Policy on Cocoa Supply Deficit

May 3, 2016

To: Richard Ware, Vice President of Supply, Research, Development & Procurement From: Marvin Saccucci

Subject: Policy on Cocoa Supply Deficit

Date: May 3, 2016

Problem

“The other black gold”, chocolate is a tremendous industry worth an estimated $98.3

billion. Mars Inc. is the industry leader with 2014 net sales of $18.5 billion (Candy Industry,

2015). While demand for chocolate is expected to increase 3-4% in the following year, the

cocoa industry realized a 160,000-ton supply deficit in 2012/2013 (ICCO, 2014). There have

been a number of press reports identifying potential deficits of one million tons by the year 2020.

While these projections are not certain, it is more certain that the world runs out of cocoa

farmers. Whether due to climate change, increased demand, the spread of Ebola, or consumers’ preference for high-end luxury chocolate, cocoa sourcing has become more uncertain (Cocoa

Barometer Consortium, 2015). As a result, it is imperative that Mars Chocolate be proactive in

its approach to remain ahead of its competitors and search for alternative sources of cocoa. This

means either sourcing outside of Côte d’Ivoire and Ghana, which alone constitute 58% of the

world cocoa supply, or increasing the countries’ intensification efforts and yields (DOL, 2016).

The goal of this policy brief is to lay out the identified threats to cocoa supply and analyze

possible solutions.

World Supply of Cocoa

It is estimated that 73% of the world cocoa supply comes from West Africa and 10%

comes from Southeast Asia. Only 17% comes from the Americas, although originally native to

the region (ICCO, 2016). Because of its strict temperature and humidity requirements, cocoa

cultivation is constrained to 10° North and South of the equator, which limits its production

possibility. About 95% of the cocoa produced in Africa is bulk ordinary Forester cocoa, as

opposed to the lower-yielding Criollo variety native to Central America and the Caribbean

(ICCO, 2016). While West Africa accounts for the majority of the world cocoa supply, the

region has been confronted by a 2% annual decrease in production (Kongor et al., .2016) This is

due to a number of factors including poor farm management practices, low-yield plant varieties,

pests and disease, aging cocoa trees, and loss of soil fertility (Kongor et al., 2016). As with any

business investment, diversification is the most important component of risk mitigation, so it is

important that Mars Chocolate consider either sourcing outside of Côte d’Ivoire and Ghana, or

increase intensification efforts in the region.

Supply Deficit Cause #1: Increased Consumption

As is well aware, world demand for chocolate is expected to increase. This increased

demand is primarily led by China, India, and Russia, as these countries’ incomes continue to

grow. As developing countries get richer, individuals tend to not allocate all of their additional

income to food, but rather spend a significant portion on nonfood items such as tobacco, alcohol,

and chocolate. In a study conducted in Maharashtra, India in 1983, a 1% increase in expenditure

only translated to a 0.67% increase in total food expenditure (Banerjee, 2007). The remaining

0.37% was allocated towards nonfood luxury items. Growth rates for chocolate demand in

China have surpassed 10% in recent years although per capita consumption is still low compared

to international standards (Squicciarini, 2016). For example, in just three years, from 2008-2011

China grew from the 12th to the 9th largest importer of cocoa paste, and from the 15th to 9th

largest importer of cocoa powder and cake (Scott, 2016). Fortunately, Mars Chocolate holds a

40% share of the Chinese market. In recent years, increase in demand has become more

sophisticated, represented by consumers’ preference for premium high-end chocolate with exotic

ingredients.

Supply Deficit Cause #2: Decreasing Labor Force Participation

A principal threat to the supply of cocoa is a decrease in the supply of labor. Both Côte

d’Ivoire and Ghana have tremendous youth populations. The percent of their populations

between 0-14 years of age are 42% and 39%, respectively (World Bank, 2014). Nonetheless,

cocoa cultivation is an arduous task and many younger people are choosing to enter the service

sector, as opposed to being subject to cocoa production’s fluctuating prices. While the

traditional structural transformation realized by developing countries has been a shift from

agriculture to manufacturing, Africa’s structural transformation has come in the form of services.

From 2009-2012 both Côte d’Ivoire and Ghana realized growth rates in the service sector greater

than 8.5% (United Nations, 2015). In addition, the countries’ cocoa supply has been marred by

the presence of child labor, placing greater importance on the use of external certification

schemes. Certification is contingent on a number of important factors including child labor

practices, working hours, freedom of association and bargaining, environment, and livable

wages. Currently, 36% of our cocoa is certified either from Fairtrade, Rainforest Alliance, or

Utz. It is our goal to purchase 100% of our cocoa from certified sources by the year 2020 (Mars

Cocoa, 2016). We believe that through verification of our supplier code of conduct, cocoa

farming can be a profitable activity. Nonetheless, there are a large number of actors in the cocoa

industry and it will take collaboration from all sides to keep our smallholder farmers participative

and happy.

