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MANAGING COSTS

A Chocolate Maker is Buffeted By Global Forces Beyond His Control
 

How long can he stay profitable?
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If you think the life of a chocolatier sounds like heaven, you had better check in with Dan Johnson, owner of Choco-Logo, a maker of gourmet chocolates in Buffalo. Johnson's travails began in 2006, when two of his wholesale chocolate suppliers persuaded him to forgo fixed-price contracts in favor of shorter-term variable-price contracts. Bad move. No sooner had Johnson switched than wholesale chocolate prices began soaring; they rose 35 percent in a year. To make matters even worse, sugar and milk prices were also sky high. Given Johnson's margins of less than 10 percent, his rising costs were making it tough for him to make a buck. With some astute cost cutting, he managed to stay profitable in 2007. But 2008 is turning out to be an even tougher year.

Johnson is no newcomer to the chocolate business. In 1983 he co-founded Lake Champlain Chocolates, one of the first U.S. makers of truffles and other epicurean chocolates. From there, he signed on as head chocolatier at Choco-Logo, in 1989. A year later, he bought the struggling business from its founders.

For the next 15 years, Johnson steadily built up the company, from low-six-figure revenue to nearly $1.4 million in annual sales today. Head count at Choco-Logo grew from four in 1989 to about 23. Like most chocolate makers, Choco-Logo depends on bulk chocolate, which it then reformulates into its upscale product. The company's annual wholesale chocolate purchases rose from less than 10,000 pounds in 1989 to more than 60,000 pounds today.

To keep Choco-Logo growing in a competitive market, Johnson relied on a combination of premium ingredients and savvy marketing, as well as a focus on service. An early player in the niche market for logo chocolates, Choco-Logo provided corporations like General Electric with logo-bearing chocolates for use as marketing tools and supplied retailers such as Bloomingdale's and Williams-Sonoma with high-end chocolates bearing their own brands.

Even as heavyweights like Hershey's entered the logo business, Choco-Logo was able to thrive. A sophisticated in-house packaging and graphics design team turned around custom package designs within a matter of hours, and the company shipped orders by air in 24 hours. Johnson also forged celebrity connections to keep new buyers calling. Rocker Jon Bon Jovi contracted Choco-Logo to create a chocolate to be sold as an exclusive product on his website for about $35 a pound. And 750 tins of Choco-Logo salty chocolate turtles were among the items served at former President Bill Clinton's 60th birthday bash, in October 2006. The company's website also scored marketing points by offering its chocolates for sale on behalf of various charities, like Help USA, a national nonprofit for the homeless.

Choco-Logo's steady growth persuaded Johnson, in 2003, to spend $350,000 to purchase and renovate a larger factory building in downtown Buffalo, more than doubling his total square footage and allowing the addition of a retail store.

Then, in late 2006, Johnson's world changed. Rumblings of price increases for chocolate were coursing through the confectionary industry. Adverse weather and then a cocoa workers' strike in Western Africa, which supplies about two-thirds of the world's cocoa beans, reduced supply and helped sharply push up prices. Although cocoa production has since picked up, the International Cocoa Organization anticipates periodic global shortfalls of the commodity, the result of increased demand from consumers as well as a shift in tastes toward darker chocolates, which require a higher amount of cocoa per ounce to produce. These tandem trends are likely to keep cocoa prices climbing throughout 2008. "Prices didn't go up at all for a long time, and then it was almost like they started going straight up," says Johnson. As other chocolates businesses started to fail, he knew he had to act.

None of Johnson's options seemed very good. He could have opted for lower quality chocolate blends, but that risked undermining Choco-Logo's reputation. He could have spent more time shopping around for lower-priced wholesale chocolate, but that is a time-consuming process fraught with risk, because batches of wholesale chocolate can vary widely in quality. Some other cost-cutting options included using less expensive packaging materials and reducing the size of each box of chocolates -- an age-old tactic in the industry that could have backfired if customers perceived Choco-Logo was cutting corners. Alternatively, Johnson could have started phasing out retail private-label customers, the least profitable segment of his business and the one with the least pricing flexibility. Finally, Johnson could have increased his prices and hoped customers would go along.

The Decision Johnson opted to pursue a number of these strategies to keep his company profitable. He switched most of his wholesale purchases to a premium American chocolate maker whose prices, thanks to the falling dollar, run about 25 percent lower than Johnson's European suppliers. But he kept buying some chocolate from his previous suppliers to experiment with creating new blends. "I called all the chocolate companies and asked them to send us samples so we could figure out a blend that worked," says Johnson. "It was almost like making our own wholesale chocolate." He also scored big by finding a large supply of reduced-price chocolate on the spot market for $1.25 per pound; the going rate is as high as $2 per pound.

As a further cost-cutting step, Johnson decided to switch to cheaper packaging materials, slicing an extra percentage point off his costs. More potentially controversial was his decision to cut his package weight by 1 or 2 ounces for some products.

Those three steps reduced his costs from 5 percent to 7 percent, allowing the company to barely stay profitable. Not a bad outcome, given that Choco-Logo's reputation appears unscathed, as evidenced by steady 10 percent annual sales growth. "I've got no complaints," says Johnson. "People who buy Choco-Logo products are looking to buy quality. They are not going to be worried if the package is an ounce or two lighter."

So far, so good. Yet with cocoa prices still on the rise, Johnson could be in a real bind. Following last year's decision to cut the weight of some boxed chocolates, Johnson is now slicing his chocolate bars for the corporate logo market from 2.3 ounces to 1.9 ounces. He wants to avoid damaging his upscale image, so further cuts on packaging quality are out. Instead, Johnson is taking a strategic approach by focusing on the corporate logo business, where margins are highest. He's revamping and redesigning his website and plans to hire at least one new sales rep. And yes, Johnson says he will probably raise prices in 2008. It's a classic candy business move. When times get tough, the bars get smaller and the price goes up.

The Experts Weigh in

Get creative

Johnson applied obvious remedies. He could have expanded sales channels to add more profitable product lines. He could have added more chocolate-coated products that cost less to produce than solid chocolates. He could have branched out to a branded approach using some guerrilla marketing tactics -- blogs and other new forms of marketing. He could also have offered more size choices to get people to trade up. And if I were going to expand retail, I'd consider kiosks in malls as opposed to leasing real estate.

Gary Karp
Executive Vice President
Technomic
Chicago

Maintain quality

Every chocolate company deals with these problems. Chocolate is a commodity, and price fluctuates. But our margins are considerably higher than Johnson's. He has to make sure he maintains high-quality standards, since one of the biggest mistakes is declining quality as your business grows. So he doesn't want to keep moving his business to various vendors. He should have annual contracts for packaging and chocolate. By doing this he can set up preferential terms and pricing.

Katrina Markoff
CEO and Founder
Vosges Haut-Chocolat
Chicago

Focus on margins

Johnson needs to improve both ends of his business -- revenue and costs. Given his costs and sales, he cannot save his way to prosperity. Still, process inefficiencies generally abound in small manufacturing environments. I would examine these with an eye toward adding one or two percentage points to the bottom line. As for Choco-Logo's corporate sales business, Johnson's instincts are dead-on. Choco-Logo should increase sales efforts to that segment, since it has both large sales potential and high margins.

Julius Walls Jr.
CEO
Greyston Bakery
Yonkers, New York

Last updated: Apr 1, 2008




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