Hershey’s response to the historically high cost of cocoa, the main ingredient in its popular chocolate bars and Hershey’s Kisses, shows how consumers may be starting to win the fight against inflation two years after the Federal Reserve began raising interest rates.
Cocoa prices have been on a tear for months, following torrential rains in the West African growing region that have led to a mounting production shortfall. On global commodity markets, cocoa hit an all-time high of $6,884 per metric ton last month and now costs roughly 150 percent more than it did one year ago.
Hershey raised its candy prices last year to offset rising costs and last month implemented what it called a “small” price increase for grocery store items such as chocolate baking chips and syrup.
But there may be a limit to how high prices can go.
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In the fourth quarter last year, Hershey reaped higher prices for its sweets but sold fewer of them. The company recently told investors it expects rising cocoa costs to dent profits in 2024. Its share price over the past 12 months has dropped more than 17 percent even as the S&P 500 index gained almost 33 percent.
The days when companies could use higher costs to justify even larger price increases appear to be over. In January, markups by the wholesalers and retailers that handle most consumer goods shrank for the fourth consecutive month — the first time that has happened in the 13 years that the government has tracked such figures.
“You have consumers pushing back on these higher prices, trading down, spending less for things, choosing a store brand rather than a name brand or buying smaller items,” said Gregory Daco, chief economist at EY-Parthenon. “There is much less pricing power today.”
When inflation first took off in spring 2021, companies were able to raise prices faster than their costs increased. As strong demand for products such as automobiles and furniture collided with supply chain limits, prices spiked, leaving consumers fuming.
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By March 2022, wholesaler and retailer markups were rising at an annual rate of almost 19 percent, according to the monthly Bureau of Labor Statistics’ report on the producer price index.
Those fat markups prompted complaints from some Democrats that “corporate greed” was responsible for the highest inflation in 40 years. In some industries, markups exceeded wage growth and contributed to higher inflation, according to National Economic Council Director Lael Brainard.
Economists use the markup data as an indication of who has pricing power at any given moment, businesses or their customers. And right now, though consumers are still irked by prices that are much higher than they were before the pandemic, power seems to be shifting from seller to buyer.
Manufacturers that were able to expand their profit margins during the pandemic when their products were in short supply now are reversing course, according to a March 4 research note from Goldman Sachs, which cited makers of primary metals, wood and chemicals.
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“Goods industries that saw the largest increases in profit margins relative to their pre-pandemic rate have also seen the largest declines,” Goldman economists said, adding that they expect the trend to continue this year.
Hershey’s profits grew each year during the pandemic era, as consumers treated themselves to chocolate while trapped at home and later as they chose to keep working there. The company reported $1.9 billion in net income last year, 62 percent more than it earned in 2019, before the pandemic.
But exceptionally heavy rain last summer in West Africa swamped cocoa farms in the Ivory Coast and Ghana, which account for about 70 percent of global production. An outbreak of black pod disease, a fungal ailment that wrecks cocoa trees, followed the deluge, further eroding crop yields.
Weather-related damage only aggravated cocoa production’s structural problems. Ivory Coast farmers generally till inefficient plots smaller than 10 acres. The growers receive meager payments from the government for their crop and lack the incentive to invest in fertilizer and pesticides.
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Global cocoa production is expected to fall to 4.5 million metric tons in the current crop year, which ends Sept. 30. That amount would be 330,000 metric tons short of estimated demand, according to the International Cocoa Organization, an intergovernmental group that includes the vast majority of cocoa-producing and cocoa-consuming countries.
Share this articleShareOther forecasts are more dire. Hugo van der Goes, the vice president for cocoa at Barry Callebaut, the world’s largest maker of bulk chocolate, said the shortfall could reach 500,000 metric tons, Bloomberg News reported.
The imbalance between supply and demand is expected to get even worse next year. Cocoa inventories are expected to cover just 31.4 percent of processing demand, a 40-year low, down from this year’s already tight 35.1 percent figure, according to ICCO.