Supply Deficit Cause #3: Climate Change

While the future effects of climate change are uncertain, increased temperatures are

expected to alter areas best suited for cocoa production. West Africa and the Sahelian region are

considered two of the most climate variable regions in the world (Brown, 2008). A MaxEnt

analysis shows an overall decrease in suitability for cocoa producing regions in West Africa by

the year 2050 resulting from an increase in temperature not compensated by an increase in

rainfall (Läderach, 2013). As a result of this climate change, cocoa producing regions are

expected to become more similar to savanna regions where little to no cocoa is grown. While

climatic suitability will improve in some higher elevated areas, total suitability is expected to

decrease (Läderach, 2013). As a result, it is necessary to find coping methods to reduce the

effect of climate change on cocoa production.

Policy Recommendation #1: Cocoa Intensification Efforts

For a crop constrained to such a limited geographic area, intensification efforts become

necessary. The global challenge facing the cocoa sector today is how to increase cocoa

productivity, without expanding the cocoa area into new lands (Vast and Somarriba, 2014).

Since cocoa trees need shade, large cocoa plantations are less productive than expansion into

forested areas. Investing in R&D to improve the productivity of cocoa is one of the best ways to

reduce the environmental pressure placed on scarce land (Byerlee, 2014). Nonetheless, for cocoa

this becomes especially difficult due to the ‘forest rent’ received by expanding into nutrient-rich

lands. Increases in cocoa cultivation have historically been dictated by forest expansion. From

Mesoamerica to Venezuela to Brazil and now West Africa, the expansion of cocoa production

has primarily been achieved by the identification of virgin forest land providing advanced soil

fertility and moisture, as opposed to mature areas where pests, disease, and weeds are prevalent

(Squicciarini, 2016). This ‘forest rent’ has allowed producers in new areas to operate at lower

costs than mature areas, at the expense of deforestation (Squicciarini, 2016). Nonetheless, Mars

Chocolate believes there is a potential benefit to be achieve by intensification efforts in Côte

d’Ivoire and Ghana. There have been a number of studies done in Cameroon on the positive

effects of cocoa intensification efforts. Farms which replaced their cocoa trees were more

profitable, with up to 50% cocoa yield increases, but with less tree shade (Magne, 2014). As a

result, Mars Chocolate should increase investment in technological R&D as a means of

improving cocoa productivity while minimizing climate change from deforestation (Byerlee,

2014).

Policy Recommendation #2: Investing in Latin America

While intensification efforts in West Africa should be pursued, Mars Chocolate should

also look at Latin America as a potential investment opportunity, specifically Colombia. Despite

being the original cocoa growing region, Latin America witnessed only modest increases in

output, area harvested, and yields during the last half century (Scott, 2016). Colombia currently

accounts for only 1% of global cocoa production (Oxford, 2014). As the country’s historic peace

agreements become more certain, USAID’s Alternative (crop) Development policy becomes

more important. Colombian farmers have historically chosen illicit coca cultivation, as opposed

to alternative crops, due to the coca leave’s higher price. Nonetheless, as the price of cocoa

continues to rise, and peace agreements remain contingent on ‘zero coca’ alternative

development programs, cocoa becomes a more viable option. USAID’s cocoa program is

currently working with 1,900 families in Colombia’s coca corridor to connect them to the cocoa

chocolate industry (USAID Stories, 2016). Many coca producing regions in Colombia are

conducive to cocoa cultivation (See attached maps for comparison). Nonetheless, it is important

to consider the implications of deforestation in Latin America as opposed to intensification

efforts in West Africa as a means of increasing production. It is also important to note that a

transfer in production to Latin America could have negative effects on the West African labor

force, as cocoa employs about 70% of Ghana’s national agricultural labor force, in which cocoa

contributes about 70-100% of farmers’ annual incomes (Kongor, 2016). The ideal compromise

would be to increase demand for, and production of fine cocoa already cultivated in the region

without expanding into uncultivated areas.

