arcor: global strategy and local turbulence …although the confectionery industry’s 1%...

9-710-407J U L Y 1 , 2 0 0 9

________________________________________________________________________________________________________________ Professors Pankaj Ghemawat and Michael G. Rukstad and Research Associate Jennifer L. Illes prepared the original version of this case, “Arcor: Global Strategy and Local Turbulence.” This is the abridged version of that case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2009 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

P A N K A J G H E M A W A T

M I C H A E L G . R U K S T A D

J E N N I F E R L . I L L E S

Arcor: Global Strategy and Local Turbulence (Abridged)

These last few years have been spent constructing a Latin American Arcor. In the next five years, we are

going to have a global Arcor. — Luis Pagani, President, Arcor Group

In May 2003, Argentina was still recovering from the devastating financial crisis that hit the country in late 2001. The Argentine peso had devalued by 70%, the government had frozen all bank withdrawals, and a wave of bankruptcies had ensued.

Arcor, principally a candy and chocolate manufacturer, was one of the Argentine companies that had survived the crisis, but not without taking a major hit: its revenues from Argentina plummeted from $650 million in 2001 to $300 million in 2002.1 International revenues increased from $350 million to $450 million over that period, but the crisis interrupted Arcor’s expansion. Now that the Argentine operations appeared to have stabilized, Luis Pagani, Arcor’s president, had to rethink the company’s international strategy: where to sell, what products to offer, whether to emphasize brand building, and how to manage the company’s growing international business.

The Confectionery Industry

In 2001, the confectionery industry had posted total revenues (at the retail level) of $125 billion.1 Chocolate confectionery accounted for 60% of the total and was growing at faster than 5% per year, while sugar confectionery (candy) accounted for 40% and was growing at less than 1% per year. North America and Western Europe combined to account for over two-thirds of the industry’s revenues (see Exhibits 1a and 1b), with Northern Europeans such as the Swiss and the British, consuming particularly large quantities of chocolate.2 Latin America accounted for roughly 10% of revenues, with Brazil, Mexico, and Argentina ranking, in that order, as the largest markets in the region. Asia accounted for roughly 10% of chocolate revenues and 20% of candy revenues, and included some of the fastest growing markets in the world: China, India, and Vietnam.

1 Unless otherwise stated, all $ amounts refer to U.S. dollars. For monthly peso/dollar exchange rates over 1999–2003, see Exhibit 11.

This document is authorized for use only in Strategy by Michael Cronin at Open University from June 2013 to December 2013.

710-407 Arcor: Global Strategy and Local Turbulence (Abridged)

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Chocolate products were divided into solid chocolate bars, molded chocolate, filled chocolate (e.g., Snickers), and panned goods (e.g., M&Ms), while candy products included hard candy, soft candy, chewing gum, and caramel. Chocolate was also segmented by quality which depended on the ingredients used (particularly cocoa beans), their processing, and product shelf life.

Within developed markets, chocolate confectionery was generally more concentrated than candy (see Exhibit 2).3 Developing markets presented a more mixed picture: consumers were more price-sensitive there, and prices only one-third or one-quarter as high. Exhibit 3 depicts the cost and margin structures for candy and chocolates for an emerging market producer such as Arcor manufacturing and selling at home. Exhibit 4 summarizes the sales, employment, and product lines of the world’s 25 largest confectionery manufacturers in 1999. The largest competitors derived more than 80% of their revenues from chocolate as opposed to sugar confectionery.4 The three largest, Nestlé, Kraft, and Mars, each sold $9–$10 billion worth of confectionery. Sales for the next three, Ferrero, Hershey, and Cadbury Schweppes, fell in the $3–$5 billion range. Levels of internationalization varied greatly even among the largest competitors: Nestlé and Kraft derived more than 90% of their sales from outside their home markets, versus about 50% for Mars and Cadbury Schweppes and 10% for Hershey.5 Internationalization had mostly taken the form of foreign direct investment (FDI): international trade in confectionery amounted to just under 15% of the value of world production.6 Both FDI and trade appeared to be regionalized. Thus, Canada and Mexico accounted for the bulk of U.S. exports and imports.

The rest of this section describes the value chains for both chocolate and sugar confectionery.

Procurement

The main inputs for chocolate included cocoa, milk, and sugar, while inputs for candy included sugar, glucose, and flavoring. For chocolate and hard candy, ingredients made up one quarter of the total manufacturer’s price.7 Cocoa typically dominated ingredient costs for chocolate. Cocoa was grown in a small number of tropical regions and was subject to significant price volatility based on growing conditions. Four large companies, one of them Nestlé, accounted for 50% of all cocoa ground in the world in 2001.8 Sugar, the key ingredient for candy, was less concentrated and was often traded based on a world reference price. However, protectionism kept sugar prices at several times world levels—recently, triple—in the United States and the European Union. Developing countries practiced protectionism as well. Mexico, for example, imposed steep import tariffs on sugar, leading to unpredictable domestic prices, sometimes even higher than in the United States. Argentina imposed 23% tariffs on Brazilian sugar that benefited from better weather and subsidies for growing sugarcane that were related to Brazil’s ethanol gasoline-substitution program and to political forces favoring protection for sugar growers in the country’s sensitive northern region. However, these tariffs had prompted an escalating trade dispute with Brazil about treaty obligations under Mercosur, the free trade agreement among countries of the Southern Cone of Latin America.

