy smaller regional competitors rely on to gain market entry over time. This approach to competing on price and private label chocolate is actually forcing the larger producers to focus on automating and expanding their production processes in order to stay more competitive over time. This is also creating an exceptionally competitive market across all retail channels as well.

The competitive dynamics of the chocolate value chain globally is making shelf space a premium asset in any retail environment. Studies indicate that one of the factors contributing to chocolate being so recession-resilient is the fact that it is one affordable luxury and has an affordable price and pervasive availability, which is due in large part to the exceptionally efficient supply chain of this industry globally (Delfosse, 2009). Market makers including Cadbury, Mars, Ferrero, and Nestle all rely on advanced forms of supply chain coordination and shared risk, including the use of Collaborative Planning Forecasting and Replenishment (CPFR) processes and systems to better manage the high variability of product demand (Doherty, 2009). Demand management in the context of the chocolate industry is one of the more difficult to anticipate and build forecasts around. The traditional spikes in demand during holiday periods are obviously an issue, yet there are aberrations in the data that often create completely unforeseen stresses on the value chains of this industry. Consider for example of how Hershey's lack of clarity and focus on their supply chain forecasting cost them an entire Easter season of selling (Sridharan, Caines, Patterson, 2005). This was primarily due to a prolonged and difficult SAP Enterprise Resource Planning (ERP) system installation process, which had left out key areas of the industry's value chain in terms of integration points. The result was that only a small percentage of the total forecast for Easter was obtained from resellers, and Hershey's suffered significant costs. This illustrates that customers preferences for each type of chocolate, by season, has a significant effect on the total value chain and can impact the overall profitability of the industry (Sridharan, Caines, Patterson, 2005). Better management of supply chain risk is critical for each member of the value chain to stay profitable.

Industry Value Chain Analysis

Using the value chain framework (Porter, Millar, 1985) as defined by Dr. Michael Porter, the chocolate industry is analyzed in the context of its interrelationships of support activities and primary activities. Figure 1, Chocolate Industry Value Chain provides an analysis of this industry's interrelationships according to the model. The primary activities of Inbound Logistics, Operations, Outbound Logistics, Marketing & Sales, and After Sales Service are supported by the Firm Infrastructure that is typical throughout this industry, which is by nature oligopolistic.

Figure 1: Chocolate Industry Value Chain

Sources: Based on analysis of (Delfosse, 2009) (Doherty, 2009) (Hildebrandt, 2009) (Monotti, 2008) (Sridharan, Caines, Patterson, 2005) (Tirone, 2008)

Next, the Human Resources practices of the industry are evaluated, which in the case of the chocolate industry have a high level of duality associated with them. On the one hand there is wage equality and fair trade which means the payment of market-based wages. On the other, especially in the more impoverished regions of Africa and throughout Southeast Asia, wages are more often seen as predatory and unethical. This has forced the entire industry to adopt a more thoroughly defined Corporate Social Responsibility (CSR) framework that can provide for greater levels of compliance to human rights guidelines and initiatives over time (Doherty, Tranchell, 2005). As a result of the human resources violations in specific countries there have been audits of specific suppliers' supply chains and their operations to ensure workers are given rights and wages that ensure an adequate quality of life (Doherty, Tranchell, 2005). In many respects this industry is comparable to the authentic shoe industry from the standpoint of ethical oversight of workers. Where Nike in the athletic shoe industry continually rejected the calls for improvements to their supply chain and worker programs, at one point ignoring them for well over a year before taking action and nearly inviting a Congressional investigation as a result, the chocolate industry has been far more forthcoming with human resources information and audit data. This has averted the industry from facing significant fines, investigations from governments that rely on the incomes of these supply chains to generate the majority of their Gross Domestic Product (GDP) and last but certainly not least, major backlash on the brands of these companies that dominate the industry. The human resources factor in the industry value chain continues to be closely analyzed and evaluated to ensure that the costs and legal constraints other industries face do not befall this one. There is a network of industry associations that also work to create more effective governance, risk and compliance (GRC) networks as well (Doherty, Tranchell, 2005), to ensure the industry does not become negatively impacted by human rights violations or a lack of compliance to global human rights standards.

