Chocolatetown meltdown

HERSHEY, Pa. - As globalization and outsourcing raged outside its corporate walls, the Hershey Co. seemed cozy and secure here in the "Sweetest Place on Earth."

The maker of Kisses and Kit Kats dominated the U.S. chocolate industry and manufactured its goodies in local factories.

Continuing a tradition of social good, the company funneled tens of million of dollars in stock dividends to the nearby Milton Hershey School for needy children, an 11,000-acre institution with a huge endowment built on chocolate. It was, says John Dunn, a local resident and former Hershey employee, a "utopic-type existence."

But reality crashed the party this year. A plunging Hershey stock price wiped out about $1 billion of the school's endowment.

No longer the patient investor, the school's financial overseer, referred to locally as The Trust, used its control of Hershey voting stock to shake up the company's corporate board last month.
Hershey chief executive officer Richard Lenny is out, saying he will resign by year's end. A new management team faces consumers who are buying more truffles and premium chocolates and a flattening market for traditional Hershey bars.

About 1,000 Pennsylvania employees are losing their jobs in a restructuring. A plant in Reading that manufactures 5th Avenue and Zagnut bars will close, the Chocolate Workers union says. Hershey plants in Connecticut and California are shutting down, too.

In the company's most controversial move, Hershey is outsourcing a good portion of its candy production to Mexico - which led to street protests at a Hershey plant in Canada.

For workers like Celso Torres, these are harrowing and sad times.

This fall, the union in Hershey negotiated an early-retirement package. About one-third of the workers at the main Hershey plant, or 600 of them, grabbed at it. Many thought the pension was more secure than the $21-an-hour job in the chocolate plant.

"It's not like we're making old-fashioned chocolate anymore," Torres, a 27-year Hershey employee, said in a tone that was more melancholy than angry on a recent morning as he ambled his stocky frame across a darkened parking lot toward one of the world's largest chocolate factories.

"You come to work every day and you don't know what's going to happen. . . . I got a good deal with my pension, and I thought I better take it."

Behind him, another longtime Hershey worker, a man in a baseball cap, said: "Nobody thinks there's a future. We say if they want to make the candy in Mexico, fine. Sell it down there. Don't bring it back."

Identity crisis

One of Pennsylvania's most recognized companies, Hershey still controls about 40 percent of the nation's mass-market sales for chocolate, according to industry estimates. The company also markets Jolly Rancher hard candies.

Its sales and profits have grown substantially this decade, driven partly by brand extensions, or limited editions, of core products, such as Elvis Reese's peanut-butter and banana-creme cups, pink Kisses and mint Kit Kats.

This strategy, critics say, sowed the seeds for the company's current crisis. As it was marketing these limited editions, Hershey slashed advertising in its big brands. Between 2001 and 2006, the company cut its advertising costs 42 percent, according to corporate documents. The company is now trying to latch onto the latest consumer trend - the boom in haute chocolates like truffles.

Over the last two years, according to market researcher Mintel International Group Ltd., the broad $15.8 billion U.S. chocolate market has been flat. But sales of premium chocolates grew 14.5 percent in 2006 to $2 billion and will grow an additional 13.7 percent this year.

Consumers are "trading up" to premium chocolate, said Joan Steuer, president of Chocolate Marketing, a consulting firm. Premium chocolate costs at least $8 a pound and as much as $100 a pound, according to experts.

Lifestyle plays a big role in the purchase of an item like chocolate. Partly driving the market shift has been recent medical research that suggests antioxidants in natural cocoa can improve the function of arteries, Steuer and others say.

In recent years, Hershey acquired organic- and dark-chocolate companies on the West Coast and launched the Cacao Reserve line of premium chocolates. But some question whether a brand like Hershey can command premium prices.

"They are getting into a smaller and smaller box. It's a mature, bordering on declining, industry," said William Madway, a marketing professor at Villanova University.

Hershey has to modernize how it markets its chocolate, taking into account parent concerns about obesity and high-sugar snacks, Madway said. In that vein, Hershey has developed and marketed Snack Barz and Smart Zone bars as alternatives to traditional candy.

"Hershey lives or dies on the U.S. market. They need to focus on their core brands," said the Bear Stearns Cos. Inc. equity analyst Terry Bivens. He said the company was "going to have to pump up marketing, and research and development. I don't see next year as a recovery year."
Mars Inc., Hershey's archrival and the maker of Snickers bars, "stirred to life" and has challenged Hershey in the U.S. market, Bivens said
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Brad Reese, whose grandfather invented Reese's peanut butter cup but who does not work for Hershey, comments frequently on the company on a Yahoo.com chat board.

"You have had a whole generation of kids who haven't seen a good Reese's ad campaign," he griped.

Hershey officials declined to comment.

Dunn, a former Hershey director of marketing, summed up the issues facing his former employer.

"We're not a highfalutin Godiva-like company," Dunn said. "We're a blue-collar chocolate company."

Seeking solutions

The Hershey Trust, the shareholder with an 80 percent voting control of Hershey, reportedly held merger discussions with European candy giant Cadbury Schweppes P.L.C. this year. Some believe Cadbury would be a good fit because of its overseas candy-distribution network. The Hershey-Cadbury talks, however, did not appear to pan out.

But the trust remains worried. In October, it said in a statement: "The company is underperforming the market and its own stated expectations."

A month later, it installed eight new Hershey board members. They included former Pennsylvania Gov. Tom Ridge, former Hershey CEO Kenneth L. Wolfe, former Unilever North America CEO Charles Strauss, and Hershey Trust chairman LeRoy S. Zimmerman.
Zimmerman, the state's first elected attorney general, declined to comment for this article, said Hershey Trust spokesman Tim Reeves.

Company founder Milton S. Hershey created the trust to finance his school for needy children. In a statement, the trust, which also owns the Hershey amusement park, said it could use its strong U.S. position to grow both domestically and overseas.

Harvard University law professor Robert Sitkoff said he thought the Hershey Trust should sell the candy company. About half of the trust's $8 billion endowment is invested in Hershey, a "breathtaking lack of diversification" for the institution with a charitable mission, Sitkoff wrote in an article that will be published in 2008 in the Columbia Law Review.

Amendments to the Pennsylvania prudent-investor law in 2002 have made it harder for the Hershey Trust to sell the company, Sitkoff said in the paper. The changes were enacted after the Hershey Trust announced that it would negotiate to sell the candy company to diversify.
Those negotiations were halted after a public outcry and fears that a new corporate owner would close the local chocolate plants and relocate the headquarters.

"You can protect a company from a takeover market, but you can't protect it from the products market," Sitkoff said in a phone interview. "I think the current arrangement is bad for the trust and bad for the company."

At the union hall for Chocolate Workers Local 464 in downtown Hershey, a topic of conversation is which candy lines will relocate to Mexico.

The Hershey chocolate bar and Kisses should stay in Pennsylvania, union officials say. The union negotiated to keep chocolate syrup in the hometown plant, said Dennis Bomberger, the local union's business agent.

Hard candy, the miniature chocolate bars, Mr. Goodbar, Heath, York peppermint patties, the Reese's crunch bar and Zagnut could relocate south of the border, based on the production lines, Bomberger said.

"Of course people are upset that Hershey is moving to Mexico," Bomberger said. "We think it's a mistake going to Mexico. It's still a question: Will the American public buy a Hershey chocolate made in Mexico? This is the gamble they're taking."