Bittersweet Lesson: Global Cocoa Beans Shortage Poses Challenges to Commodities BuyersPublished May 31, 2011 in Arabic Knowledge@Wharton
A sudden halt in supply of cocoa beans from the world's largest supplier drove prices to a 32-year high in early March, creating a severe, albeit temporary, shortage for chocolate manufacturers and renewing questions about how to safeguard supplies of commodities that may be threatened by factors ranging from weather to politics to international trade sanctions.
The New York/London average price of cocoa futures reached a peak of US$3,730 a metric ton on March 3, its highest since January 1979, after the Ivory Coast, which supplies about 40% of the world's cocoa, halted exports amid a political standoff in the West African country.
President-elect Alessane Ouattara banned cocoa exports in January in an effort to prevent tax revenues from the crop reaching the government of incumbent President Laurent Gbagbo who refused to step down for more than four months after losing the presidential election to Ouattara on Nov. 28 last year.
International pressure on Gbagbo rose when the European Union halted trade with Ivory Coast, and the United Nations Security Council called for him to step down as hundreds died and thousands fled their homes in post-election violence between supporters of Ouattara and the discredited incumbent.
Cocoa prices began to rise after the election failed to result in a transfer of power to Ouattara, whose victory was internationally recognized. But they dropped in late March on news that Ouattara was in control of one of the country's major ports, and fell further when Gbagbo was finally captured on April 11, signaling that exports would soon resume.
By May 16, the price retreated to US$3,041 per metric ton, within its normal range, and analysts said prices may decline further with the expectation of a plentiful crop from Ivory Coast and other West African countries in the current "mid-crop" growing season as favorable weather has provided ideal growing conditions.
The export ban kept about 500,000 tons of cocoa beans, or about 12% of the current season's global supply, off the market for more than three months, according to the London-based International Cocoa Organization.
The trade group said in its April bulletin that it expects the "imminent resumption" of cocoa exports from Ivory Coast. But it warned that a labor shortage created by displacement of the population in some key cocoa-growing areas is likely to delay a full recovery of the country's economic mainstay.
Still, the U.S. agribusiness giant Cargill, a major buyer of cocoa from Ivory Coast, resumed trading the commodity by mid-May, signaling that business was returning to normal.
But the volatility of recent months raises questions about how buyers of cocoa and other commodities can build a supply chain that is more resistant to interruptions by factors such as political unrest in countries of origin.
Wharton lecturer Edwin Keh, a supply-chain specialist, says the cocoa crisis illustrates the dangers of overreliance on a single source, and should encourage buyers to consider alternative suppliers.
The fragility of the cocoa supply chain is exacerbated by the pervasiveness of just-in-time inventory management, exposing the chain to potential shortages, said Keh, a former senior vice president of global procurement for Wal-Mart. "It assumes that the world works like clockwork," Keh said. "If one of the links is broken, you are in trouble."
Examine The Supply Chain
In a time of turbulence such as the Ivory Coast situation, supply chains need to be more robust, with backup for critical suppliers, and links that can be substituted for those that cannot be obtained, he said.
Such a management approach can be applied beyond the world of commodities, such as in the auto industry where buyers need to establish systems that can use a different component to perform the function of another in case of a supply shortage.
The shorter the supply chain, the more reliable and profitable it is likely to be on both ends, Keh says. He cites an agreement between Wal-Mart and around 750,000 Chinese farmers under which the U.S. retail giant would directly buy a range of vegetables, cutting out middle men whose involvement in the supply chain had driven up Wal-Mart's costs while reducing the reliability of supply and depressing farmers' revenue.
The result was that farmers obtained a much higher price, and Wal-Mart got a more reliable and transparent supply. By having a direct relationship with the farmers - who organized themselves into coops in order to deal with the world's biggest retailer - Wal-Mart could also ensure better-quality produce by insisting on growing standards including organic agriculture, Keh notes
Buyers of a commodity like cocoa beans can also make their supplies more reliable by ensuring the right growing conditions, Keh adds. They should consider whether crop-management techniques are efficient, and whether supply is being affected by local corruption.