The next support activity is technology development. The entire chocolate value chain and industry is heavily dependent on this support activity. From supply chain synchronization, supplier collaboration, consortia supplier-buyer exchanges, and the use of advanced manufacturing techniques based on process goods manufacturing, this area of the value chain is one of the most rapidly changing today as well. The use of supply chain management, supply chain optimization systems for ensuring that inventory positions are optimized from the cocoa suppliers through the manufacturers, is critically important as the demand curve for this industry is exceptionally seasonal and spikes during specific times of the year. In conjunction with the need to have exceptional insights into the supply chain on the one hand, and an accurate and trustworthy measure of forecasted demand on the other, this industry is heavily dependent on the quality management and traceability aspects of supplier quality management (Pacyniak, 2006). It is in fact the essence of efficiency for this industry's value chain to have sufficient levels of supply chain visibility and synchronization to the product level on the one hand, and accurate and believable forecasts of demand on the other. Keeping in mind that chocolate is inherently a process good, the need for accurately tracking sales-out data through Point of Sale terminals and the use of Electronic Data Interchange (EDI), a batch-oriented communications protocol that functions as a distributed order inquiry and order management system to ascertain sales by stocking unit (SKU) or box, the industry is grappling with what standard to use to track sales at the product level. The use of Radio Frequency Identification (RFID) on individual chocolate packing is making it possible to know item-level inventory positions within the largest retailers for example including Wal-Mart, an early adopter of this technology (Zhou, 2009). The use of RFID is also excellent at managing traceability of specific lots or delivery portions of chocolate (Pacyniak, 2006). With the many quality management concerns within the industry as a result of the Chinese lapses on toys (The lead paint incident with Mattel) and the use of milk in chocolates produced in Japan, quality management is far and way the most critical process area that this industry is grappling with today. The use of technologies to mitigate the risk of bad quality products is the fastest growing area of strategic change in the industry.

The last supporting activity area of procurement has also seen radical change in this industry over the last decade, with strategic sourcing, supplier collaboration, and the use of CPFR-based technologies for creating more of an equal distribution of risk throughout the supply chain. There is also a stronger focus on pricing and revenue management as chocolate is by nature a process good that requires accrual accounting, and more complex approaches to managing cost allocations. All this translates into procurement being one of the more difficult areas of coordination in the industry today. All of these supporting factors are in turn coordinated to support the primary value drivers of the industry, which include Inbound Logistics, Operations, Outbound Logistics, Marketing & Sales, and After-Sales Service. All of these factors and their relative efficiency by competitor have a direct impact on the profitability of the industry as well (Doherty, Tranchell, 2005).

The approaches used for support activities throughout this industry are also forcing it to become more oligopolistic in structure, as is shown in Figure 2, Global 2008 Market Share. The dominance of this industry by Cadbury plc, Mars, Ferrero and Nestle define in turn how vertical integration from a supply chain and sourcing standpoint is managed. As could be seen from the analysis of this industry's supply chain, it is fairly common to find market makers such as Cadbury attempt to own their entire supply chain from the field to the store floor. This is only possible given the process improvements and corresponding technologies that are becoming increasingly prevalent in this industry, significantly driving down costs and enabling greater supplier-buyer integration.

Figure 2: Global 2008 Market Shares

Major Player

Market Share

Cadbury plc

10.2%

Mars, Incorporated

9.7%

Ferrero S.p.A.

8.2%

Nestle SA

8.0%

Other

63.9%

Totals: 100.0%

Sources: Based on analysis of (Delfosse, 2009) (Doherty, Tranchell, 2005) (Hildebrandt, 2009)

These process improvements are in turn making it possible for the market makers, or largest companies in this industry to become completely integrated vertically. As has been mentioned, the use of CPFR technologies for creating more shared risk has also significantly reduced the costs of vertical integration as well.