Production

Producing chocolate was more complicated and investment-intensive than producing candy, largely because of cocoa processing requirements. However, both processes were highly automated—with multinationals running their machinery around the clock—and did not require much in the way of labor or hard-to-find skills.9 In 2002, a world-scale chocolate line capable of producing 50 tons per day or 16,000 tons per year might cost $9–$10 million, and a candy line of the same scale $2.5 million—although one-third of that scale might be efficient for candy.10 Multiple lines and infrastructure could boost the cost of a world-class chocolate plant to as high as $100 million, but


Arcor: Global Strategy and Local Turbulence (Abridged) 710-407

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even the leading competitors varied greatly in terms of their production structures. Kraft, in the mid-1990s, closed more than half its plants worldwide, including 14 of 20 in Europe, to “increase economies of scale.”11 Mars produced the bulk of its products in the United States but had begun to employ regional mandates, with one country, or a few, producing a product for a whole region.12 Nestlé, which had the most dispersed production structure, with operations in over 70 countries, explained that “We could not have achieved growth simply through exports, since many countries protect their own manufacturers by erecting customs barriers.”13

Channels and Distribution

In developed markets, supermarkets were the most important retail channel, accounting for 55% of confectionery sales by value, followed by convenience stores (10%) and independent retailers (5%). In emerging markets, distributors had to devote much more attention to serving a proliferation of small, independent retailers. In Argentina, for example, 70% of confectionery goods were sold at mom-and-pop shops or in kiosks, and only 10% of candy and 22% of chocolate was bought in supermarkets.14 Distributors’ margins in emerging markets could be up to 20%, in return for undertaking a relatively extensive set of tasks, versus margins of about 6% for distributors in developed markets. In addition, large confectionary manufacturers often had exclusive distribution, while smaller ones generally did not.

Marketing and Product Development

According to industry analysts, the confectionery industry in developed markets depended heavily on advertising, while price competition “played a very secondary role.”15 Chocolate had 3%–6% advertising-to-sales ratios in developed markets (putting chocolate in the top quartile of manufacturing industries) and candy generally lagged behind (see Exhibit 5). Chocolate also seemed more susceptible to product differentiation based on ingredient/product quality, brand longevity (some chocolate brands were over 200 years old), and the viability of global branding. It was hard to think of global candy products other than Chupa Chups’ lollipops and Ferrero’s Tic Tac. But in chocolate, Mars alone had at least five global brands: Snickers, Mars, M&Ms, Twix, and Milky Way. Annual advertising spending for Chocolate worldwide was nearly half-a-billion dollars of which 80%–90% was spent on television.16 Advertising levels tended to be significantly lower in emerging markets, where purchases were mainly driven by price, particularly for low-income customers.17

Although the confectionery industry’s 1% R&D-to-sales ratio put it in the bottom half of all manufacturing industries,18 new product development and product adjustments were still important. In 2001, a brand new product required a $2 million investment and took about 18 months to develop; alternatively, a minor product adjustment cost approximately $300,000 and took only six months. Changing products for a local market (e.g., saltier for the United States, spicier for Mexico, and sweeter for Europe) might simply require mixing different proportions of standard ingredients. However, total technology investment for a customized ingredient mix and marketing expense to sell a product globally could be as high as $100 million.19 In addition, failure rates on new confectionary introductions were high.

The role of private labels in the food industry was also growing in developed markets. Typically referred to as store brands, house brands, no-name generics, signature brands, or exclusive brands, private label goods were sold by non-manufacturers that owned the name of the product or private label (PL). Compared to widely available national brands, PLs were usually less expensive and limited to a company’s distribution or licensed marketing area. According to ACNielsen, in 2003, US sales of PL foods and beverages that exceeded $1 billion (including Wal-Mart) were milk,



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bread/baked goods, cheese, fresh eggs, carbonated beverages, and unprepared frozen meat/seafood. The most popular PL food products by volume were fresh eggs, milk and sugar/sugar substitutes.20

According to a report by PriceWaterhouseCoopers, by 2010, the market value of private-label food alone was expected to surpass $100 billion. The report stated that because of PLs, some retailers and manufacturers crossed over into each other's industries, where they had traditionally been separate. Also, in some cases, companies manufactured private-label products that competed with their own branded goods. In other instances, retailers' manufacturing operations produced their own private-label goods and supplied the products to others.

Arcor Group

Fulvio Pagani and two partners founded Arcor to manufacture candy in 1951 in Arroyito, a small rural town in the interior province of Córdoba, in Argentina. The firm expanded gradually, from serving the Cordovan market in the 1950s to other provincial Argentine markets in the 1960s, the Buenos Aires market in the 1970s, and to markets in the Southern Cone of Latin America in the 1980s.

After Fulvio Pagani died in a car crash in late 1990, Luis Pagani, his eldest son who was previously a sales director, took over Arcor (see Exhibit 6 for summary financials over this period). By 1999, Arcor had significantly increased its domestic market share, to 54% in candy and 33% in chocolate (see Exhibits 7a and 7b). Although major multinationals—Kraft, Danone, and Cadbury-Schweppes—entered Argentina during the 1990s or expanded by acquiring large local companies, Arcor built its market share through smaller acquisitions and capacity expansions. Internationally, Arcor’s exports soared from about $25 million to $200 million during the 1990s, and stretched beyond the Southern Cone. It had first attempted to export overseas in 1969, with an 80-ton candy shipment to a U.S. distributor, but when the ship containing the cargo crossed the equator, the candy melted, and it arrived in the United States as one solid block. By the end of the 1990s, though, Arcor exported successfully to more than 100 countries, although volumes remained focused on the Americas. Arcor also made large foreign investments, particularly in Chile and Brazil, each of which accounted for roughly 10% of Arcor’s revenues of over $1 billion in 2000 (see Exhibit 8).21

Geographic diversification was accompanied by product diversification, principally at home. In addition to offering a particularly wide array of chocolate and candy products (see Exhibit 4), Arcor also sold cookies and crackers, and packaged foods (e.g., jam and canned fruit), representing more than 1,500 SKUs in total. Each of these four product categories accounted for roughly one-quarter of its domestic non-industrial sales (see Exhibit 9). Arcor owned 5 of the top 10 chocolate brands, representing 25% of market value. The candy market was highly fragmented by brand and suited Arcor’s signature strategy of high volumes across a broad variety of products. In terms of domestic positioning, Arcor targeted good quality products at affordable prices—parity to 10% below competitors’ prices—and with mass appeal. The rest of this section describes the distinctive features of its domestic value chain, pre-crisis.