A further challenge for supply-chain management is the demise of the traditional global pattern of east-west trade, Keh says. With surging demand for consumer goods from an exploding middle class in India, China and elsewhere, he notes the historic flow of goods from east to west no longer dominates trade, and requires a different model.
Jane Barrett, managing vice president of supply-chain research at Gartner Inc., says the risk of supply-chain breakdown may exist among middlemen or manufacturers within the chain, rather than at either end, and that risk should be understood by buyers. "There's a need to understand the risk in tier-2 or 3 suppliers," Barrett says. "We are seeing companies trying to identify where their risk is."
Insulating Against Supply Shock
To establish resiliency against supply shocks such as the cocoa-bean shortage, companies need to combine risk-management techniques with a diverse supply network, a multi-tier understanding of their supply chain, and an agile response to supply interruptions, Barrett says
"The companies that achieve these four (goals) will have the most resiliency," she says. "Companies that have weak supply-chain management are being more exposed."
On the demand side, the multi-pronged approach to supply-chain management will help companies deal with a more volatile environment driven by surging demand from emerging economies as well as a smarter, more cautious, better-informed consumer in developed economies where demand is still sluggish after the recent recession.
Barrett cites networking giant Cisco Systems Inc. as an exemplar of effective supply-chain risk-management. A Gartner case study found Cisco's procedures allowed its business to survive major crises.
Among them was the Chinese earthquake of May 2008 in which the company was able to shift suppliers and reschedule orders within 24 hours of the earthquake, minimizing impact on key customers.
In the U.S. financial crisis starting in fall 2008, Cisco avoided damage to its business by ending its relationship with five key suppliers after an analysis revealed that they faced a high risk of disruption. The five later filed for bankruptcy, the Gartner study found.
Companies can also help insulate themselves from a supply-chain shock by working harder to integrate different operations, Barrett argued. If sourcing and procurement operations coordinate with planning, manufacturing, and logistics, for example, companies are more likely to survive any interruption in supply because they have a more integrated approach to serving their customers.
Pierre Mercier, global head of the supply-chain practice at Boston Consulting Group, calls the Ivory Coast situation a "perfect storm" of forces to break the cocoa supply chain.
Even without the export ban, cocoa supply would have been severely constricted by a labor shortage caused by the displacement of thousands of people fleeing the fighting between rival factions, and by a widespread withdrawal of banking services that normally provide financing for the cocoa trade -- both impediments that Ivory Coast is still recovering from, Mercier says.
Those circumstances exemplify the increasing need for risk management among many different businesses, he says. "We would be better off understanding exactly what risks we are exposed to."
Back-up Sources Required
Businesses seeking to strengthen supply chains can choose from risk-management tools including hedging, multiple sourcing, inventory buildup, and vertical integration.
But companies may be tempted to trade off such measures against cost controls in an era of increasing competition and relentless shareholder pressure for lean operations. For instance, a business may choose to source its raw materials from three different suppliers with the aim of guarding against any future shortage, but will pay more for that perceived security than it would have done if it had decided to rely on a single supplier.
The lone supplier, though intrinsically less reliable than multiple sources, is more likely to agree a lower price for its goods because of the customer's purchasing power.
Any effort to ensure supply by building up inventories is likely to come under pressure from the need to run a lean operation, Mercier says. "You might decide to have six weeks' supply but that's six weeks' working capital. The trend is very much continuing to have a lean inventory."
The answer to such conundrums is to identify product lines that represent 70% to 80% of profits and use risk-management tools to protect the supplies that sustain those lines, Mercier adds. "Ask yourself, 'What are the supply lines that are most critical to my survival?'"
Buyers of cocoa -- as well as those of other commodities -- seeking to draw lessons from the recent Ivory Coast experience should ask themselves whether there are alternative sources or substitutes that can be used in their products in the event of another dramatic shortage of the crop, says Wharton's Keh.
"There's a need to be a lot more robust and to back up the source from a critical supplier because demand is so hard to predict. You need more places where you can change your mind."
Above all, don't assume that your sources of supply will be reliable, Keh notes. "If the assumption is that the world is a predictable place, you're in trouble."