Restructuring, raw material costs and a poor product mix all contributed to a disastrous performance by Hershey in 2007.But the company says it has learned from its mistakes and is preparing a new assault on America’s increasingly refined tastebuds.     

 

Hershey  goes back to basics  

One factor dominated the global food industry in 2007, affecting companies the world over and in almost every product sector. Rising raw material costs – caused by poor harvests, investor speculation, a shift towards greater use of agricultural land for biofuel crop cultivation, or indeed a combination of all three – had a major impact on the margins of food companies across the globe. These higher ingredient costs, coupled with a surge in the price of energy –the price of a barrel of crude oil topped theUS$100 mark by the end of the year – shaved65 per cent off Hershey’s profits, which plummeted to US$214 million, and pushed pre tax profit margins down by three per cent to17.6 per cent.

The company cited a number of reasons for the poor performance. Firstly, the so-called Global Supply Chain Transformation – or restructuring– programme, which led to a sharp increase in costs: US$83.3 million, related primarily to the closure of production facilities in the US and ongoing construction work at a new facility in Monterrey, Mexico. A further US$12.6 million in charges came from business realignment in Brazil, where the company bought a small confectionery company in 2001. This business lacked scale, according to Hershey president and CEO Dave West – Hershey has around three per cent of the Brazilian confectionery market – and with no nationwide distribution it was struggling to make an impact. There alignment of the business will see Hershey’s products sold across Brazil via a joint venture with baker Bauducco, which West said would “ leverage their strong sales and distribution capabilities throughout the country”.

Restructuring costs were only part of the story, however. West also confirmed that the rise in ingredients costs – particularly dairy ingredients– had been bigger than the company had expected. “Accelerating commodity costs, primarily dairy, was one of the toughest challenges we faced in 2007,” he said. “While we expected prices to rise, the rate at which they accelerated in the second quarter surprised both the market and us.”

Other ingredient costs rose too, and will continue to affect the company in 2008, he said, although he refused to comment on the scale of the increases. Hershey has, however, finally succumbed to pressure to increase prices, announcing price hikes across the large part of its US portfolio in January 2008 after resisting pressure to do so throughout 2007.

Marketing mix The final reason for Hershey’s poor 2007 performance, and in many ways the most worrying, was a much stronger performance in the core US market by the company’s main competitors, which include Mars and Wrigley’s. But West suggested that it was less about Hershey being outperformed by its competitors and more about the company failing to compete at all in the right areas of the market.

“It’s less about what the competition has done to us than about what we didn’t do with the consumer,” he said. “In 2004-05, we decided to focus on increasing our range of snacking products but that proved not to be as incremental as we hoped it would be, because consumer demands shifted towards ‘trading-up’ and premium products,” West said. So at a time when consumers wanted more luxurious, European-style dark chocolate, Hershey was giving them more variants on its sweeter, milk chocolate brands such as the eponymous Hershey’s bar and Reese’s peanut butter cups. “Clearly we did not meet that emerging consumer demand,” said West, adding that the company has “a laser-like focus on that consumer interest right now”.

“It’s less about what the competition has done to us than about what we
didn’t do with the consumer”

“The growth rate in the premium and trade-up categories is better than that of the chocolate sector average, and it is clear that some of our competitors have done better than we have at tapping into this,” said West. “We have some strong brands – Hershey’s Special Dark, Extra Dark and Cacao Reserve, Scharffen Berger, Joseph Schmidt, Dagoba Organic – but we haven’t had the scale in this premium dark chocolate segment. Two new product launches for the first quarter of 2008 – Hershey’s Blissand Starbucks – should give us that scale.” Bliss, a “chocolate is for those who appreciate the everyday joys of chocolate… that gives you an indulgent just-for-you experience every time”, according to the marketing blurb, comes in three variants – milk, milk with a “meltawaycentre” and dark. The Starbucks product, meanwhile, is a premium chocolate carrying the coffeemaker’s brand that “combines the highest quality chocolate with Starbucks beverages and cafe flavours”.

Both brands will come with sizeable marketing and merchandising budgets to help them get off to the best possible start – an admission by West that this was another area where Hershey had preformed badly in 2007. “Frankly, wedidn’t have a particularly good merchandising programme because we didn’t have the type ofinnovation that we needed in 2007,” he said.Advertising and merchandising expenditure willincrease by 20 per cent in 2008, but West saidthat the issue “was less about not having themoney to promote our products [in 2007] and more about not having anything to really promote”.
“The challenge for us is not just the level of spending but how we spend it. Reese’s last year went phenomenally well, but you could argue that Kisses didn’t,” said West. The company’s most recognisable brand, the trademark conical chocolate wrapped in silver foil, had a particularly poor Christmas period, due to a combination of weak advertising expenditure and intense competition from Hershey’s rivals. “The Kisses product was just not positioned where it needed to be, and we are working on that,” said West, adding that “we feel much better about ourselves on marketing going into2008”.

 

Core brand In tandem with the new premium launches, this year will see the company more focused than ever on increasing US sales of its four core brands: Hershey’s, Reese’s, Kisses and KitKat, the Nestlé brand produced under licence. “Our innovation profile in recent years was about providing variety to the consumer – varieties of the brands that weal ready have – and that proved to not be as sustainable as we would have liked it to have been,” said West. “Some of our brands and some of our pack sizes need to be repositioned as they have lost relevance with consumers.” Part of this “lost relevance” was due to Hershey’s historical inflexibility when it comes o offering a wide range of pack sizes or variants, West suggested. The Reese’s brand, for example – the biggest within the Hershey portfolio – is complicated to manufacture, with the chocolate casing, peanut butter filling, paper cup and foil wrapper all produced in house at the Reese’s facility in Hershey, the central Pennsylvania town created by company founder Milton Hershey to house his chocolate plant workers. But with little space available in the 50-year-old facility, and production lines with only a limited capacity to adapt to different product shapes or packaging formats, the company has been restricted in the level of innovation it can bring to one of its core brands.