Suppliers

Throughout the 1960s and 1970s, the poor development of input markets in Argentina made finding competitively priced ingredients and other supplies difficult, so Arcor acquired farmland and constructed processing facilities of its own.22 By 2000, Arcor owned almost 400,000 acres of farmland in Argentina; it produced its own sugar cane, milked its own cows, and used its own mills to extract fructose and glucose from its corn and sorghum plantations. It was also vertically integrated into



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supplying its own electricity and packaging materials, some of which it also sold to third parties.23 Chocolate, however, had to be imported.

Production

Arcor’s production facility in Arroyito had been characterized—in the international business press—as “the largest in the world” and “a model of efficiency.”24 Overall, there were 31 production locations: 25 in Argentina, three in Chile, two in Brazil, and one in Peru.25 Arcor’s managers believed that producing high volumes and utilizing in-house suppliers allowed Arcor to keep product costs low. The potential for efficiency was enhanced by continuous investment in new equipment and technology. In a five-year span prior to the crisis, Arcor reinvested over $600 million in acquiring, building, and upgrading plants (Exhibit 10).26 Internationally, significant Chilean and Brazilian capacity was added to Arcor’s network and accounted for about 20% of total production in 2002.

Channels and Distribution

Domestic distribution occurred via Arcor’s 160 exclusive third-party distributors who transported boxes to their final destinations, 72% of which were independent family companies, such as kiosks or mom-and-pop shops.27 The company also dealt directly with a number of wholesalers and supermarkets. Arcor claimed 80% of shelf space in the interior of Argentina and 50% in Buenos Aires and surrounding areas. Since the distributors served as the salespeople, promoters, and deliverers, Arcor worked hard to train them, spending half a million dollars on distributor training a year, three to four times more than many competitors, according to the company. Channels in other Latin American markets resembled Argentina’s more closely than did those in developed markets.


Historically, Arcor had invested heavily in distribution and new product introductions rather than advertising. In addition to being prolific at developing new product lines, Arcor also looked for opportunities to extend existing lines, use new ingredients, or tailor an existing products for a new countries or markets. It introduced approximately 120 new products each year. Thus, in 2002, Arcor launched 50 new candy SKUs, while competitors launched around 10 each, and between 1998 and 2002, Arcor offered four times as many new chocolate products as competitors offered.28 Advertising at the time a new product was first introduced had historically been quite limited. “It’s a complex task because it takes longer to hire and train distributors to understand our product lines and our distribution techniques than it takes to enter a market with a huge media blitz,” said Fernando Falco, an Arcor General Manager. “However, it ensures that we don’t waste money, and it has been a very successful strategy for the company.”29 Advertising expenditures had increased in the 1990s, though, in response to increasing competition.

Argentina’s Financial Crisis and Arcor

Argentina, which shared the southernmost part of South America with Chile, was abundantly endowed with agricultural resources. It ranked among the richest countries in the world through the nineteenth century and the first few decades of the twentieth, but slipped into a long decline after the Great Depression. More recently, the 1970s and particularly 1980s had seen tremendous economic and political turmoil that appeared to draw to an end with the assumption of the presidency by Carlos Menem in 1989. Menem launched a program of radical reform that involved privatizing



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virtually everything, including the postal system and the national oil company, encouraging extensive foreign investment, lowering tariff rates, establishing a currency board that pegged the new currency, the peso, at a one-for-one exchange rate to the U.S. dollar, and forbidding the central bank from printing pesos in excess of its international reserves.30

For most of the 1990s, Argentina was seen as a successful case of reform because the fixed exchange rate ended hyperinflation, reducing inflation to single digits.31 Nevertheless, economic reforms stalled again by the end of the decade. In January 1999, a financial crisis hit Brazil and Argentina, affecting both the countries exports dramatically; Argentina’s exports to Brazil fell by 30%. This marked the beginning of a three-year negative GDP growth period. By 2001, uncertainty about the growing public debt and the contracting economy led to a drop-off in government bond purchases and to higher interest rates. Doubts about the currency peg’s durability and the financial system’s ability to uphold dollar liabilities (backed significantly by peso assets, including government debt) led to bank runs. In response, the Argentine government suspended payments on its external debt and restricted bank withdrawals in December 2001. In January 2002, it abandoned the fixed exchange rate. In the next few months, the peso depreciated 70% against the dollar (see Exhibit 11), output declined by 15%, and unemployment surged to over 20%. At one point, Argentina had four different presidents during a 10-day period.32 Relative calm set in by 2003, as Nestor Kirchner became the new president and exports picked up.

Luis Pagani attributed Arcor’s ability to survive the crisis largely to its financial conservatism and its people. At the height of the crisis, Arcor had net debts of $360 million ($260 of which was in U.S. dollars) and a post-devaluation leverage ratio of 42%, versus an average of 177% for other Argentine companies. By the end of 2002, Arcor was current on its interest payments thanks to its limited initial leverage and the successful restructuring of $30 million in loans from foreign banks that were originally due in mid-2002.

