Sustainability and efficiency in the global chocolate industry value chain

¶ … 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.

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.

As is the case in the transitions within this industry, the value chain analysis portrays the functional strengths and weaknesses of the primary and supporting activities and underscores the need for them to become more process-driven over time. The essence of the value chain model as defined provides a framework for interpreting the external events impacting an industry while also looking at how its key strengths will be able to respond over time (Porter, Millar, 1985). The crisis on tainted milk forced this industry to break down the lack of collaboration between the groups of external stakeholders themselves and with internal stakeholders as well. What emerges then is more of a model of collaboration in conjunction with the need for a more process-centric approach to evaluating the entire industry. With the role of quality management audits continually driving the need for greater focus supplier management strategies and techniques, the industry for the first time is able to derive key performance measures and key performance indicators (KPIs) over time. This is instrumental in eventually answering the concerns of external stakeholders who are more concerned about the quantified measure of product quality and its impact on profitability (Pacyniak, 2006) in the short-term vs. The aberration in forecast data over time. There is also the need for even tighter levels of supply chain variability analysis in light of the CPFR advances to date, only taken into account quality management audit results as part of the supply chain information system over time (Doherty, 2009). Quality management data then must become part of the supply chain "dial tone" of the market over time, and focus on providing an alleviating effect on anxiety over product quality.

The entire industry averted a crisis by concentrating on creating a high level of collaboration to the supplier level which in turn created the need for an industry-wide Enterprise Quality Management and Compliance (ECQM) platform and initiative. This was initially seen in the work of the external and internal stakeholders working with the World Health Organization to define acceptable levels of audit controls, and then enforcing them to earn greater trust. Yet this factor has made even more prevalent in its need for focus and creating a globally implementable ECQM framework that can alleviate crises in the future (Doherty, Tranchell, 2005).

As the crisis emerged over Chinese tainted milk it became clear that there were also no supplier rating, supplier audit, or CPFR-based approaches to lot and per carton management from third world nations. These attempts at supply chain efficiency had been hampered by the lack of consistent Corporate Social Responsibility initiatives throughout 3rd world nations and the need for ensuring fair trade levels of wages for workers in these regions. There was also significant backlash from these nations with regard to price curbs based on contracting demand as a result of the crisis. All of these factors were in fact amplified in nations that had not created CSR programs to align with market maker's more globally-based and brand-building efforts vs. genuine efforts to make the industry more egalitarian in terms of profit sharing. This entire aspect of quality highlighted how CSR efforts had been heavily skewed to supporting the areas of branding and less about creating a more egalitarian-based approach to creating a value-based supply chain over time. Most troubling was the wide chasms found between claims of CSR initiatives and program support in 3rd world nations throughout Africa and South America and the actual performance of the market maker companies in this regard. Nothing like a good crisis to drive out the truth of any value chain, and this is exactly what happened in this regard. CSR programs then had taken on the position of branding (Hildebrandt, 2009) instead of ensuring a high level of egalitarianism and quality management throughout the supply chains of the industry. Ironically it took a genuine crisis to make more visible the lack of CSR follow through an initiative support over time.

The need for greater governance, risk and compliance (GRC) also was very significant as well, as the industry strove to create more traceability (Pacyniak, 2006) of products and a more transparent supply chain in the process. The adoption of RFID (Zhou, 2009) and the heavy use of technologies actually gave the industry a more efficient response to the many challenges of the crisis in quality they had faced over time. There is evidence from the exceptional level of technological adoption in this industry, which is inherently process-based, that forecasting and demand management is heavily predicated on trust and transparency to the channel and retail level. A crisis of trust in chocolate was averted due to both external stakeholders and internal stakeholders taking a more involved role in the managing of the value chain from being functionally driven to more process-based.