Divine Decadence or Business Turnaround?

The Case of Venezuelan Chocolate

By Rohit Deshpandé and Gustavo Herrero

Photos courtesy of Jorge Redmond

Haga clic aquí para leer en español.

Back in 2006, we became intrigued about a chocolate company in Venezuela. Rohit had done quite a bit of work on companies that were integrating country of origin into their product branding. He called it the Provenance Paradox. As Director of HBS’s Latin America Research Center, Gustavo had collaborated on some of Rohit’s research. There were the case studies of Chilean wine, Mexican beer and Colombian coffee. Gustavo had also worked on Peruvian gourmet cuisine, and Rohit’s coverage expanded well beyond Latin America into subjects such as Indian yoga, Japanese soy sauce, and even Turkish chocolate!.

Our interest in the Venezuelan company resulted in the teaching case Chocolates El Rey that we wrote with Regina García Cuellar, published by Harvard Business Publishing.

When we learned that ReVista was planning to focus its Fall 2020 issue on chocolate, we figured we could share our takeaways from writing the case. We learned that chocolate lends itself to multiple contexts, ranging from romantic aspirations to macro-economic impact. In the middle, there are nutritional, health, gourmet tasting and business aspects that make it an interesting subject on which to write. 

 

A Market Overview

About 50 million people depend on cocoa production for their livelihood, according to the World Cocoa Foundation. The world production of cocoa was 4.78 million tons in 2019. Of this production, more than 75% of beans were grown in Africa, 18% in Central and South America and the Caribbean, and 6% in Asia and Oceania. Just two countries, Ivory Coast and Ghana, accounted for more than 60% of world production. Cocoa beans exports accounted for almost two-thirds of Ivory Coast’s exports. 

But what is interesting is that a profound asymmetry exists between production and consumption. The leading producer countries do not account for the majority of consumption. More than 80% of the world’s cocoa beans are exported from developing nations to industrial countries where chocolate is manufactured. In a clear demonstration of the economic models that prevail with many commodities, value to transform raw materials is added in other countries. The largest importers of cocoa beans were from Europe and the United States: almost two-thirds of exports went into the Netherlands, Germany, the United States, Belgium, France, the United Kingdom and Switzerland. These countries, in turn, exported finished chocolate for $14.8 billion, roughly half of a $29.2 billion trade market. This finishing of the chocolate includes sweetening with sugar, diluting with milk, and of course the mass production processes of packaging and later branding, advertising and mass marketing.

Annual retail sales of chocolate add up to more than $90 billion, with Europe accounting for nearly half of that figure and the United States for over 20%. Chocolate consumption is believed to be a sign of economic development and wealth. Despite producing more than 75% of the world’s cocoa, African consumers only account for 3% of the chocolate that is consumed annually. It is hence unsurprising that most consumers of finished chocolate believe that cocoa originates in Europe, perhaps identifying Switzerland (because of Lindt) and Belgium (because of Godiva). Both of these large firms purchase raw material from other countries because cocoa, for instance, can only grow in the tropics.

 

Venezuelan Cocoa

With a population of 27.5 million people, Venezuela is the 14th largest producer of cocoa beans in the world. Located on the northern tip of South America, bordering the equator, Venezuela enjoys the same warmth and humidity that led to the origin of Kakau (cacao). Its criollo quality stems from the Theobroma cacao tree that grows in its terrain. Contrasted with the forastero quality, criollo is sweeter and less bitter. This makes Venezuelan cocoa highly prized in terms of quality. Cocoa bean quality is further determined by its shape, size, color, flavor and aroma. These attributes result from the quality of the terrain, climate and humidity of the site where it is grown, and to the fermentation and drying processes that follow. Venezuelan cacao has historically commanded a 30% price premium over cacao from other national origins in the world commodity market.

