Candy makers face high prices for cocoa, so get creative

There are pricing pressures gripping a certain corner of global agriculture – and it's bittersweet.

Cocoa prices have more than tripled over the past year, creating a major headache for candy makers and other food companies that use the ingredient to make chocolate.

In recent years, the price of cocoa has hovered around $2,500 per metric ton. But reports of a weaker-than-expected crop have raised concerns about supply, sending prices for the commodity higher in recent months. Cocoa reached an all-time high of more than $11,000 per metric ton in April. Since then, the price rise has eased slightly, but the yield is still far more than what food companies used to pay.

Currently, many of the largest candy companies — HersheyMars, maker of M&Ms, owner of Kinder Ferrero, and parent of Cadbury Mondelez – They are likely to be protected from rising cocoa costs, thanks to long-term contracts that lock in the prices they pay for the commodity to protect them from events like this. This gives them some time to deal with the issue. But by 2025, they will likely end up paying more for cocoa.

“This absolutely impacts the ways these companies do business, just because the cost impact is so incredibly significant,” said Steve Rosenstock, head of consumer products at Clarkston Consulting, which advises clients on how to deal with problems like this. High cost of cocoa.

Mars declined to participate in this story. Mondelez, Ferrero and Hershey did not respond to CNBC's requests for comment.

West Africa, which produces the majority of the world's cocoa supplies, has been hit by crop diseases and falling prices paid to farmers at the point of sale, called farm-gate pricing, which prompt them to grow more profitable crops such as rubber instead of cocoa. This season's cocoa crop is expected to face the largest deficit in at least six decades, according to a Rabobank report issued in May.

Reuters reported on Wednesday that Ghana, the second-largest cocoa producer, is looking to delay deliveries of up to 350,000 tons of beans for next season, sending prices soaring again.

On recent earnings calls, executives from Mondelez and Hershey said they believe market speculation is driving at least some of the rise in cocoa prices. It is possible that prices will fall in September, once more information is available about the new crop, but this does not mean that they will return to normal.

The rising cost of this commodity comes at a difficult time for many food companies. Over the past two years, many have been raising prices to deal with inflation affecting a wide range of goods. As a result, shoppers are becoming more selective about what they buy and more dissatisfied with the prices they see in grocery stores. Consumers' focus on value leaves candy companies little room when it comes to pricing to deal with the rising cost of cocoa.

Then there's deflation, a buzzword that has entered the average person's vocabulary over the past couple of years. Companies will reduce the quantity or weight of the product while the price remains the same. But consumers are getting wise to this trick. A YouGov poll in October showed that 72% of US respondents noticed a shrinkage in food products.

As a result, many companies will have to become more creative.

Johnson & Johnson snack foods CEO Daniel Wachner has been monitoring cocoa and chocolate prices. The company owns brands including Dippin' Dots, SuperPretzel and Hola Churros and makes products for other companies, such as Subway's footlong churro. Chocolate is a popular flavor in its portfolio, which includes desserts like chocolate-filled churros.

“It won't stop us from using chocolate, but it will make us think and say, 'Now, if we make this innovation at this new price, will it be salable?'” And then when we sell it, “is it at a low enough cost that the customer can sell it and still make a profit?” Good margin?’” Fashner told CNBC in May.

One hypothetical solution, suggested by Fachner, could involve reducing the number of chocolate chips from 12 to nine in a given product. He also said that Johnson & Johnson is looking into any potential alternatives that could work for some of its recipes.

RBC Capital Markets analyst Nick Moody cited Hershey's new Jumbo Reese's Cup as one creative solution.

“These have extra peanut butter, so it's a nice way to try to bring innovation to the market at a premium price, and make the consumer feel like they're getting value, but just changing the product itself to reduce reliance on chocolate,” he said.

For food companies that don't primarily deal with chocolate, they may start to avoid flavor, especially when it comes to new products.

“I think people will, more or less, try to stay away from chocolate at this point,” Modi said.

While the spike in cocoa prices this year is historic, it likely won't be the last time food companies find themselves paying more for the commodity. Analysts are already predicting another cocoa shortage next year, although it is likely to be less dramatic than this season.

However, systemic issues, such as government-controlled farm-gate pricing and climate change, are likely to continue to hurt the bean crop. In addition, the use of child labor and slavery on cocoa plantations in West Africa has led to lawsuits and scandal for candy companies.

In the long term, this means that many companies will have to look for more sustainable solutions. In some cases, this may mean alternatives to cocoa.

“There are examples where companies are increasing the amount of non-cocoa additives, like sugar, and more economical things like cocoa butter equivalents, shea butter, palm oil, coconut oil, those types of things,” Rosenstock said.

It takes about nine months on average to reformulate a recipe, according to a research note published Thursday from Bank of America Securities analyst Antoine Prévot. He said he believes FMCG companies have been looking to change their formulas since the start of this year, meaning the new candy could start flowing as soon as August.

There are more extreme alternatives, too. Startups like Voyage Foods and Win-Win have created cocoa-free chocolate using alternatives like grape seeds and legumes.

At least one candy company doesn't plan to make any major changes to its formulas.

“We will reduce costs, but we will not change recipes or do things that are not necessarily the right thing for the company in the long term,” Luca Zaramella, Mondelez's chief financial officer, said June 4 at a Deutsche Bank conference.

There is also the possibility of diversification with other types of snacks. When Kraft was spun off from Mondelez more than a decade ago, it already had Triscuit, Sour Patch Kids and Wheat Thins snacks, as well as Milka, Oreo, Toblerone and Chips Ahoy chocolate products.

Other candy companies followed suit, adding more salty snacks to their lineups to achieve further growth. For example, Hershey bought Amplify Snack Brands in 2017, added SkinnyPop to its portfolio, and Dot's Homestyle Pretzels in 2021.

“I don't think they did it to be less dependent on cocoa — they did it to react more easily to fluctuations in consumer trends and to be able to diversify their portfolio,” Rosenstock said. “But being able to lean into some categories other than chocolate, whether it's salty snacks or jelly beans or gummy products, I think that's a good way to combat the cocoa crisis.”