The aspect of stakeholders in this industry centers on the governance, risk and compliance frameworks (GRC) used for defining supply chain quality levels, sourcing and procurement practices, and the safeguards against cartel-oriented pricing and demand structure approaches. Internal stakeholders are more concerned with the ongoing profitability and long-term viability of generating a significant rate of return on their investments. Internal stakeholders, in this era of transparency and trust, are most concerned about creating and implementing exceptionally strong Corporate Social Responsibility (CSR) programs and the ability to integrate these into sustainability and green initiatives. The most strategic of areas that companies are grappling with in this industry today from an internal standpoint is the ability to stay focused on CSR initiatives and has them translate industry-wide into compliance and focus. External stakeholders, from the distribution channels, channel partners, and many members of the industry value chain, all are most concerned about the implications of the rising focus on CSR initiatives globally and how they potentially impact profits. The need for creating more of an alignment with external stakeholders in this industry is clear, given their focus on creating programs, some profit-driven such as CPFR for supply chain coordination, and some CSR-driven such as fair trade cocoa, into a comprehensive stakeholder framework which can scale globally over time and through turbulent economic environments.

Analysis of Significant Industry Issues

Quality management is the most critical issue from a strategic perspective influencing the chocolate industry today. The continued concerns over supply chains throughout China, including the tainted milk found in chocolates last year (Monotti, 2008) and the translation of the rigorous Toyota Production System (TPS) programs and initiatives from the auto industry into the chocolate industry (Mark, 2006), make quality management the most strategically important issue by a wide margin. In terms of analyzing the impact of quality management from a stakeholder perspective, the Stakeholder Issue Life Cycle is used as the framework for analyzing the importance of product and process quality in the chocolate industry. The Toyota Production System (TPS) is one of the most advanced supply chain and sourcing systems and set of processes in the world, with a strong focus on supplier qualification and the monitoring of supplier quality and coordination globally. The TPS framework of supplier qualification and continual improvement aligns with the concepts of the Stakeholder Issue Life Cycle from the standpoint of averting exceptionally disruptive issues from impacting a business.

In addressing the chocolate industry's evolution from being highly fragmented in terms of its focus on quality from stakeholder perspective to one where entire networks of suppliers created based on stringent quality standards, the chocolate industry is in effect using the Stakeholder Issue Life Cycle as a means to consolidate strategic processes impacting quality and making them more accountable, auditable and transparent. Beginning with T1, or the time period when both external stakeholders and internal stakeholders are cognizant of the issues of quality from only a strategic, not operational perspective, there is a level of trust that the market makers that are driving this industry have it under control. Yet in fact as the events in China (Monotti, 2008) become more significant over time, and both external stakeholders including national governments starting to see there is a growing issue in this industry regarding quality, internal stakeholders become involved in terms of responding to requests to compliance within the industry. Given the transparency and immediacy of data and information the Internet has made available, there was a corresponding groundswell (Bernoff, Li, 2008) of interest in the issues of quality that continue to gain news coverage throughout nations seeing problems with chocolate quality. Children getting sick, store-wide recalls, immediate impacts to channel partner inventory levels and the need for lot-based audits from manufacturers who had used the factories in China affected all lead to stage 3 (T3) of the Stakeholder Issue Life Cycle, which is the prominence of quality as an issue industry-wide. By this point in the escalation of quality as an issue in the industry, the market makers including Cadbury, Mars, Ferrero, and Nestle all must issue statements as to how they will alleviate the potential of their entire distribution networks coming to a grinding halt due to quality concerns. There are also the issues for the external stakeholders who are shareholders, and their expectat6ions of earnings which vary by season of the year, being either met or not based on the sales interruption due to quality. T3 is the stage in the Stakeholder Issue Life Cycle where quality's shortfalls and issues now begin to directly impact profitability value-chain wide. This serves to heighten the anxiety of every external stakeholder, from the most strategic including institutional investors in the equities and stocks issued by Cadbury, Mars, Ferrero, and Nestle to the government agencies of China, European Union, and the oversight agencies of each country that chocolate is distributed within. There is in effect an overarching advisory about chocolate quality due to the tainted milk in China setting off a groundswell of concern globally. At this level of the crisis there is now the need for the market maker companies globally to respond in unison with a plan for averting an all-out crisis that will drive the trust out of their products. Troubling to the market makers is the fact that Cadbury, Mars, Ferrero, and Nestle resellers are now beginning to not trust their products as well. Recalls and lot-level analysis using CPFR analytics tools are beginning to arrive back at each of the four dominant company's headquarters. Internal stakeholders, from the CEOs down to the store clerks, are all expressing doubt and a lack of trust in products coming from the specific region of China that had the outbreak of tainted milk.