Policy Recommendation #3: Improving the Competitiveness of Fine Flavor Cocoa

As was previously mentioned, demand for fine aromatic chocolate has increased, as

opposed to the bulk cocoa primarily produced. Fine flavor cocoa is sold in smaller quantities in

niche markets at higher prices. Although fine flavor cocoa currently only accounts for only 5%

of total production, it can be sold at much higher prices (ICCO, 2015). Godiva’s “G” collection

costs as much as $120 per pound. Most major chocolate manufacturers from Western Europe

(Belgium, France, Germany, Switzerland, etc.), have premium quality chocolate products in their

portfolios. Colombia is the fourth largest producer of fine flavor cocoa, accounting for 12% of

the global market, falling behind the likes of Madagascar, Mexico, and neighboring Ecuador.

95% of Colombian cocoa is classified as this fine sort (ICCO, 2015). Nonetheless, the fine

cocoa plant is considered much more finicky, producing lower yields, and requiring a costlier

production process. As consumer preference shifts to this luxury sort, it becomes important to

increase intensification efforts of this variety found in Latin America.

Concluding Remarks

In summary, it is necessary that Mars Chocolate be proactive in its approach to search for

alternative sources of cocoa. As demand for chocolate increases and the supply of labor

decreases, cocoa sourcing becomes more uncertain. The ideal method would be through

intensification efforts in Côte d’Ivoire and Ghana so as to reduce future deforestation.

Nonetheless, as climate change takes a greater toll on the environment, cocoa sourcing from

Latin America becomes a more viable option. Colombia presents a promising business

opportunity due to the growth potential of fine Criollo cocoa. Colombia also presents Mars with

a potential Corporate Social Responsibility initiative by pairing with USAID’s Alternate

Development Program. If not in Colombia, Mars Chocolate should consider fine flavor cocoa

intensification throughout the rest of the region as demand for high-end luxury chocolate grows.

Works Cited

Banerjee, Abhijit V. "The Economic Lives of the Poor." The Journal of Economic Perspectives 21.1 (2007): 141-68. JSTOR. Web. 01 May 2016. Brown O, and Crawford A. “Assessing the security implications of climate change for West Africa.” International Institute for Sustainable Development. Denmark, 2008. Byerlee, Derek, James Stevenson, and Nelson Villoria. "Does Intensification Slow Crop Land Expansion or Encourage Deforestation?" Global Food Security 3.2 (2014): 92-98. Web. Candy Industry, “2015 Global Top 100 Confectionary Companies”, New York, March 2, 2015. Cocoa Barometer Consortium. “Cocoa Barometer”, 2015. Department of Labor, “Child Labor in the Production of Cocoa”, ILAB in Cote d’Ivoire, 2016 International Cocoa Organization, “The Cocoa Market Situation”. Quarterly Bulletin, July 2014. International Cocoa Organization. “What is Fine or Flavor Cocoa”. July, 2015. http:// www.icco.org/about-cocoa/fine-or-flavour-cocoa.html Kongor, John Edem, Michael Hinneh, Davy Van De Walle, Emmanuel Ohene Afoakwa, Pascal Boeckx, and Koen Dewettinck. "Factors Influencing Quality Variation in Cocoa (Theobroma Cacao) Bean Flavour Profile — A Review." Food Research International 82 (2016): 44-52. Web. Läderach, P., A. Martinez-Valle, G. Schroth, and N. Castro. "Predicting the Future Climatic Suitability for Cocoa Farming of the World’s Leading Producer Countries, Ghana and Côte d’Ivoire." Climatic Change 119.3-4 (2013): 841-54. Web Magne, Anne Nadege, Nathalie Ewane Nonga, Martin Yemefack, and Valentina Robiglio. "Profitability and Implications of Cocoa Intensification on Carbon Emissions in Southern Cameroun." Agroforestry Systems 88.6 (2014): 1133-142. Web. Mars, “Cocoa”, http://www.mars.com/global/about-mars/mars-pia/our-supply-chain/cocoa.aspx, 2016 Oxford Business Group, “The Report: Colombia 2016”, Oxford Business Group, Web. May 2014 Scott, Gregory. “Growing Money on Trees in Latin America.” American-Eurasian Journal of Agricultural & Environmental Sciences. Lima, Peru. 2016 Squicciarini, M., and Johan F. M. Swinnen. The Economics of Chocolate. 1st ed. N.p.: Oxford UP, 2016. Print. United Nations, “Economic Development in Africa: Unlocking the potential of Africa’s services

trade for growth and development”. New York and Geneva, 2015. USAID, “One Bean at a Time”,https://stories.usaid.gov/one-bean-at-a-time/#page-1. 2016 Vast, Philippe, and Somarriba, Eduardo. “Trade-offs between crop intensification and ecosystem services: the role of agroforestry in cocoa cultivation”. Agroforestry Systems. 2014 World Bank, “World Development Indicators”. Population, ages 0-14 (% of total), 2014.