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Hershey's is North America's largest chocolate producer and confectioner. The company holds about a 40% market share in the United States chocolate market behind brands that are household names like Hershey's, Reese's, and Hershey's Kisses^[1]. In fiscal 2007, Hershey's generated $4.95B in revenue and $458M in operating income^[2].

Hershey's is struggling to reverse a deterioration of its financial performance since FY 2004. Rising costs are a particularly difficult challenge for Hershey's; in 2007 commodity cost increases totaled $100 million and lowered gross margins by 2.4%^[3]. The company is particularly vulnerable to market prices for key ingredients like cocoa, corn sweeteners, sugar and peanuts- each of which is up 20% to 45% since the beginning of 2008^[4]. In response, the company has raised domestic wholesale prices twice in 2008 which may result in a loss of market share to competitors like Mars-Wrigley's and Cadbury^[5].

Hershey's heavy concentration in the U.S. market (85% of sales) is another challenge as the American economy languishes and growth in the U.S. Chocolate market slows^[6]. Hershey's is boosting marketing spending by 40% over 2008 and 2009^[7] to grow its lagging revenue in this key market. Hershey's has also turned to the rapidly growing premium and dark Chocolate segments but has thus far failed to introduce a formidable product in this segment. Hershey's is also pursuing international growth by teaming up with international players such as Korea's Lotte Confectionary and India's Godrej to extend its reach into untapped Indian and Chinese markets.

Contents 1 Business Overview 1.1 History 1.2 Products 2 Trends and Forces 2.1 Rising Commodity Costs Pressuring Margins 2.2 Growing Global Demand Makes International Expansion Attractive 2.3 Premium and Dark Chocolates are Fast Growing Segments 2.4 Competitive Pressure Calls for Higher Ad Spending 2.5 Restructuring Initiative Promises Increased Savings 3 Competition 4 References

[edit] Business Overview

[edit] History

In 1894, Milton S. Hershey founded the Hershey Chocolate Company as a subsidiary of his Lancaster Caramel Company. In 1900, he sold the prosperous Lancaster Caramel Company but retained the Chocolate business. He used the proceeds from the sale to acquire almost 40,000 acres of land northwest of Lancaster, Pennsylvania with a vision to create a community based around Chocolate production.

In 1905, Hershey completed his factory which was designed to mass produce Chocolates. The Hershey’s Chocolate bar became the first nationally marketed product of its kind and put the company on track for success. The next product, Hershey’s Kisses, introduced in 1907, went on to become one of the most successful and well-known products ever produced by the company.

The Hershey Chocolate Corporation went public in 1927 and since then has grown both organically and through mergers and acquisitions, most notably that of Reese’s in 1963. The corporation changed its name to Hershey Foods Corp. in 1968 and finally to The Hershey Company in 2005.

The Hershey Trust Company inherited the most of Milton Hershey’s assets including the majority of voting rights in the Hershey Chocolate Corporation. To this day, the trust controls 79 percent of the voting rights and has 31 percent ownership of Hershey's. Efforts to sell off its holdings in 2002 generated strong resistance and led to the forced resignation of 10 out of 17 Trustees. In Hershey's latest controversy, the Trust forced the resignation of eight of Hershey's ten board members due to sagging profits and disagreements with the company's managing team.

[edit] Products

Hershey’s primarily makes cocoa for the production of chocolates, candies and other confectioneries. With 90% of its sales in North America^[8], Hershey's production facilities are primarily located in the U.S., Mexico and Canada. Beyond production, Hershey's offers its products through a variety of distribution channels including wholesale distributors, chain grocery stores, mass merchandisers, chain drug stores, vending companies, convenience stores, dollar stores and department stores^[9]. In 2007, Hershey's business with the McLane Company, distributor to Wal-Mart accounted for 26% of net sales^[10]. Hershey's products are available in over 2 million retail outlets worldwide.^[11]. Hershey's offers products in several categories:

Chocolates:

• Hershey’s
• Reese’s'
• Hershey’s Kisses
• Milk Dud
• U.S. licensing of Nestle's Kit Kat

Premium Chocolates:

• Cacao Reserve
• Joseph Schmidt
• Dagoba

Refreshment products:

• Ice Breakers
• Breath Savers
• Bubble Yum

Chocolate confectionary products account for roughly 73 percent of Hershey's revenues. Though Hershey’s products are sold in over 90 countries, sales outside of the United States account for just 15% percent of total revenues^[13]. Hershey’s is pursuing joint ventures and partnerships, most notably with Korea's Lotte Confectionery and India's Godrej, to expand it's global reach.