But the crisis required more than just financial renegotiation: its onset reduced Arcor’s domestic volume by 40% in December 2001 relative to December 2000. Executives initially discussed idling operations and running machinery less than 24 hours a day, seven days a week. They soon realized, however, that reducing the utilization of the vertically-integrated capital-intensive facilities was not an adequate solution: customer demand for lower price points would persist and had to be addressed rather than ignored. They responded along multiple dimensions:

Products

Arcor executives began thinking about how to change products to appeal to customer’s new price points. With their successful chewing gum, Top Line, for example, they considered reducing the packages from six sticks to four or even two. Product adaptation was considered an easy process, given Arcor’s experience in developing and producing a wide assortment of items that sold for just a few cents apiece.

Procurement

Costs could also be reduced by changing the quantity and mix of inputs. The prices of some inputs such as milk were essentially local. For others, local prices were related to world reference prices, but the pass-through of exchange rate changes was expected to be variable. Thus, in the case of sugar (and glucose), which Argentina exported and on which the government was likely to levy a significant export tax, pass-through might be about 50%. In other words, an amount of sugar that cost 1 peso or dollar before the devaluation, after realignment, for a 3 peso-per-dollar exchange rate, cost 2



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pesos (or $0.67) rather than the 3 pesos that would be implied by 100% pass-through of the exchange rate change. But for inputs such as cocoa, which was imported, pass-through was expected to be 100%. In addition, world cocoa prices had recently increased 80% in dollar terms because of crop failures in the Ivory Coast.33 As a result, Arcor was considering replacing some of the chocolate in its products with wafer, cream, and other fillings.

Production

Resizing and reformulation of products was costly, and the risk involved was heightened by the rapidly changing environment. Arcor paid careful attention to competitors’ production changes; “The multinationals are much bigger, and therefore, slower to react. They have centralized production and are more standardized, which creates difficulty in tailoring products,” said Guillermo Ortiz de Rozas, General Manager of New Businesses.34 According to him, competitors matched many of Arcor’s moves, but with a lag of up to six months. Ortiz de Rozas attributed Arcor’s quicker responses on this and other fronts to the fact that its management had a collective memory of past Argentine crises and the company’s responses to them. He contrasted Arcor in this regard with multinationals’ local operations: “Many managers of other companies were young and were not local. They had not experienced earlier crises that Argentina had suffered and did not know how to react.”

Channels

The confectionery industry’s traditionally long payment terms for the organized trade, up to 90–120 days, had to be shortened given the pressures imposed by a depreciating currency and capital constraints. Arcor shortened its collection window to 35–40 days and stopped delivering to a major retailer that did not comply with its new terms.


Immense instability created nearly continuous pressure on repricing. Arcor struggled to decide whether to rely on raw material costs, the previous year’s product prices, or some other measure for repricing. It also cut back on advertising and product development expenditures, and reoriented them to focus even more on consumer value.

Governmental Relationships

The crisis also brought about numerous changes in government regulations, some of which were not helpful. For example, as of 2001, exporters did not have to pay taxes until consumers bought their products, but in January 2002, the government began requiring companies to pay taxes upon export, further weakening their financing. Pagani, who became president of the Argentine Entrepreneurs Association (AEA) in September 2002, hoped to use his position to push for export tax repeal, exchange rate normalization, and a host of other business-friendly measures.

These adjustments notwithstanding, Arcor’s revenues from Argentina dropped from $650 million in 2001 to $300 million in 2002. Over the same period, international revenues’ increased from 35% to 60%. As the crisis started to subside at the end of 2002 and the Argentine business slowly began to recover, Luis Pagani was able to begin turning his attention back to Arcor’s international strategy.



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Plans for International Expansion

From the onset, Arcor’s vision had been “to become Latin America’s leading purveyor of candy.”35 In the 1970s, Arcor began to emphasize sustained exports—“even under unfavorable conditions” so as to maintain market access—and invested in small plants in two of Argentina’s neighbors, Paraguay and Uruguay. In the early 1980s, it purchased Nechar, a small Brazilian candy company, and built a chewing gum factory in Brazil. The gum factory doubled Arcor’s gum production and the company began to use it to supply all of its South American markets. In the late 1980s, Arcor also set up a small plant in Chile, completing the process of establishing manufacturing footholds in all the countries that would become members of Mercosur.

The process of international expansion continued in the 1990s, after Luis Pagani succeeded his father as Arcor’s president. Anticipating further integration between Mercosur countries and countries that belonged to the Andean Pact, Arcor established a commercial office in Bolivia and, in 1996, invested in a small plant in Peru. It also set up a subsidiary in Miami to distribute its products in the United States and started to build up its exports outside the Americas. However, its largest foreign investments came at the end of the decade. In 1998, Arcor invested approximately $200 million to acquire Chilean confectionery manufacturer Dos en Uno. In 1999, it opened a state-of-the-art chocolate factory in Brazil, at a cost of about $50 million, as well as a large logistics center.

In 2000, Arcor added commercial offices in two other Andean Pact countries, Ecuador and Colombia, and in Mexico. That year, 61% of Arcor’s total exports were to South American countries, 19% to North America and 7% to Central America and the Caribbean (see Exhibit 12).36 The fastest growth, however, was taking place in the other regional markets that Arcor had recently entered. According to the company, it had become “The Argentine Group with the greatest number of [export] markets in the world” with exports to more than 100 countries.37

With the onset of the Argentine economic crisis, further internationalization was deemed imperative. Arcor initially responded by adding employees and markets to its international division and moving its international headquarters from Buenos Aires to Barcelona—although the Brazilian and Chilean operations continued to report directly to corporate headquarters in Buenos Aires (Exhibit 13a and Exhibit 13b). As conditions in Argentina began to stabilize, Pagani felt that it was time for Arcor to map out its strategic options: which regional markets to emphasize, where to manufacture, what products to offer, and whether to emphasize brand building or the private-label business. However, resources were an issue because Pagani had originally envisioned funding Arcor’s international expansion with an initial public offering (IPO) in 2004 or 2005—no longer a viable option because of the crisis.

