Chocolates El Rey: Industrial modernization and export strategy

ELSEVIER Chocolates E1 Rey: Industrial Modernization and Export Strategy Luis V. Dominguez FLORIDA ATLANTIC UNIVERSITY Mariana INCAE Cirigliano The introductory article to this special issue points out that export-oriented policies have proven superior to inward-oriented policies in delivering both long-term economic growth and quality of life indicators. One reason is that export-oriented policies demand economic liberalization as well as reductions in market distortions fro m import barriers, subsidies, and internal market inefficiencies. However, a number of management writers, including Porter, Michael E., The Competitive Advantage of Nations, Free Press, New York, (1990), have suggested that factor costs and availability are not a sufficient basis for sustainable competitiveness in world markets. Nations will attain global competitive advantages to the extent that they are able to foster a spectrum of related industries led by companies possessing a broad set of managerial competencies. Understanding how world-class industries and companies develop remains one of the major research issues in public and corporate policy. This is even less well understood in the case of developing nations, because they have been less well researched and because most studies have focused on industry policy for newly industrializing countries (NICs) and highly industrialized nations. The dilemmas and decisions of Chocolates El Rey and the Venezuelan cocoa industry richly illustrate the commitment required to achieve world-class competitiveness at company and industry levels. In the early 1990s, Venezuela began to open its economy and to encourage nontraditional exports. This transition came to an early halt as a result of a number of political scandals and public opinion backlash in a country accustomed to big government and managed markets. The policy reversals that followed have had a dismal effect on the Venezuelan economy, which has plunged from one crisis to another. Nonetheless, there have been an increase in internal competition and a drive to increase nontraditional exports. Heightened competition has challenged Venezuelan companies to increase their capabilities, even if they do not enter international markets. Some companies simply have sold out to multinational firms. Others have attempted to develop into world-class competitors. For example, some have forged strate,~c alliances with multinational companies (see Ickis article in this issue). Some, as Chocolates El Rey, have attempted to go it alone. The Chocolates El Rey case traces the Address correspondence to Luis V. Dominguez, College of Business, Florida Atlantic University, Reuben O'D. Askew University Tower, 220 S.E. 2nd Avenue, Ft. Lauderdale, FL 33301. Journal of Business Research 38, 35-45 (1997) © 1997 Elsevier Science Inc. 655 Avenue of the Americas, New York, NY 10010 efforts made by that company both to raise standards in the Venezuelan cocoa industry and to forge a niche for high-quality products in industrial markets. In those markets, there is a wide supply of high-quality goods, intense competition, and well-defined user preferences. Two of the major challenges set forth in the case are: • Export Strategy: Which market segments to target, how to advantageously differentiate the company from entrenched competitors, how to distribute its products to the appropriate segments, what sort of presence to have in export markets, and what price to charge different channel members. • Developing Brand Equity: How to overcome the negative image associated with goods from underdeveloped countries in such a way that an adequate market share may be achieved at profitable prices. The case lends itself to other teaching purposes as well. It illustrates the scope, uses, and limitations of market research; it also is good for a discussion of the company-level process of industrial reconversion in countries that are liberalizing their economies. The case also would be suited to a discussion of the effects of development policies on company and industry performance. The clouds that were gathering over the Venezuelan economy in 1994 raised once again the specter of renewed exchange control regimes and overvalued currencies that have plagued Venezuela's economy. An overvalued currency could greatly complicate El Rey's pricing in export markets. We hope that the case will encourage research on the development of brand equity (Aaker, D. G., Managing Brand Equity, Free Press, New York, 1991; Keller, K. L., Conceptualizing, Measuring and Managing Customer-based Brand Equity, Journal of Marketing 57 (January 1993): 1-22)by firms from less developed countries (LDCs). Venezuela's cocoa industry faced many of the same problems as other emerging industries; for example, the marketability of whose products is hampered by adverse consumer perceptions (Heslop, Louise A., and Papadopoulos, Nicholas, But who knows where and when: Reflections on the images of countries and their products, in Product-Country Images, International Business Press, New York, 1993; Samiee, Saeed, Customer evaluations of products in a global market. J. Int. Bus. Stud. 25,mo. (1994):579-604). Venezuela as a tropical country is ideally suited to cocoa production. However, El Rey.faced resistance from industrial cusISSN 0148-2963/97/$17.00 PII S0148-2963(96)00116-6 36 J Busn Res 1997:38:35-45 tomers and household consumers who did not associate Venezuela with the production of high-quality chocolate; in fact, there were negative perceptions that derived from Venezuela's industrial policy mistakes. The case raises interesting issues about overcoming negative associations and determining which kinds of associations should be favored (e.g., whether functional or hedonic) in building brand equity with the trade. El Rey's internationalization diverged from the notion of a process of incrementally deeper commitments to export markets in response to unsolicited initial orders and gradual learning. El Rey started out with a major investment in plant design, process improvements, and human resources, all in response to a vision and a strategic imperative identified by top management. Whereas early stages of internationalization are supposed to respond to importer pull, that is, to the needs and designs of developed-country exporters (Wortzel, L. H., and Vernon-Wortzel, H., Globalizing strategies for multinationals from developing countries. ColumbiaJournal of World Business (Spring 1988):27-35), El Rey contemplated immediately participating in the domestic channel in the United States with its own company and brand name identity. © 1997 Elsevier Science Inc. j BUSNaES 1997. 