Venezuela’s Gross Domestic Product (GDP) plunged from $483 billion in 2015 to $180 billion in 2019, measured in International Dollars per 2011 PPP prices, because of political turmoil and lower international oil prices. Oil was the country’s largest source of national wealth, to the neglect of other products that used to be healthy contributors to its GDP. Oil got to account for more than 95% of Venezuelan exports and nearly half of the country’s government revenues. Following the crude oil WTI price (WTI, which stands for West Texas Intermediate, is a benchmark for global crude oil)  drop from $145 per barrel in July 2008 to $51 in January 2009, Venezuela’s exports dropped from $95.9 billion in 2008 to $16.5 billion in 2019. President Hugo Chávez had expropriated hundreds of companies, including the largest telephone operator (CANTV) and the capital’s power generator (Electricidad de Caracas), discouraging private investment. Chávez died in 2013 and was succeeded by his appointed Vice-President Nicolás Maduro, who continued his policies. Chávez and Maduro are broadly viewed as representatives of an expression of 21st century socialism, along with other Latin American leaders such as Néstor and Cristina Kirchner of Argentina, Lula da Silva and Dilma Rousseff of Brazil, Rafael Correa of Ecuador and Evo Morales of Bolivia.

On January 23, 2019, the opposition-controlled National Assembly elected Juan Guaidó as the country’s acting President, alleging that Maduro’s 2018 reelection had been fraudulent. Venezuela added an institutional crisis to its already difficult situation: 60 countries, including the United States and most Western European and Latin American nations, recognized Guaidó as the country’s ruling president. The United States, Venezuela’s largest trading partner, instituted an embargo on oil imports, and froze Venezuelan assets, imposing further sanctions on Venezuelans who are known members of the Maduro regime. The Bank of England repeatedly denied Maduro’s access to 14 tonnes of gold reserves deposited in the United Kingdom. 

In the meantime, cocoa beans accounted for just 0.3% of Venezuelan exports in 2019. A shocking revelation, considering Venezuela had been the world’s largest exporter of cocoa beans in the 17th century, with the beans becoming the largest export product for the country in the 1620s, a fact that remained true for the next two centuries.

According to historians and economists, Venezuela is suffering a typical “resource curse,” stemming from its predominant focus on a single commodity, to the detriment of other historical sources of revenues for the country. Such a resource curse is unfortunately not at all uncommon in developing countries, especially where the single commodity discovery has been oil. Politics, embargos and world oil prices deepen that curse.

 

Chocolates El Rey

Chocolates El Rey offices

Chocolates El Rey, founded in 1929, was Venezuela’s second-oldest chocolate company. In 2006 its president was Jorge Redmond, great-grandson of Pius Schlageter, who was responsible for providing the original loan that funded the company. 

El Rey exported 27% of its production as an ingredient to foreign chocolate manufacturers. In the domestic market, it served four segments: 

  • Food Services. Chips, bars and discs sold through distributors for wholesale use to restaurants, bakeries, pastry shops and chocolatiers.
  • Beverages. Chocolate powder used to produce instant chocolate milk, sold to supermarkets, restaurants and bakeries.
  • Industrial. Tailor-made chocolate products used by manufacturers as raw material for products such as ice cream, chocolate chip cookies, and cereal frostings.
  • Retail. Mostly bars and tablets, branded and unbranded, consumed as confectionery or raw material for cooking, sold through the same distributors that served the beverages market.

El Rey was a relatively small company, with sales of $13.6 million in 2006, processing 3,000 tons of chocolate. It was a well-known, established company, leveraging the quality of the Venezuelan cacao beans and its longstanding tradition. It developed the Cacao Route (Ruta de cacao), similar to country-of-origin tours created by other nations and regions to promote their natural products, such as wine, cheese and coffee. The Route convened international top chefs and gourmet-magazine writers, exposing them to cocoa haciendas where they could witness how the beans were planted, harvested and processed. Visits were complemented with folklore music and dancing, related to cocoa traditions. Visitors were then taken to El Rey’s Barquisimento plant, where El Rey chocolates were produced, to observe premium quality processes. The visit ended with a stay in Caracas, where chefs were taken to top chocolatiers who used El Rey’s products exclusively. The purpose of the Cacao Route was not just to sell El Rey chocolate but also to sell Venezuela, a country with exquisite cocoa beans production and extensive cultural traditions surrounding the cocoa harvest.

El Rey held dominant positions in the food services and industrial markets, serving as the main supplier for multinational firms that used chocolate in their product lines (such as. McDonald’s ice cream, Nabisco’s chocolate chip cookies, and Kellogg’s choco-muesli cereal). Its Taco 30% share of the chocolate powder market for instant beverage was second only to Nestlé’s Rock-o-late. It had also become the exclusive chocolate provider for Venezuela’s premium chefs and chocolatiers. 