[edit] Trends and Forces

[edit] Rising Commodity Costs Pressuring Margins

Rising commodity costs are putting negative pressure on Hershey's operating margins. Hershey's is particularly sensitive to the prices of commodities like cocoa, milk and sugar which are all key ingredients in Chocolate making. Since the beginning of 2008, prices for key ingredients like cocoa, milk, sugar and peanuts are all up 20% to 40%^[15]. These rapid price increases show no signs of abating as Hershey's predicts commodity prices will increase twice as fast in 2009 compared to 2008^[16]. Commodity costs are having a substantial impact on Hershey's operating margins. In FY 2007, the company reported operating margins of 9%, almost half its five-year average of 17%^[17]. Hershey's combats increasing input costs with a combination of price increases and various hedging strategies. In 2008 alone, the company has twice raised wholesale prices^[18].

[edit] Growing Global Demand Makes International Expansion Attractive

Huge markets in China, India and other developing countries also present a big opportunity for Hershey's. Chocolate sales in China have doubled to $813 million over the last five years while India's chocolate sales have risen 64% over the same period^[19] Hershey's has tried to move into these markets with through joint ventures with Lotte Confectionery of South Korea and Godrej in India. Still, with 90% of sales within North America, international expansion remains a big opportunity.

[edit] Premium and Dark Chocolates are Fast Growing Segments

As the U.S. chocolate market matures, Hershey's is seeking out new avenues for growth. Premium and dark chocolate are two rapidly growing segments of the chocolate market. U.S. premium chocolate sales grew 129% from 2001 to 2006 while dark chocolate sales increased 49 percent to $1.88 billion between 2003 and 2006^[21], much faster than the overall chocolate market. Dark chocolates are gaining popularity due to their newly perceived healthiness; studies have shown that dark chocolate has antioxidant properties and may provide cardiovascular benefits^[22]. Hershey's has taken advantage of this trend by introducing it's own dark chocolate products, Extra Dark and Cacao Reserve, as well as acquiring smaller premium chocolate companies such as Dagoba and Joseph Schmidt^[23].

[edit] Competitive Pressure Calls for Higher Ad Spending

For years, Hershey’s has consistently reduced advertising and marketing of its core brands; in 2001 marketing spending accounted 4.5% of sales compared to just 2.2% of sales in 2006^[24]. At the same time, both Mars and Néstle have increased their advertising budgets aggressively; the new Mars-Wrigley merger promises more of the same. The graph below shows Hershey’s advertising spending as a percentage of the advertising spending in the whole industry. During the same period Hershey’s has increased its market share with the introduction of new products, sales promotions and brand extensions. Due to the high-impulse nature of confectionery sales (67% of adults purchase chocolate at the urge of a chocolate craving^[25]) and consumers’ desire for new products this strategy had worked well for the company. Increased pressure from competitors, however, is now forcing the company to reverse its trend of lower ad spending. Especially concerning for the firm is the juggernaut created by the Mars-Wrigley merger - in response, Hershey's is boosting its ad spending by 40% over 2008 and 2009^[26].

[edit] Restructuring Initiative Promises Increased Savings

Hershey's lags behind its competitors in terms of operating margins. While traditional margins in the packaged food and Chocolate industry have been around 25 percent, Hershey's margins are below 20 percent.

In order to expand margins, Hershey's is undertaking a $525-$575 million supply-chain restructuring plan. As part of its "Global Supply Chain Transformations" the company will reduce production lines, outsource the production of many of it's low value-added products and build a new cost effective facility in Mexico. The company expects to save $180 million annually by 2010 if this plan is implemented properly. Hershey's has indicated that this initiative would lead to greater manufacturing flexibility and allow the company to support its strategy to penetrate into new markets^[27].