38.35--45 ¢ ¢ ~ - r ,~ his is an exquisite chocolate. Its flavor reminds me of walnuts and hazelnuts. Its scent is evocative of jasmine and gardenias. This is a truly brilliant blend of very special cocoa varieties. Am I before another stroke of brilliance from Valrona or Carma?" These were the words of Jacques De Sable as he blind-tasted a sample of milk chocolate. De Sable, executive chef and owner of Le Gallion and one of the most renowned confectionery chefs in North America, had accepted Norma Peletier's invitation to taste "some newly arrived new chocolates." Mrs. Peletier was a chocolate industry expert who had been engaged by Chocolates El Rey to survey the opinions of several prestigious U.S. chefs regarding chocolates and couvertures produced by that company. Couvertures are high-quality chocolate bars with a 32%-39% cocoa butter content. They are used industrially to make sweets, fine desserts, candy, and ice cream. "Sacre dieu! Ce n'est pas possible!" [Dear God! It cannot be!], exclaimed De Sable when he learned from Mrs. Peletier that the milk chocolate was produced by a Venezuelan company, that had used a single variety of specialty cocoa beans of the Carenero Superior denomination. "How have they been able to achieve such a well-rounded flavor with only one variety of cocoa? This is an extraordinary product!" Jorge Redmond, president of Chocolates E1 Rey, was not overly surprised by the noted chef's reaction. "Venezuela grows the best cocoa in the world. Our chocolates and couvertures reflect the quality of our cocoa. We must measure ourselves against the standards of the topmost Belgian and Swiss chocolates. Our challenge now is to reach the proper market segment with the appropriate message." These were Mr. Redmond's opening words at the executive committee meeting that had gathered on January 8, 1994, to debate E1 I L.V. Dominguez and M. Cirigliano Rey's strategic options for the export market. The executive committee members were Mrs. Calderon (marketing manager), Guevara (executive VP), Medina (manufacturing manager), and Redmond. Chocolates El Rey dated back to the beginning of Venezuela's chocolate industry. E1 Rey had become an important competitor in the Venezuelan consumer market. It also was the leading supplier of bulk chocolate and couvertures to food processors. In 1989, Venezuela's internal market was opened to international competition. Despite the fierce competition that ensued, E1 Rey had increased its share of domestic markets through acquisitions, product improvements, and significant investments in storage and production facilities. The operating structure and philosophy adopted by E1 Rey's executive committee established world exports as one of its top priorities. Historically, the company had faced great challenges and risks. Although it had exported intermediate cocoa products in earlier times, the risk and investment involved in the new export project would require a carefully thought-out marketing strategy. Evolution of Chocolates El Rey The E1 Rey brand name dated back to the beginning of industrial production of chocolate in Venezuela. It was the brand name given to a soluble chocolate bar made by Tuozzo Zozava & Cia., a family-owned firm founded in 1923. This product was consumed as a snack or dissolved in hot milk or water as a breakfast drink. Because of insufficient investments in production and marketing, the company had come to play only a secondary role in consumer markets. In 1973, Inversora Cresta, C.A., purchased 45% of Tuozzo Zozava stock. The company name was changed to Chocolates E1 Rey, C.A. The new owners invested in a new processing plant and made exports of cocoa and intermediate cocoa by-products a priority. By 1976, E1 Rey was successfully exporting to Europe, the United States, and Japan. In 1980, with machinery for the new plant on its way to Venezuela, the government fixed domestic cocoa prices above world levels. Given that the intermediate-goods business is based on deliveries against future contracts, the company lost money on each shipment. Nevertheless, E1 Rey honored its export contracts to preserve the goodwill of its international customers. In this new scenario, E1 Rey decided to focus on domestic markets. In 1985, it acquired a 50% interest in La Unica, another chocolate-producing, family-owned company. One year later, E1 Rey acquired a controlling interest in PROINS& a company whose major product was a powdered chocolate-flavored instant beverage. When the internal market was opened to international competition in 1990, E1 Rey found itself competing directly with multinational corporations such as Nestle, Suchard, Lindt, and Valrona. These companies enjoyed a global reputation for quality, backed by massive budgets for product and Chocolates El Rey: Export Strategy J Bush Res 1997:38:35-45 I ! "" ~ ; I "Ommm 19.3 Hil 1 ion (Sll ml) 3S2,141,3 > ¢It9 ~latl~ D O~IP / t , q m ) , ~ t~ Otq~" .~Q,ilOQ ' m,,, +~'~'~ O Capital Figure 1. MapofVenezuela. market development. The executive committee began to examine the long-run strategic implications of the country's market liberalization policies. According to Redmond, "We concluded that the company's operating scheme and philosophy had to change in order to achieve world-class levels of productivity and quality." The company's commitment to international markets was also renewed. El Rey's platform would be the reputation and quality of Venezuelan cocoa. A 5-year modernization plan was implemented with a substantial capital disbursement from stockholders and a long-term domestic bank loan. In the initial stages of the modernization program, between 1990 and 1993, the entire sourcing, storage, processing, and production structure was redesigned. The purpose was substantially to upgrade the company's production capacity, efficiency, and product quality. An Agricultural Division in charge of acquiring raw materials was created. E1 Rey made a jointventure agreement with a subsidiary of Venezuela's stateowned oil company to operate a 350-hectare (ha, 1 ha = ,-o 1 city block) farm in the State of Barinas, in the eastern region of Venezuela (see Figure 1 for map of Venezuela). In addition, several farms were established to the south of Lake Maracaibo and in the states of La Portuguesa and Monagas. These were strategic sites for producing the different varieties of cocoa that would be required. The project was vertically integrated so as to ensure a supply of the best ingredients and to assist growers in selecting the most appropriate cocoa varieties and in using modern