“We’re going to have another round of ‘shrinkflation.’ The size of your chocolate bar is going to get smaller,” said Ole Hansen, the head of commodity strategy for Saxo Bank in Copenhagen.
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Coupled with sugar prices that are running about 25 percent above their five-year average, higher cocoa costs will eat into candy makers’ profits. Mondelez, maker of Oreo cookies and Toblerone chocolates, said late last year it planned to raise prices this year. Previous increases in Europe led to what the company called “customer disruption,” as higher prices discouraged some shoppers from buying.
European customers in the fourth quarter largely shrugged off Mondelez’s higher prices. But CEO Dirk Van de Put said consumer price sensitivity in Europe may increase this year.
“We might maybe expect a little bit of an uptick as prices keep on going up for a third year in a row, particularly in chocolate,” he said.
In the United States, consumers also are rethinking purchases as prices rise, waiting for products to go on sale or buying smaller sizes, he added. .
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Hershey’s American customers became more resistant to higher prices in the final three months of 2023, sending volumes down by more than 5 percent for the company’s core confectionery unit.
At Hershey, the goal is to raise prices enough over time to cover higher raw material costs. This year, though, it forecasts “relatively flat” earnings as higher cocoa and sugar costs bite. Executives won’t discuss plans for future price increases but say they are evaluating potential changes to product sizes designed to attract more price-sensitive shoppers.
“Given where cocoa prices are, we will be using every tool in our toolbox, including pricing, as a way to manage the business,” CEO Michele Buck told investors in early February.
Food was a big part of the pandemic-era inflation problem. In summer 2022, food prices rose at an annual rate around 12 percent, almost double the overall increase in the personal consumption expenditures index, the Fed’s preferred gauge of rising prices. An outbreak of avian influenza and the effects of the war in Ukraine on global commodity prices drove the increase.
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But one year later, as global supply chains normalized, food prices increased at a slower pace than economy-wide measures.
In January, food prices rose 0.5 percent from the prior month, faster than overall prices and a sign that the Fed’s campaign to bring inflation under control may suffer occasional setbacks. Prices for food consumed at home, which tend to jump around, had been essentially flat for the previous two months.
“We’re in a very weird environment. There’s lots of volatility,” said Michael Strain, an economist with the American Enterprise Institute.
Managing through the late stages of this inflationary episode represents an especially acute challenge for candy makers given the extraordinary rise in their cocoa costs. For nonfinancial companies in general, input costs have fallen by 3 percent over the past year, according to Goldman Sachs.
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Hershey’s strategy for coping with an unrelenting increase in its raw materials costs suggests that inflation will continue subsiding, as many economists anticipate. But even if prices stop rising as quickly as they have, consumers may still grumble: Prices have risen by a cumulative 18 percent since January 2021.
Fed officials, meanwhile, remain intent on reaching their target for price stability, defined as annual inflation of 2 percent. Investors began the year anticipating the Fed’s first interest rate cut as soon as March. But those hopes faded after the central bank’s preferred inflation measure rose in January at the fastest pace in four months and is now 2.4 percent higher than one year ago.
At his most recent news conference, Fed Chair Jerome H. Powell said he was “encouraged” by progress in eradicating inflation. But he said there is a risk that inflation could get stuck “at a level meaningfully above 2 percent.”
Powell also made a point of acknowledging downbeat readings of consumer sentiment. Despite the cooling of inflation, prices remain at levels well above their pre-pandemic trend.
“Prices went up much more than 2 percent per year for a couple of years and people are going to the store and they’re paying much more for the basics of life than they were two years ago, three years ago. And they’re not happy about it, and it’s fine that inflation is coming down, but the prices they’re paying are still high,” Powell said. “So that has to be some part of why people are unhappy. And they’re right to be unhappy.”
correction
A previous version of this story incorrectly reported that this year's cocoa production is expected to fall 330 million tons short of demand. It's 330,000 metric tons. This story has been corrected.
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