Why This Chocolate Maker Doesn't Fear the Threat of Private Labels
According to a 2012 research report, Rabobank expects U.S. private-label penetration to hit 25%-30% in the next decade. However, not all branded product categories are equally at risk; one that's not is chocolate. Despite the fact that the private-label category is gaining momentum, chocolate producer Hershey boasts a remarkable financial track record.
Notwithstanding the 2008-2009 global financial crisis, Hershey has increased its revenue in every single year for the past 10 years. It was also profitable and free cash flow positive during the same period. To understand the reasons behind Hershey's success, it is worth comparing chocolate with other consumer products such as sodas and tissue paper.
Chocolates versus sodas
While the U.S. carbonated soft-drink (CSD) volumes continue to fall because of increased health consciousness, the market shares of the top branded soda companies have been incredibly stable. Coca-Cola and PepsiCo have a combined 70% share of the market, while the largest private-label soda company in the U.S., Cott, only boasts a 4.7% market share as of 2012.
This is very similar to the industry structure for chocolate makers. The two branded U.S. confectionery players Hershey and Mars had 60% of the market share in 2013, while private-label penetration was low at only 3.2%. Based on the results of a 2012 poll conducted by Harris Interactive, eight of the top-nine U.S. chocolate brands are manufactured by either Hershey or Mars. In addition, Hershey's Kisses chocolate candy was ranked as the top chocolate brand for the fifth time in eight years. Such consistency speaks volumes about the intense loyalty that chocolate lovers have for their favorite brands.
The best case study of such brand loyalty behavior is New Coke. When Coca-Cola launched a reformulated version of its coke in 1985, there was an uproar among Coca-Cola fans. Coca-Cola had to reintroduce its classic Coke within months, showing that old habits die hard when it comes to your favorite drink or snack.
Chocolates versus tissue paper
In contrast to chocolates and soda, tissue paper is experiencing high levels of private-label penetration, and Orchids Paper Products , a leading manufacturer of private-label tissue products, is a key beneficiary. Private-label penetration for bath tissue increased to 23.2% in 2013 from 15.4% in 2012; private-label paper towels market share rose from 18% to 31.4% over the past decade. Over the same period, Orchids Paper has more than doubled its revenue and operating margin.
The key reason for the high private-label penetration in tissue products is that consumers aren't willing to pay more for tissue paper, unlike chocolates. Hershey's history of price increases is an indication of the pricing power that chocolate producers enjoy. In 2011, it announced a weighted average 9.8% increase in wholesale prices across its U.S., Puerto Rico, and export chocolate and sugar confectionery lines. Prior to that, a 3% price increase over Hershey's entire domestic product line was announced in 2008.
Firstly, quality matters more in the case of chocolates. As long as tissue papers meet the minimum strength and absorbency requirements, people aren't particular about the brands. However, chocolate tastes vary widely.
Secondly, chocolates are bought with discretionary dollars; while tissue paper products are consumer staples needed at home. Since consumers spend their loose change on the sweet things, they are less sensitive to price.
Thirdly, since a significant part of the monthly budget is spent on replenishing bath tissues, paper towels, facial tissues, and napkins, consumers are price conscious. In comparison, chocolates don't cost a bomb on average but deliver high benefit-to-cost ratios in the form of enjoyment and satisfaction.
Foolish final thoughts
It would be a mistake to avoid all consumer packaged-goods companies because of fear of private-label substitution. Hershey is one good example of a successful branded products company benefiting from brand loyalty and strong pricing power.
What would Buffett do?
Warren Buffett has made billions through his investing and he wants you to be able to invest like him. Through the years, Buffett has offered up investing tips to shareholders of Berkshire Hathaway. Now you can tap into the best of Warren Buffett's wisdom in a new special report from The Motley Fool. Click here now for a free copy of this invaluable report.
The article Why This Chocolate Maker Doesn't Fear the Threat of Private Labels originally appeared on Fool.com.Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola. The Motley Fool owns shares of Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.