farming techniques. The resulting increased productivity and quality of the harvested cocoa would benefit everyone. As an integral part of this effort, E1 Rey created a Research Center whose main objective was to develop and spread state-of-the-art technologies. The last stage of the modernization program was the installation of what was regarded as the most modern and efficient cocoa processing plant in all of Latin America. Located in Barquismeto, it processed E1 Rey's entire production of cocoa 3"/ butter, cocoa powder, chocolate-flavored beverages, chocolates, and couvertures. Couvertures must be melted to prepare the end product. Bulk chocolate includes couvertures as well as other forms, such as the chocolate chips that are used in making cookies. Henceforth, the term chocolate and couvertures is used synonymously with bulk chocolate. The initial processing capacity of the new plant was 3,000 metric tons (MT; 1 MT = 1,000 kg = 2,200 lb) of chocolates and couvertures, expandable to 15,000 MT. The processing machinery, imported from Switzerland and Germany, permitted on-line computer control of the whole process and remote adjustment via modem directly from Europe. Once the plant was fully functional, E1 Rey's other plants were closed down. To guarantee the integrity of each product and avoid flavor contamination, the production line used separate tanks for processing each variety of cocoa. The process also made it feasible to produce custom blends in quantities as small as 1 MT. For instance, a milk chocolate with specific amounts of sugar, milk, and vanilla could be created to suite a specific customer on a special-order basis. A Swiss master chocolate taster was hired to supervise the formulas and control quality. The production manager held both an MBA and a degree in chemical engineering. Longtime employees were encouraged to attend evening classes to obtain their secondary school degrees. All new plant personnel were required to have completed secondary education. The Venezuelan Cocoa Industry Despite its sophisticated technology, cocoa processing dated back to ancient history. In 1502, Christopher Columbus, during his fourth trip to America, was the first European to come in contact with cocoa trees. Cocoa beans were used by the Aztecs both as currency and as the basis of a bitter drink made of cocoa, corn, and pepper. In 1519 Monctezuma offered the brew to Hernan Cortez. The conquistador was more impressed with the use of cocoa as currency than with the drink itself. Soon he established the first commercial cocoa plantation organized by Spaniards. Nine years later, cocoa was introduced into Europe, where it proved to be a remarkable success, although another crop implanted in South America, coffee, displaced it as the continent's premier beverage. Cocoa bean cultivation had reached a high degree of sophistication among indigenous peoples of South and Central America. Its influence extended from what today are Brazil and Ecuador to Mexico. Both cocoa consumption and its use as a means of exchange were widespread among all cultures in the region. According to Spanish chronicles, a plantation with hundreds of thousands of trees was found along the banks of Lake Maracaibo in what today is Venezuela. In fact, a special cocoa bean called Criollo originated in the Maracaibo Lake Basin. From there Indian cultures spread the crop throughout South and Central America and as far away as Mexico before the arrival of the Spanish conquistadores. The 38 J Busn Res 1997:38:35-45 L.V. Dominguez and M. Cirigliano Table 1. Venezuelan Cocoa Bean and Cocoa by-Product Exports to Main Importing Countries Products and Countries Cocoa beans Holland Japan United States Belgium Cocoa butter, fat, and oil United States Holland United Kingdom Volume (MT) Value ($000) 3,476 1,575 726 441 4,582 2,334 986 535 446 41 41 941 84 84 most widespread variety of cocoa today, known as Forastero ("forester"), is indigenous to the Amazon Basin. From there it was transplanted to Africa and Southeast Asia by Dutch, English, and Portuguese traders. In Venezuela, commercial, cocoa production dated back to the early 18th century. At that time, cocoa was one of the pillars of its economy. Venezuela was the chief cocoa-exporting country to Europe for 30 years into the following century. The reputation of Venezuela's cocoa stemmed from the flavor and aroma of its indigenous cocoa varieties. All Venezuelan varieties were considered specialty cocoas. Some of the varieties have never been grown successfully elsewhere. The bulk of Venezuelan cocoa exports went to Europe. The United States was Venezuela's major importer of cocoa butter, oil, and fat (Table 1). The Appendix describes the world cocoa industry and the chocolate production process. It also itemizes the varieties grown in Venezuela. Cocoa cultivation in Venezuela was typically a small-farmer activity. It was estimated that around 17,000 farmers cultivated 56,000 ha at a rate of 675 to 1,000 trees per hectare. Although there were some plantations of 1,000 has or more, a typical plantation was around 5 ha. Output ranged from 300 kg/ha using primitive methods to 1,000 kg/ha when using the most modern techniques. Although operating expenses per ha with improved techniques are only 20% higher, small farmers typically used traditional methods. A combination of adverse internal factors had kept Venezuela from capitalizing on its comparative advantage in cocoa. Agriculture had taken a back seat to oil, mining, and industrial activities. Government controls had discouraged private investors. Between 1975 and 1989, the National Cocoa Fund (acronym in Spanish, FONCACAO) was given exclusive rights to purchase and resell cocoa beans, fix cocoa prices, and assign supply quotas to industrial users. FONCACAO altered the grading system, consolidating all traditional cocoa varieties (see Appendix) into only three quality categories. These were called "extra fine," "fine first class," and "fine second class." In addition, domestic cocoa prices were fixed above world prices, placing private exporters at a distinct disadvantage. All these factors adversely affected the quality and image of Venezuelan cocoa among its traditional customers. International customers were no longer able to choose Venezuelan varieties with very distinct features for specific uses. Over the years, the premiums above world prices that buyers were willing to pay for Venezuelan cocoa had been declining. Reportedly, some Venezuelan varieties were obtaining minimal premiums or no premiums at all at a time when some highquality African cocoa varieties were receiving premiums of up to $250/MT. In 1991, FONCACAO's monopolistic control was terminated, enabling private companies to set up cocoa storage, marketing, and export operations. By 1992, FONCACAO's market share had decreased by 50%. The balance of Venezuela's production of 16,000 MT was handled by two new private companies. E1 Rey's management was part owner of Agropecuaria APROCAO, one of these two companies. APROCAO operated as a nonprofit organization, acquiring cocoa beans at international prices and placing cocoa by-products (liqueur, cocoa butter, and cocoa powder) in the market. APROCAO had 22 offices and several storage centers throughout the country. Its purpose was to acquire top-quality cocoa and to provide technical assistance to farmers. International cocoa bean prices had been decreasing since the mid-1980s. A significant rise was not foreseeable in the near future. Analysts believed that exporting higher-valueadded products was a strategic opportunity. In addition, although E1 Rey was taking steps to increase its share of the domestic chocolate market, the prospect for domestic market growth did not seem too encouraging. According to industry sources, a looming economic crisis would bring Venezuela's market to a standstill by 1994-95. Consequently, domestic competition would probably heighten. The Venezuelan Market Domestic production of cocoa was about 16,000 MT in 1991. Half of this was destined to domestic consumption. The rest was exported. Recently Venezuela had exported around 600 MT of cocoa paste and liqueur and 1,000 MT of cocoa butter. Venezuela was a net importer of chocolates and couvertures; exports reached 85 MT compared to imports of 400 MT (Rivas, 1994). Although Venezuela was a cocoa producer and exporter, Venezuelans annually consumed only 350 g of chocolate per capita. By comparison, Colombians consumed 2 kg and the Dutch 10 kg. In 1993, 13 cocoa-processing companies operated in Venezuela. The chocolate market had recorded sales of approximately $139 million at producer prices. Nestle and its recently acquired Savoy line held 55% of the consumer market. La India, La Universal (managed by Perugina), Capachos, and La Grita were other consumer brands. Several companies also supplied both consumer and industry markets. These included E1 Rey, Yukery, and Nuciven. In the chocolate-flavored instant Chocolates El Rey: Export Strategy beverage category the leader with 23% was Toddy, followed by Taco (18%), Chocoloco (5%), and Kresty (1%), all three of which were owned by El Rey. E1 Rey's sales in this segment had reached $3.5 million in 1993 (Rivas, 1994). Industrial users acquired cocoa butter, powder, liqueur, and couvertures. By the end of 1993, Venezuela's domestic market for bulk chocolate was estimated at approximately $3.5 million and 1,200 MT (Rivas, 1994). El Rey led this market with an estimated 60% market share. It had become the leader through acquisitions and improved product quality. La Marcona, Nestle, Astro, and Kron, in that order, were the other major competitors. Management estimated that E1 Rey held approximately three times La Marcona's share, which in turn sold almost twice the amount of chocolates and couvertures as did Nestle. Astro and Kron combined held about 10% of the market. Chocolate-flavored beverages and couvertures combined made up 80% of E1 Rey's income (sales). The remaining 20% was derived from cocoa bean and byproduct marketing operations in Venezuela, the Caribbean, Andean countries, and other parts of the world. The U.S. Market In view of the decision to expand internationally, in 1992 E1 Rey engaged a food market research firm to survey the U.S. bulk chocolate and couverture market. The U.S. market was considered a key to E1 Rey's internationalization. In Mr. Raymond's words, "The experience that we acquire in U.S. markets will help us in entering other markets, such as the European Economic Community (EEC) and Japan. We will not only develop further by competing, but we will also gain prestige and recognition that will facilitate access to other markets." The purpose of the initial research was to provide basic market information that would enable E1 Rey to evaluate and select market segments. The survey estimated the size of the industrial market and its segments, identified purchasing criteria by market segment, estimated prevailing price ranges, and described distribution channels, their business practices, and operating margins. In 1992 the United States imported 378,980 MT of cocoa beans with a CIF value (cost, insurance, and freight value prior to customs duties) of $432.6 million. Five countries accounted for 75% of United States imports. The Ivory Coast, Indonesia, and Ghana, in descending order of importance, jointly supplied 57% of the imports. Brazil and the Dominican Republic followed with another 18%. Bulk chocolate imports amounted to approximately 60,000 MT, representing 30% of domestic consumption. Seventy-eight percent of imports came from Canada, followed by Belgium (11%), Brazil (6%), France, Switzerland, and Germany, each with 1% of total imports (Food and Agriculture Organization, 1994). Although the projected annual growth rate of the consumer market for chocolates and candy was approximately 3% to 5%, bulk sales were expected to increase at a rate of 5% to 10% and couverture J Busn Res 1997:38:35-45 39 imports by 15%. Import growth was due to the perception that imported couvertures were the best and that chocolate was becoming a gourmet product. According to industrial sources, high-quality chocolate added value to products, justified higher prices, and attracted upscale consumers with high purchasing power. Market Segmentation The research firm also conducted an expert opinion survey to segment the market and identify the channels of distribution for couvertures. The study found two segments, food processors and retail food service companies. There were important differences in the purchasing needs and distribution channels for these two segments. Food processing companies as a whole made up 90% of total demand for domestic and imported couvertures. These companies included large retail chain stores and restaurants, whose purchases represented about 10% to 15% of the foodprocessing segment. Import distributors sold directly to food processors and large chains. As a rule, these firms bought full 10,000-1b (4,600-kg) containers or more. Some of the better known companies in this field included makers of ice cream (Breyer's and Haagen-Dazs), confectionery (Godiva), and baked goods (Pepperidge Farms). Most of these clients were owned by large multinational corporations. Food processing companies