As cocoa prices rise, candy manufacturers must innovate.

• This year, record-high cocoa prices have been causing problems for candy companies.
• High cocoa prices could alter how Hershey and Mondelez approach innovation, despite their hedging contracts currently safeguarding them.
• Consumer pushback on the last two years' price hikes may make it difficult for food companies to increase their prices.

The corner of global agriculture is facing pricing pressure, which is both bitter and sweet.

The increase in cocoa prices has caused problems for candy makers and other companies that use it to make chocolate.

In recent years, cocoa had been priced at approximately $2,500 per metric ton. However, concerns about supply due to weaker-than-expected crop reports caused the commodity's price to increase in recent months. Cocoa reached an all-time high of over $11,000 per metric ton in April. Although the price has since decreased slightly, it remains significantly higher than what food companies are accustomed to paying.

The major candy companies, including Mars, Ferrero, and Cadbury, are likely shielded from rising cocoa costs due to long-term contracts that secure the prices they pay for essential commodities. However, by 2025, they will likely face significant increases in their cocoa expenses.

The significant cost impact is greatly affecting the ways companies manage their businesses, as Steve Rosenstock, the consumer products lead at Clarkston Consulting, stated.

Mars opted out of participating in this story. Mondelez, Ferrero, and Hershey did not respond to CNBC's inquiries.

Costly cocoa

The cocoa supply in West Africa, which accounts for the majority of the world's cocoa production, has been affected by crop disease and low farmgate pricing, leading farmers to shift towards more profitable crops like rubber. According to a Rabobank report from May, this season's cocoa crop is expected to experience the largest deficit in at least six decades.

Ghana, the second-largest cocoa producer, is considering postponing the delivery of up to 350,000 tons of beans to the next season, which is expected to increase prices once again.

Executives from Mondelez and Hershey stated that market speculation is contributing to the increase in cocoa prices. Although prices may decrease in September with the release of more information about the new crop, they may not return to their normal levels.

The rising cost of cocoa poses a challenge for candy companies, as consumers are becoming more price-sensitive and selective in their purchases due to inflation affecting a range of commodities.

Shrinkflation, a term that refers to companies reducing a product's quantity or weight while keeping the price the same, has become a well-known concept among consumers. A recent YouGov survey revealed that 72% of U.S. respondents have noticed shrinkflation in food products.

Near-term workarounds

As a result, many companies will have to become more creative.

Daniel Fachner, CEO of the company, has been monitoring cocoa and chocolate prices. The company owns several brands, including Dippin' Dots, SuperPretzel, and Hola Churros, and produces products for other companies, such as Subway's footlong churro. Chocolate is a popular flavor in their product portfolio, which includes chocolate-filled churros.

Fachner stated in May that while we won't be stopped from using chocolate, we will have to consider and say, "Now, if we innovate with this new pricing, will it be sellable?" And then, when we sell it, we will have to think about whether the cost is low enough for customers to sell it and still make a good margin.

Fachner proposed a solution to reduce the number of chocolate chips from 12 to 9 in a product. Additionally, J&J is searching for alternatives that could replace some ingredients in its recipes.

One creative solution, according to RBC Capital Markets analyst Nik Modi, is Hershey's new Jumbo Reese's Cup.

He stated that this product has more peanut butter, which makes it a premium option that offers value to consumers, while also reducing the product's reliance on chocolate.

New products from food companies that don't specialize in chocolate may exclude this flavor to appeal to a wider audience.

Modi stated that people are likely to avoid chocolate at this stage, to a greater or lesser extent.

The long tail of the cocoa crisis

The current increase in cocoa prices is unprecedented, but it may not be the only time food companies face higher costs for the commodity. Experts anticipate another cocoa shortage next year, although it may not be as severe as this year's.

The beans' crop is likely to be affected by systemic issues such as government-controlled farmgate pricing and climate change, while the use of child labor and slavery in West African cocoa farms has led to lawsuits and scandal for candy companies.

In the future, companies may need to explore alternative solutions to cocoa in order to find more permanent solutions.

Rosenstock stated that some companies are increasing the use of non-cocoa additives, such as sugar, more cost-effective alternatives like cocoa butter equivalents, shea butter, palm oil, and coconut oil, in their products.

On average, it takes approximately nine months to reformulate a recipe, according to a research note published by Bank of America Securities analyst Antoine Prevot. He believes that fast-moving consumer goods companies have been considering changes to their formulas since the beginning of the year, which means the new candy could be released as early as August.

Some startups, including Voyage Foods and Win-Win, have created chocolate without cocoa by using alternatives like grape seeds and legumes.

One candy company is not planning any significant alterations to its recipes.

Mondelez CFO Luca Zaramella stated on June 4 at a Deutsche Bank conference that while they will tighten costs, they will not alter recipes or engage in actions that are not aligned with the company's long-term interests.

Kraft had a diverse portfolio of snacks, including Triscuit, Sour Patch Kids, Wheat Thins, chocolate products Milka, Oreo, Toblerone, and Chips Ahoy, when it spun out Mondelez more than a decade ago.

To boost sales, candy companies are now adding more salty snacks to their product lines. For instance, Hershey acquired Amplify Snack Brands in 2017 and added SkinnyPop to its portfolio, while in 2021, it bought Dot's Homestyle Pretzels.

"Rosenstock stated that the company did not reduce their dependence on cocoa, but rather diversified their portfolio and increased their ability to react to consumer trends. He suggested that relying on non-chocolate categories, such as salty snacks, jelly beans, or gummy products, could help combat the cocoa crisis."