The Sweet Business of Gourmet Chocolate

Sales and profits are up in the high-end chocolate segment as consumers continue to splurge on these affordable indulgences

Is Campbell's getting out of the chocolate market at just the right time? Earlier this month, the $7.34 billion Camden (N.J.) soup maker disclosed that it is looking to sell Godiva Chocolatier after more than 40 years of ownership. The announcement came as a wave of new competitors has entered the premium chocolate market and as the cost of raw materials has skyrocketed (see, 8/14/07, "Chocolate Prices on the Rise").

The popular luxury chocolate brand, which brings in $500 million in annual sales, is expected to sell for more than $1 billion, according to analyst estimates. Campbell's (CPB) acquired Godiva in 1966 and expanded the company to more than 450 boutiques in over 80 countries. "Godiva has been doing a great job in the last five years in reinvigorating the brand," claims Clay Gordon, chocolate critic and author of the forthcoming book Discover Chocolate.

Godiva's strong global brand image and established presence in the luxury market makes it a hot target for acquisition. Major chocolate players such as Hershey (HSY), Cadbury Schweppes (CSG) and Lindt & Sprüngli (LISN) have been discussed by analysts as potential suitors, with possibilities outside the industry including luxury brand group LVMH Moët Hennessy Louis Vuitton (LVMHF) or even private ownership.

A Taste for the Good Stuff

Godiva has played a large role in the way premium chocolates are consumed in the U.S. For years, the chocolate giants—Hershey, Nestlé Mars, and Russell Stover (the maker of Whitman Samplers)—dominated the American candy counter. Today more consumers are indicating that if they are going to indulge, they want to do it in style. In much the same way that Americans have acquired a taste for single-malt whiskey, craft beers, and gourmet coffees, they are now also choosing premium chocolates over Snickers bars.

Sales of all chocolate in the U.S. reached $15.6 billion in 2006. Premium chocolate made up over 13% of the market with $2 billion in sales, up from 9.1% in 2002, according to the Chicago branch of market research company Mintel International Group. In comparison, while the overall market grew at a rate of 16.6% from 2002 to 2006, the premium sector grew at a rate of 67.8% in the same period. Future growth forecasts predict the overall chocolate market will grow 13.5%, to $17.8 billion by 2011, while the premium segment is expected to grow 73.4%, to $3.6 billion in the same five-year span.

Marcia Mogelonsky, a senior research analyst at Mintel International, says the increased accessibility of premium chocolates coupled with increasingly sophisticated consumer tastes has led to the strong growth of this sector. "I think it changed when three or four years ago Lindt came out with those Lindor truffle balls that are now ubiquitous," she says. "They're not super-expensive, they're enough to satisfy whatever craving you might have, and it's really fine-quality chocolate."

The Zurich-based chocolatier's business strategy has worked out well for shareholders, too. When it announced its semiannual earnings Aug. 21, the company saw record sales growth of 15.7% to CHF1.138 billion ($943 million) from January, 2007 to July, 2007 as compared with CHF983.4 million ($815 million) for the same six-month period in 2006, along with a doubling in operating profits.

Building a Better Bon-Bon

To hold on to their market share, mainstream chocolate makers have introduced branded organic and premium chocolates, a segment that has been pegged by Hershey's and others as an essential sector for future growth. In a July conference call with investors, Hershey's Chief Executive Officer Rick Lenny announced that the "platform that is most promising is dark and premium chocolate. This segment is expected to show continued strong growth. Over the next five years we expect this segment to measure $2.5 billion at retail, representing a mid-teens compounded growth rate."

In recent years Hershey's has bought premium chocolate makers Scharffen Berger Chocolate Maker, Joseph Schmidt Confections, and Dagoba Organic Chocolate, which offer products that range from pricier high-quality bars that can be found in your local supermarket to luxury gift-box items like truffles. Hershey's has spent between $46.6 million and $61.1 million, respectively, to acquire Scharffen Berger and Joseph Schmidt, (with the final amount reflecting actual sales growth through 2007); combined annual sales of the two amount to $25 million. Last month, the company also signed an agreement with coffee giant Starbucks (SBUX) to produce, distribute, and market a range of Starbucks-branded chocolate. The new products are set to hit the shelves by early 2008.

Hershey's is not the only chocolate giant getting in on the act. Cadbury last year bought fast-growing organic brand Green & Black's. "My question is why Cadbury wouldn't be interested [in Godiva]," Mintel's Mogelonsky muses. "They've been talking about spinning off the beverages to focus on confectionaries. If they're going to do that, why not buy an already established confectionary? It saves Cadbury a lot of legwork."

Meanwhile, McLean (Va.)-based Mars has staked out a unique position in the high-end market with Ethel's Chocolate, which sells gift items online and operates cozy, coffeehouse-style chocolate "lounges." "Mars has taken an existing brand [from within the company] and is trying to improve its visibility in the marketplace," says Gordon, the critic and author. Originally named the Ethel M Chocolate Factory, after the wife of company founder Franklin Mars, Ethel M evolved into Ethel’s Chocolate, which was launched in 2005 with a more contemporary image. However, Mars' move of developing a premium product from within the company as opposed to Hershey's style of acquisition seems to indicate that Mars is an unlikely contender in the bidding to become Godiva's parent company.

Godiva's Best Match

Thus far, Lindt & Sprüngli is the only chocolate company that has expressed public interest in the acquisition of Godiva. Such a move would make sense to industry observers, given the two companies' complementary business models and branding. The Swiss chocolate maker, which is "head and shoulders above everyone else" in the premium segment according to Mogelonsky, also acquired the San Leandro (Calif.)-based Ghirardelli Chocolate in 1998. "They're similar businesses," Credit Suisse (CS) analyst Robert Moskow says, pointing to the company's premium chocolate product and boutique stores. "Combining manufacturing, sourcing, and retail-management expertise could be a benefit."

What might result in a poor fit, according to Moskow and Gordon, would be the acquisition of Godiva by a mass-market chocolate maker that might dilute the exclusivity of the luxury brand. Gordon thinks a good fit would be a luxury group such as LVMH or even a private equity fund, but Mogelonsky disagrees. Godiva, despite being a premium brand, may not be luxurious enough, she says. With its chocolates available in shopping malls around the country, its growing popularity has come at the expense of the brand's exclusivity.

Regardless of Godiva's future ownership, one thing is for sure: The premium segment is growing, and that means fat profits for the chocolate industry. "Overall, I think the Hershey's acquisitions and pending sale of Godiva say a lot of good things about the chocolate industry," Gordon says. "Before it was about people wanting to start a family business; now there's a potential exit strategy for doing a really good job. This pending sale points to the overall potential of the industry rather than the other way around."

For a look at today's best premium chocolate brands, see BusinessWeek's slide show.

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