consumed approximately 85% of couverture imports; most of their import purchases originated from Canada. Several chocolate companies produced couvertures in Canada in order to avoid quotas and duties imposed on U.S. sugar imports. The remaining 10% of total demand for couvertures and 15% of imported couvertures were consumed by the retail food service segment. This segment purchased in small quantities. The food service segment was chiefly composed of industry businesses, small confectionery chains, delicatessens, bakeries, hotels, restaurants, and caterers. This segment was in turn divided according to the type of customers served. The most upscale segment, including "white table cloth" restaurants and gourmet-type bakeries and candy stores targeted highly educated professionals, business owners, and managers with household incomes of at least $50,000 and an interest in haute cuisine. A typical food service company made frequent purchases in quantities as small as 10 lb or even less if the supplier provided smaller packages. Imported European couvertures represented about 45% of this segment's consumption. Dark, semi-sweet, and bitter-sweet couvertures, favored by upscale establishments, represented about 60% of the retail food service demand. Another 35°,6 was comprised of milk chocolate, and the remaining 5% was white chocolates or a combination of the above. Competition among Imported Chocolate and Couvertures Three companies (Ambrosia, Blommer, and Nestle Peters) led the market for imported bulk chocolate. Among foreign 40 J Busn Res 1997:38:35-45 companies, only Ambrosia and Blommer operated as their own import distributors. Prices to final users depended on customer type, product quality, purchase quantities, and the producer's image and price policies. Among food processing companies list prices ranged between $0.80 and $2.50 per pound. Substantial discounts were available on bulk purchases. In the food service segment prices ranged from $1.75 to $6.00 or more per pound. Table 2 shows the open-market sales of couvertures of all major companies, the segments they served, the prices charged to end users, and several other features. Distribution Channels Because the purchasing patterns of food processing and food service companies were substantially different, some companies specialized in a given segment. Figure 2 illustrates distribution channels and shows the commission and margin structure per market segment. Among companies exporting to the United States, only Callebaut, with sales of 4,000 MT per year, had its own importing organization. All the rest dealt with an import distributor who handled the distribution of their products. Whether through a company office acting as its own import distributor or through an independent distributor, the following tasks had to be performed: • • • • • • • • • • • Request orders from foreign manufacturer Receive shipments, handle customs procedures Arrange delivery to customers Keep inventory (particularly important in the case of food service customers) Visit and educate customers about the products Seek orders and close sales Bill customers and collect payments Promote products Monitor quality of goods received Handle complaints, returns, and credits Develop ideas for new products and industrial packaging Depending on the service provided, an import distributor charged the following markups: 50% to 75% markup on the CIF price when selling directly to large industrial customers; 75% to 100% markup on sales to wholesalers serving food service retail companies; and between 100% and 200% on direct orders from food service retail end users. An import distributor normally earned about 10% to 12% of sales before taxes. Managing this type of importing operation typically implied annual baseline administrative and sales expenses, freight, credits, and returns of approximately $750,000. Distribution channels varied by market segment. Import distributors reached food processing industry customers through sales representatives and brokers. A broker found customers but did not keep inventories or make deliveries. Representatives differed from brokers in that they generally worked under contract and maintained a closer relationship with buyers and sellers. Reps could facilitate delivery, although L.V. Dorninguez and M. Cirigliano import distributors were ultimately responsible. Reps and brokers offered the distributor their knowledge of the territory and expertise in selling product features and negotiating prices. They also collected on behalf of the distributor. Although brokers and reps handled various product lines, they normally did not manage directly competitive lines. Most large customers exercised their negotiating power to demand better prices. Thus, El Rey would have to set base prices and quantity discounts either directly or through the import distributor. For their services, brokers and reps charged between 3% to 10% of the list price, depending on the level of service provided and the quantity involved. The food service segment was reached mainly through wholesalers who served a defined territory on an exclusive basis. They did business with a large number of small accounts. Wholesalers purchased the merchandise from the import distributor, kept inventories, took care of the invoicing, and arranged domestic shipping to the end user. Wholesalers were responsible for keeping adequate stocks to provide their customers with the types of couvertures (e.g., package size and flavor) required for each application. Wholesale markups fluctuated between 20% and 40% of the price charged by the importer. Higher percentage margins corresponded to higherquality goods. Market Perceptions of Venezuelan Cocoa As part of the market survey, the research agency polled a small sample of food industry experts on their opinions of couvertures and chocolates from different countries. Mr. Redmond and his management group were concerned by the lack of detailed information about Venezuelan products. Also, the interviews revealed potential concerns about the perceived quality and flavor of Venezuelan cocoa. The results were as follows: • The most important factor for bulk food processing companies is price and consistency in terms of flavor and other sensory characteristics. Delivery dependability also is very important. The product's country of origin and a high-quality level are less important. • In high food service segments, couverture quality, its characteristics, and country of origin are more important, but price is not as crucial. In the white table cloth segment, chefs are loyal to European couvertures because of familiarity