Latin America

Arcor was the largest sugar confectionery manufacturer in Latin America and ranked fourth in terms of total confectionery sales, behind Nestlé, Kraft, and Warner-Lambert.38 Apart from its domestic sales, Brazil and Chile were its largest markets in the region.

Brazil represented 45% of total Latin American confectionery volume and was roughly five times the size of the Argentine market. However, the dollar term value of the Brazilian market had shrunk significantly in 1998, as the Brazilian Real depreciated from 1 R/$ to about 3 R/$ by spring 2003—(roughly the same devaluation experienced by the Argentine Peso since the end of 2001). Still, Arcor continued to invest in Brazil; in December 2001, it purchased “Kid’s” and several other candy brands with annual sales of about $30 million from Nestlé, raising its share of the Brazilian candy market to 10% and making it market leader. It also held a significant share—roughly 15%—of the Brazilian



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market for chewing gum. Its share in chocolate confectionery, largely sold through supermarkets rather than the immediate consumption channels such as the kiosks that Arcor emphasized in Argentina, was approximately 3%. In 2002, Arcor lost its bid to Nestle (26% market share) for loss-making local chocolate manufacturer Garoto, which accounted for 19% of the local market. The acquisition of Garoto for $250 million let Nestlé leapfrog Lacta, which had previously been acquired by Kraft and accounted for 30% of the market, to become the market leader in Brazilian chocolate.39 This realignment was accompanied, however, by a bitter price war.

In Chile, which was less than half the size of the Argentine market, Arcor’s position largely reflected its acquisition of Dos en Uno in 1998. In 2000, it held 83% of the Chilean market for gum, was the second largest player in candy, with a share of 35% versus 38% for local competitor Costa/Ambrosoli, and the third largest in chocolate, with a share of 26%, behind 36% for Costa/Ambrosoli and 27% for Nestlé. It also held 14% of the Chilean market for biscuits, behind 38% for Nestlé and 25% for Costa/Ambrosoli.

In the run-up to the crisis, Arcor had also begun to pay significant attention to the Mexican market, which was roughly twice as large as the Argentina’s. As Pagani had explained in 2001, “The company is evaluating the possibility of building a factory in Mexico within a few years. We can’t think about leading Latin America without Mexico.”40 However, Arcor felt that it lacked a good distribution model in Mexico and had not mastered local tastes (which included spicier items such as jalapeño-flavored candy). Additionally, as Ortiz de Rozas explained, “There are two very big players in Mexico. Bimbo, a Mexican conglomerate, has thousands of vans and large access to small mom-and-pops, and Pepsi Co. has strong door-to-door capability.”41

The United States/Canada

The U.S. market for confectionery was nearly 10 times larger than the Argentine market in volume terms and significantly larger still in value terms. Exhibit 14 summarizes U.S. domestic shipments, exports, and imports and Exhibit 15 disaggregates U.S. imports of hard candy—more than one-half of total U.S. confectionery import volume and more than three-quarters of U.S. imports of sugar confectionery—by country of origin. Imports from the major source countries, including Argentina, were subject to zero tariffs. However, transportation costs from Buenos Aires to New York for a 40-foot container that might hold 17.8 tons of Arcor’s typical export mix stood at $1,700 per container in the first quarter of 2003. Additional barriers facing Arcor in penetrating the U.S. market included different distribution channels, with less volume flowing through immediate consumption channels of the sort that Arcor had emphasized in much of South America, and the high value placed by U.S. consumers on brands and on premium products. Furthermore, the level of concentration in the chocolate confectionery segment was higher in the United States than in other major developed markets, although the reverse was true in sugar confectionery (see Exhibit 2).

In order to penetrate the U.S. market, Arcor had, in 1993, set up what became a 20-person office in Miami that oversaw the distribution of approximately 300 SKUs to an array of outlets. A web of U.S. distributors supplied large supermarkets and wholesalers, while a group of brokers supplied smaller independent outlets, which represented approximately 80% of Arcor’s 500 U.S. clients. In addition, as Kees Bowkamp, U.S. General Sales Manager, noted, “More and more Buenos Aires-based employees find themselves devoting parts of their workday to U.S. operations.”42

In the late 1990s, Arcor signed a supply contract with Wal-Mart, to sell its products under the labels “Whisper” and “Sweet Enticement.” Whisper, which was essentially the same as a Bon O Bon, “has had incredible success in the U.S., establishing Arcor as a serious player in the American confectionery market,” according to Mike Filgueras, a North American sales manager.43 He added



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that Arcor sometimes bundled these private label products with other Arcor products to “help us introduce new confectionery products into the U.S. market, while simultaneously pushing our brand.”44 Additionally, in April 2001 Arcor signed an agreement with Brach’s Confections Inc. to manufacture and export 30,000 tons of Brach’s candies, annually. This deal increased Arcor’s annual exports by $40 million.45 Overall, by 2002, approximately 20% of Arcor’s exports—almost all from its Argentine and Brazilian plants—were directed to the United States.

The Canadian market for confectionery was also larger than the Argentine market. In 2001, Arcor opened a sales office in Toronto, and executives hoped to achieve $10 million in Canadian sales by 2004. According to Gustavo Bandino, the General Manager for Canada, Arcor’s Canadian strategy would resemble its U.S. strategy, but “without overlooking the differences between each market. In Canada, nearly 60% of the products sold in the supermarket bear a private brand.”46

Europe

Europe was the largest regional market for confectionery, particularly chocolate confectionery. Transportation costs from Buenos Aires to the European gateway of Rotterdam for a 40-foot container were lower than to New York: they stood at $1,610 per container in the first quarter of 2003. However, Argentine exports to the European Union faced tariffs of about 35%.47 In addition, West European markets were considered as competitive as the U.S. market, and even more oriented towards premium products.