[edit] Competition

Hershey’s enjoys the largest share of the US Chocolate market and is the leader in both single-serve and bulk (boxes/large bars/bags) Chocolate products. For years Masterfoods (Mars) has been Hershey's closest rival which owns well-known brands such as Mars, Snickers, M&M's, Milky Way and Twix. In April 2008, Mars announced the $23B acquisition of Wrigley. The tie-up creates a confectionery giant combining many stable of brands with global distribution^[28]. The new Mars-Wrigley could pose a serious threat in Hershey's core North American market.

Hershey’s recently acquired the upscale brands Joseph Schmidt (November 2005) and Dagoba (November 2006). This move reflects Hershey’s plan to expand into premium Chocolates, i.e. Chocolates which sell for more than $7 per pound. This also puts Hershey’s into head-to-head competition with brands such as Toblerone, Ferrero Rocher and Lindt.

The threat of competition in North America from powerful global confectionary companies such as Néstle and Cadbury Schweppes is effectively mitigated through Hershey’s licensing agreements. In the case of Néstle, Hershey's owns exclusive US licensing rights to Kit Kat – one of Néstle strongest brands. Without the Kit Kat platform it will be difficult for Néstle to gain a competitive edge in the US market. Hershey’s also owns the US licensing rights to all the Cadbury brands thus preventing Cadbury from entering the US market.

[edit] References

1. ↑ Hershey's 2007 10-K 1. Business- Products
2. ↑ WSJ Hershey's Annual Income Statement
3. ↑ HSY 2007 10k- Item 7. Management's Discussion of Financial Results
4. ↑ WSJ.com Hershey, Again, Raises Prices To Help Offest Higher Costs
5. ↑ WSJ.com Hershey, Again, Raises Prices To Help Offest Higher Costs
6. ↑ Chocolate-cx_sy_0208feat_ls.html
7. ↑ Hershey Posts Higher Profit As Costs Rise
8. ↑ Hershey's 2007 10K- Item 1. Business- Reportable Segment
9. ↑ Hershey's 2007 10K- Item 1. Business- Customers
10. ↑ Hershey's 2007 10K- Item 1. Business- Customers
11. ↑ Hershey's 2007 10K- Item 1. Business- Customers
12. ↑ Morningstar HSY Analyst Report
13. ↑ Morningstar HSY Analyst Report
14. ↑ International Cocoa Organization
15. ↑ WSJ.com Hershey's Raises Wholesale Prices Again
16. ↑ WSJ.com Hershey's Raises Wholesale Prices Again
17. ↑ WSJ.com Hershey's Raises Wholesale Prices Again
18. ↑ WSJ.com Hershey's Raises Wholesale Prices Again
19. ↑ Motley Fool- Chocolate in Asia: A Very Sweet Megatrend
20. ↑ Mintel U.S. Chocolate Confectionery Report
21. ↑ Boston Globe- U.S. dark chocolate sales soar on health benefits
22. ↑ Boston Globe- U.S. dark chocolate sales soar on health benefits
23. ↑ Boston Globe- U.S. dark chocolate sales soar on health benefits
24. ↑ Morningstar HSY Analyst Report
25. ↑ Mintel U.S. Chocolate Confectionery Report
26. ↑ Hershey Posts Higher Profit as Costs Rise
27. ↑ Hershey's 2007 10-K Item 7. Management's Discussion- Business Realignment Initiatives
28. ↑ New York Times- Mars to Buy Wrigley's for $23B
29. ↑ Mintel U.S. Chocolate Confectionery Report
30. ↑ ^{30.0 30.1} 2007 CBY 20-F:Pg F-3
31. ↑ ^{31.0 31.1} 2007 CBY 20-F:Pg F-21; Pg 11
32. ↑ ^{32.0 32.1} 2008 CZZ 424B3: Pg F-5
33. ↑ 2008 CZZ 424B3: Pg F-34
34. ↑ ^{34.0 34.1} 2007 HSY 10-K: Pg 55
35. ↑ ^{35.0 35.1} 2007 TR 10-k: Pg 12
36. ↑ 2007 TR 10-k: Pg 20
37. ↑ ^{37.0 37.1} 2007 WWY 10-K:Pg 49

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