borne of training. • In the lower food service segment, price is a determining factor, followed by the product's chemical components. In this segment, end users tend to be less aware of the product and rely more on the distributor's advice and brand recognition. • The prevailing opinion in the industry is that the best couvertures come from Europe, where the best roasters are located. Chocolates El Rey: Export Strategy J Busn Res 1997:38:35-45 41 Table 2. Main U.S. Open-Market Competitors for Imported Bulk Couvertures a Company Company Origin Segment Served Couverture Sales in the U.S. (MT) Price Range ($/lb) End User Other Observations Ambrosia USA Food processing companies 15,000 1.75-2.00 Operates 10 company-owned distribution centers. Recently entered food service business. Handles most complete line of bulk chocolate couvertures. Blommer USA Food processing companies 15,000 0.80-1.25 Direct sales through own sales force and distribution network. Specializes in sales to large customers. Cacao Barry Belgium Both. In food service, gourmet confectioneries, bakeries, and restaurants. Ingredients for bakeries. 1,300 2.20-3.30 Distributes and produces in the United States through American Cocoa. Wide packaging and ingredient line in addition to couvertures. Targets chefs, restaurants, and top places. Positioned as top Belgian company. Callebaut European Both. 10%-15% of food processing segment. Hotels, confectioneries, bakeries, and gourmet restaurants. 4,000 2.20-3.30 Jacobs Suchard subsidiary. Has own office in the United States. Keeps technical support staff. Sells through distributors on exclusive basis. Wide chocolate product line in addition to couvertures. Carma Swiss Food service < 500 3.50-5.50 Uses exclusive distributor in the United States. Specializes in serving chefs. Distributes directly to clients from three distribution centers. Ghirardelli USA Both 2,200 1.75-2.00 Quaker Oats division. Uses brokers who serve both food processing companies and food service distributors. Guittard USA Both 2,200 2.20-3.30 Markets other products. Serves upscale market segment. Uses brokers for food service segment. Hershey USA Food processing companies N/A N/A (low prices) U.S. company with own offices and direct distribution network to large end users. Lindt Swiss Food service. Ingredients for bakeries. < 500 4.00-6.00 Couverture market is served by one person. Serves top restaurants, confectioneries, bakeries. Also offers other chocolate products. Renowned for quality, service, and integrity. Nestle Peters USA subsidiary of Swiss company Both. 40%-45% of food processing segment. 7,000 1.60-2.50 Markets many other chocolate products besides couvertures. Leader in food processing market. Van Leer/ Van Houtten European Food processing companies. Ingredients for bakeries. 7,000 1.75-2.00 Line targets bulk food processing companies. Valrona Belgium Food Service. Confectioneries, bakeries, and top gourmet restaurants. < 500 4.00-5.00 Markets other chocolate products in addition to couvertures. Wilbur European Food processing companies 9,000 1.50-2.20 Markets other chocolate products besides couvertures. *Excludesinternalsalesto own subsidiariesand manufacturers. 42 J Busn Res 1997:38:35-45 Producer L.V. Dominguez and M. Cirigliano I ImportDImlbutoror I ProduceCsSublldlary 50-75% msrkup 75--100% mad(up t00-200% I markup rokers& Repl ~20-40%commissio o~selli,ngpdce 3-10%cornnli~ion ,d,no~ct I FoodProceuors I [=,=, Figure 2. U.S. channel structure and margins. • Chocolate bars are used to dip candy and desserts. Disks and chips are easier to handle for special applications, such as desserts and cookies. Although 10-1b bar packages are predominant, 1-1b bars are easier to handle and are becoming increasingly popular. • Quality is associated with strongly flavored chocolate without any bitterness and that is easy to melt and keep at desired viscosity, particularly for precise recipes. • Venezuela's cocoa beans are good and richly flavored, but are losing in quality. Some experts believe the beans may be too bitter, lacking balanced flavor. Balance is achieved by blending proper varieties. There is the notion that some excellent chocolates are obtained by blending cocoa beans from several countries. • End users are generally satisfied. There is a wide range of products available with various degrees of quality. The Executive Committee Meeting Venezuela's deteriorating economic and political situation was expected to lead to a contraction in real consumption in 1994. This would aggravate competition in domestic markets. It would also increase the need to find markets for the company's increased capacity. The question was how to achieve this. During the meeting several strategic options began taking shape. An option favored by Mr. Medina, manufacturing manager, involved selling couvertures to food processing companies. His reasoning was based on cost advantages that would enable E1 Rey to fix relatively low prices. He was attracted by the size of the segment and the chances of making almost immediate sales if large customer orders were obtained. "These advantages are crucial if we consider the new production capacity and the need to cover the fixed costs we have incurred." Mr. Redmond wondered if E1 Rey could directly confront giant industry suppliers. Another option was to market couvertures to the food service industry. Mr. Calder6n, Marketing Manager, liked the idea. By specializing in this segment, E1Rey could differentiate itself on the basis of Venezuela's top-quality cocoa. It could also take advantage of the high-quality couvertures that could be made in the new plant. This platform could eventually be used to expand to other countries based on the position achieved in U.S. markets. Mr. Redmond and other committee members, however, wondered whether a virtually unknown Latin American company could carve a niche in such a competitive environment as that of the United States. A third option, proposed by Mr. Guevara, executive VP, was to combine elements from both strategies. Guevara's idea was to start with the food processing market and to diversify on the basis of the lessons learned from this segment. Eventually E1 Rey could diversify into the food service retail market with the expertise and reputation acquired. Still another option was to focus on exporting cocoa beans, butter, and powder to U.S. processing companies. Other Latin American countries,where competition was not as fierce nor entry barriers as high, could be targeted for couvertures. At the executive committee meeting, couverture exports were brainstormed. One idea was to educate U.S. industrial users