With the crisis of confidence comes the escalation of both external stakeholder and internal stakeholder focus on how to avert a melt-down of their channels and the industry based on lack of trust in product quality. T4, Peak, which is the fourth phase of the Stakeholder Issue Life Cycle, illustrates how an industry can build to a crescendo quickly from a lack of unified response to a given issue. With the external stakeholders now focused on averting government intervention in the industry and the inevitable reduction in profitability that would happen, there is more pressure than ever on companies to get their quality management strategies in place and eradicate any and all products from their channels that may be tainted with bad raw materials from China. The external stakeholders pressure company management teams to quickly resolve the issue by threatening to sell their institutional investments of stock into the open market for security, which will drastically drop the firms' valuation and also dilute its long-term value. This is because institutional investors are concerned that if the product quality issues do not get addressed the companies' sales will drop quickly, leaving the investors with stocks that are only worth a fraction of what they had been in the past. There are also the external stakeholders that represent the supply chain, and the denial many of them have started of sourcing the tainted milk from Chinese regions. There are the distribution channel partners throughout Asia, Europe, and the U.S. all looking at how to move into more organically-based chocolates (Tirone, 2008) and this presents a threat to internal stakeholders in terms of both immediately profitability and longer-term forecasting accuracy. This represents a significant shift in the overall market structure of the industry and one that is not known from previous selling history. As a result the crescendos of the Stakeholder Issue Life Cycle in T4 as both internal and external stakeholders finally choose to collaborate and create an entirely new work-around to the Chinese milk quality issue. The decision to enforce global milk and milk product standards immediately and audit all factories and to the lot level destroy all products possibly tainted becomes the strategy chosen. In conjunction with this strategy, the decision to partner with the World Health Organization (WHO) to oversee the audits and also remove infected lots and sourcing materials is defined as part of the rollout. This is specifically done to ensure rigorous quality standards are included in the process, but more importantly, to inject a higher level of trust into the entire program and recovery efforts as well. The T5 Decline phase is next, and the culmination of the efforts of both external and internal stakeholders to reach an agreeable solution and execute the strategy is completed. This is where the metrics of performance relative to alleviating the crisis are published, and external stakeholders including those from institutional investors are provided with evidence of the crisis being averted. With the high level of collaboration between the external and internal stakeholders the entire industry has redefine the role of how they will interact with each other. Paradoxically crises can make industries stronger and the scare over tainted milk in China does that, enabling entirely new series of processes for communicating and sharing information quickly.

Conclusion

One of the most significant insights gained from this research is the fact that the entire chocolate industry had focused entirely on the functional aspects of its value chain, ignoring the more critical process-based workflows and information flows. This became evident in how pervasive the lack of quality management had become relative to other industries (Mark, 2006). There are also the issues of no processes in place for communicating with a single voice, combining external and internal stakeholder interests and communication strategies into a single voice to consumers. As can be seen from this analysis, the critical need for managing communication with customers as represented by the groundswell of public opinion (Bernoff, Li, 2008) impacting this industry as a result of tainted milk in China at first is chaotic and lacks any cohesion whatsoever. There is also a complete lack of coordination to the expectation level for standards throughout the supply chain as well (Sridharan, Caines, Patterson, 2005). The exceptional growth of the industry (Delfosse, 2009) and its resilience in the midst of a recession keeps the sales momentum going despite the potential for distribution channels to completely be stocked out in the event auditing shows tainted milk impacting entire lots of products.

As the external stakeholders and internal stakeholders began to embrace more collaboration and less division and conflict, the crisis was averted as both groups sought to re-align their expectations. At stake was trust in their industry, and with the threat of competitive products, completely organically grown (Tirone, 2008), was becoming more prevalent given the quality management standards in place within that area of the industry. There is also a consistency of product quality management and compliance standards that the industry is in the midst of adopting during this time, based on the Toyota Production System (TPS) precepts and structures of product quality to the supplier level (Mark, 2006). The crisis in quality only serves to accentuate and drive this to faster adoption in conjunction with entirely new supplier audit procedures and workflows.