These barriers notwithstanding, Europe had recently assumed a much more important role in Arcor’s international strategy. In 2002, it relocated its International Division from Buenos Aires to Barcelona and recruited Alejandro Siniawski, formerly with Barcelona-based Chupa Chups—a lollipop manufacturer that was less than one-half Arcor’s size but sold more than 90% of its production outside its home market—to be its International Director. According to Horacio Aumann, Arcor’s Argentina-based Export Manager, “We really wanted to move this base into Europe because in the U.S. we have an 8-year history but in Europe we are starting from scratch.” 48 Siniawski would head up Arcor’s 300-strong international sales force, recently redeployed to the field, and would be in charge of market selection and development worldwide, excluding only the South American countries in which Arcor operated manufacturing capacity (see Exhibit 13b). The Corporate Office in Buenos Aires would allocate the orders generated by the International Division across Arcor’s factories.

Within Europe, Arcor had begun, according to the European Director who served under Siniawski, Gustavo D’Alessandro, to target five or six key markets in 2003.49

Asia

Asia was the third largest regional market for confectionery, after Europe and North America, and was more oriented towards candy than chocolate. Prior to the crisis, Pagani had targeted Asia, along with Europe, for penetration by Arcor, and the company continued to consider the region to be a priority. “The size of the market is enormous, so it has big appeal for us. All the competitors have gone there,” Guillermo Ortiz de Rozas explained.50 Arcor first entered the market using Sims, a Chinese importer, and planned to continue with the importer model to gain a toehold of the market. However, executives anticipated that the market would eventually call for local production and an exclusive distribution network. In the near term, Arcor planned to open a sales office in Hong Kong and to investigate other large Asian markets, such as Malaysia, Vietnam, Indonesia, and India. As



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Ortiz de Rozas put it, “In Latin America we feel we understand everything, but we know little about Asia.”



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Exhibit 1a Chocolate: Sales by Region (US$ million)

Region 1998 1999 2000 2001 2002 CAGR

1998-2001 Western Europe 22,876 23,639 24,348 25,030 NA 3.0% Eastern Europe 6,153 7,290 8,329 9,353 NA 15.0% North America 18,803 19,469 20,162 20,901 NA 3.6% South America 5,843 6,286 6,681 7,208 NA 7.2%a Asia-Pacific 7,472 7,883 8,333 8,792 NA 5.6% Middle East 1,374 1,425 1,484 1,543 NA 3.9% Africa 1,075 1,230 1,428 1,662 NA 15.6% Southern Asia 303 389 495 663 NA 27.8%

WORLD TOTAL 63,899 67,611 71,260 75,122 NA 5.5%

Source: Adapted from MRI, World Market for Chocolate Confectionery, January 2002; casewriter estimates.

aThe compounded annual growth rate for 1993–2001 was 13.5%.

Exhibit 1b Candy: Sales by Region (US$ million)

Region 1998 1999 2000 2001 2002 CAGR

1998–2002 Western Europe 13,859 13,878 12,825 12,814 13,250 -1.1%Eastern Europe 3,564 3,702 3,477 3,739 3,939 2.5%North America 11,015 11,555 11,817 12,016 12,340 2.9%South America 6,895 5,594 5,953 5,704 5,583 -5.1%Asia 8,911 9,988 10,467 10,207 10,387 3.9%Australia 508 539 501 471 516 0.4%Africa & Middle East 2,562 2,622 2,611 2,489 2,434 -1.3%WORLD TOTAL 47,314 47,877 47,650 47,439 48,450 0.6%

Source: Company documents; casewriter estimates.

Exhibit 2 Four-firm Sales Concentration Ratios for Confectionery Manufacturers

Sugar

Confectionery (%) Chocolate

Confectionery (%)

France 51 38 Germany 39 77 Italy 29 48 Japan 42 60 United Kingdom 38 80 United States 17 86

Source: Adapted from MRI, World Brand Strategies in Confectionery, February 1999.



13

Exhibit 3a Typical Cost Structure for Chocolate Production in Emerging Markets

Source: Company documents; Professor John Wells; interviews by authors, June 2003; casewriter estimates.

Retailer’s gross margin (50%)

Retail price of chocolate (approximately $4.80 per pound)

Distributor’s gross margin (20%)

Manufacturer’s gross margin (41%)

Cost of goods sold (59%)

100% Manufacturer’s price

19% Manufacturer’s operating margin

22% SG&A (9% selling; 5% administrative; 8% marketing

17% Manufacturing overhead (5% managers’ salaries; 6% depreciation; 6% other)

13% Packaging

5% Direct manufacturing labor

Ingredients (24%) Milk (15%) Sugar (6%) Other (33%)

Cocoa (46%)

100% Cost of Goods

100%

50%

40%

0%



14

Exhibit 3b Typical Cost Structure for Candy Production in Emerging Markets

Source: Company documents; Professor John Wells; interviews by authors, June 2003; casewriter estimates.