about E1 Rey's superior couvertures through some sort of promotional campaign. For instance, E1 Rey could invite leading chefs in the United States to taste its products. The chefs could be invited to Venezuela to visit the plant and discuss the fine points of chocolate making with the company's technical staff. This way, they would be able to see the cocoa plantations, the selection, fermentation and storage processes, and the production process that resulted in the highest quality standards. Another possibility was to participate in annual food industry trade shows. One such show would take place in Miami in mid-1994. Most of the country's top chefs were attending. The idea was for influential chefs to endorse E1 Rey's couvertures as products comparable to the finest couvertures in the world. Another idea involved positioning the company's image: There was this small company in Venezuela called E1 Rey. Unknown to the world, a group of chocolate fanatics (The Kings of Chocolate) were producing mind-boggling chocolates and couvertures; at long last, their couvertures were reaching international markets. Last, there was a talk of providing intermediaries with initial discounts of up to 20% on list prices. Discounts would be passed on to customers, motivating them to buy El Rey couvertures. If the food service market was targeted, it would probably be necessary to organize a distribution network capable of supplying top confectioneries, hotels, and restaurants. According to Sales and Marketing Management, high-income consumers were heavily concentrated in New York, Los Angeles, San Francisco, Boston, Chicago, Philadelphia, the District of Columbia, Dallas, Atlanta, and Minneapolis. There were also high-income enclaves served by fine restaurants, pastry shops, and confectioneries in cities such as New Orleans, St. Louis, Chocolates El Rey: Export Strategy Seattle, Miami, and Denver. There were seasonal tourist resorts geared toward high-purchasing-power customers in Palm Beach (Florida), Aspen (Colorado), or Hilton Head (South Carolina). The debate over the options extended well into the night. Mr. Redmond asked the executive committee to reach a consensus over the weekend about the best export strategy for U.S. markets. He emphasized that the strategy should fulfill the strategic vision that had taken so much effort to define. If couvertures were exported, at least 500 MT should be profitably sold in 1994 and twice that much in 1995. By the end of the century, couverture exports could reach between 5,000 to 8,000 MT. Although the dreams and aspirations of many people were involved in this project, the strategy would have to be based on an objective and rational analysis. Mr. Redmond would submit the consensus strategy to major stockholders at the upcoming Board meeting so that if approved it could be implemented immediately. Mr. Redmond was well aware that the Board would ask many difficult questions. References Food and Agriculture Organization, Production Yearbook and Trade Yearbook, Food and Agriculture Organization, Rome, 1994. Rivas, Luis M., Produccion de Cacao, Proyecto Venezuela Competitiva, vol. 6, Ediciones IESA, Caracas: 1994. Appendix The World Cocoa Industry Figure A-1 summarizes the main steps involved in producing cocoa and its by-products. Cocoa liqueur is pressed into cocoa torte, then ground to make cocoa powder. Food processors utilize the powder as a flavor additive in cakes, ice cream, chocolate-flavored beverages, cookies and biscuits. Couvertures are employed in making cakes, desserts, and candy. Cocoa butter is produced by heat pressing or chemically extracting cocoa paste from peeled, roasted, stripped, and germfreed seeds. Pressed cocoa butter contains natural and powerful antioxidants that make it one of the more stable fats. Refined cocoa butter is softer and especially suited to make the finest quality couvertures. However, refined cocoa butter has a shelf life of only 3 months, even if it is kept under ideal conditions, at a constant temperature of 14°C. To extend its life, cocoa butter is mixed with unrefined cocoa butter. Chocolate is produced by blending cocoa butter with cocoa liqueur, sugar, and other ingredients such as milk, vanilla, and nuts. According to FAO statistics, in 1991 eight countries supplied 87% of the world's cocoa bean production (Table A-l). In that year, the worldwide cocoa trade increased to approximately 1.779 million MT or $2,141 million. Cocoa produc- J Busn Res 1997:38:35-45 43 Production Pmcus for Chocolm and By-Products I I I ,~, + Liqueur extraction NdudlzJlon & clehurnidl~ion + ] I Exlnctio. of cocoa buttw & fat + Cocoa powder , I-=-- I Figure A-1. Production Process for Chocolate and By-Products. tion was expanding and Asian producers were increasing their share of market by means of intensive farming of ordinary cocoa beans whose yield per hectare was three to five times that of specialty cocoa beans produced in Latin America. Asian producers were also achieving substantial quality improvement and efficiency in cocoa processing. Cocoa bean prices had reached historic lows. Although world prices were expected to rebound slightly, prices were expected to remain low. In 1990, world trade in cocoa powder had risen 322,000 MT and was valued at $354.5 million. In descending order, Holland, Brazil, Germany, and the Ivory Coast were the main exporters of cocoa powder. In addition, 163,000 MT of cocoa paste were exported for a total of $296.3 million. The chief exporters of cocoa paste were Brazil, Colombia, Holland, and Germany. These countries were also world leaders in the cocoa butter trade. Worldwide cocoa butter exports had totaled Table A-1. World Cocoa Production, 1991 Country Ivory Coast Brazil Ghana Malaysia Indonesia Nigeria Cameroon Ecuador Venezuela Rest of the world World Total Source: Yearly Production (thousands of MT) 750 291 240 220 185 110 95 90 17 269 2,267 Commodity Yearbook, Food and Agriculture Organizatioin, Rome, 1993 44 J Busn Res 1997:38:35-45 L.V. Dominguez and M. Cirigliano Table A-2. Selected Features of Main Specialty Cocoa-Importing Countries Specialty Share of Per Capita Cocoa Specialty Cocoa Chocolate Imports in Total Consumption (thousands Country Imports (kg) of MT) (%) United States Germany Japan United Kingdom Switzerland 4.6 6.7 1.4 8.0 10.0 38.0 8.1 0.3 2.6 1.8 14 4 12 2.4 8 • • • 364,300 MT and were valued at $1.2 billion. World chocolate sales reached 1,235 thousand MT and were valued at $4,206.3 million (Food and Agriculture Organization, 1994). Like coffee and grape growing, high-quality cocoa production requires very specific combinations of chemical soil