Jorge Redmond and El Rey’s management wished to grow their business and pondered different alternatives. The difficulties that characterized the Venezuelan business environment imposed restrictions on the availability of capital even then. In the late 1990s, El Rey had tried to integrate backwards into cocoa bean production in the late 1990s, investing in a hacienda called San Joaquín. This was an attempt to improve profitability through experimental accelerated bean production, but, according to Jorge Redmond ,the hacienda was occupied by Chávez supporters (pisatarios) and El Rey lost its investment. 

After this frustrating experience with the San Joaquín hacienda, El Rey decided to stay out of cocoa bean production and concentrate on just chocolate production. Under El Rey’s leadership, 11 cocoa-processing companies came together under a not-for-profit organization called Aprocao, with the purpose of running a research institute that promoted best practices in cocoa bean production, furthering industry-government relations, and buying beans directly from producers that observed best practices in harvesting and processing. Aprocao bought 38% of the cocoa beans produced in the country. El Rey was the company that bought almost exclusively the more expensive and rarer fermented beans produced.

Consistent with their focus on chocolate production, in 2015 El Rey decided to increase its investment in its Barquisimento plant (inaugurated in 1995), integrating it backwards to process all of the beans it required, doubling its physical capacity at a cost of eight million dollars.  

At the same time, El Rey decided to explore businesses that offered higher margins, especially in the exports market. By then, the company enjoyed a good reputation among chocolate manufacturers and chocolatiers abroad, especially in the United States, Europe and Japan. Accessing foreign revenues in Venezuela’s troubled environment was critical to achieve growth.

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Fast-forward to 2019, Jorge Redmond found himself and his company in an even more frustrating situation. Sales in 2018 dropped to $1 million, with 820 tons processed. The investment in the Barquisimento plant was halted. Venezuela’s rampant inflation and devaluation liquidated the company’s working capital. Credit was unavailable, and the Venezuelan bolívar lost most of its purchasing power, leading to greater levels of poverty and unemployment in the country.

We spoke with Jorge Redmond at the time of this article. The Covid-19 pandemic has worsened the situation in Venezuela, posing yet higher hurdles to recovery. Yet, we found him to be in good spirits, fighting for survival, and planning to step up to the occasion when the situation improved. The equipment for the Barquisimento plant is already in the country, and El Rey’s product reputation is stellar. Foreign customers continue to value the company’s quality, and are willing to increase their purchases when they overcome their own pandemic effects and when buying from Venezuela regains reliability.

El Rey has presented to the government a Plan Cacao to increase Venezuela’s cocoa bean production from the 15,000 tons/year where it has been stagnant for the last 50 years to over 85,000 tons in a span of 15 years, with an investment of $350 million. Redmond affirms that there is interest from the Inter-American Development Bank (IDB) and from European funds to finance the project, when things get back to normal.

In the meantime, chocolate has kept its ascribed psychosocial properties, and dark chocolate gained further recognition over the years for its attributes to lower blood pressure, prevent memory decline, balance hormones and protect the body from stress. Recent reports state that the soothing effects of chocolate’s chemical components play a positive role in the Pandemic Era. Chocolate continues to enjoy its denomination as Food of the Gods ascribed to it by the Aztecs.

Time for another case? 

 

 

Rohit Deshpandé is the Sebastian S. Kresge Professor of Marketing at the Harvard Business School. He earned his degree of Bachelor of Science from the University of Bombay, his MBA from Northwestern University’s Kellogg School of Management, and his Ph.D. from the University of Pittsburgh. Throughout his tenure at HBS, he has worked on various fields of study, such as Customer-Centric Marketing Strategy, on Workplace Ethics and Global Business Standards, and lately on Cultural Entrepreneurship and the Business of the Arts.

Gustavo Herrero graduated from Harvard Business School in 1976 and worked as a business executive in Argentina, Paraguay and the United States. He became the Executive Director of HBS’s Latin America Research Center in November 1999, a position he held until he retired in December 2013. He currently serves on the Advisory Committee of the David Rockefeller Center for Latin American Studies and on the HBS Latin American Advisory Board.