Retailer’s gross margin (50%)

Retail price of candy (approximately $2.50 per pound)

Distributor’s gross margin (20%)

Manufacturer’s gross margin (36%)

Cost of goods sold (59%)

100% Manufacturer’s price

17% Manufacturer’s operating margin

19% SG&A (9% selling; 5% administrative; 5% marketing)

17% Manufacturing overhead (6% managers’ salaries; 4% depreciation; 7% other)

15% Packaging

7% Direct manufacturing labor

Ingredients (25%) Flavor (5%) Filling (5%) Other (41%)

Sugar (25%)

100% Cost of Goods

100%

Glucose (25%)

50%

40%

0%


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17

Exhibit 7a Argentine Chocolate Confectionery Leaders, 1999

Company Market Share by Volume Market Share by Value Arcor Group 33% 34%

Kraft-Suchard 10% 10%RJR Nabisco 9% 10%

Alfajores Jorgito 8% 4%

Danone 3% 1%All others 37% 41%

Source: Juan Rodriguez Nouche; interview by authors, Buenos Aires, Argentina, November 2001.

Exhibit 7b Argentine Candy Confectionery Leaders, 1999

Company Market Share by Volume Market Share by Value Arcor Group 54% 45% Cadbury Schweppes 15% 21%

Warner Lambert 13% 19% Costa Group 4% 2%

Lipo 3% 2%

L. Hentier 2% NA Georgalos 2% NA

All others 7% 11%

Source: Juan Rodriguez Nouche; interview by authors, Buenos Aires, Argentina, November 2001.


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74.5

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170.9

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117.6

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108.5

153.6

102.9

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ce:

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20

Exhibit 10 Selected Arcor Investments and Disposals (1997–2001)

Year Amount

($ thousand) Country Description Investments

1997 $193,948 Argentina Acquired LIA cookie and cracker manufacturing company Brazil Acquired large plastic packaging company

Various Installed new candy and cookie production lines

Argentina Built distribution center in Tucumán

1998 $232,852 Chile Acquired Dos en Uno confectionary company

Brazil Constructed chocolate manufacturing plant Various Installed new chocolate candies lines

Argentina Enlarged and improved canned food lines

Argentina Installed cardboard production line

1999 $77,145 Chile Built new distribution center

Various Enlarged and improved candy lines Argentina Improved sugar extraction system

2000 $47,403 Various Improved soft and jelly candy lines Argentina Installed can-manufacturing line

Argentina Built new offices in Córdoba

2001 $58,007 Brazil Acquired children’s candy and lollipop brand from Nestlé

Various Installed and improved lines that produced exports

Various Installed cream candy line Argentina Installed printing line

Disposals

2000 $110,855 Brazil Sold plastic packaging company

Argentina Sold beverage brand to Kraft

2001 $29,319 Various Sold various non-strategic assets

Source: Company documents.



21

Exhibit 11 Argentina—CPI Inflation and Exchange Rate for Crisis Period

CPI Inflation (%)

Exchange Rate Peso/US$ (avg)

2001: January -1.49 1 February -1.71 1 March -1.00 1 April -0.23 1 May 0.22 1 June -0.31 1 July -1.07 1 August -1.20 1 September -1.13 1 October -1.75 1 November -1.58 1 December -1.54 1

2002: January 0.64 1.40 February 4.02 1.95 March 7.94 2.38 April 18.36 2.84 May 23.03 3.31 June 28.41 3.60 July 32.94 3.57 August 36.53 3.57 September 38.48 3.60 October 39.40 3.61 November 40.57 3.49 December 40.95 3.44

2003: January 39.60 3.21 February 36.13 3.11 March 31.71 3.06 April NA 2.92 May NA 2.86

Source: Compiled from Economic Intelligence Unit Country Data and Datastream International.

Exhibit 12 Arcor Exports by Destination 1994–2000 (US$ thousand)

Destination 1994 1995 1996 1997 1998 1999 2000 Africa 3,021.0 3,275.1 3,471.7 5,844.7 4,863.6 4,340.3 10,768Asia 2,225.1 5,878.5 4,676.7 8,803.1 7,942.8 14,417.1 11,590Central America

and Caribbean 6,779.2 3,669.6 2,665.5 4,723.8 13,207.3 16,572.3 15,199Europe 883.2 702.9 979.2 1,124.5 1,452.9 2,300.7 5,024North America 15,901.2 16,849.8 16,064.0 14,470.5 21,323.6 20,688.6 41,608Oceania 36.0 43.4 73.8 272.3 246.8 687.8 1,162South America 73,404.3 120,185.7 130,302.6 134,750.5 187,670.0 141,022.6 132,403

Total Arcor exports 102,250.0 150,635.0 158,224.5 169,990.4 236,713.9 200,029.4 217,754

Source: Adapted from Bernardo Kosacoff, Jorge Forteza, M. Barbero, F. Porta, E. Alejandro Stengel, Going Global from Latin America: The Arcor Case, (Buenos Aires: McGraw Hill, 2002).



22

Exhibit 13a Arcor’s International Division Organizational Structure, December 2000

North AmericanDivision

(Based in the U.S.)21 employees



South & CentralAmerican Division

(Based in Chile)44 employees



OverseasDivision

(Based in Argentina)6 employees

OverseasDivision


Planning &Administration




International Division(Based in Argentina)

3 employees


3 employees

— United States — Central America— Mexico— Colombia— Venezuela— Caribbean

— Europe— Africa— Middle East— Asia-Pacific

87 Total Employees









OverseasDivision


OverseasDivision







3 employees


3 employees

— United States — Central America— Mexico— Colombia— Venezuela— Caribbean

— Europe— Africa— Middle East— Asia-Pacific

87 Total Employees


Exhibit 13b Arcor’s International Division Organizational Structure, May 2003

North, South &Central American

Division(Based in the U.S.)