composition, temperature, sunshine, and rainfall. Also, beans must be carefully selected. Planting, harvesting, grading, and storage are just as crucial. World markets make a distinction between two basic cocoa types: ordinary cocoa, and specialty or aromatic cocoa. The difference is based on aroma, flavor, purity, size, and degree of cocoa bean ripeness. The bean's quality and variety determine its application. Ordinary cocoa beans are used in chocolate products for the mass market. Specialty beans made up less than 5% of the world's cocoa trade. Their share of world markets had decreased gradually because of several factors. Trees had lower yields per hectare, were more prone to disease, and required a more sophisticated grading and storage process. On the other hand, large food processing companies needed a stable and dependable supply to strictly control flavor and production formulas. For many mass-consumption products, such as filled milk chocolate bars, high-quality cocoa beans were not considered necessary. Specialty beans were blended with ordinary cocoa to achieve desired flavors and aromas. As a result, specialty cocoa was mostly used to prepare couvertures, fine chocolates, and delicacies requiring cocoa beans with specific characteristics. The United States, Germany, Japan, Switzerland, France, and the United Kingdom, in that order, were the main markets for cocoa and cocoa by-products. Table A-2 summarizes selected indicators for those countries. According to industry experts, cocoa and cocoa by-product demand was increasingly concentrated as a result of the consolidation and globalization of the food processing industry. The following companies were acknowledged as world leaders in manufacturing mass consumption chocolate products: • Nestl~ was the world's leading chocolate producer, with its own bean grinding and processing capacity. It was also the chief cocoa bean buyer in the world. Its annual purchases exceeded 250,000 MT. • Rowntree, a British company, specialized in filled choco- • • late bars and chocolate-coated cookies. These products were mostly targeted at European markets. It annually purchased approximately 250,000 MT of cocoa beans. Jacobs Suchard, a Swiss company owned by Phillip Morris since 1990, was acquiring world brands to increase its share of the market. These brands included E.J. Brach in the United States, COte d'Or in Belgium, and Leonard Monheim in Germany. Its total cocoa bean purchases bordered 250,000 MT. Cadbury Schweppes, also from the United Kingdom, specialized in chocolates and sweets. Through its acquisitions and its own brands it reached 110 countries. Its cocoa bean purchases totaled 95,000 MT. Hershey Foods, from the United States mostly focused on the U.S. market. In the United States, it controlled almost half the chocolate market through renowned brands. It also ground 30% of the cocoa consumed in the United States. Its annual cocoa bean purchases rose to 145,000 MT. Mars, with a share of approximately 30% of U.S. chocolate markets, was Hershey's main competitor. It also had operations running throughout the world. Its annual cocoa bean purchases were approximately 220,000 MT. Finally, the Japanese market was supplied through its famous sogo shosha, or trading companies. Large multinational corporations did not buy directly from cocoa producers. They channeled their purchases through large traders such as Man Cocoa, General Cocoa, and Walter Matter. Traders in turn bought from cocoa processors in the producing countries. Processors could either be private companies, producer associations or government entities and marketing boards handling cocoa storage, processing, and marketing operations. Processing companies paid farmers according to world reference prices. In the case of specialty cocoas, it was possible to obtain a premium or bonus that was largely passed on to the growers. Premiums that had once reached $400/MT rarely exceeded 12% to 15% of the world reference price, which was approximately $900/MT in the early 1990s. The size of the premium depended on the country's capacity to control the quality of its cocoa varieties. Worldwide, there were four major types of cocoa grades: Forastero, Criollo, Trinitario, and Nacional. Forasteros made up 80% of world production. The best known varieties were West African and Far Eastern. The eastern portion of Venezuela produced three varieties of Forastero known as Carenero Superior, Caracas Natural, and Rio Caribe, all considered in world markets as specialty cocoas. Criollo cocoa was a specialty cocoa originating in Mexico's rain forest and the Central American isthmus. The color of its shell ranged from dark ivory to light brown, with a sweet and delicate flavor arid distinctive aroma. The better-known varieties of Venezuelan Criollos were Porcelana, Chuao, Puerto Cabello, and Carupano. These were grown in the vicinity of Lake Maracaibo and in the central coastal region East of Caracas, known as Barlovento. None of these Chocolates El Rey: Export Strategy varieties had been successfully grown in other countries. Trinitario was a brown, long-bean cocoa, a hybrid of Forastero and Criollo. It took its aroma and flavor from the Criollo and its resistance to disease and its productivity from the Forastero. Much of Venezuela's cocoa were Trinitario varieties. Pure Criollos, on the other hand, were mostly planted close to their place of origin, in the western portion of Venezuela. Finally, a cocoa variety known as Nacional, of a light brown color, long beans, and pleasant aroma, was chiefly concentrated in the western Andean region. It was a much sought-after variety in Europe, but like the Criollo, it was prone to disease and very difficult to grow. This cocoa type was not produced in Venezuela. The approximate mix of Venezuela's specialty exporting cocoa varieties, by volume, were: J Busn Res 1997:38:35-45 Carenero Superior Rio Caribe Puerto CabeUo, Chuao, Ca~pano, Choroni, Sur del Lago, etc. 45 55% 27% 18% Each of these cocoa varieties had distinctive qualities that made them more suitable for certain applications. Also, the amounts of other ingredients such as vanilla, milk, and sugar, defined the product type. For instance, E1 Rey used Carenero Superior to prepare a milk chocolate with 35% cocoa (other companies in the industry used 20% or less). It employed 55% cocoa for semi-bitter chocolates and 75% for extra-bitter. Many considered the extra-bitter as the best chocolate for couvertures, with an even more "European" flavor. For example, extra-bitter bars were especially suited for certain baked desserts and other top Italian delicacies such as tiramisu.