77 employees



77 employees

Europe, Africa &Middle East Division

(Based in Spain)17 employees



OverseasDivision


OverseasDivision






International Division(Based in Spain)

1 employees


1 employees

— United States— Canada— Central America— Mexico— Colombia— Venezuela— Caribbean

— Europe— Africa— Middle East

— Oceania— Far East— India— Southeast Asia— China & Hong Kong

105 Total Employees



77 employees



77 employees





OverseasDivision


OverseasDivision







1 employees


1 employees

— United States— Canada— Central America— Mexico— Colombia— Venezuela— Caribbean

— Europe— Africa— Middle East

— Oceania— Far East— India— Southeast Asia— China & Hong Kong

105 Total Employees




23

Exhibit 14 US Shipments, Exports, and Imports of Confectionery Products

Volumes (000 tons) Price ($/lb.) 1996 1997 1998 1999 2000 2001 2002 2002 Chocolate Confectionery Total Domestic Shipments 1406 1464 1475 1459 1493 1452 1509 2.54 Domestic Exports 32 85 77 82 124 174 125 1.4 Imports 80 88 93 100 116 129 136 1.82 Domestic Consumption 1454 1467 1491 1477 1485 1407 1520 Sugar Confectionery Total Domestic Shipments 1383 1426 1393 1267 1249 1234 1036 1.84 Domestic Exports 70 83 82 82 98 102 86 1.01 Imports 158 177 208 248 272 301 346 0.98 Domestic Consumption 1471 1520 1519 1433 1423 1433 1296 Chewing Gum Total Domestic Shipments NA 193 185 178 184 197 197 3.86 Domestic Exports 15 20 16 15 12 11 17 1.36 Imports 39 41 41 45 43 42 47 1.34 Domestic Consumption NA 214 210 208 215 228 227

Source: U.S. Census Bureau.

Exhibit 15 U.S. Imports of Hard Candy

Country Volumes (000 tons) Price ($/lb.) 1998 1999 2000 2001 2002 2002

Canada 32 43 50 66 67 1.01 Mexico 17 42 51 63 75 0.64 Argentina 8 8 11 14 33 0.54 Brazil 4 8 10 15 13 0.75 Other 55 66 78 76 81 1.35 Total 115 169 200 234 270 0.94

Source: U.S. Census Bureau.



24

Endnotes 1 This paragraph is based on MRI, World Market for Chocolate Confectionery, January 1999, Cadbury

Schweppes’ Annual Report for 2002, and data provided by Arcor.

2 George S. Yip and George A. Coundouriotis, “Diagnosing Global Strategy Potential: The World Chocolate Confectionery Industry,” Planning Review, January/February 1991, p. 6.

3 John Sutton, “The Confectionery Industries,” Sunk Costs and Market Structure, (Cambridge: MIT Press, 1991), p. 267.

4 U.S. Department of Agriculture Foreign Agricultural Service, World Market Profile for Confectionery Products, May 2005.



7 Professor John Wells, interview by authors, June 2003.



10 Guillermo Ortiz de Rozas, interview by authors, June 2003.


12 Ronald Calori et al., “Innovative International Strategies,” Journal of World Business, 2000, p. 344.


14 Guillermo Ortiz de Rozas, interview by authors, Buenos Aires, Argentina, November 2001.

15 John Sutton, “The Confectionery Industries,” Sunk Costs and Market Structure, (Cambridge: MIT Press, 1991), p. 267.

16 MRI, World Brand Strategies in Confectionery, February 1999, p. 12.

17 Juan Rodriguez Nouche, interview by authors, Buenos Aires, Argentina, November 2001.

18 Professor John Wells, interview by authors, June 2003.


20 ‘Cosmetic Players Find New Ways to Cut Operating Costs, Cosmetics Design.com Jan 18, 2007, available at: http://www.cosmeticsdesign.com/news-by-product/news.asp?id=73458&idCat=74&k=CPG-outsourcing-cosmetics

21 Arcor Group, company documents.

22 Professor Guillermo D’Andrea, “Arcor International,” IAE Case Study, 1998, p. 2.

23 Juan Rodriguez Nouche, interview by authors, Buenos Aires, Argentina, November 2001.



25

24 Joshua Goodman, “Argentina’s Candy King,” BusinessWeek International, Latin American edition, June 4,

2001.

25 Arcor Group company website, www.arcor.com.ar.

26 Jennifer Galloway, “Arcor’s Bittersweet Success,” Latin Finance, September 2002.

27 Arcor Group, company documents.


29 Wendy Kimbrell, “Global Goal,” Candy Industry, 2001.

30 “Survey: Argentina,” The Economist, May 4, 2000.

31 Ramon Moreno, “Learning from Argentina’s Crisis,” Federal Reserve Bank of San Francisco Economic Letter, October 18, 2002.

32 Ramon Moreno, “Learning from Argentina’s Crisis,” Federal Reserve Bank of San Francisco Economic Letter, October 18, 2002.



35 “Arcor: The Power of A Marketing Vision,” The Copernicus MZine, March 2002, available at:

http://www.copernicusmarketing.com/about/mzine/monthlyeds/mar02.html, accessed October 2005. 36 Arcor Group, company documents.

37 “Arcor: 50 Años Dándole Sabor al Mundo,” 2001, p. 6.

38 “Argentina's Candy King,” BusinessWeek International (Latin America), June 4, 2001.

39 “Nestlé’s Market Power Challenged,” EIU Viewswire, April 15, 2002.

40 Wendy Kimbrell, “Global Goal,” Candy Industry, 2001.


42 Elsa Rico, “North American Muscle,” Candy Industry, 2001.





47 “Arcor Preparing European Assault,” http://www.confectionerynews.com, December 11, 2002.

48 Horacio Aumann, interview by authors, Buenos Aires, Argentina, November 2002.

49 “Arcor Preparing European Assault,” http://www.confectionerynews.com, December 11, 2002.



arcor: global strategy and local turbulence …although the confectionery industry’s 1%...

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